The IMF released a treasure trove of stuff on Australia last week. I’ve been enjoying it immensely. Partly because it’s very good and in line with the MB view of the economy and partly because I’ve had the time to read it thoroughly. The campaign for national ignorance spearheaded by Gittins! ensured there was no rush to post on it.
Yesterday I looked at the IMF’s China bust stress tests and the financial stability assessment. Today I want to look at another special study that the IMF conducted into why Australian saving rates are currently so high.:
1. Australia’s net household saving rate began rising in the mid-2000s and jumpedto over 10 percent of gross disposable income after the global financial crisis of 2008–09.This was the highest level in nearly 25 years, but was still about 3 percent below the average for the 1970s and early 1980s. The recent spike in saving was higher thanin some other advanced economies. Even though the economy is recovering from the crisis,house prices have declined in real terms and the stock market has not fully recovered to its previous highs. In this environment, consumers have remained cautious and households havecontinued to save and rebuild their balance sheets.2. Past staff analysis identified wealth effects, public saving, demography, and the terms of trade as the main factors associated with changes in Australian private sector saving. Cross-country regressions on annual data for 19 advanced economies suggest that private saving is negatively correlated with public saving (interpreted as a Ricardian offset) and old age dependency, and is positively correlated with the terms of trade. Single equation estimates for Australia confirm the negative correlation between private and public saving,and show a quantitatively large co-movement between private saving and the terms of trade. They also show a strong negative correlation between changes in household net worth and private saving.3. This paper relates Australian household saving more closely to movements in asset markets using two approaches:
- Event study analysis examining deleveraging episodes in a broad sample of advanced economies following different asset market shocks;
- Econometric analysis using quarterly disaggregated household asset data and staff-constructed asset returns for Australia, Canada, and the United States4. The event study analysis suggests that the jump in Australian saving has been large in comparison to past deleveraging episodes in advanced economies. The annual data for 20 advanced economies over 1990–2010 suggests that the pace of deleveraging, and the extent of the jump in the saving rate, is more strongly affected by movements in house prices than in stock prices.
This finding will probably go into the “no shit Sherlock” file for most readers. That rising house prices are negatively correlated with savings is entirely intuitive. Nonetheless, it’s good that a few economic models have caught up with the fact (even if negative correlations between public and private sector savings are still seen as some ‘Ricardian offset’ instead of a simple accounting identity.
Also unsurprising is that the IMF found a strong correlation between rising terms of trade and savings. More surprising to me is that falls in pension wealth has just as high effect in promoting the savings rate, which, in Australia, would have a strong correlation with the stock market. Still, over time, the IMF modeling maintains that house prices are more significant in determining savings rates:
7. The increase in household saving in Australia has been larger than the historical average for deleveraging episode. For advanced economies in the past, the gross saving ratio has increased after a negative house price shock, but not after a negative stock market shock alone. The magnitude of the jump in saving in Australia seems unprecedentedly large given that the housing market merely slowed down since the crisis, but did not crash.
8. Housing market shocks are more likely than stock market shocks to be associated with a deleveraging episode, suggesting that the future behavior of Australian households is sensitive to the evolution of house prices. In the sample, there are eight housing market declines (defined by a 5 percent fall in real house prices), and seven of these were associated with deleveraging episodes. By contrast, only 15 out of the 35 stock market crashes in the data (a crash defined by a 10 percent decline in real stock prices) were associated with deleveraging. Moreover, of these 15 stock market crashes, house prices were concurrently declining by some degree in six of them.
These are sobering findings for the consumption sectors of the Australian economy. According to the IMF, so long as house prices fall (and their definition of falls is very conservative) then savings rates will remain high. They will be even higher if share market volatility persists. The IMF goes to some length to provide an econometric model that define the correlations. You can read those findings in the document below.
The IMF then concludes:
21. Household saving is sensitive to the values of housing and pension assets, and monetary policy can influence consumer behavior by affecting these. Adding real interest rates such as real mortgage rates to the above regressions does not yield statistically significant coefficients, but monetary policy rates are known to affect asset prices and household saving decisions are sensitive to these prices. Moreover, an increase in interest rates would lower net-of-interest disposable income and hence reduce the level of consumption, even if the saving rate remains unchanged. In addition to the wealth effects from housing and pension wealth, expected housing returns are robustly statistically significant. Even if house prices plateau for a prolonged period without falling, expected housing returns would eventually fall and household saving would rise.
22. Some of the Commonwealth government’s fiscal consolidation may be offset by households. Therefore, further policy steps to support household saving may be needed if the government wishes to maintain the current high level of household saving. Adding our crude annual data on superannuation contributions yields mixed results on their effectiveness: member contributions tend to be significant (which means they are not fully offset by households) but employer contributions tend not to be. However, other more detailed studies have identified positive effects from employer superannuation contributions.
23. According to the decomposition analysis, the terms of trade robustly accounts for a large portion of the changes in household saving, and more research is needed to understand this link. Perhaps households view most of the increase in the terms of trade as temporary (quite different from the government’s view), or the higher income flows may be accruing to individuals in the upper portion of the income distribution who have a high propensity to save. Regarding the post-crisis period specifically, higher income growth in Australia relative to other advanced economies (driven by commodity income) may make it easier for households to begin the deleveraging process, contributing to higher saving. On the other hand, households may view the increase in the terms of trade as a sign that their own jobs may be under threat as the mining sector crowds out their industry of employment, or they may be induced by terms of trade volatility to upgrade their general assessment of economic uncertainty, and therefore to save more. As far as we can tell, the terms of trade is not simply a proxy for the real exchange rate or real oil prices: both are statistically insignificant if added. To the extent that a negative shock to the terms of trade would tend to reduce household saving, consumption would be cushioned from the associated fall in household income. The significant effect of the terms of trade persists even if the sample is restricted to 1990–2004.
In short, the very high Australian savings rate is the result of a perfect storm of factors: falling asset prices and a terms of trade boom, as well as economic adjustment to Quarry Australia that makes folks feel quite unsettled.
To my mind, this research has much greater importance for the RBA than it does the government. Adjusting interest rates has the potential to alter two of these forces significantly. That is, if the RBA pushes rate cuts too hard, causing house prices to stabilise (or grow, albeit temporarily) and the dollar to fall, diminishing the adjustment to Quarry Australia, then savings will fall significantly and the current account deficit will rise. As savings fall and credit demand rises, the transformation of bank liability profiles from wholesale funding to deposits will reverse as their offshore debts swell once more. Global markets and ratings agencies will not greet this with enthusiasm.
Finding a happy medium will not be an easy task with a blunt tool like interest rates.