[Excerpt] Household saving matters for two reasons. First, it is an important source of funds to finance domestic investment. Second, it is the means by which workers accumulate wealth and maintain their living standard into retirement. Congress has indicated its desire to promote household saving by, among other things, creating individual retirement accounts, and saving is an important consideration in proposals to reform Social Security. At a time, however, when policymakers have been looking for ways to increase spending to minimize the downturn and get the economy growing again, households have begun to save more.
For the 40 months between January 2005 and April 2008, the personal saving rate averaged 1.8%. In contrast, in the 1970s, the average personal saving rate was 9.6%. In May 2008, the personal saving rate began to rise. It remains too early to tell with certainty if that represents the reversal of the long-term decline. What may seem unusual is that it occurred at a time of general economic weakness. The increase in household saving resulted in more than $300 billion less in consumer spending than would have occurred had the saving rate not risen.
Prudent individuals might be expected to save enough to avoid a substantial decline in their living standard on retirement. If consumers seek to maintain a fairly stable level of consumption over their entire lives, then the level of consumption at any given point in their lives will depend on their current wealth and some expectation about their income over the rest of their lives.
Changes in household net worth in recent years seem to have contributed to the swings in the household saving rate. In the 1990s, equity prices rose substantially. Between 1991, the beginning of an economic expansion, and 2001, the year it ended, the Standard and Poor’s index of 500 stock prices rose by 217%. It is widely believed those increases in equity prices contributed to a decline in the household saving rate.
After the turn of the century, increased house prices insulated household balance sheets from the effects of a decline in equity values, and the household saving rate fell to near zero.
More recently, both equity and house prices have fallen. The combined drop in asset prices had a significant effect on household net worth. At a time when current incomes have been falling, the personal saving rate rose to more than 5%. It may be that the economic downturn is limiting the saving response to the decline in household net worth. If that is the case, the saving rate might be expected to continue to rise, or at least remain steady at current levels, when the economy begins to recover, unless asset prices recover to levels now considered by many to have constituted a “bubble.”