why are we saving?

The Reserve Bank has us right where it want's us: saving

SMH April 2, 2001: IS THIS the dawn of a new age of consumer frugality in which we stay at home, darn our socks and knit our underwear? The Reserve Bank is hoping so, but remains to be convinced.

After a decade-long debt-binge, households are saving again. Over the past five years the household savings rate – what we save out of every dollar we earn – has undergone its steepest rise since records began in the 1960s. We have gone from spending even more than we earned, to spending 90ยข in every dollar.

Why have we seemingly abandoned our love of stuff? There are a number of factors at play.

First, households have completed their adjustment to a new era of permanently lower interest rates. In the mid ’90s, nominal interest rates halved, increasing the borrowing capacity of families. Households could suddenly service much bigger mortgages for the same interest cost. Meanwhile, financial deregulation meant debt was even cheaper and freely available. So households spend the late ’90s and early 2000s merrily borrowing to fund bigger bathrooms, holidays and TVs. Strong income growth enabled them to borrow even more.

At some point however, it was inevitable that households would reach the limit of what they were able and willing to pay out of their income to service their debts. It seems we reached that point around 2005.

More recently, the global financial crisis has given an added incentive to the savings drive. Right around the world, the crisis has forced us to think again about the riskiness of holding high levels of debt. Households have just had a vivid demonstration that asset prices – housing and shares – do not always rise. There is less faith that asset price inflation will erode the relative size of the debt used to purchase the assets. If households want to build equity, they’ll have to save.

In Australia, the crisis not only provided households with the motive to save, but also the means. Lower rates and government stimulus money meant households were able to quickly start building their financial buffer. But with the crisis fading into memory, why are we still saving?

The simple answer is that we are saving because that’s what the Reserve Bank wants us to.
The biggest mining investment boom in history means companies are spending a lot of money to expand operations. There is simply no room in the economy for a household spending boom too. To have both would be to unleash inflation pressure.

So interest rates are sitting slightly above their historic norm, acting as a drag on the economy and household spending. The Reserve Bank’s biggest fear is that after this period of saving, consumers are simply preparing to go on an even bigger spending binge than before. So should households show signs they are beginning to spend big again, you can be sure the Reserve Bank will step in again to raise interest rates.

Turns out our new-found frugality needs a big stick to make it stick.

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