Abstract
In recent years, the IMF has released a growing number of reports and other documents covering economic and financial developments and trends in member countries. Each report, prepared by a staff team after discussions with government officials, is published at the option of the member country.
II. What Drives the UK’s Household Saving Rate?1
A. Introduction
1. There is significant uncertainty surrounding the future path of the UK’s household saving rate. The UK’s gross household saving rate has long been one of the lowest among G7 economies (Figure 1).2 Indeed, the saving rate fell to very low levels during the pre-crisis boom, reaching a nadir of 2 percent in 2008 (annual rate). It subsequently rose sharply to 6 percent in 2009 in the wake of the financial crisis. Although it began declining slightly again last year to 5.3 percent, it remains well above pre-crisis levels. This higher saving rate could reflect heightened uncertainty and households’ efforts to strengthen their balance sheets following the bust of an unsustainable balance sheet expansion in the run-up to the financial crisis, among other factors. Historical episodes suggest that deleveraging following run-ups in household debt often takes many years, as households slowly rebuild their net wealth through higher savings (see, for example, McKinsey Global Institute, 2010). This, and the fact that the UK household saving rate remains low by international standards, suggests that the saving rate may remain elevated for some time or even rise further. On the other hand, the household saving rate is currently high by recent UK historical standards, suggesting that the saving rate may continue to revert gradually back to pre-crisis levels. These conflicting considerations create substantial uncertainty about the future path of the household saving rate.
G7: Household Gross Saving Rate
(Percent)
Citation: IMF Staff Country Reports 2011, 221; 10.5089/9781462337521.002.A002
Sources: OECD; and IMF staff calculations.G7: Household Gross Saving Rate
(Percent)
Citation: IMF Staff Country Reports 2011, 221; 10.5089/9781462337521.002.A002
Sources: OECD; and IMF staff calculations.G7: Household Gross Saving Rate
(Percent)
Citation: IMF Staff Country Reports 2011, 221; 10.5089/9781462337521.002.A002
Sources: OECD; and IMF staff calculations.2. The outlook for the household saving rate is important to judging how the UK economy will evolve over the medium term. Movements in the household saving rate have important effects on near-term growth, as private consumption accounts for two-thirds of GDP. The medium-term path of the household saving rate is also critical to determining the degree to which the economy will rebalance toward investment- and external-led demand.
3. Against this background, this chapter studies the determinants of the UK household saving rate using panel data for G7 economies. It finds that a substantial part of the UK’s relatively low saving rate cannot be explained by standard variables and instead appears to reflect country-specific fixed effects. However, variations in the UK saving rate over time can be largely explained by several factors, including changes in housing wealth and the fiscal balance. These two factors appear to have been especially important drivers of changes in the saving rate during the last decade.
4. The results suggest that the UK household saving rate is likely to stay broadly flat in the medium term. On one hand, likely declines in the house price-to-income ratio will put upward pressure on the household saving rate. On the other hand, the ongoing implementation of a multi-year fiscal consolidation plan will put downward pressure on the saving rate, offsetting the effect emanating from house prices. However, the results are sensitive to assumptions regarding the future path of key explanatory variables.
5. The rest of the chapter is organized as follows. Section B discusses potential factors that could explain variation in the household saving rate and underlying economic theories. Section C discusses the empirical model. Section D discusses the empirical results and their interpretations. Section E uses the results and assumptions about the future path of explanatory variables to project the future path of the UK saving rate. Section F discusses the implications of this saving rate path for household balance sheets. Section G concludes.
B. Potential Factors Driving the Household Saving Rate
6. The analysis in this paper focuses on economic forces that are likely to influence the household saving rate.3 In particular, the following factors are studied:
Demographic trends. The permanent income hypothesis implies that workers save part of their labor income while they are of working age to finance consumption in retirement. Once retired, they save less or even draw down on financial assets. In a similar vein, children usually do not have income, but still consume. A change in a country’s demographic structure could therefore affect the aggregate household saving rate. In particular, the higher is the share of the population that is elderly or young, the lower the aggregate saving rate should be.
Temporary income fluctuations. The permanent income hypothesis also implies that households should smooth consumption over the business cycle. From an economy-wide perspective, this effect implies that aggregate household savings should rise during cyclical booms and fall during cyclical downturns, all other things equal. Such cyclical economy-wide fluctuations in income could be proxied by variables such as the unemployment rate or estimated output gap.
