High savings are the new normal by Leith van Onselen

RBA Assistant Governor, Phil Lowe, yesterday gave an interesting speech on the changing patterns in Australian household saving and spending. In particular, the speech describes some of the possible reasons underpinning the recent rise in Australia’s household savings rate and ponders whether this shift is a temporary phenomenon or likely to be long-lasting.

First of all, Mr Lowe noted that the decline in Australia’s savings rate throughout the 2000s was likely a “one-off event” brought about by financial deregulation (increased credit availability) and lower nominal interest rates:

From the mid 1980s to the mid 2000s, the aggregate household saving ratio declined significantly (Graph 1)… as nominal interest rates declined and the availability of credit increased, household spending grew more quickly than income for around a decade or so. Although this adjustment was drawn out, it was, by nature, a one-off event. So even before the North Atlantic financial crisis, households were returning to more traditional norms of saving and borrowing, and, no doubt, the crisis accelerated this return.

Mr Lowe then dissects the recent Household, Income and Labour Dynamics in Australia (HILDA) releases to determine which population cohorts are driving this increase in savings. He produces the below chart showing that the peak in the ratio in 2009:

Mr Lowe also notes that the increase in the savings ratio has been broad-based across the income distribution, although the increase was smaller for lower income earners (reflecting their lower disposable incomes):

And the increase in savings has been largest for younger households, and smaller for older households:

The discussion then moved on to some of the reasons behind the shift in savings behaviour.

First, there’s the argument that higher house prices and debt levels require younger households, in particular, to save a larger deposit:

…this evidence is consistent with the idea that higher housing prices and debt levels have contributed to a reassessment of saving decisions, although, obviously, the reasons for the increase in saving go well beyond what has happened in the housing market. Higher housing prices have required higher deposits and this requires more savings. This trend has probably been reinforced by developments on the lending side, with most lenders lowering their maximum loan-to-valuation ratio over recent years. Saving decisions today are also likely being influenced by the earlier rise in debt levels relative to incomes and by debt servicing burdens that are staying higher for longer. The adjustments seem to have been particularly pronounced among younger households who are hoping to enter the housing market or who have recently entered the market.

Then there’s the view that the destruction of financial wealth in the wake of the global financial crisis (GFC) caused higher income households, in particular, to tighten their belts and save in order to rebuild their ‘balance sheets’:

…the fall in financial asset prices over recent years led households to increase their saving out of current income in order to rebuild their asset positions. When share prices fell, household wealth declined and, as a consequence, increased saving was required to attain any desired level of wealth. This was particularly the case for those households that held a lot of financial assets. This experience is the flipside of what happened during the decade to the mid 2000s. During that period, household wealth increased substantially by way of increasing asset prices, despite households saving relatively little out of their current income.

Arguably, the same argument could be made about the housing market. In the decade leading up to the GFC, when global credit conditions were benign, house prices rose almost unabated:

These conditions made Australians feel richer (the ‘wealth effect’), spurring consumer confidence, spending and employment growth. With house prices rising inexorably, Australians began using their homes as ATMs, withdrawing large amounts of their new found home equity between 2001 and 2007 (see below RBA chart). Much of this money was spent on consumption, thus further boosting incomes and employment.

However, households changed tack once the GFC arrived, house prices fell sharply temporarily, and they witnessed the turmoil overseas.

Anyway, back to the speech.

The third key reason that Mr Lowe provides for the sharp rise in the savings rate is the general feeling of uncertainty in the population and the declining levels of confidence:

It is clear from [the below] graph that the largest increase in saving ratios is for those households that have become a lot more concerned over time about losing their job. And conversely, the smallest increases in saving have been for those who have become less concerned about losing their job.

Here, the evidence is consistent with the idea that when people become more uncertain they save more to build up larger buffers against the possibility that something goes wrong later on. It is also consistent with earlier work at the Reserve Bank showing that households that are particularly uncertain about the future tend to spend less of any increase in income than do households that are more confident.

Mr Lowe then wraps-up his discussion on the savings ratio with the following remarks:

In summary, this work on savings using household level data confirms many of the popular explanations for the recent increase in savings. Higher housing prices and debt levels have had an effect, as have falls in the prices of investment portfolios and a general increase in uncertainty. This work also confirms that the increase in saving has been widespread across the population…

The increased household saving is, however, a positive development from a national risk-management perspective. Households are using some of their income growth to build up bigger financial buffers, and this should hold them in good stead in the uncertain world in which we live. These higher saving rates are likely to be quite persistent and they represent a return to more traditional patterns. While they partly reflect the ongoing adjustment to the earlier big run up in housing debt and housing prices, the evidence that I have talked about today suggests that there are also other factors at play. In particular, many households appear to have increased their saving in response to the decline in equity prices and an increase in uncertainty about the future. It is reasonable to expect that, at some point, the impact of these factors will begin to wane, although exactly when remains an open question.

Overall, Mr Lowe’s explanation of the increase in the savings ratio is logical, and I agree that it will likely remain elevated for an extended period. As shown by the below chart from Bill Mitchell, the running-down of the savings ratio over the past decade or so was really an aberration and this ratio appears to merely be returning to its long-run trend level. As you can see, if we get historical reversion, savings could go much higher again:

Moreover, with households seemingly loaded-up with debt, there appears to be little scope to return to their recent spend-thrift ways:

This is the new normal…

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