We Really Do Need to Rethink the Economics of Saving, Most of Which Is Nonsense

Yves here. Another point to add to Richard Murphy’s discussion of the illogical way economists think about savings: their lack of interest in how savers think about risk also leads to bizarre ideas about negative interest rates. One of the big reasons for promoting negative interest rates was the belief that consumers would spend more when negative interest rates deprived them of safe interest income because they’d preserve their lifestyles. In fact, most savers wind up saving even more because their interest income has fallen and they don’t want to deplete their capital. And on top of that, negative interest rates signal deflation, which means their dollars will be worth more in the future than now.

By Richard Murphy, a chartered accountant and a political economist. He has been described by the Guardian newspaper as an “anti-poverty campaigner and tax expert”. He is Professor of Practice in International Political Economy at City University, London and Director of Tax Research UK. He is a non-executive director of Cambridge Econometrics. He is a member of the Progressive Economy Forum. Originally published at Tax Research UK

I had a look at the FT’s round-up of latest savings rates this morning. It’s not something that I do that often. But the message on this occasion was loud and clear. It is that if you can make 0.5% on your cash savings you are very lucky indeed, and probably should not expect it to last.

My suggestion in that case is a simple one, given that there are record cash savings at present. And that is that people do not save for income any more. And what is more, the old arguments about liquidity preference and the time value for money all look rather meaningless.

To put it another way, the zero bound, as it is called, where interest rates equate to near enough nothing (or, in real terms, less) has changed behaviour in the microeconomy as much as it has in the macroeconomy.

My suggestion is that it is time to rethink the economics of saving. People don’t change their plans as to when they wish to consume, or not, because of financial inducement. When it comes to saving they do not consume now because they simply do not want to, knowing that they would prefer to do so at another time. And they draw upon their savings because the time has come when they wish to do so,  and not for anything to do with the financial return on offer.

We do, in other words, save for almost entirely non financial reasons. And when we do so security ranks very high in most of our priorities because the social goal for saving dominates all else. And our consciences may play a part if, and only if, we are persuaded to save when not wholly understanding why, which is almost entirely true with regard to pensions.

In all this I exclude from consideration the very wealthy, because they do not save in any meaningful sense. They put aside excess wealth knowing that they can always do what they want, which renders the idea of saving meaningless in any ordinary sense.

I also caution that saving and borrowing are not the flip side of each other. The psychology is almost entirely different.

But saving does matter. It does impact the economy . And I would suggest almost all economic theory on it is wrong, as is much financial advice. We save for specific reasons unrelated to return. This crisis is showing that. We really do need to remember it.

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  1. vlade

    “People don’t change their plans as to when they wish to consume, or not, because of financial inducement.”

    Well, yes and no. The do, which is why there are always some discounts and special deals and what have you, and they clearly do change the consumption patterns. But all these things do is some shifting of consumption over time, and the _aggregate_ pattern won’t switch much.

    So I’d put the sentence above differently – the aggregate consumption is only trivially suspectible to most changes in saving interest rates (as we’re talking about saving. borrowing rates do matter more, especially mortgages).

    1. Ignacio

      That I think is the main point of low rates: not to promote spending but to avoid bankrupting of the highly indebted and promote higher lending which in turn requires higher saving (somewhere in the planet, may be in a country that is not yours and promotes saving), if I am correct. So the net effect may depend on how much this stimulates lending and where the money comes from.

      1. Ignacio

        Regarding the car industry I think that nowadays most cars are acquired by renting/lending schemes and this is almost certainly promoted by low interest rates. So if rates hike this might result in less car sales, or if it doesn’t, in less spending in other items. Less car sales and a switch to other items rather than cars wouldn’t be a bad outcome in my opinion.

      2. Steven Greenberg

        Are you still hanging on to the loanable funds model of lending? This has been discarded quite a while ago. The way I like to clear this up is to point out that private banks do not create money. What they create is promises of money. Most of those promises never have to get turned into actual money. Those that do get turned into actual money use money income to the bank, interbank lending, other borrowing by the bank, or the Federal Reserve Bank as a last resort.