Real interest rate. The real interest rate is a potentially important determinant of the household saving rate. Changes in the real interest rate have both a substitution and an income effect. The substitution effect arises because a higher rate raises the opportunity cost of consumption today and should encourage saving. The income effect arises because higher real interest rates also increase the total amount of future consumption possible for any fixed amount of initial wealth. This income effect is likely to increase consumption today (and all future periods) and thus tends to create a negative relationship between real interest rates and saving. Whether the net effect of interest rates on saving is positive or negative depends on whether the substitution or income effect dominates. In addition to these effects, higher real interest rates might also redistribute income to individuals with higher propensities to save, thereby raising the saving rate.
Fiscal balance. Government saving can influence household saving because government saving eventually affects household disposable income through taxes and transfers. Pure “Ricardian equivalence” is unlikely to hold in reality because its underlying assumptions (e.g., perfect capital markets) do not fully hold. However, existing research finds that government saving does affect household saving to some extent. This could reflect imperfect Ricardian effects or simply reflect sticky household consumption in the face of changes in taxes/transfers and associated changes in disposable income.
Uncertainty. Uncertainty about future income streams might be one reason why risk-averse households save part of their income as a precaution against future income declines and associated consumption drops (Carroll, 2001). Past studies attempt to capture such uncertainties using variables that measure macroeconomic volatility, such as the inflation rate, the volatility of real GDP growth, or the unemployment rate.
Wealth (net financial wealth). Together with income flows, net financial wealth represents part of household resources that can finance consumption. An increase in wealth is therefore likely to increase consumption today and lower the household saving rate, all other things equal. Confidence effects are another channel through which changes in net financial wealth resulting from asset price changes might affect saving behavior.4 The wealth effect has been studied extensively in the literature, usually in the context of its relation to consumption growth (Ludwig and Sløk, 2002; Byrne and Davis, 2003), but also in analysis of the household saving rate (IMF, 2010).
Wealth (tangible wealth). Tangible wealth, a large part of which is housing wealth, represents the remaining part of household wealth. However, housing wealth plays a role somewhat different from the one played by net financial wealth. Unlike net financial wealth, housing wealth generates a stream of housing services that owner-occupants consume. Appreciation of house prices, if matched by a commensurate increase in rents of comparable properties, can be thought of as an increase in the prices of current, as well as future, housing services that owner-occupied housing generates. As a result, higher housing wealth might not increase the present value of real resources available for non-housing consumption and therefore might not affect household saving, at least in theory. However, there are at least three reasons why higher housing wealth might increase consumption:
Liquidity constraints. The housing equity that grows with such house price appreciation can be withdrawn, either by selling the house or using equity loans. This may allow households to achieve higher consumption today (at the expense of less future consumption) that they desired before the house price appreciation but were unable to achieve due to liquidity constraints.
Shift to non-housing consumption. Higher housing costs due to higher house prices could incentivize households to shift consumption toward lower-priced non-housing goods and services today and away from higher-priced future housing services. One example of this behavior is an elderly household taking a home equity loan to finance higher consumption today in the face of high house prices and in anticipation of downsizing of their housing earlier than previously planned. Such behavior would reduce the household saving rate.
Wealth illusion. Households might perceive the increase in their home equity more clearly than they perceive the associated increase in the implicit rental cost of owner-occupied housing, especially if rents on non-owner occupied housing do not rise commensurately (a common feature of housing bubbles). Such “wealth illusion” could prompt higher current consumption and lower saving rates. Similarly, permanent house price increases generate capital gains to homeowners cashing out of the housing market but make future first-time homebuyers worse off. Owners cashing out might perceive these capital gains more clearly than future first-time buyers perceive the higher future cost of owner-occupied housing.
Papers that study the effects of tangible wealth on the household saving rate at the macroeconomic level are somewhat limited, perhaps reflecting data availability.
C. Empirical Model
7. The starting point of the empirical analysis is the following linear model of the saving rate:
SAVi,t = α + γi·t+β · xi,t + εi,t
where SAVi,t is gross saving by households and nonprofit institutions serving households divided by gross disposable income. αi captures country-specific, time-invariant effects; γi represents the country-specific effect of the time trend; β is a vector of coefficients of explanatory variables xit; and εi,t is an error term. For parsimony, the coefficients (β) for explanatory variables are restricted to be the same across countries—with a few exceptions discussed in the next paragraph—as the magnitude of most effects is expected to be broadly similar across countries.
8. The choice of explanatory variables is guided by theories aimed at explaining household saving behavior as well as some existing empirical findings in the literature. In particular, the following variables are used to capture the effects of economic forces underlying household saving behaviors discussed in the previous section and form a list of explanatory variables in the model:
Dependency ratio (denoted by DEP). This is defined as the share of the +65 population and 0-14 population in the total population. A higher dependency ratio should be associated with a lower saving rate because these “dependents” save less.
Real long-term interest rate (denoted by RIRL). This is derived by subtracting the CPI inflation rate from the interest rate on the 10-year government bond. The expected sign of the coefficient is negative, as the substitution effect is expected to dominate.
General government fiscal balance (in percent of GDP; denoted by GGBY). Larger fiscal surpluses should be associated with lower household savings. The expected sign is negative.
Inflation (log difference of CPI; denoted by INF). The expected sign of the coefficient is positive because inflation may capture macroeconomic uncertainty and because nominal interest income rises in times of high inflation—even if there is no real increase in income and therefore no real increase in consumption—causing measured household saving rates to rise (Jump, 1980).
Unemployment rate (denoted by UNR). This is an additional variable that potentially captures uncertainly associated with the probability of joblessness and income volatility. If this variable captures purely precautionary saving, the sign of the coefficient should be positive. However, households might use accumulated assets to smooth consumption in the face of income losses associated with joblessness, rather than increasing savings. If this effect dominates, the sign will be negative.
Tangible wealth (in percent of gross disposable income; denoted by HW). Some existing papers find that this effect is much stronger in economies with well-developed and highly flexible mortgage markets, which might increase effects related to liquidity constraints. Studies have observed that “Anglo-Saxon” economies exhibit such features most strongly.5 To take into account this observation, the specification is modified to let the variable HW interact with a dummy variable for Anglo-Saxon economies (Canada, UK, and US) as follows:
HWi,t + DAnglo-Saxon ·HWi,t
where DAnglo-Saxon is a dummy variable that takes a value of one for observations on Anglo-Saxon economies and zero otherwise. The coefficient of the first term is relevant for non-Anglo-Saxon economies while the sum of the first and the second terms represents the effect of HWit on the saving rate in Anglo-Saxon economies. The expected signs of the coefficients for both the first and second terms are negative.
Household net financial wealth (in percent of gross disposable income; denoted by NFWH). The expected sign is negative. As alternative variables, household gross financial assets (FAH) and liabilities (FLH) can be used. Expected coefficients of these variables are negative and positive, respectively.
9. The analysis uses panel data for G7 economies. This choice of countries is driven by data availability, especially for households’ tangible wealth.6 To ensure a balanced panel, the analysis uses data starting in 1980.7
10. For the UK, CPI excluding effects of indirect taxes is used instead of headline CPI.8 CPI inflation in the UK has recently been heavily affected by changes in indirect taxes (especially the VAT rate). However, these tax changes are unlikely to affect significantly the economic uncertainty or changes in nominal interest income that the inflation variable is trying to capture. It is therefore desirable to take out the effect of the VAT changes from CPI inflation, given that estimates for the UK are the central focus of the study.
D. Results
11. Data are stationary once adjusted for fixed and time effects. Some unadjusted explanatory variables appear non-stationary. However, when deviations of the time-series data from fitted values resulting from regressions of the explanatory variables on country fixed effects and time trends (as implied by the econometric specification above) are used, panel unit root tests based on individual ADF tests, a la Maddala and Wu (1999) and Choi (2001), reject the null hypothesis of a unit root at the 1 percent level for all series except the dependency ratio (DEP). However, this finding does not necessarily imply a unit root and may instead reflect insufficient test power.
12. The estimated coefficients are reported in Table 1 and largely confirm the predictions discussed in the previous section. The baseline case uses household net financial wealth in the regression (column A). The coefficients of the long-term real interest rate and CPI inflation are both positive (one percentage point increases in the long-term real interest rate and CPI inflation result in 0.31 percentage point and 0.50 percentage point increases in the saving rate, respectively). The coefficients of the dependency ratio and the general government overall fiscal balance are negative (a one percentage point increase in the dependency ratio and a one percent of GDP increase in the balance result in 0.66 percentage point and 0.42 percentage point declines in the saving rate, respectively). The coefficient of the tangible wealth-to-gross disposable income ratio is positive for non-Anglo-Saxon economies. This implies that, contrary to predictions, higher tangible wealth raises saving in these countries. However, the magnitude of the coefficient is small, and it is only significant at the 10 percent level. In contrast, for Anglo-Saxon economies, the sign of the sum of the coefficient and the dummy term is sizeable, statistically significant at the 1 percent level, and—as predicted—negative (a one percentage point increase in the tangible wealth-to-income ratio results in a 0.03 percentage point decline in the saving rate). This is consistent with findings in the literature: the negative effect of housing wealth on the saving rate is evident in economies that are characterized by well-developed mortgage markets. The coefficient of the unemployment rate is statistically significant and has a negative sign, which suggests that this variable mainly captures the consumption-smoothing effect.
Saving Rate Regressions 1/2/3/
Coefficients of country specific-constants and country-specific time trends are not reported for simplicity.
Figures in parentheses are t-statistic values for the null hypothesis that the coefficient statistically is not significantly different from zero.
*** p<0.01, ** p<0.05, * p<0.1
Saving Rate Regressions 1/2/3/
| Dependent variable: Gross saving rate (SAV) | (A) | (B) | (C) | |||
|---|---|---|---|---|---|---|
| Dependency ratio (DEP) | -0.6568 | *** | -0.7218 | *** | -0.5694 | *** |
| (-5.53) | (-6.05) | (-4.29) | ||||
| Real long-term interest rate (RIRL) | 0.3106 | *** | 0.2729 | *** | 0.2596 | *** |
| (3.90) | (3.42) | (2.72) | ||||
| General government overall balance (GGBY) | -0.4179 | *** | -0.4405 | *** | -0.4468 | *** |
| (-8.83) | (-9.30) | (-8.29) | ||||
| CPI inflation (INF) | 50.4878 | *** | 48.6650 | *** | 49.3581 | *** |
| (6.26) | (6.10) | (5.95) | ||||
| Unemployment rate (UNR) | -0.1784 ** | -0.2097 ** | -0.1135 | |||
| (-2.20) | (-2.59) | (-1.33) | ||||
| Household net financial wealth (NFWH) | 0.0063 | |||||
| (1.50) | ||||||
| Tangible wealth (HW) | 0.0047 * | 0.0082 | *** | |||
| (1.65) | (2.65) | |||||
| Tangible wealth (HW), Anglo-Saxon | -0.0347 | *** | -0.0316 | *** | ||
| (-7.63) | (-6.83) | |||||
| Lagged (t-1) household net financial wealth (NFWH) | ||||||
| Lagged (t-1) tangible wealth (HW) | 0.0094 | *** | ||||
| (2.89) | ||||||
| Lagged (t-1) tangible wealth (HW), Anglo-Saxon | -0.0322 | *** | ||||
| (-6.68) | ||||||
| Household gross financial assets (FAH) | 0.0049 | |||||
| (1.16) | ||||||
| Household gross financial liabilities (FLH) | -0.0429 | *** | ||||
| (-3.02) | ||||||
| Lagged (t-1) household gross financial assets (FAH) | 0.0021 | |||||
| (0.47) | ||||||
| Lagged (t-1) household gross financial liabilities (FLH) | -0.0225 | |||||
| (-1.44) | ||||||
| Observations | 210 | 210 | 203 | |||
| Sample period | 1980-2009 | 1980-2009 | 1981-2009 | |||
| R-squared | 0.564 | 0.579 | 0.537 |
Coefficients of country specific-constants and country-specific time trends are not reported for simplicity.
Figures in parentheses are t-statistic values for the null hypothesis that the coefficient statistically is not significantly different from zero.
*** p<0.01, ** p<0.05, * p<0.1
Saving Rate Regressions 1/2/3/
| Dependent variable: Gross saving rate (SAV) | (A) | (B) | (C) | |||
|---|---|---|---|---|---|---|
| Dependency ratio (DEP) | -0.6568 | *** | -0.7218 | *** | -0.5694 | *** |
| (-5.53) | (-6.05) | (-4.29) | ||||
| Real long-term interest rate (RIRL) | 0.3106 | *** | 0.2729 | *** | 0.2596 | *** |
| (3.90) | (3.42) | (2.72) | ||||
| General government overall balance (GGBY) | -0.4179 | *** | -0.4405 | *** | -0.4468 | *** |
| (-8.83) | (-9.30) | (-8.29) | ||||
| CPI inflation (INF) | 50.4878 | *** | 48.6650 | *** | 49.3581 | *** |
| (6.26) | (6.10) | (5.95) | ||||
| Unemployment rate (UNR) | -0.1784 ** | -0.2097 ** | -0.1135 | |||
| (-2.20) | (-2.59) | (-1.33) | ||||
| Household net financial wealth (NFWH) | 0.0063 | |||||
| (1.50) | ||||||
| Tangible wealth (HW) | 0.0047 * | 0.0082 | *** | |||
| (1.65) | (2.65) | |||||
| Tangible wealth (HW), Anglo-Saxon | -0.0347 | *** | -0.0316 | *** | ||
| (-7.63) | (-6.83) | |||||
| Lagged (t-1) household net financial wealth (NFWH) | ||||||
| Lagged (t-1) tangible wealth (HW) | 0.0094 | *** | ||||
| (2.89) | ||||||
| Lagged (t-1) tangible wealth (HW), Anglo-Saxon | -0.0322 | *** | ||||
| (-6.68) | ||||||
| Household gross financial assets (FAH) | 0.0049 | |||||
| (1.16) | ||||||
| Household gross financial liabilities (FLH) | -0.0429 | *** | ||||
| (-3.02) | ||||||
| Lagged (t-1) household gross financial assets (FAH) | 0.0021 | |||||
| (0.47) | ||||||
| Lagged (t-1) household gross financial liabilities (FLH) | -0.0225 | |||||
| (-1.44) | ||||||
| Observations | 210 | 210 | 203 | |||
| Sample period | 1980-2009 | 1980-2009 | 1981-2009 | |||
| R-squared | 0.564 | 0.579 | 0.537 |
Coefficients of country specific-constants and country-specific time trends are not reported for simplicity.
