Exploring the Psychology of Savings

 | Dec 12, 2011 | 4:30 PM EST
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Americans actually saved more than previous estimates from other sources have shown, but their net worth has fallen by a notable amount in the third quarter, as the Federal Reserve's Flow of Funds (FOF) report, which was released last week, shows. Here, we see that the net worth of U.S. households and nonprofits fell by $2.45 trillion during the third quarter to reach $57.35 trillion, reflecting a decline in assets of $2.51 trillion, even as liabilities dipped by $61 billion. That puts total assets at $71.12 trillion and liabilities at $13.77 trillion. The third quarter saw a sharp plunge in the stock market, of course, so this 4.1% drop in net worth should hardly be surprising.

The stock market has since recovered a bit since the end of the third quarter, but I am not so much interested in how much households' assets went up or down, but, rather, what they may do in response. The psychology of savings is what interests me -- and we can also tie in consumer confidence data to get an inkling of what may lie ahead.

Consumer spending accounts for about 70% of the U.S. economy, and a dollar saved is, well, a dollar that isn't spent -- and that unspent dollar could have been someone else's income. We do need the savings rate to increase over time to fund an aging population's retirement needs, but we also need consumer spending to increase now so companies will have enough demand to justify an increase in hiring.

An often-cited rule of thumb is that a dollar decline in the aggregate net worth of consumers leads to a $0.06 decrease in consumer spending, with the savings rate increasing in tandem, all other factors held equal. I am not quite convinced that it always applies or should be used now. However, it does allude to the very general nature of consumers to save more and spend less in response to a drop in their net worth.

Recent stock market volatility might exacerbate that tendency, especially as 401k balances and home values are still well below their nearby peaks from a few years ago. More specifically, the net worth of consumers and nonprofits is $7.82 trillion less than what it was at the end of 2006, a 12% decline.

As a result, households have already increased their savings, according to these data. However, here's where I'm going to confuse you. The most widely followed savings rate is published by the Bureau of Economic Analysis in its National Income and Product Accounts (NIPA) and it includes the Personal Income and Outlays report. This metric showed that consumers saved $434.6 billion at an annual rate in the third quarter, or a 3.8% savings rate. These data show a falling savings rate over the past year or so, down from a nearby peak of 5.6% in mid-2010, and lower than that of the years of 2008 to 2010.

The Flow of Funds (FOF) data show that Americans actually saved $850.4 billion, using the same basic concept as the NIPA data, but derived from different methodologies and sources. This represents quite a sizable divergence of $415.8 billion, but this type of difference is not uncommon between these two reports. And the savings rate is not 3.8%, but rather 7.4%, which is closer to its long-run average of 8% to 10%. This is actually an increase from previous quarters, when it was 3.3% in the second quarter and 5.5% in the first, and is higher than it was in 2008 and 2009 and matches the 2010 rate. This suggests that Americans may actually be earning more money than other government data, such as from the BEA, might suggest.


How much Americans are currently saving is crucial, especially if the direction is changing. With the FOF data showing that the savings rate is actually much higher than the NIPA data might suggest – and has already risen in recent quarters – we might not see a sizable drop in spending and a further increase in savings that we might otherwise expect. In other words, consumers may already have adjusted their savings higher, allowing for spending patterns to continue largely as they are now.

This is corroborated by consumer confidence data that show consumer confidence has been on the upswing. Whether one looks at data from the University of Michigan or the Conference Board, consumers' attitudes are improving. Additionally, a recent increase in consumer credit outside of mortgages shows that consumers are becoming more comfortable with borrowing and banks more willing to lend.

Needless to say, any large shock, from Europe or elsewhere, can damage confidence going forward. Still, that consumers have taken events so far in stride and see improving prospects for their incomes and economy going forward can likely cause them to look past the decline in their net worth. The rebound in the stock market helps, too, and so does a stabilization of housing prices.

Thus, I think that consumers are in a better shape than more widely-followed, but less comprehensive, data might suggest, and that their spending has room to continue. However, it's likely they will eschew returning  to the spendthrift ways they practiced during the housing bubble.

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