Household Deleveraging Slows, But Savings Rate Continues to Decline


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 repairing balance sheets. Earlier today, we examined Fed data on consumer credit, which continues to show individuals are shying away from taking on new debt.

As we have argued before, an important factor 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: (1) the ratio of household net worth to disposable income (NW/DPI), which reflects household balance sheets, and (2) 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 middle of 2007 at a value of 6.35 of NW/DPI (meaning households’ net worth totaled 6.35 times current income), that measure reached a minimum of 4.5 in the first quarter of 2009 during the depths of the Great Recession.

As a result of this decline in the conditions of household finances, the rate of personal savings (the red line, plotted along the right axis on the graph) increased from 1.8% in the third quarter of 2007 to a recent high of 7.2% in the second quarter of 2009. Since that peak, the savings rate has declined to 5.1% for the first quarter of 2011 (and stood, on a monthly basis, at 4.9% for April 2011). 

This decline in the savings rate has run counter to some market analysts’ forecasts that the savings rate would in fact climb again, perhaps higher than 8%.

Nonetheless, while the deleveraging process continues, it has slowed. We have pushed back our forecast for when household balance sheets will return to historical levels relative to income. The current data, and ongoing stock and housing price declines in the second quarter 2011, suggest that the historical level for household net worth will be reached in the fourth quarter of 2011.

But as we’ve seen since 2009, as NW/DPI increases, the savings rate should continue to fall. Over the long-run, the rate should return to the 3% to 4% range, thereby freeing household budgets for consumption and investment and promoting more robust economic expansion.

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