The Case for Savings (in the context of economic crisis)

The financial crisis has quickly become an economic crisis of large proportion, triggering a recession that looks like it will be a bit deeper and longer than any in recent memory. Our best minds are needed to respond to this moment and ensure there is a robust policy response that minimizes the social and economic costs of an extended retraction of the economy.

We should expect major reforms to our social and economic policy framework. Many of these changes may entail the creation of new public institutions, practices, and even a realignment of power relationships among the major sectors of our economy that essentially redrafts the social contract. This will meant that many aspects of conventional wisdom will be overturned. Alan Greenspan doesn’t apologize everyday. We should not gloss over his recognition that the free market is not able to police itself. For many, it will be difficult to have their basic assumptions uprooted so fundamentally and abruptly. But it is clear that the prevailing assumptions as to the role and size of government will have to be revisited. This will necessarily include a reconsideration of the optimal distribution of savings, consumption, and debt at both the household and national levels in order to drive sustained economic growth.

For a number of reasons, the expenditures of government should necessarily increase. The efficacy of pursuing balanced budgets over the course of the business cycle remains a reasonable proposition, and there will be a time to revisit this debate at a later date. As for now, it will be irresponsible (fiscally and otherwise) for the government not to undertake increased deficit-financed spending. This spending should be focused on three primary objectives, including ameliorating economic hardship, creating the conditions for the next economic recovery, and promoting robust economic growth over the long term.

However, increased government spending does not remove the importance of saving, especially at the household level. This attention afforded to consumption as a driver of the economy seemingly undermines the argument to increase savings. But the case for saving is not intended to be a one time shot in the arm like flooding the economy with rebate checks. While it is true that declining consumption in the near future will increase recessionary pressure on the economy, it is also true that the economic health and stability of many families will require they realign their spending and debt with their long-term savings needs.

This does not have to happen all at once. The recession will naturally push up savings rates as economic uncertainty will drive people to prefer holding on to more of their income (a liquidity preference is what the economists call it). This preference is exactly what the increased government spending must counter, so economic activity continues even though consumer spending declines.

Although the spending of the American consumer is remarkable in many respects, it should not be considered a birthright or an obligation. We can’t place the responsibility of ending the economic slowdown on the spending households that are already in debt and with low savings. We need to be thinking now about creating the set of incentives, institutions, and policy supports that can establish the long-term foundations of our economy.

In the near term, government spending should offset declines in consumer spending associated with the recession, but over an extended time horizon, there is a strong case to be made for increased savings and a justification for a policy response that enables greater savings to occur, especially for families with lower incomes and fewer resources.