Are savings rates building the foundation of the next recovery?

September 01, 2010

| MoneyRates.com Senior Financial Analyst, CFA

Ask anyone from an esteemed economist to a casual observer, and they will probably agree that excessive debt was a big reason behind the economic collapse in 2008. In that context, it seems ironic that the Federal Reserve has been intent on reviving the economy by stimulating more borrowing -- and perhaps it's less surprising that this strategy has failed.

Instead, US consumers might have a better idea. By rebuilding their savings rates, they may be laying the foundation for a stronger economic recovery.

Savings rates are on the mend

There is ample evidence that savings rates are on the rise. The Bureau of Economic Analysis reported a rise in the Personal Saving Rate in the second quarter of 2010, and this measure of saving as a percentage of income has been above 5% since the fourth quarter of 2008.

The Household Debt Service Ratio reported by the Federal Reserve, which is a measure of the burden represented by regular debt payments, has fallen sharply since the recession began. This has begun to counteract the effects of a 15-year debt binge that began in the early 1990s.

Higher savings rates today may build a stronger recovery tomorrow

All this fiscal responsibility on the household front has thwarted the Federal Reserve's strategy of stimulating borrowing by lowering interest rates. The FDIC reported weak borrowing demand in the second quarter of 2010, though banks were still able to turn a healthy profit in the quarter.

If debt burdens had been low -- or even moderate -- going into this recession, then stimulating lending would have been a viable quick fix for the economy. As it happens, debt service ratios were at an all-time high, so scaling back on borrowing is a necessary process to reposition households for future spending. Repairing savings rates might not be a quick fix, but it does lay a stronger foundation for the eventual reovery.

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