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YOU DECIDE: Why are we finally saving more?

May 29, 2009

MEDIA CONTACT: Dr. Mike Walden, 919.515.4671 or michael_walden@ncsu.edu


Dr. Mike Walden
Media representatives:For a black-and-white or color copy of this photo, call 919.513.3127 or e-mail dave_caldwell@ncsu.edu.

They've been called reckless spenders, foolish financial planners, and the "got to have it now" generation. Who are these people? They're you and me, the American consumer. For the last 20 years, we've been on a spending binge that drove our saving rate to zero.

But recently we've changed our ways. We're now saving more. In fact, the personal saving rate, which measures how much we save out of our paycheck and other income, hit 4 percent in the first three months of this year. This is still only half of the average saving rate from the end of World War II to the mid-1980s, but it's certainly better than the zero percent rate earlier this decade.

What happened? Why have we suddenly become more frugal? Does it have something to do with the economic conditions created by the recession?

Before I answer these questions, let's look at why people save and the factors that impact saving. People save for a variety of reasons: to buy a big ticket item like a car or home in the future, to put children through college or to supplement their Social Security checks when they retire.

The common link is the future. Saving means a person is giving up the benefit and enjoyment of buying things today in order to have more money to spend later. In economics lingo, saving is a way to transfer purchasing power from today to tomorrow.

This suggests one big determinant of saving should be age. The older you are, the less time you have remaining to spend, so you'll save less and spend more now. Indeed, studies show the aging of our population in recent decades has worked to reduce the saving rate.

Another factor impacting how much we save is the value of our assets, like stocks, bonds and CDs (certificates of deposit, not compact discs). The idea is that these assets can be sold in the future and converted to cash for living expenses. Therefore, the bigger your asset cushion, the less you need to save out of your current income.

Research has found a tie between assets like stocks and the saving rate. The more stocks rise, the more the saving rate falls. So one reason behind the big drop in the saving rate from 1985 to 2007 was the jump - on trend - in stock portfolios during that period.

But what about the biggest asset of all - people's homes? For a long time, economists thought people treated their homes differently and didn't consider home value (called home equity) to be a substitute for saving.

However, there's been a re-examination of the role of home equity and saving since the boom (and then bust)in home prices this decade. Researchers, including yours truly, have found that rising home prices in the 2000s could have played a role in the plunging saving rate. Homeowners came to view their homes as big piggy banks that just kept growing and growing. The attitude became, there's no need to save, my home is doing the saving for me.

There's one other way we can save for the future besides watching our financial assets grow or taking money from our paycheck. This is to spend money, increasing our ability to earn more in the future. Spending money on higher education (community colleges and four-year colleges and universities) is like saving because the money spent is returned many times over in the form of the increased salary the better-educated worker eventually earns.

This means that as spending on higher education has gone up in recent decades, the saving rate has gone down.

With this background, I think we can solve the saving puzzle. For over two decades we cut our saving rate because we were aging, we were spending more on higher education and because our assets were increasing in value. In the past two years our assets - especially homes - have taken a big hit, and although education still pays, its luster has been tarnished a bit by the recession. The result - our saving rate has increased.

Now, the big question is, what about the future? As a country, we will continue to age, so this factor will work to push the saving rate down. But if stock and home prices don't recover and if the payoff to higher education dips a bit, the return to thrift may be permanent. Ultimately, each of us will have to decide.

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Dr. Mike Walden is a William Neal Reynolds Professor and North Carolina Cooperative Extension economist in the Department of Agricultural and Resource Economics of N.C. State University's College of Agriculture and Life Sciences. He teaches and writes on personal finance, economic outlook and public policy. The Department of Communication Services provides his You Decide column every two weeks. Earlier You Decide columns are at http://www.cals.ncsu.edu/agcomm/writing/walden/decide.htm

Related audio files are at http://www.ncsu.edu/waldenradio/

Posted by Dave at May 29, 2009 08:58 AM