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Is Increased Savings Good or Bad For the Economy?

March 4th, 2015 by 
PK

We'll get to the point early: increased savings is good for the economy.

The most likely forms your increased savings will take won't hurt the economy and will probably help it. You probably don't have to worry that your savings will spike the broader economy.

What is Savings?

Savings is simply spending less than the amount you have coming in via cash-flow.

Now, we usually think of savings as 'cash' savings... whether buried in your backyard, hoarded in your piggy bank, or deposited in a savings or checking checking account at a bank.

Oft-ignored is that "investing" in things is really savings as well. In this case it's usually funding a business or partaking in some other riskier venture. And that's the key - investing is generally riskier than saving in a bank.

Confusingly, too, 'savings' often takes the form of 'investment', or at least 'spending'.

When you deposit money in a bank, the bank doesn't just put it under a well-guarded mattress. Banks generally (see recent exceptions) lend it out for various things:

  • Personal loans
  • Credit cards
  • Mortgages
  • Car loans
  • And other debt

That goes for companies too: they 'invest' and 'spend' on humans - employees - along with capital assets, research and development, and all sorts of other things.

They also, of course, invest themselves - in financial assets, and even, yes, cash and cash equivalents(!).

Even governments play a role! Consider that a lot of people save in government assets... a lot of government debt is actually held by the public (pdf).  

The government, in turn, spends your investment dollars on various things - sure, they service the interest on existing debt, but they spend by proxy through transfer payments, as well as spending on various things... such as the military.

And, yes, governments do sometimes invest in the "traditional" way.

Why Would Anyone Consider Increased Savings Bad For the Economy?

It all boils down to a zero-sum theorem known as the "Paradox of Thrift".

In essence, this paradox makes intuitive sense - your spending is someone else's income.  

If you spend $500 a month eating out, and suddenly stop... well, that means there are $500 less of your dollars in the local restaurants next month. Multiply that by enough people and the economy falls apart, right?  

Q.E.D., spend more money, it's the Patriotic way!

St. Louis Fed graph on GDP vs Savings Rate: Is Increased Savings Good?
NGDP vs. the Personal Savings Rate (from the St. Louis Fed, linked nearby)

That's the argument advanced by Ryan Cooper of The Week.  He calls out bloggers such as Mr. Money Mustache who call for radically increased savings rates (and us and others, by proxy):

"These [savings] pitfalls are not surprising, given the libertarian-flecked ideology of personal finance. Through its bleary lens, money is sui generis — something that exists apart from human society and actions. The scold focus is solely on accumulating a big enough money pile for oneself, never on the broader economic ecosystem that supports that wealth."

What's the point of saving?

Obviously, using "libertarian" as a scare-word is a pretty big red flag ("Those liberal hippies! Those conservative warmongers!") in itself - but the article falls apart on further review.

Mr. Money Mustache needs no defense from our site, but personal finance 'scolds' in general see savings as a means to an end... not the actual end itself.  

And that's the important part: the point isn't to die with the most money under your mattress. That's ridiculous, and probably a deliberate misreading of savings advice.

The point of saving starting now is to accumulate enough resources that you'll be in the driver's seat as you get older. (Time waters down the options that would otherwise be available to you!)

If you don't believe me, tell me how a 48 year old couple with 3 kids and no savings can work as long or as hard as a 22 year old recent college grad with no savings... I'll wait.  If you agree with me, I'll point this out: if the 48 year olds started saving at 22, they'd have a lot more options at 48.

Deliberate misreadings

Cooper also quotes sources which pretty much directly contradict all of his points. From Steve Randy Waldman, of the blog Interfluidity, Cooper links an article about the "Evils" of savings.

Waldman, too, separates savings into different buckets.

He calls out banks and governments as poor stewards of your money in light of the Great Recession: "But if you keep your wealth in bank CDs or government bonds, you are a deadbeat.".

He simultaneously recognizes that companies have the possibility to fail – that's how an 'investment' is supposed to work! "Savers were supposed to be investors who monitored how the wealth they put aside was used to generate future wealth.".  

So, shareholders in companies that can fail. Hard to disagree about that.

Waldman makes an excellent point on banks & government, along with the savers who saved using banks and government debt:

  • Banks screwed up their lending practices.
  • We messed up by believing they would be good stewards of our money (in deposits over $100,000 and money market accounts).
  • The government screwed up by bailing us and the banks out with increased FDIC limits.

Because of these changes, deposits were (and supposedly no longer are) no-risk. Investing isn't supposed to work this way. That just encourages further risky behavior, since we've got insurance in the form of Uncle Sam bailing us out.

Too big to fail

How many of you really believe "Too Big to Fail" was a common phrase before 2008-2009? How about Moral Hazard

Cite sources, please.

