Duncan’s Economic Blog

The Household Savings Ratio is now key

Posted in Uncategorized by duncanseconomicblog on April 4, 2011

This past week has seen a lot of comment on the likely path of UK household debt growth following blog posts from myself (both at False Economy and here) Richard Murphy and Sturdyblog, Parliamentary questioning by Chuka Umunna, an intervention by Paul Krugman and a big splash in the Observer.

What has become clear is that the OBR is expecting a big increase in household indebtedness over the next few years.

As the Observer put it:

The Office for Budget Responsibility has raised its prediction of total household debt in 2015 by a staggering £303bn since late last year, in the belief that families and individuals will respond to straitened times by extra borrowing. Average household debt based on the OBR figures is forecast to rise to £77,309 by 2015, rather than the £66,291 under previous projections.

Krugman explained the reasoning:

Why? Because the only way the economy can avoid taking a hit from government cuts is if private spending rises to fill the gap — and although you rarely hear the austerians admitting this, the only way that can happen is if people take on more debt. So we have the spectacle of a government that inveighs against the evils of debt pinning all its hopes on an assumption that over-indebted households will dig their hole even deeper.

An important point was raised last week by Richard Excell, who asked if this forecast for strong household debt growth was realistic.  He noted a half dozen recent data points suggesting that a large increase in debt was unlikely.

Adam Posen, of the MPC, appears to agree telling the Guardian last week that:

“Household consumption is going to be pretty darn weak. It may even contract a little”.

Consumers, he said, were unlikely to run down their savings in an attempt to maintain spending patterns, while the weakness of trade unions meant it would be hard for wage bargainers to push up pay settlements in response to higher inflation.

Posen then is taking the contray line to the OBR which belives that:

This subdued consumption outlook requires households to dip into their savings again in 2011, so the saving ratio continues to fall back from its post recession peak. Thereafter, the saving ratio stabilises at around 3½ per cent in our forecast (much the same as forecast in November), which is around half its average over the last 50 years.

This is the key divide between Posen and the OBR – the OBR believe that the household savings ratio (the amount of post tax income households save) will fall in the coming years providing a boost to consumption and hence GDP growth (at the cost of increased personal debt), whilst Posen thinks it won’t fall and hence squeezed incomes will lead to lower spending and lower growth.

The household savings ratio will be a key economic indicator to watch over the coming year.

It is currently 4.9%, the ONR expect it to fall to 3.4% – as they say, half of its average of the past 50 years. (Clearly the OBR aren’t big fans of mean reversion!)

To get a sense of how key it will be, it’s worth looking in more detail at the OBR forecasts. Despite Osborne’s talk of investment, exports and rebalancing – consumption will still be key to the UK economy according to the OBR – as the table below shows.

Overall household consumption (on the OBR forecasts) will provide around 38.3% of all UK growth by 2015.

How crucial is a falling savings ratio to this forecast?

Very, as the table below demonstrates.


As can be seen, in 4 of the next 5 years the OBR expects consumption to grow by more than household income – obviously this can only happen if the savings ratio falls.

If consumer confidence took a bigger hit and nervous households started to save more (or if banks were unwilling to lend), then consumption growth could actually be slower than income growth. (The ratio would rise, and remember its half it’s long-run average at the moment)

Weaker consumption growth (or in Posen’s case possibly an outright fall), would clearly have a major impact on the OBR’s growth forecasts – and hence its government borrowing forecast.

The household savings ratio (along side business investment) is now a key factor to watch. Either it falls and we get consumption growth at the cost of a huge increase in household debt or it doesn;t and we get much weaker growth.


6 Responses

Subscribe to comments with RSS.

  1. Dave Holden said, on April 4, 2011 at 9:58 am

    All reasonable. We’re at the end of a debt supercycle which there is no good way out of. If on the other hand government spends debt interest goes up and we’re in the same position. There is no alternative other than eventually debt write offs.

    • Barry Thompson said, on April 22, 2011 at 9:48 am

      Not sure what you mean by ‘debt supercycle’. Net debt is zero because credit = debt.

      The issue is stocks versus flows: the stock of debt versus the flow of incomes. We have problems because asset price bubbles burst and leave participants with more debt than they can service with income – so they pay down the debt (or, in the US, default). But if many people and companies pay down debt at the same time, the total stock of credit/debt falls (or fails to grow quickly enough) and this then reduces the flow of money (incomes) in the economy, compounding the problem. This is the classic debt-deflation theory of recessions from Irving Fisher.

      The solution is to maintain the incomes so that debt can be repayed without recession. The private sector can pay down debt if the government borrows to maintain the money stock. Increased government borrowing is what should be happening now, but is being blocked by irrational fear of the bond markets and inflation.

      If governments won’t borrow due to these irrational fears, central banks can use quantitative easing to ‘print’ the money to maintain the flow of incomes as both private sector and government de-leverage. This is possible because central bank bond purchases increase both deposits and reserves in the banking system without increasing debt.

  2. Tyler said, on April 4, 2011 at 1:20 pm

    Or we could have both the government and consumers paying down debt, productivity increases and a good chances of falling living standards.

    GDP growth is not exclusive to more debt/deficit spending.

    Whilst falling living standards (or more likely, less rapidly improving) might be unpalatable politically, its hardly a shock in an inflationary environment with a country heavily burdened by debt. Why should it be, especially when much of the increases in spending/living standards werre paid for by a fall in the savings ratio and massive increases in debt financing?

  3. […] – The household savings ratio has to fall and households having to starting borrowing and spending […]

  4. […] they are wrong (and Broadbent’s, Posen’s and my own fears are realised) then the growth picture just became even […]

  5. […] – The household savings ratio has to fall and households having to starting borrowing and spending […]

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )


Connecting to %s

%d bloggers like this: