AS Macro Revision: Household Saving

In this revision blog we look at the economic significance of household saving. Saving has become a huge macroeconomic issue in the UK in recent years. There was a trend decline in the savings ratio during the late 1990s and for most of this decade and many have seen this as one of the reasons why the economy was at such high risk during the credit crunch. According to a recent news report, Britain entered the financial crisis and recession with the lowest savings rate since the Second World War, the second lowest of all major economies. The UK national household savings rate fell to a post-war low of -0.5% in January 2008. That compared with a peak of 13.4% in 1984.

1/ Real interest rate on savings deposits – i.e. the nominal return on savings adjusted for inflation. In recent years the real return to saving has become negative as interest rates paid on deposit and current accounts have collapsed whilst consumer price inflation has been persistently above the government’s 2 per cent target

2/ Expectations of future incomes and job security / all linked to consumer confidence. This is one key reason why we expect to see a rise in the savings ratio during a recession

3/ Availability of credit – e.g. borrowing to finance extra spending counts as dis-saving. The credit crunch has made it tougher to get new loans.

4/ Taxation of saving e.g. tax efficient savings schemes such as Individual Saving Accounts.

5/ The need to save to repay debts – an example would be property owners stuck in negative equity where their house is worth less than their outstanding mortgage debt. Or consumers who have stacked up hefty debts on their (expensive) credit cards and who now need to cut back on spending to cut existing loans

6/ A need to save to build up a deposit for a mortgage, pay school and university fees, and save for retirement.

Importance of saving for macro-economy

Decisions by people and businesses about how much to save can have a powerful effect on macroeconomic performance in both the short and the longer-term – here are some reasons:

*Corporate savings provide an important cushion for businesses during a recession
*Business savings can be used as finance for merger and takeover activity
*Our savings flow into financial institutions such as banks and these deposits are used for lending out to businesses to finance investment. Banks need retail deposits as capital from which they can lend (this is especially important during the credit crunch). Savings also flow into pension funds - and can be reinvested in stock markets
*Savings provide a source of household wealth and a buffer against uncertain times

The Paradox of Thrift

The paradox of thrift is an important idea from Keynesian economics. Saving is regarded as positive for the economy, not least because it provides the funds to finance the capital investment needed to promote long-term growth. But if enough people start saving more at the same time, the result is a reduction on consumer demand and an even deeper recession. What is rational and virtuous for an individual might be damaging for the economy as a whole.

In 2010 the real return for savers in the UK is negative. None of the 257 easy-access savings accounts for balances of £1,000 pays enough interest to offset the effects of inflation and tax, according to Moneysupermarket.com.