Wednesday, February 01, 2006

Negative Saving Rate

In 2005, the U.S. personal saving rate fell to -0.5%--the lowest personal saving rate since the Great Depression! Some facts about the negative personal saving rate are presented in this Associated Press article. What does a negative personal saving rate mean and what does it imply for the U.S. trade deficit?

The personal saving rate is the percentage of real GDP saved by households within a given year. A negative personal saving rate implies that households consumed more than they earned by using their current stock of savings or borrowing money.

Saving becomes loans to U.S. businesses that use the funds for investment spending--the purchase of new capital.

So does a decrease in the personal saving rate mean that the investment rate, too, must shrink? Not necessarily. In a closed economy, the investment rate is equal to the national saving rate. However, in an open economy, this need not be true, because American firms can borrow funds from overseas. A negative personal saving rate means that not only are American firms borrowing from overseas to finance investment--American consumers are also borrowing from foreigners to finance consumption of foreign goods and services. In effect, one of the U.S.'s biggest imports is foreign saving.

This importing of foreign saving has an important implication for the U.S. trade deficit. Think about what happens when Chinese financial investors buy U.S. treasury bonds--in effect, lending money to the U.S. government. In order to do so, they must have U.S. denominated assets (dollars). In order to get those dollars, China must export more than it imports--that is, the Chinese must sell more of their goods and services to the United States than they buy from the United States. The leftover dollars can then be lent to the U.S. government or American firms.

The graph above shows that a decrease in the national saving rate causes the trade deficit as a share of real GDP to increase if the investment rate stays at (I/Y)*.

Discussion Questions

1. Why are foreign financial investors willing to lend to the United States?

2. If foreign financial investors refuse to continue lending funds to the United States, how would this affect the U.S. investment rate?

3. In the 1930's, the saving rate was negative because incomes were so low that people had to dip into prior savings in order to survive. But the United States is prosperous now. Why, then, do you think the U.S. saving rate is so low?

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