Figures in parentheses are t-statistic values for the null hypothesis that the coefficient statistically is not significantly different from zero.
*** p<0.01, ** p<0.05, * p<0.1
13. The results do not find the expected wealth effect associated with financial wealth.
Estimated coefficients of net financial wealth are not statistically significant. This result holds even when a one-year lag of household net financial wealth is used in the regression (not reported in the table for simplicity) to reduce potential endogeneity.
As another robustness check, regressions are re-estimated using household gross financial assets and liabilities as explanatory variables. When contemporaneous gross financial assets and financial liabilities are used (column B in Table 1), only the coefficient of gross financial liabilities is statistically significant, but with an unexpected negative sign (a higher gross financial liability-to-gross disposable income ratio results in a lower saving rate). This suggests a possibility of endogeneity (i.e., a high saving rate leads to a low level of gross debt as households use saving to reduce their debts). When one-year lags of gross financial assets and liabilities are used as a way to control for endogeneity, however, the coefficients are not statistically significant (column C in Table 1), suggesting that the statistically significant negative coefficient of contemporaneous gross financial liabilities is due to endogeneity.
14. Estimation results suggest that housing wealth has contributed to the very low level of the household saving rate in the UK. Figure 2 uses the estimated coefficients in column A to quantify the contributions of explanatory variables to changes in the saving rate over the last 15 years.9 These results suggest that the decline in the saving rate in the late 1990s owes to improvements in the fiscal balance and increases in the value of housing wealth. Housing wealth continued to exert downward pressures on the saving rate during much of the decade leading up to the recent financial crisis; to a lesser extent, lower real interest rates also played a role.
UK: Saving Rate and Contribution to Its Changes
(Percentage points, unless otherwise noted)
Citation: IMF Staff Country Reports 2011, 221; 10.5089/9781462337521.002.A002
Sources: OECD; and IMF staff estimates.UK: Saving Rate and Contribution to Its Changes
(Percentage points, unless otherwise noted)
Citation: IMF Staff Country Reports 2011, 221; 10.5089/9781462337521.002.A002
Sources: OECD; and IMF staff estimates.UK: Saving Rate and Contribution to Its Changes
(Percentage points, unless otherwise noted)
Citation: IMF Staff Country Reports 2011, 221; 10.5089/9781462337521.002.A002
Sources: OECD; and IMF staff estimates.15. Another way to look at the extent to which explanatory variables explain the difference between the saving rate in the UK and other G7 countries is to compare fitted household saving rates. In particular, the average values of explanatory variables for the six G7 countries other than the UK can be used to derive fitted values that are then compared to the fitted value of the UK household saving rate (Figure 3). This exercise is equivalent to asking what the saving rate in the UK would have been had the explanatory variables been at the levels equal to the average of the six G7 countries other than the UK. Figure 3 shows that housing wealth is the single most important factor that has contributed to the growing difference in the household saving rate between the UK and other G7 countries. However, Figure 4 also shows that the low level of the household saving rate in the UK is not accounted for solely by differences in the explanatory variables. Indeed, the explanatory variables account for, on average, only about 35 percent of the difference between the UK saving rate and the average for other G7 countries over the last 10 years, with the remaining difference attributable to country fixed-effects and time trends. This indicates that other country-specific effects, such as institutions, are important in explaining the difference.