        As long as the bank feels that they have a way to fulfill the promises of money that get called, then they can make loans whether they have the money in hand or not.

  2. harry

    I agree with Mr Murphy. We speak in generalities.
    There are always exceptions but Chinese grandparents do not save at real rates of -7% because they like the return but because they gave no other way of intertemporarily transferring consumption. Catfood does not become an attractive meal because of interest rates.

    1. skippy

      In Econ terms whenever I hear the term Savings … T bills and Gov bonds pop into my mind …

      Peasants savings – ????? – Lmmao ….

      1. Mel

        I dunno. I’m binge-reading Michael Hudson, currently in The Bubble and Beyond from 2012. From this book, the preponderance of saving in the American economy is institutional, within the FIRE sector, and is recycled as more lending. So when I hear the term Savings, I’m thinking Shadow Banking. Maybe that will be established further down the book.

    2. JEHR

      “intertemporarily transferring consumption”–an impressive amount of mental gymnastics is needed to suss out the meaning of this phrase.

  3. marcel

    Our family earns more than we spend (we are rather thrifty than really big earners), so we accumulate savings. The question to us is rather what to do what these savings. Any ‘investment’ turns money into (more) money, so these are useless. Buying a house, yes, we did that, and it is paid for. Buying a rental? Again, transforming money into (more) money, so useless again.
    So the question is, where can an individual ‘invest’ into something ‘useful’ for the people, the “economy” or whatever? And for lack of an answer, we have been accumulating for quite some time.

    1. Larry Gilman

      “Any ‘investment’ turns money into (more) money, so these are useless. . . . Buying a rental? Again, transforming money into (more) money, so useless again.”

      I don’t understand. How can making money, whether from investment or landlording, be useless? I have done both, and found the “(more) money” quite useful.

      If “useful for the people” (not just to me and mine) is a desideratum, then (a) doesn’t responsibly running an affordable rental property provide something useful? and (b) isn’t socially responsible investing an option? Viz. https://www.morningstar.com/articles/679225/the-benefits-and-costs-of-socially-responsible-investing .

    2. Michael McK

      Please invest in endangered ecosystems near you. Even a few acres set aside for future generations can make a huge difference. Land trusts are a good idea too, especially if they get ethical farmers access to land.

  4. Jesper

    Yep, the classic mistake by economists: assuming that a model that predicts well in some conditions predicts well in all conditions.

    Not knowing under which conditions the model predicts well means that the model is almost useless for predictions. A long long time ago I was dealing with building mathematical models, one takeaway for me from that was a warning/example from the professors/teachers:
    Sometimes it is ok to approximate a horse to be a sphere, other times it is not.
    Knowing when assumptions and approximations are correct is key. The calculations of the model might be resolved correctly but if the model is not describing reality correctly the predictions of the model are unlikely to be correct. By chance they can be but a model that is correct by chance….

    So yes, a rethink is definitely needed. Accept that most models are accurate only under some conditions, figure out what those conditions are and then maybe the models might have better value.

    1. Cas

      Your point about models is an important one. Unfortunately, models are sold as “science”, somehow more accurate than human reasoning. But if the assumptions are wrong, the results will be wrong; and there are so many assumptions! And it isn’t always obvious which assumption/variable is significant. It seems business, finance, government, all run on models and power point presentations. Too bad for us.

  5. Amateur Socialist

    The nonsensical nature of savings is related to the dubious prospect of investing in an annuity.

    As a involuntary pandemic triggered early retiree (probably… I have applied for jobs for 10 months regularly and have had exactly 1 interview) I’ve had to examine my own assumptions regarding my (now a few years short) 401K account. It looks like I’m offered the choice of principal/asset risk and volatility by continuing to stay in the equity markets or interest rate/income risk by migrating into safer bond/money market assets. So employment insecurity turns into retirement insecurity. So it goes.

    When I examined the options my Fortune 500 employer offered regarding converting assets to annuities it looked like a fairly obvious scam. The “safest” name brand annuities with the top ratings for security of course offered the most pitiful returns. The higher returns get you an annuity from a firm you never heard of with a significantly reduced security rating. Okay. More insecurity.

