Saving and investment ; Crowding out (Economics) ; Budget deficits

John Scadding

English

Research Papers in Economics

August 22, 1980 
Are We Saving Enough? 
The most recent business expansion saw 
a steady erosion in household saving. The 
personal saving rate-the ratio of personal 
saving to disposable (after-tax) income-
averaged 7.7 percent in 1975, the first year of 
the expansion. The ratio thereafter dropped 
precipitously, however, and in 1979 aver-
aged only 4.5 percent, the lowest figure of  the 
past quarter-century. 
Many observers view this decline with dis-
may, if not outright alarm. In view of  the 
nation's lagging productivity and growth, 
more and more attention has come to be 
focused on supply-side economics, with its 
emphasis on how  decisions to work, save and 
invest affect the long-run performance of  the 
economy. Savings behavior plays a 
prominent role in this analysis, because 
savings set an upper limit to the amount of 
resources devoted to capital accumulation 
(investment}-believed by many to be a ma-
jor contributor to growth. In this context, the 
decline in the saving ratio has been particu-
larly unsettling, because it suggests that in-
vestment, and hence productivity and 
growth, are likely to suffer even more. 
There is no question that the rate of in-
vestment in the u.s. has slowed in recent 
years. Whether that represents a permanent 
change remains to be seen. But one thing 
seems clear-the decline in the personal 
saving rate has had very little to do with the 
investment decline. 
To understand that surprising statement, we 
should keep three points in mind. First, part of 
the decline in the personal saving rate is 
transitory, while another part represents a re-
version to more typical behavior. Second, 
personal saving represents a relatively small 
part of  total saving, and its movements are a 
poor.indicator of what is happening to the 
total. Finally, investment must compete with 
other uses of savings-primarily government 
borrowing-to finance the deficit. Indeed, 
the growth in government borrowing has 
contributed more than the drop in saving to 
the decline in the investment rate. 
Personal saving 
Part of  the recent decline in the personal 
saving rate probably represents normal cycli-
cal behavior. As a business expansion nears 
its end, income growth typically slows, as it 
did in 1979. Consumption, on the other 
hand, continues to forge ahead for a while, 
because people find it difficult to reduce 
their spending habits as quickly. The ratio of 
saving to income therefore falls as con-
sumption temporarily runs ahead of income. 
This phenomenon has occurred at practically 
every business-cycle peak of the past 
quarter  -centu  ry. 
Every recession of this period, however, has 
witnessed a recovery in the saving rate, re-
flecting the way that households adjust their 
consumption in response to falling income~ 
and increased economic uncertainty. Thus, if 
cycle history continues to repeat itself, we 
should expect to see some recovery in the 
saving rate this year. Indeed, the turnaround 
may already have occurred, in view of the 
rise in the ratio, from 3.7 to 4.7 percent, 
between the first and second quarters of this 
year. 
The decline in the personal saving rate during 
the last expansion also represents a return to 
more "normal" long-run behavior (see 
chart). The average saving rate over the last 
cycle was quite similar to the average for the 
entire 1954-79 period-5.9 versus 6.0 per-
cent. Indeed, the anomaly was not the last 
cycle, but the one before it  -1970  to 1973 
when the rate averaged 7.3 percent. That 
anomalous jump in the ratio has been attrib-
uted to high and variable inflation, which 
added to economic uncertainty, and thus led 
people as a precautionary measu re to save 
more. This argument is not very convincing, 
however, in view of  the subsequent decline in {){  tt1f~  Ft·~cit:(aJ  r~~E·.~SE'1rVf:  1.1ar) k ()f  ~;ar1 
nor 01  the board eli  C;ovccnol':; cd  the Federal 
Re~·)erv(:~ 
the saving rate, which occurred in the face of 
continuing high and erratic inflation. But no 
better explanation has yet emerged, although 
some investigators believe that the post-1975 
decline reflects an inflation-caused reduction 
in real after-tax returns to saving. 