Fitted Saving Rates for UK and G7 Average excl. UK and Contributions to Their Differences
(Percentage points unless otherwise noted)
Citation: IMF Staff Country Reports 2011, 221; 10.5089/9781462337521.002.A002
Source: IMF staff estimates.Fitted Saving Rates for UK and G7 Average excl. UK and Contributions to Their Differences
(Percentage points unless otherwise noted)
Citation: IMF Staff Country Reports 2011, 221; 10.5089/9781462337521.002.A002
Source: IMF staff estimates.Fitted Saving Rates for UK and G7 Average excl. UK and Contributions to Their Differences
(Percentage points unless otherwise noted)
Citation: IMF Staff Country Reports 2011, 221; 10.5089/9781462337521.002.A002
Source: IMF staff estimates.
Comparison of Fitted Saving Rates—UK, UK Fitted for Other G7 variables, and Other G7
(Percent)
Citation: IMF Staff Country Reports 2011, 221; 10.5089/9781462337521.002.A002
Source: IMF staff estimates.Comparison of Fitted Saving Rates—UK, UK Fitted for Other G7 variables, and Other G7
(Percent)
Citation: IMF Staff Country Reports 2011, 221; 10.5089/9781462337521.002.A002
Source: IMF staff estimates.Comparison of Fitted Saving Rates—UK, UK Fitted for Other G7 variables, and Other G7
(Percent)
Citation: IMF Staff Country Reports 2011, 221; 10.5089/9781462337521.002.A002
Source: IMF staff estimates.E. Using the Model to Project the UK Household Saving Rate
16. The estimated econometric model, together with assumptions on the future path of explanatory variables, can be used to project the near-term path of the household saving rate. The following assumptions for explanatory variables are used for this exercise:
For the long-term interest rate, CPI inflation, the unemployment rate, and the general government overall balance, Spring 2011 WEO projections are used.10
The dependency ratio is assumed to follow its current trend, which changes only slowly.
Net financial wealth (and gross financial assets and liabilities) is assumed to remain constant in percent of gross disposable income at the 2010 level.
The tangible wealth-to-gross disposable income ratio in 2010, for which data are not yet available, is estimated by assuming that the percent change in tangible wealth was equal to the percent change in the simple average of the Halifax house price index and the Nationwide house price index. The ratio is further assumed to decline by 48 percentage points (equivalent to a 12 percent cumulative decline in the ratio) over the six years through 2016. This projected decline balances two considerations: on the one hand, the ratio is currently about 30 percent above its historical average; this suggests that some decline in the ratio is likely going forward; on the other hand, tight planning restrictions in the UK have restrained the supply response to higher house prices; these supply constraints may keep the house price-to-income ratio from fully returning to its historical average in the foreseeable future.
17. The resulting projections indicate that the saving rate will stay broadly flat over the medium term, as the effects of weak house prices and fiscal consolidation offset each other (Figure 2). The ongoing multi-year fiscal consolidation will have a dampening effect on the saving rate over the projection period while the projected decline in the tangible wealth-to-gross disposable income ratio will have an offsetting upward effect. On balance, the household saving rate is projected to stay broadly flat (easing just slightly to around 4½ percent by 2016).11
F. Implications of the Projections for Households’ Balance Sheets
18. The household saving rate is a factor driving the dynamics of households’ balance sheet items. In order to derive fitted out-of-sample values of the saving rate, values of net financial wealth and tangible wealth were assumed to follow particular paths over the projection horizon in the previous section. In reality, however, the saving rate also affects the pace of household net wealth accumulation. This dynamic relationship between the flow variable (saving rate) and the stock variable (household net wealth), along with influences of other exogenous factors on the stock variable, is described by the following law of motion of net financial wealth:
Nt – Nt-1 = St – δt + CGt
where Nt, is net wealth at the end of period t. Nt is defined as
Nt ≡ FAt – FDt+HWt.
FAt, FDt, and HWt are gross household financial assets, gross financial liabilities, and tangible wealth at the end of period t, respectively, while St, δt, and CGt are household saving (a function of explanatory variables, including lagged net financial wealth and housing wealth), depreciation of tangible wealth, and net unrealized capital gains/losses (which are typically not included in gross disposable income measures from which household saving is derived) in period t, respectively. This equation shows that changes in the values of FA, FD, and HW reflect four factors: (i) unrealized capital gains/losses, (ii) depreciation of tangible wealth, (iii) the saving rate, and (iv) offsetting increases in both assets and liabilities (i.e., leveraging and deleveraging). However, this equation does not necessarily imply causality running from the right-hand side of the equations to the left-hand side, as households make decisions about the desired paths of consumption/savings, assets, and liabilities simultaneously. Rather, the equation presents the way households’ balance sheet evolves conditional on savings and other factors.
