In a posting yesterday on this blog on the initial GDP estimates for the first quarter of 2012, I noted that GDP growth had slowed further (to just 2.2%) from a rate that was already less than what it needs to be in a recovery. The primary reason for this slow growth was the continued cuts (yes cuts, despite what Romney has been saying) in government expenditures, which reduced GDP growth by 0.6% points from what it otherwise would have been. The cuts in government expenditures are now at the federal level in addition to cuts at the state and local level, and they act as a substantial drag on demand for production. GDP growth also decelerated, although to a lesser extent, due to a fall in business fixed investment (which reduced GDP growth by 0.2% points for what it would otherwise have been).
The primary bright spot in the new numbers was the acceleration in growth of personal consumption expenditure, which grew at a 2.9% rate and accounted for 2.0% points of the GDP growth, and especially the growth of residential fixed investment (housing construction primarily), which grew at a 19.1% rate and added 0.4% points to growth.
Some observers of this data also noted that the figure for the personal savings rate declined in the quarter, as personal consumption rose at a faster rate than personal income. This is correct, and there is therefore the concern whether personal consumption will be able to continue to grow at the rate it did in the first quarter. Specifically, the personal savings rate was 4.5% in the fourth quarter of 2011, and this fell to 3.9% in the first quarter of 2012. If personal consumption expenditure will end up being forced down as households seek to keep savings at some level, the primary support to recent growth of GDP will be lost. Coupled with the political pressure from Republicans and other conservatives to keep cutting government expenditures further, and with weak business investment due to the still high excess capacity in the economy and weak demand for production, growth could slow further and perhaps drop down into negative territory and thus into a new recession.
The question then is whether the reduction in the savings rate to 3.9% from 4.5% in the previous quarter may lead to pressure on households to reverse this and start saving more, and hence end up cutting personal consumption. This is indeed possible, and the consequence could then be slower growth if government remains constrained in what it is allowed to spend. It is not really possible to predict with any confidence whether this will happen, but it is useful to put the reduction in savings to 3.9% this past quarter in a longer term context, to see where it now stands compared to what it has been in the past.
The diagram above does this, showing the personal savings rate in the national income accounts going back all the way to 1950. The data comes from the GDP and Personal Income Accounts of the Bureau of Economic Analysis. The lines in red show the trends, and are simply hand-drawn to make the trends easier to discern. What is interesting is how the person savings rate trended upwards from 1950 to the early 1980s, rising from roughly 7 to 8%, to around 10 to 11% (although with a good deal of short-term variation around the trend rate in these quarterly numbers). But then the trend shifted to a steady fall, bringing the personal savings rate to just 1 to 2% by around 2005. Savings then jumped to around 5 to 6% at the time of the economic and financial collapse in 2008, and has then come down some, to the current 3.9%. It is too soon to tell where the recent fluctuations since the trough in 2005 will lead, and what the new trend, if any, will be.
A careful analysis that might explain why the personal savings rate has varied in the way it has in the post-World War II period is beyond the scope of this note. But a good hypothesis would be that the shift to a strong downward trend since the early 1980s is related to changes brought in by Reagan, and in particular due to the deregulation of the financial markets that started then. As a consequence of regulatory and other changes of the period, it became easier for banks to provide home equity loans to households, with only a second lien on the homes backing these credit lines. As a result, home equity loans exploded, from just $1 billion outstanding in 1982 to $100 billion in 1988 (these figures are from a New York Times article describing the early growth and the impact of advertising in encouraging this), to $215 billion in 1990, $408 billion in 2000, and $1.1 trillion in 2006. The market then finally stabilized, started to fall in 2009, and by 2011 the outstanding was $873 billion (the figures since 1990 are from the US Fed; its series on home equity credit lines do not go back further than 1990). There were also other regulatory and consequent institutional changes in the credit markets during this period, which made it easier for households to borrow.
As households found it possible to borrow against their home equity values, during a period when house prices rose and then soared, it was possible for households to spend on consumption beyond what their current income alone would allow. Some households thus had negative savings, some had low savings, and averaged across all households, savings rates fell. This is what one sees in the graph above.
This all ended with the 2008 collapse, and indeed the housing bubble was already starting to deflate earlier, as the housing peak was in 2006 (see my blog posting here). Home prices collapsed, there was no home equity to borrow against, spending in excess of income could not be done, and the average savings rate then rose. With the crisis now easing and with credit slowly becoming more available, it is not yet clear whether savings rates will fall back down to where they were in the decade prior to 2008, or whether they will remain roughly where they have been since 2008, or indeed whether they will rise back to where they were before Reagan.
Savings rates more like what they have been in recent years, and indeed higher than that and back to where they were prior the changes launched by Reagan, will be important for the long-term health of the US economy. Investment needs to be higher, while the US international deficits (the trade and current account deficits) need to be smaller. This can only happen with higher savings. But higher savings in the near term, when the economy remains weak and with government constrained by Republican opposition in what it is allowed to spend, will lead to even slower GDP growth. Finding the right path through this will be tricky.