Former Federal Reserve Chief Janet Yellen once wrote about the Paradox of Thrift. She opined on the 'paradox of deleveraging', where unwinding bad loans causes decreased investments across the economy as even the relatively responsible companies and savers cut back even more.  

Still, the Federal Reserve party line remains - savings is inherently good because:

"...in the long run, the accumulated money from individual savers is available for capital investment, a situation where businesses borrow to purchase capital (e.g., machinery and technology). Thus, an increase in the saving rate increases capital investment (e.g., investment in machinery for production)."

Cooper's article is thoroughly debunked at this point. Individuals who are not productive with their assets are investing those assets in people and institutions which can be more productive. Saving, in other words, is good and productive.

Not all saving is equal

There is one distinction to make before we continue. If you are only investing in your checking account or burying money and gold in the backyard and can convince a lot of other people to do the same?  

That's likely a bad thing for the economy. That's especially true if you think banks are bad stewards of your money.

Cooper doesn't acknowledge this distinction between unproductive savings and other forms of savings. He talks of his own struggle to invest in the stock market - he hasn't yet invested in any stocks or mutual funds. (Apparently he keeps a lot of his own assets as cash).  

Cooper makes some valuable points about mutual funds being confusing or, perhaps, being too expensive. Mr. Cooper, if you're reading, we'd love to help you take charge with passive investing - set it and forget it.

(We'd love to see you taking advantage of your 401(k), especially in a broad index fund with low fees.)

Mr. Money Mustache (and most finance writers, present company included!), is a huge believer in investing. MMM puts his money where his mouth is and invests in companies, which invest it on his behalf in capital, people, R&D, and spending.

Verdict: savings is not evil.

Other Problems With the Paradox of Thrift: "The Long Run"

John Maynard Keynes, is probably the most important economist to our current-day economic understanding. (For better or worse) Keynes is credited with popularizing the Paradox of Thrift.

However, Keynes also once said: "In the long run, we're all dead."  

His concerns with the effects of excess savings lead to his ideas on active government support for the economy. Keynes believed that when the general population stops spending, government should step in to fill its place.

All of this nihilism-flecked ideology of personal spending ignores the life-cycle aspect to all of this savings and spending.  

Cooper may claim Social Security is a success, but one fact remains: it is supposed to be supplemental. It's true, retirees rely heavily on Social Security in their retirement.

Contrast that with finance writers. We generally target a younger audience - folks in their 20s-40s who are interested in improving their future financial situation. They'll maximize their own retirement lifestyle if they defer consumption today.

Death and taxes

Here's the other thing: death is one of the only certainties of life (taxes being the other). It's also certain that you can't take your money with you.  

No matter what you – or Mr. Money Mustache – do, that money will be spent at some point.

  • Your great grandchildren might attempt to live on the trust funds you left them
  • You and your spouse might spend some in retirement
  • You might donate some to charity
  • The government might take it in taxes or forfeiture

That means all of us "scolds" are saving money today, but we're really only delaying consumption until some tomorrow.  Since we are supplementing our own Social Security (or equivalent), we will also have the ability to spend on non-necessities in our retirements!

People who save now will have the ability to spend that money more lavishly than the spending-scolds when we stop accumulating.  

Remember: you'll always buy necessities. You can't eat an iPad, but you do need to eat something, sleep somewhere, have a reasonably temperate room, and wear clothing. Even Mr. Money Mustache agrees - he may have stopped working a day job at 30 to work a web site and other side jobs, but he himself states his two cars and larger-than-average house are not necessities.  

And, newsflash: MMM and myself are too young to take Social Security. In Mr. Money Mustache's case, he bought these lavish things before Social Security even kicked in.

People spread their consumption over a lifetime: student loans beget savings for retirement. Later, you'll draw down wealth in retirement

The takeaway: it's going to be spent someday.

Don't Worry About Your Increased Savings Rate!  Your Conscience is Clean.

All of that goes to say: assuming that a working age person is 'evil' or 'hurting the economy' for increasing their savings rate is absurd.  

Savings almost never means money sitting in a pile - it generally goes to productive means through proxies like banks, companies, and the government. Furthermore, some spending exists as a baseline people will not stop:

  • Eating
  • Wearing clothes
  • Heating and cooling their homes
  • Living under a roof

Just because it happens to be a recession.

 And, finally, the majority of people trying to increase their savings are relatively young. When they – we – age, they'll be spending money in retirement. Further, they'll likely spend even more in retirement than people who are spending lavishly today.

If you were somehow worried that your savings are bad for the broader economy, they aren't. Unless you have your money buried in holes, it's likely going to productive activities - even if you only provided the funds without any advice attached to them.

Don't Quit Your Day Job...

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