Monday, February 4, 2013

Is "Precautionary Saving" Still a Problem?

John Cochrane has an interesting post where he considers the various reasons why consumption has failed to return to its trend path. One area where I disagreed with him was this statement:
"[A] more precise version of my first equation adds a "precautionary saving" term. When people are very uncertain about the future, they save more...This story seems possible for 2008 and 2009, in the depths of the financial crisis and recession. But I'm less convinced that it describes our current moment."
As I noted in his comments, it does seem strange to think that almost five years later precautionary savings would still be an important part of the story.  But the data clearly shows that this is the case, as seen in the figure below. The blue line in the figure shows liquid assets (checking and cash, saving and time deposits, money market accounts, and treasuries) of households as a percent of total household assets. Now this indicator is really a measure of liquidity demand, but it gets at the same notion as precautionary savings. The red line shows the unemployment rate.

The figure indicates that liquidity demand rises before recessions and leads changes in unemployment. (Josh Hendrickson and I show in a paper that this indicator is systematically related to swings in aggregate nominal expenditures.) More importantly, this measure of liquidity demand still remains elevated to this day. So yes, precautionary savings (or precautionary demand for liquidity) still appears to be an important part of the ongoing slump.

P.S. This elevated demand for liquidity is just another way of seeing the inordinately high risk premium problem.


  1. David
    Twenty some years ago the young Cochrane used consumption (non durables & services) to predict income (PIH). Now he tweaks his original model and includes "precautionary saving" for a period (08-09). As you point out, that´s not enough because "precautionary saving" is still going on, so what we need is not mainly his "structural" improvements but principally "better monetary policy".
    Matt Yglesias discusses Cochrane´s post also:

  2. This raises a worrisome issue, that of permanent liquidity traps and ZLB and high savings rates.

    Many people save for reasons unrelated to interest rates; for security, for college, for retirement, to buy a business, to buy a house etc. That save even at ZLB.

    Add in a scary recession...people save even more.

    For me, this raises questions of whether QE, if not aggressive enough, will have to become nearly permanent. After all, QE was tried in Japan for five years, with good success. But then they stopped, and went back into monetary asphyxiation.

    So, does that mean 10 years of QE in the USA is on tap? And what will that mean for the federal budget? Will QE become conventional?

    Should the Fed be a part of the Treasury Dept, as once advocated by Reagan Treasury Secy Don T Regan?