The savings rate is one of those elusive economic indicators that is often mentioned in the media but its significance is not always clear. The savings rate is the percentage that people set aside from their disposable income for retirement or tougher days ahead. When people feel assured and believe that their jobs and incomes are secure, they do not feel the need to save as much and end up spending on discretionary items instead. Spending on discretionary items, such as restaurants, vacations, and other non-essential items is an important engine for economic growth and prosperity in the short run.
When the savings rate is elevated the majority are trying to limit discretionary purchases and instead focusing on necessities at the lowest possible price, saving the remainder for the future. This typically occurs due to unclear job prospects and anticipation of tougher conditions ahead. So in the short run a lower savings rate is good for economic growth and is related to higher consumer sentiment and consumer spending. However, in the long run, a higher savings rate is positive and sets the stage for more sustainable economic growth, as people will be better covered in case of a sudden loss of income or an economic downturn.
So what does this indicator show us today?
Today the savings rate is about 5.4% and the six month moving average is at 5.7%, which is down from a high of 8.2% in December of 2012 and 6.6% in May of 2009. This is encouraging and illustrates that people are not as insecure as they were a few years ago in the immediate aftermath of the Great Recession. Despite more optimism, the savings rate is a far cry from where it was in July of 2005 when just 1.9% of disposable income was being saved. Since 2013, the metric seems to have found a sweet spot at a higher level than the previous decade. It looks like consumers have become more cautious after the recession, which should be good for their finances in the long run, but it is not very encouraging for consumer spending in the near future.
So what is the path forward? Can we expect the savings rate to decline as people become more confident? Or is constant uncertainty the reason why we continue to feel the urge to save as much as we can? It turns out that we need to further break down and understand the components of this indicator in order to answer these questions. According to our friends at Cornerstone Macro, the top 20% of income earners have a savings rate of over 20% compared with a negative savings rate for the bottom 40%. This leads to the conclusion that in order for the savings rate to decline and spending to increase, either lower income earners need to have an even more negative savings rate, which could lead to disaster down the road, or higher income earners need to spend more.
The current elevated levels of the savings rate do not really provide the security we would expect in the future. If 40% of Americans, do not have any savings, this leaves them and the economy vulnerable if a recession hits. In addition, those investors expecting a decline in the savings rate to spur economic growth are banking on wealthy individuals opening up their pocketbooks and parting ways with their cash. Until uncertainty fades, the likelihood of a significant spending binge seems low.