19. It is convenient to rewrite the dynamics of household net wealth in terms of ratios to disposable income. Ultimately, households make decisions about their saving and balance sheet in relation to their disposable income levels. Changes of net wealth-to-disposable income can be written as follows:
where It is disposable income in period t. Combining this with the equation for changes in Nt above results in the following equation:
20. The dynamics of household net wealth above provide a simple cross-check for the plausibility of the saving rate projections in the previous section. As evident by the law of motion, the paths of net financial wealth, FAt—FDt, and tangible wealth, HWt, reflect both households’ saving decision (and thus their desired speed of net wealth accumulation) as well as exogenous factors (depreciation of the housing stock and capital gains). However, the regression model assumes that households’ saving decision is affected by net financial and housing wealth, and thus the regression does not model the dynamics of asset variables as a function of the saving rate. Thus, pre-determining the paths of assets and liabilities and projecting the saving rate using the estimated model, as has been done in the previous section, amounts to making assumptions about exogenous factors driving the dynamics of the balance sheet. While the implied paths of these exogenous factors cannot be uniquely pinned down by a single equation describing the law of motion, further assumptions can be made to derive implied capital gains/losses and compare them to historical values.
21. Implied rates of unrealized capital gains are broadly in line with historical averages. Using the equation describing the dynamics of the net wealth-to-gross disposable income ratio to derive implied unrealized capital gains requires assumptions on depreciation of tangible wealth and the growth rate of household disposable income:
Projections of depreciation of tangible wealth can be based on historical data on depreciation in percent of tangible wealth. For the five-year period 2005–09, the average deprecation rate was 1.2 percent per annum.
Projections of household gross disposable income growth are available in various economic outlooks. The authorities’ latest projections are available from the OBR (OBR, 2011). The authorities project that real household disposable income growth will rebound to 1.4 percent in 2012 after falling slightly in 2011 and will gradually rise to 2.1 percent by 2015. This, together with the authorities’ CPI inflation projections, implies nominal disposable income growth rising gradually from 3.8 percent in 2011 to 4.1 percent in 2015.
Under these assumptions and given the equation above defining the evolution of net worth, an average unrealized capital gains return on assets of 3.5 percent during 2011–16 would equilibrate the saving rate projections in Section E with the assumptions on the evolution of net worth in Section E. This compares with an historical average unrealized capital gains rate of 5 percent of the stock of gross assets (this average is calculated over 1988–2010—the period for which the current national accounts data are available).12 The fact that the implied capital gains rate is broadly comparable to the historical average indicates that assumptions underlying the saving rate projections are at least consistent with a historical benchmark, which offers a reasonable criterion to judge the appropriateness of assumptions on exogenous variables and the internal consistency of the assumptions on other variables.
G. Conclusion
22. Empirical estimates in this chapter suggest that the UK’s low household saving rate during the pre-crisis years partly reflected (i) the rapid increase in housing wealth on the back of rapid price appreciation, (ii) low real interest rates, and (iii) in the 1990s, improvements in the government fiscal balance. Looking forward, the estimation results suggest that the saving rate may stay broadly flat—easing just slightly to about 4½ percent by 2016. This largely unchanged saving rate reflects the net effect of opposing forces: falling house price-to-income ratios and, to a lesser extent, rising long-term real interest rate are likely to put upward pressure on the saving rate, but this is expected to be offset by downward pressure from the ongoing fiscal consolidation.
Appendix I. Data Definitions and Sources
The definition and sources of data used in the analysis are described below:
Saving rate (SAV): gross saving of households and nonprofit organizations serving households (NPISH), divided by gross disposable income of households and NPISH. Sources: OECD Analytic Database. Data for Japan are extended to 2009 using data from Cabinet Office/Haver Analytics; data for Germany are extended to 1970–90 using IMF World Economic Outlook (WEO).
Dependency ratio (DEP): population of children (14 years and below) and elderly (65 years and up) in percent of total population. Sources: World Bank World Development Indicators (WDI). Data are extended to 2008–09 using the following: Eurostat for European countries; Census Bureau/Haver Analytics for US; total population growth rates from OECD Analytic Database for Canada; and the elderly population growth rate in 2008 from WDI for Japan.
General government balance in percent of GDP (GGBY): Sources: WEO for Canada, Japan, UK, and US; Eurostat for France, Germany, and Italy.
Inflation (INF): percent change in consumer price index. Sources: WEO. Data are extended back to 1969 using IMF International Finance Statistics (IFS).
