Ireland's falling household savings rate defies expectations

 

If savings figures prove correct, the only real hope of a short-term boost to the economy has been dashed

YOU CAN do two things with your money: spend it or save it. The collective decision of a people on which to do has a big influence on how much growth there is in an economy and, as importantly, what kind of growth.

If economies spend too much and save too little, they will not be able to invest enough (unless they borrow from foreigners, something that can have disastrous consequences if done to excess, as we and the rest of the world are finding out).

But economies can also save too much, resulting in over-investment (unless they export their capital, as, for instance, Germany has done in recent years, only to have foreigners lose large amounts of it).

Households saved too little during the property boom in Ireland, but, because the banks imported massive amounts of foreign capital, there was no shortage of savings to invest. Over-investment in housing, offices and hotels took place on a massive scale, egged on by those who parroted the line that “the fundamentals of the property market are sound, going forward” and dismissed any suggestion that property was over-valued. To the profession’s shame, some economists took this position too.

Yesterday’s sectoral national accounts figures, published by the Central Statistics Office, confirmed that savings and investment patterns among Irish households are unusual in a number of respects.

First, and as the chart shows, during the eight years for which Irish figures are available, the savings rate was much more volatile than the European norm.

A second unusual feature is that the rate is consistently lower than the euro zone average. As with almost every indicator that relates to the property market, 2003/04 marked an inflection point. The same is true of the household savings rate. It began to fall at that point, reaching its nadir in 2007. The gross savings ratio then stood at half the rate in the euro zone.

The net household savings ratio – which deducts from the gross figure depreciation on such things as cars, computers and property – fell to zero by 2007, a very unusual position. Across all economies householders are almost always net savers, while businesses and governments are as frequently net borrowers.

This fall in the household savings rate in 2004-07 was typical of a boom/bubble period. During such periods, the rate of growth in the value of assets outstrips the rate at which liabilities are growing. As households feel richer, a “positive wealth effect” takes hold. When people feel wealthier, they spend more and save less. But when a boom turns out to be an asset bubble, that process goes sharply into reverse. The value of assets falls, but liabilities must be repaid nonetheless. People thus feel poorer. They spend less and save more. A “negative wealth effect” kicks in, amplifying the downturn.

That was the pattern in evidence in Ireland before the bubble burst and after it – until 2009. Yesterday’s savings figures for 2010 suggest that the household savings ratio fell sharply from the spike of 2009. This was unexpected. A fall of more than four percentage points in the savings rate would usually fuel spending, as measured by private consumption. But private consumption fell by 1.4 per cent in 2010 compared to the previous year.

It was also surprising because Irish households have many reasons to continue saving. First, they are still highly indebted. Second, as property prices go on falling, their wealth position (assets minus liabilities) continues to deteriorate, making the paying down of debt the only way to rebuild their balance sheets. Third, there is a lot of uncertainty about, making precautionary saving a sensible thing to do.

If the savings figures prove correct (they may be revised by the CSO) the only real hope of a short-term boost to the economy has been dashed.

Before yesterday, there was a chance that there was pent-up demand waiting to be unleashed. If only some certainty could be restored, the argument went, the high savings rate would fall, giving a boost to spending.

But yesterday’s figures show that the savings rate is back below the euro zone average, and this despite the greater than average need to deleverage. It cannot realistically fall any further without postponing the necessary process of balance sheet rebuilding.