    I wasted a local investment advisor’s time for a few minutes when I explained to him what I really wished I could find was some kind of valid 401K approved investment that would focus on local needs for affordable housing. Southern Vermont is woefully short on this critically needed resource, one I would love to find a way to support without participating in the recent pandemic fueled real estate boom. I’m fine with taking lower returns if I know the money is going into my community. But as marcel commented above it’s not easy to do that without buying rentals and becoming a landlord etc. And he chuckled gently and agreed “yeah that would be nice” but acknowledged he wasn’t aware of any such possible investment.

    Like so many things these days, perhaps it’s time to acknowledge that the market isn’t really working very well. As the poster acknowledges, savers are being financially sanctioned for pursuing the safety of FDIC insurance. Perhaps it’s time to let 401K savers (the ones who have been lucky enough to accumulate some past the crashes etc.) invest in a social security backed annuity. I doubt I’m the only reliable voter who would appreciate some kind of policy based approach that mitigates the insecurity without it amounting to “save more loser”.

  6. a different chris

    I strongly suspect that if you brought back 5.25% passbook savings people would spend a lot more.

    The thing (top-tier) economists never, ever get is simple psychology. I guess because they are a bunch of weirdos that are never invited to good parties. Which is funny because that (psychology, not parties) should be the very basis of their professional lives.

  7. FluffytheObeseCat

    This is a great piece. It’s extremely short….. and extremely accurate. Well written and addresses an issue that gets far too little coverage. The vast majority of wage earners – who are the vast majority period – save to be safe. To provide for themselves when they can no longer earn a wage (or at least a good wage).

  8. Susan the other

    This unassuming little meditation could keep us going for days; years. I’m instantly mind boggled. The buzzards are circling our superficial definition of “credit”. Because how can you have credit in our financial system if you do not have debt? Double entry accounting seems to maintain the illusion that they are two sides of the same coin. “Somebody’s credit is another person’s debt.” And if borrowing and debt then actually become a credit, a savings to the borrower because it is spent in a wise and timely manner, then what do we have?? We have very imprecise language, that’s what. And saving up for rainy old age is a form of credit, like paying funeral expenses in advance, then old age must logically be an obligation that must be paid. So in terms of retirement, credit and debt are offsetting. Because we are counting the money. But I’d love to think that there’s no such thing as debt, only degrees of credit (to paraphrase whoever said There’s no such thing as evil, only degrees of good.)

    1. Bruce Elrick

      Your meditation reminds me of listening to the audiobook of Debt: The First 5000 Years. That and a summary of MMT.

  9. Wellstone's Ghost

    This pandemic has taught me, and a lot of other people I would imagine, that having a substantial emergency savings fund is a necessity.
    However, even an emergency savings fund has become a luxury item in the USA.
    A cash reserve to pay rent/mortgage obligations, utilities, food, gas, etc., but also unexpected expenses like the dislocated fingertip I experienced a few weeks back which set me back $1200, after insurance paid their half of $1200 as well.
    The money to pay these fees must be liquid so a savings account is really your only option.
    To cover an average of 6 months of these expenses would amount to $25,000 to $30,000 dollars on the conservative side.
    This is money just parked on the sideline doing nothing and amounting to nothing at present interest rates.
    If 50% of Americans, I believe that is a rounded number, can’t afford a $400 or $1000 (or whatever amount) unexpected bill, it is no wonder the tents are popping up on the side of the road more and more very day.
    The economic insecurity that millions of Americans are facing is crippling this country.
    If Biden and team D don’t open up the purse and start spending the money on the people in a practical and direct way our institutions will continue to decay and trust in the system will continue to erode as we see already see in our daily lives.
    I would definitely spend more money into the economy if I didn’t have to park so much on the curb to not get screwed over when things take an unexpected turn.

    1. Objective Ace

      Credit cards are a great source to increase liquidity (and maybe even a HELOCs). I guess not everyone has 10s of thousands of dollar limits they could use to cover the time period it takes to sell stocks to cover any issues

        1. Pea Sea

          If I were a peasant in dire need of immediate bread, I would simply sell some of my cake shares.

