We’ve been tracking data from the Federal Reserve’s Flow of Funds and the Bureau of Economic Analysis to get a sense of how quickly households are paying down debts.

One of the factors preventing a robust economic recovery is deleveraging, as households and businesses pay down debts and restore net worth to long-run norms. 

A consequence of deleveraging is an elevated personal savings rate, which holds down levels of consumption and investment and slows economic growth.

The following chart shows the ratio of household Net Worth to Disposable Income (NW/DPI), which reflects household balance sheets, and the personal savings rate.  The purple line is the 25-year average of the NW/DPI variable.

As the chart illustrates, the Great Recession took a toll on household wealth. Peaking in the fourth quarter of 2006 at a value of 6.34 of NW/DPI (meaning households’ net worth totaled 6.34 current income), that measure reached a minimum of 4.5 in the first quarter of 2009.

As a result of this decline in the conditions of household finances, the rate of personal savings increased from 1.8% in the third quarter of 2007 to a high of 7.2% in the second quarter of 2009. The rate then declined to less than 6%, but recently bumped up to 6.2% in the second quarter of 2010 as a result of  mid-year stock market and housing price declines.

At the current post-2009 trend, NW/DPI will return to the 25-year historical average level of 5.2 at mid-year of 2012. As NW/DPI increases, historical correlations suggest the personal savings rate will continue to decline, perhaps approaching 3%, thereby freeing household budgets for consumption and investment and promoting more robust economic growth.