Private saving 
This discussion may be somewhat beside the 
point, however, because the rate of total sav-
ing (gross private saving) has not declined 
significantly in recent years-and this is the 
more relevant measure for determining the 
amount ofthe nation's outputthat is available 
for investment. Personal saving represents 
only part-and a relatively small part-of 
gross private saving. The bulk of the total 
consists of business saving-that is, the 
amounts firms set aside for depreciation plus 
the profits they retain rather than payout to 
their owners. Last year, business saving made 
up almost four-fifths of  total saving. 
The cyclical behavior of  the gross private 
saving rate (the ratio of  gross private saving to 
GNP) contrasts strikingly with the behavior of 
the personal saving rate. The former varies 
hardly at all from cycle to cycle, while the 
latter is much more variable. The difference 
between the highest and lowest cyclical aver-
age for the gross private saving rate is only 0.2 
percentage point, a relatively insignificant 
amount compared to the long-term average 
of 15.8 percent. In contrast, the maximum 
cyclical difference for the personal saving 
rate is 1.5 percentage points, which is rela-
tively large compared to its long-term aver-
age of 6.0 percent. 
The gross private saving rate has been 
relatively constant for much more than the 
quarter-century we are surveying. In fact, 
analysis of Io.ng-run U.S. saving behavior 
shows that the rate has not changed signifi-
cantly in the last 90 years. In other words, the 
U.S. economy saves about the same fraction 
of GNP today that it did before the turn of  the 
century. Thus, while we may not be saving 
enough in some absolute sense, as a propor-
tion of  GNP we are doing about as well as we 
have ever done. 
2 
The secular stability of this rate supports the 
viewthat saving is relatively insensitive to 
interest rates. Over the past 90 years, the 
return on saving has varied substantially, 
whereas the proportion of GNP saved has 
remained unchanged. This suggests that 
household and business saving decisions are 
not significantly influenced by the yield on 
saving. The economics profession is divided 
about  th  is interpretation of  the data. The issue 
has important policy implications, however, 
because if saving is interest-insensitive, tax 
breaks to encourage saving or investment will 
be ineffectual. 
Crowding out 
The fact that saving may be relatively imper-
vious to rates of return does not mean, how-
ever, that investment could not be raised in 
other ways. One obvious way is suggested by 
the vertical bars in the chart-reduce the 
government deficit. 
Like investment spending, government bor-
rowing to finance the deficit draws on the 
resources provided by saving. For a given 
amount of saving, every extra dollar of gov-
ernment spending means thatthere is a dollar 
less of  saving for investment. In this sense, 
government borrowing can be thought of  as 
"crowding-out" investment, and this is the 
name given to this phenomenon. 
Crowding-out may be largely responsible for 
the lagging investment rate (see chart). The 
bars in the chart show how total savings are 
used either to fi nance domestic investment or 
the government deficit, with all variables 
measured as a percentage of GNP. Overlap-
ping bars indicate that investment plus the 
deficit exceed total savings. The difference 
is made up by importing resources from 
abroad, and hence impl  icitly measures the 
current-account deficit in the balance of  pay-
ments (the current account measures net 
trade in goods and services plus investment 
income). 
Effects of deficit 
Variations in the investment rate have been 
associated largely with variations in the size of  the governmentdeficitto GNP. In 1954-57, 
for example, government on average ran a 
small surplus, and the associated investment 
rate of 16.0 percent was the largest of  the past 
quarter-century. In contrast, the deficit's share 
of GNP in the 1974-79 cycle was the largest 
of  the entire period, and the investment rate 
correspondingly was about the lowest-15.1 
percent. The swing in the government deficit 
between the two cycles was more than one 
percentage point, while the decline in the 
saving rate was only two-tenths of a percent. 
Thus most of  the 0.9-percentage-point de-
cline in the investment rate was accounted 
for by the rise in the size of the government 
deficit. 
