Feeding the Piggy Bank Could Hurt U.S. Expansion

Thu Sep 23, 2004
By Victoria Thieberger

NEW YORK (Reuters) - For years, profligate American consumers have been chided for putting aside nothing for a rainy day.

Now, with the Federal Reserve raising interest rates, the prospect that households could start to rebuild their savings raises another worry: a slowdown in spending, just when the economy is struggling to regain its footing.

Even some senior officials within the Federal Reserve are concerned about the potential fallout from increased savings, which could be a side-effect of the central bank's campaign to boost interest rates.

The Fed this week raised official interest rates for the third time since June, making savings more attractive. Banks have reported a surge in interest in certificates of deposit in recent months.

"With interest rates rising and equity prices declining, households may try to get their finances in order and bring the saving rate up to more normal levels by cutting spending," San Francisco Fed President Janet Yellen said in a recent speech.

"A noticeable increase from today's historically low levels could have important adverse consequences for the pace of economic expansion going forward," she cautioned.

The savings rate -- the difference between what Americans earn and what they spend -- has gradually drifted down from the 7 percent to 8 percent range a decade ago to just positive rates of hovering between 0.5 percent and 2.0 percent.

In July, the rate dropped to a near-record low of 0.6 percent while incomes barely rose 0.1 percent, suggesting consumers will find it increasingly difficult to fund their spending habits.

The low rate is seen as symptomatic of America's many sins of economic excess, such as pushing up the current account deficit to 5 percent of the economy and running huge budget deficits.


If the labor market doesn't pick up strongly from the anemic growth rates of the past three months, consumers may be tempted to boost savings as a cushion for the future.

That was the concern raised by the International Monetary Fund in a recent scorecard on the U.S. economy. IMF economists warned that "any upward adjustment (to savings) could weigh on the short-term outlook ... and a larger correction in the savings rate remains a risk if the economic recovery disappoints."

Americans have run down their savings as their assets have grown, first with out-sized returns on equities in the bubble years and now in housing, where values have soared nearly 40 percent since late 2000, according to recent Fed data.

Goldman Sachs senior economist Jan Hatzius said investors seem too optimistic about likely long-term asset returns, and therefore are not saving enough. He estimates the personal savings rate needs to rise to around 10 percent over the next five to 10 years.

"Our best guess is that the adjustment will be a long slog that keeps consumption growth sluggish for several years, but does not involve an outright spending slump," Hatzius said.

As official interest rates plunged through 2001 and remained near historical lows around 1.0 percent, there has been little incentive to build savings.

The slide in savings comes just as retirement looms for the first wave of baby boomers, a massive demographic shift that should tend to raise the savings rate. The Bush administration has looked at various schemes, such as tax incentives, to make savings more attractive.

Still, the immediate downside of a minimal savings level is unclear, especially when compared with the anemic economies of high-savings nations such as Germany (11.1 percent savings rate), France (also 11.1 percent) and Japan (6.4 percent), according to OECD data.

For example, Australia's economy has chugged along quite comfortably despite a negative savings rate in 2002, 2003 and most likely in 2004, 13 years into an economic expansion.

"For some economists, the low (U.S. rate) looks like an aberration or an imbalance that will create problems down the road," said JP Morgan senior economist Jim Glassman.

"But the average household has benefited from this huge wealth gain over the past decade. Today's generation is better off than previous ones and that's why savings is where it is."



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