John Maynard Keynes was and remains the most controversial economist of the short existence (relative) of the dismal science, economics.  So powerful influential was he, that an entire school of thought is named after him, Keynesian Economics.  Keynesian economics promotes a number of ideas I disagree with, most notably, and the subject of today’s post is the idea of saving.

Keynes believed that excessive saving can potentially create recessions, or make existing recessions worse.  This is supported by facts like 70% of the economy is based on consumer spending.  An increase is savings means a decrease in spending, a decrease in spending means less demand.  Less demand can lead to reduced output; or in other words, reductions in spending hurt the economy.  The post 9/11 economic boom further supports this.  Saving was low, and consumption was high, much of it on credit.  Of course this led to an eventual recession but hang on to that thought.  Greater consumption is good for the economy.

The reason I don’t like this is greater consumption eventually catches up to the consumer.  With so much purchased on credit and practically no savings, the American consumer literally stuck their Jimmy Choos in their mouths.  Call it the Weakonomics Paradox, consumption is good for the economy in the short term but bad for the consumer in the long term.  Humans are classically short-sighted, and so we seemed destined to continue such bad habits.

Keynsians are influential SOBs and many of them are high up in government giving advice to the policy makers.  Keynesians really like all these stimulus packages because they encourage the American consumer to spend.  It was with great pleasure that I learned the personal savings rate for May jumped to 6.9%.  This is incredible considering just a few years ago it was actually negative.  However compared to a few decades ago this rate is still sad.

It got me thinking though, are the Keynesians right?  Do we need to increase spending (thusly decreasing saving) in order to get ourselves out of the recession?  Thanks to the St. Louis Federal Reserve website we can find out.  Look at the chart below:

Some notes about the chart: The fact that % change in GDP and personal savings cross paths is insignificant.  Also, the GDP is a % change, not actual GDP.  So simply because it goes down does not mean recession, it just means slower growth.  The grayed areas are the actual recessions.

So in order to challenge the theory I need to find something in the chart that disagrees with the Keynesian thought that increased saving hurts the economy.  And it’s there in the 1980s.  After the recession in the early 80s economic growth was followed by an increase in savings.  Also a large dip in savings in the later 80s was not followed by a large increase in GDP.  Two immediate shots at the theory.

But then again, upon closer inspection I noticed something disturbing.  It’s common knowledge in the economics community that recessions lead to an increase in saving.  It’s a reactionary effect that is only natural in humans.  Take a look at each recession and you’ll confirm this.  Now take a look at the last few months of each recession.  In each of the last 4 recessions, we sort of actually did spend our way out.  How?  Though savings remains high in the recession, in each case the recession ended after a slight decrease in savings.  It’s most profound in the post 9/11 recession but exists in each recession.  Decreases in savings are increases in spending.  Score one for Keynes.

Miserably, you’ll notice that we have not yet hit that decrease in savings yet in our current recession.  We may not need one, but if we’re going by patterns here we are not yet on schedule to end this recession yet.

This chart basically makes the argument a wash in this guy’s opinion.  We’ve got examples of savings growing but not leading to recession but at the same time see examples of decreases in savings pulling us out of recession.  I guess this argument will continue to be one for the economist’s to debate for a while yet.  Perhaps savings hurt us, perhaps not.

HOLD ON JUST A DARNED SECOND!

This is Weakonomics.  This isn’t about stuffy PhDs bickering policy decisions for you.  You shouldn’t have to feel guilty about saving thinking it might could possibly hurt the recession.  You also shouldn’t have a license to spend thinking you’re helping the economy.  There is one very profound conclusion that can be drawn from this graph that we forgot about.  The % change in GDP remains between 0% and 2.5% for the almost the entire 30 year span.  Meanwhile, the savings rate changes A LOT.  It goes from the high to the low while the overall % change in GDP doesn’t move very much at all.  This biased Weakonomist sees only one conclusion:

The personal savings rate may play a role in GDP, however its specific rate has no significant impact on the health of an economy unless it reaches an extreme.  Savings rates of 1% or less are correlated with consumption bubbles and recessions and should be considered such an extreme.  It’s theoretically possible that on the high end of savings GDP growth could once again show a recession, but if it’s between 2% and 10% the savings rate’s contribution to GDP is not significant enough to warrant scrutiny or policy changes.

In other words, a normal savings rate between 2% and 10% does not have an observable correlational effect on GDP growth and therefore should not be considered a major contributor or inhibitor of GDP growth.

Stay out of my finances, Keynes.

By The Weakonomist

The Weakonomist is the founder of Weakonomics. Clicking the picture of the puppy will tell you more about him. If you like what you're reading consider subscribing to the blog, following him on Twitter, and checking out the related posts below. Please consider a donation if you really enjoy Weakonomics.

categories: economics, government, personal finance