Real long-term interest rate (RIRL): interest rate on the 10-year government bond deflated by CPI. Source: OECD Analytic Database.
Housing wealth (HW): tangible assets held by households and NPISH, divided by gross disposable income. Sources: NiGEM and national statistics:
Canada - 1970–2008 from NiGEM; nonfinancial assets in 2009 from Statistics Canada.
France - 1971–2006 from NiGEM; nonfinancial assets in 2007–09 from INSEE.
Germany - 1971–2006 from NiGEM; extended to 2009 using house price-to-income ratio from OECD.
Italy - 1970–2006 from NiGEM; extended to 2009 using house price-to-income ratio from OECD.
Japan - 1980–2009, nonfinancial assets from Japan Statistics Bureau and Statistics Center. United Kingdom - 1970–2007 from NiGEM; total nonfinancial assets in 2008–09 from Office for National Statistics/Haver Analytics.
United States -1970–2008 from NiGEM; extended to 2009 using tangible assets from Federal Reserve Board/Haver Analytics.
Financial assets (FAH): financial assets held by households and NPISH, divided by gross disposable income.
Financial liabilities (FLH): financial liabilities owed by households and NPISH, divided by gross disposable income.
Net financial wealth (NFWH): FAH minus FLH.
Data from national statistics were extracted from Haver Analytics and used as the baseline source for FAH, FLH, and NFWH, except for Canada, Italy, and Japan. To obtain maximum coverage, Italy is extended back using growth rates from the OECD non-consolidated balance sheet of households and NPISH.
Canada -1980–2009, OECD non-consolidated balance sheet of households and NPISH. France - 1978–93, OECD Analytic Database; 1994–2009, Banque de France/Haver Analytics.
Germany - 1991–2009, Deutsche Bundesbank/Haver Analytics.
Italy - 1975–94, OECD Analytic Database; 1995–2009, OECD non-consolidated balance sheet of households and NPISH.
Japan - 1980–2009, Japan Statistics Bureau and Statistics Center.
United Kingdom - 1970–2000, Office for National Statistics Economic and Labour Review Vol. 2, No. 4, April 2008; 2001–09, Office for National Statistics/Haver Analytics.
United States - 1970–2009, Federal Reserve Board/Haver Analytics.
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Prepared by Hajime Takizawa (EUR) with research assistance from Stephanie Denis (EUR).
The gross household saving rate is defined as gross household saving divided by gross household gross disposable income. All references to the “household saving rate” in this chapter refer to the household gross saving rate, but the qualifier “gross” is dropped in most cases for brevity.
Hüfner and Koske (2010) offer a concise summary of determinants of the household saving rate explored in the literature.
Wealth variables—both financial and tangible (housing)—might also partly capture credit condition effects, as rapid asset price growth is likely to lead to loose credit conditions, and vice versa. Ideally, regressions would control for credit conditions directly, but comparable cross-country data on credit conditions are difficult to obtain.
For example, see Slacalek (2009).
The OECD does offer data on the index of the value of the housing stock as a percent of gross disposable income for a wider set of countries. However, because the data are index values, they cannot explain cross-country differences in the saving rate level.
Data for Germany and Japan start in 1980. Pre-unification (pre-1991) data for Germany are derived by splicing data on West Germany backward using growth rates.
This official inflation measure is calculated by the UK Office for National Statistics by mechanically removing indirect taxes from prices, assuming full pass-through.
The results from column A are used in all of the analysis behind the discussion in the rest of this chapter. However, the estimated effects do not change materially if other specifications are used, as the magnitude of the coefficients is broadly similar across the specifications.
To derive CPI excluding effects of indirect taxes, a pass-through coefficient of 0.75 is assumed for the VAT hike in January 2011.
The projected saving rate is somewhat higher than the saving rate of 3½ percent projected by the Office for Budget Responsibility (OBR, 2011). The OBR believes that UK corporate sectors’ large financial surplus will reduce needs for households to save. This effect, however, might not materialize in the medium term for a few reasons. First, it might be an optimal response for the corporate sector (and shareholders) to maintain large amounts of cash and not increase dividends in the face of continuing high uncertainty. Second, the large financial surplus might lead to a surge of investment first rather than increases in dividends. Third, while the previous two responses may still result in higher equity prices, the regression results suggest that changes in financial wealth may not have large effects on household saving.
Since the liability side of households’ balance sheet is largely loans, capital gains/losses derive mainly from the asset side, and the rate of gains/losses can be expressed simply in percent of gross assets.