    2. fajensen

      In my experience, the quality of life improves dramatically once one has arrived at 2-3 months wages in savings. Consumption goes way down also. It is not that one becomes stingy, it is just that when one knows that one can just buy “whatever” if and when one wanted to, the false idea of “scarcity of goods” (which is ridiculous in an industrial economy) goes away, and one realise that maybe one does not need “whatever”.

      Leaving people with nothing, except what is needed for “now”, IMO, is what characterises a third world economy and it will yield the same outcomes eventually.

      If Biden and team D don’t open up the purse and start spending the money on the people in a practical and direct way our institutions will continue to decay and trust in the system will continue to erode

      Yup. That is the weird thing with Donald Trump that the Dims still don’t get, how close they got to extinction, and how they were saved by Donald Trump:

      Trump only had to do two things: Mount an effective Covid-19 response and funnel money / opportunities into the dishevelled layers of society (a national program for fixing potholes, basically) and he would have become the American Putin: Un-assailable, Constitution Rewritten, Father-of-the-Nation for Life!

      Just getting one of those two things half-right would have been a certain re-election.

      The Covid-19 would have been easy, like: “Fauci, you deal with this virus thing, No, don’t tell me about it, I really don’t care, just get it done, Now!”, The funnelling of money would have been more work, not enough Pork in it for anyone to be interested, but, doable.

      And Yet, he just had to go and make an effort to screw it all up!

      The next Donald Trump will not screw up on easy, populist, stuff!

      1. cnchal

        > And Yet, he just had to go and make an effort to screw it all up!

        C’mon man! Failure to understand narcissistic personality disorder is the root of your misunderstanding.

        The virus was an iresistable lure used to gain ever moar attention for himself. It’s an affliction and they can’t help themselves. Its what they are.

        The next Donald Trump will do exactly the same thing.

  10. Sub-Boreal

    Thanks for providing this succinct and sensible piece.

    As a personal data point, I’m postponing retirement to 68 after looking at annuity rates. My employer’s pension plan is of the “Defined Contribution” type, which places all of the market risk on the plan members, so of course it’s perfectly rational to err on the side of saving more (working longer) rather than less. It’s astounding that something so obvious hadn’t occurred to economists.

    With the abolition of mandatory retirement at 65 and the spread of DC pension plans, I’m not the only one making this calculation. I’m curious to know if employers thought through the consequences of these trends: they save money by not having to guarantee payments to their retirees, but OTOH they have more senior people – at the top of their pay scales – hanging on instead of retiring at 65 and getting replaced by cheaper youngsters.

  11. JEHR

    Such is my feeling of unease looking into an unknown future, that at 81 years old I am still saving. I saved when interest rates were above 10% (yes, that’s the truth) and I am saving now when the best interest rate is 1.60%. I have never been in debt for anything and I have a credit rating of 0 which I revel in. Consequently, I have been able to help my daughter when she became ill until she recovered. If I hadn’t saved, I wouldn’t have been able to do that.

    I do not think that the wealthy, including wealthy economists, can even understand that kind of saving.

    1. scott s.

      Sounds like the “Micawber principle”. In my case stock market paper returns far exceed my “savings” so there doesn’t seem much point, but that doesn’t stop me from “saving”. But I do just leave savings in a checking account, as there doesn’t seem to be enough justification to spend effort hunting down CD rates. Have a bunch of EE savings bonds that had good rates but now are matured and haven’t bothered redeeming them.

  12. Mikerw0

    Raises a dilemma I have been pondering for several years. Interest rates have been very low for a decade, yet the target IRRs that credit and hedge fund quote have not adjusted. And, to make things worse there is more cash in these vehicles than deals. Other than cooking the books and increasing leverage how can they all get mid double digit IRRs?

    1. Jeff in NY

      I believe you answered your own question:
      “…how can they all get mid double digit IRRs?”

      Answer: Financial Engineering a.k.a. “…cooking the books and increasing leverage.” Asset stripping also comes in handy.

  13. Steven Greenberg

    Different people under different circumstances have different psychology about borrowing and saving. How do you get the net psychology of large numbers of people with different ideas?

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