Originally published in THE BOSTON GLOBE
Tuesday, July 20, 1999
Accumulation of wealth insulates individual overspending
Martin and Kathleen Feldstein
"The overall national saving, including the saving of businesses and government, has actually increased."
Readers of business pages learned recently the startling fact that saving by American households fell to zero late last year and actually became negative in the first part of this year. That means Americans are spending more than they are earning. While there are plenty of households that are continuing to set aside some of their income for various purposes such as retirement, the aggregate dissaving of some Americans outweighs the saving of others.
This is the first time since the 1930s that the United States has recorded negative personal saving. This sounds like very bad news for the American economy, since saving provides the means to make the productive investment that ultimately determines our standard of living. But unlike the 1930s, negative saving in the late 1990s reflects good times, rather than an attempt to maintain a standard of living in the face of falling income. Given the huge recent increase in wealth, it isnt so surprising that, overall, American households are spending more than they are earning.
How long can Americans continue to spend more on consumption than their disposable income can finance? Based on the increase in financial wealth, Americans can continue such spending for many years. In the past four years alone, the wealth of Americans increased by more than 10 trillion dollars. Thats equivalent to about 30 years worth of saving, if Americans were saving now at the rate they were 10 years ago. In other words, as long as the stock market remains at the current level or goes on rising, Americans can continue to outspend their incomes for decades.
Of course, it is the sensational rise in the stock market that has created the new wealth. The value of the US stock market has more than doubled just since 1995. And because share ownership has become very widespread through mutual funds, IRAs, and 401(k) plans, Americans across a broad spectrum of income have seen a rapid and substantial rise in their wealth.
But what if there is a reversal of fortune and the stock market drops sharply? While we have no reason to expect a sharp collapse of share prices in the next year, it remains a possibility. If a large decline in the stock market occurs, households would undoubtedly cut back on their consumption, particularly if they interpret a drop as the possible beginning of a series of market declines. That decline in spending could, in principle, trigger a recession.
Fortunately, however, the Federal Reserve and the Congress would be in a good position to take steps to dampen any such downturn. The Federal Reserve has considerable flexibility to lower its key interest rate from its current level of 5 percent, taking it back to the 3 percent level that it set in 1993, when it worried about economic weakness. And Congress could use some of the growing federal budget surplus to finance counter cyclical tax cuts. So while a sharp stock market decline would undoubtedly slow the economy, the right policy response would significantly limit any damage.
Although the household saving rate has fallen sharply in recent years, the overall national saving, including the saving of businesses and government, has actually increased. Business profits as a share of GDP have risen significantly in the 1990s, permitting companies to increase their own saving at the same time that they have raised dividends to shareholders. A further reason for the rise of national saving is that the government is no longer absorbing a large part of household saving to finance its deficit. Instead, it has shifted to a budget surplus that contributes to the rate of saving.
While it is impossible to forecast future business and government saving with a high degree of confidence, both are likely to remain strong for years to come. The high level of the stock market indicates a consensus that profits will remain high and rise further. And both the administration and the Congressional Budget Office are predicting very large budget surpluses for years to come. If both of these continue, the national saving rate will remain high, even if households continue to spend more than their incomes.
A further source of funds to finance investment has been the inflow of capital from abroad. Our capital inflow this year will equal about 3 percent of GDP, enough to finance about one fifth of total US investment in business plant and equipment and in housing. The United States is able to attract these funds because of the high return on our stocks and bonds and global faith in the integrity of American capital markets. While the supply of foreign funds cannot continue to increase forever, this need not become a problem any time soon.
Because the decline in household saving has been countered by the rise in business and government saving and the increased inflow of foreign funds, investment as a share of GDP has actually increased from 14 percent in the early 1990s to 16 percent last year. This higher rate of investment and the ability of the US financial markets and corporations to channel those investments to productive uses means that one of the key determinants of economic growth will continue.
Martin Feldstein, the former chairman of the Council of Economic Advisers, and his wife, Kathleen, also an economist, write frequently together on economics.