Evans On The Economy -- Less-Than-Zero-Savings? Don't Believe It

Nov. 22, 2005
The real numbers explain why consumers continue to buy.

During the past three years, the principal engine of economic growth in the U.S. has been the surge in amount of money people have been taking out of their homes, a phenomenon that economists like to call equity extraction from owner-occupied dwellings. Call it what you want, it's likely to continue. Indeed, even if the increase in housing prices slows to 3% in 2006, as I expect it will, the phenomenon is likely to continue boosting consumer spending for several more years.

Why bring it up? Because there's been a lot of talk lately about the personal savings rate in the U.S. being less than zero. That's because of what numbers from the Commerce Department's Bureau of Economic Analysis (BEA) say. I don't believe them.

For example, recently the Federal Reserve Board issued an important working paper, co-authored by none other than Alan Greenspan himself. It estimates "gross equity extraction" from homes on a quarterly basis from 1990 to the present. As I read through the numbers, they suggest that the personal savings rate is about 9%, not less than zero.

They are not the only numbers we can look at. The U.S. Labor Department's Bureau of Labor Statistics publishes a comprehensive consumer expenditure survey on an annual basis. The personal saving rate, calculated from that survey, increased from 3% in 2000 to a whopping 12% in 2003, the latest year for which data are available. I don't think the saving rate is that high, but the point is that the BEA measure of personal saving is far from the only measure available, and in my opinion is irrelevant.

How could there be such a mammoth difference in the federal government estimates of the personal saving rate? To a certain extent, it is caused by different methodology to determine consumption. The main difference occurs in housing. Suppose, for example, that the typical mortgage rate declined from 7% to 5%, and many homeowners refinanced. They would then spend less on their mortgage payments, which would leave more money for either other purchases or an increase in saving. Note that this development is independent of the extraction of home equity, which increases the actual cash saving rate even more.

The Fed's paper has gone far to resolve the conundrum that consumers keep buying other goods and services at the same rate even when energy prices rise and even though the personal saving rate is reportedly negative. The personal saving rate is nothing of the sort. It is probably about 10% when refinancing at lower rates and extraction of home equity are taken into account.

If this figure continues to rise $100 billion per year as it has over the past five years -- admittedly a big if -- that would offset most of the rise in gasoline, heating and electricity costs. Admittedly, even with the continuing increase in home equity extraction, the additional payments for gasoline, natural gas, heating oil and electricity must come from somewhere. However, the question is whether they will come out of spending or saving. Taking home equity extraction into consideration, they will come out of saving. As a result, real consumer spending will grow at the same rate in 2006 as it did in 2005. BEA will continue to report that the personal saving rate continues to become even more negative, but those figures can be safely ignored.

Michael K. Evans is chief economist for American Economics Group, Washington, D.C., and president of the Evans Group, an economics consulting firm in Boca Raton, Fla.

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