These calculations by themselves cannot 
prove that the higher deficits caused the 
lower investment rates, although they are 
consistent with that interpretation. Low in-
vestment rates could be symptoms of weak 
investment demand, which caused the gov-
ernment to run larger deficits in order to 
maintain aggregate demand. However, that 
interpretation would imply downward pres-
sure on interest rates, with a tendency to 
capital outflows and surpluses in the current 
account. 
The facts are just the opposite. The high gov-
ernment deficits of  the 1970s have been ac-
companied by large chronic deficits in the 
current account. This suggests a world in 
which heavy government borrowing put up-
ward pressure on interest rates-causing on 
the one hand a reduction in domestic invest-
ment, and on the other, a capital inflow and 
deficits in the current account. In other 
words, the picture is one of crowding-out, in 
which the government deficit was partly fi-
nanced by drawing resources away from 
home investment, and partly by absorbing 
resou rces from abroad. 
Two conclusions follow from the analysis. 
First, given the remarkable stability of  the 
total saving rate, it is likely that the only prac-
tical way  to spur investment is to reduce the 
government deficit. Secondly, a reduction in 
the deficit may not show up entirely in higher 
investment at home. Part of it may show up  as 
an improvement in the current-account bal-
ance-which, given the large deficits in that 
account, would also be welcome. 
Joltn Scaddin-g 
Saving and Investment-Cyclical Averages 
16  Gross  private saving rate 
15 
14 
13 
12 
1954- 1958- 1961- 1970- 1974 -
1957  1960  1969  1973  1979 
Deficit ratio is ratio of government surplus/deficit to GNP. 
Investment ratio is ratio of gross private domestic investment to GNP. 
3 
8 
7 
6 
5 BANKING DATA-,.TWELFTH fEDERAL RESERVE DISTRICT 
(Dollar amounts in millions) 
Selected Assets and liabilities 
large Commercial Banl<s 
Loans (gross, adjusted) and investments* 
Loans (gross, adjusted) - total# 
Commercial and industrial 
Real estate 
Loans to individuals 
Securities loans 
U.s. Treasury securities* 
Other securities* 
Demand deposits - total # 
Demand deposits - adjusted 
Savings deposits - total 
Time deposits - total # 
Individuals, part. & corp. 
(Large negotiable CD's) 
Amount 
Outstanding 
8/6/80 
137,937 
116,235 
33,356 
46,925 
23,542 
1,123 
6,229 
15,473 
44,409 
32,173 
29,268 
61,832 
53,662 
22,620 
Change 
from 
7/30/80 
964 
982 
116 
35 
- 49 
254 
- 70 
52 
1,612 
1,054 
343 
190 
245 
215 
-
-
Weekly Averages  Weekended  Weekended 
of Daily Figures 
Member Bank Reserve Position 
Excess Reserves (+ )/Deficiency (-) 
Borrowings 
Net free reserves (  + )/Net borrowed (  - ) 
* Excludes trading account securities. 
#  Includes items not shown separately. 
8/6/80  7/30/80 
16  93 
12  4 
4  97 
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!!eMPH  e!UJo:l!leJ  l?UOZ!JY"  P>lsPIV 
~~~~~\ill~Jr~ \~)J~C£ 
~~  ~\ill~C@I 
~AJr~~~CQI TI~Jr~1P~~ 
:{1 \\lr~m:{1J1~w~cm ~J)J1\~~~~CQI 
Change from 
year ago 
Dollar  Percent 
6,827  5.2 
7,949  7.3 
1,533  4.8 
7,397  18.7 
825  3.6 
750  - 40.0 
1,257  - 16.8 
135  0.9 
1,895  4.5 
756  2.4 
1,375  - 4.5 
10,294  20.0 
10,541  24.4 
4,247  23.1 
Comparable 
year-ago period 
23 
30 
7 
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and other Federal Reserve publications can be obtained by calling or writing the Public Information Section, 
Federal Reserve Banl(-Of San Francisco, P.O. Box 7702, San Francisco 94120. Phone (415) 544-2184. 

Are we saving enough?

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Are we saving enough?

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