On the eve of the FOMC’s rate hike, one could also ask how a potential higher interest rate affects the U.S. savings rate. After all, the basic idea we are all thought in econ101 is that when interest rates go up, savings rate should also follow and pick up: It could come because people want to postpone their consumption to a later date as they get a bigger carrot in the form of higher rates. Or perhaps it could be because higher rates also suggest a potential decline in wealth – if we were to assume that interest rates have an adverse impact on stocks and real estate – so that people feel they have less money and as such consume less. If they consume less, it means, by definition, people save more.
All this is good and seems like a very convincing story line, the only problem is that the data suggest otherwise.
Source: FRED
The chart above shows the changes in 10-year yield bonds and savings rates. So yes, it’s long term yields, but the picture doesn’t change by much even if were to examine the 1 year yield bonds as you can see for yourself in this link to FRED.
And even though the correlation of the monthly percentage points is weak at only -0.07 the trend lines have a much strong correlation of -0.70. So this finding also suggest that in times of high interest rates, savings rates are low and vice versa (or is it the other way around).
So what is going on?
For one, it could be a matter of putting the cart before the horse: Perhaps we see low interest rates because of weaker consumption and Fed’s policy to stimulate the economy as was the case in the past few years, so of course we’ll see higher savings rates. When the economy is heating up, the Fed tries to cool it down so it won’t overheat with high inflation and as such interest rates pick up as in the mid-00’ and savings rates were low.
Another possibility is that in dire times with soaring high debt levels, people are deleveraging and spend less. So no matter how attractive or low the interest rates are, people want to keep on cutting down their debt burden.
I could go on and examine more possibilities, we haven’t even talked about the role of government and its impact on savings rates and total savings; does it cause a paradox of thrift; I could make the case for this negative relation — there are certainly more appealing “stories” that will tell why higher interest rates are also linked to lower savings.
But the bottom line is that when interest rates will start rising again, we could see lower savings rates. Is it good or bad for the U.S. economy? It will suggest higher consumption, which most people aren’t likely to oppose. But since savings, under equilibrium, equal investments; then lower savings could suggest lower investments, which isn’t good for companies. So it all depends on which side of the economy you are at. In any case, rates are likely to remain low this year and even next so we should expect any major changes in the savings rates anytime soon.
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