Falling Debt and Rising Savings - Feb 2009

A key determinant of the severity of the recession in the global economy and in Australia will be the extent to which households in the US and Australia boost their level of savings in order to cut their debt levels.

Some are claiming that we are about to see a massive cut in household debt in Australia and that this will drag the economy down into a very severe recession if not depression. This note looks at the main issues.

The key points are as follows:

  • Household savings rates are set to move higher in the years ahead as households seek to cut debt in the face of a tighter credit environment, economic uncertainty and a loss of wealth. A return to pre 1980s levels for household savings rates in the US and Australia is quite likely.

  • However, lower interest rates and government measures to boost household finances should help ease this adjustment, heading off the economic calamity that some predict.
Lower interest rates and government payments to households are helping Australians rapidly rebuild their savings and cut their debts without having to slash their spending levels. This was clearly evident in December when it appears that the $8 billion in payments to households helped boost savings while at the same time only a small proportion (maybe just 10-15%) was spent helping to drive an improvement in retail sales. Such an approach probably won't prevent a recession from occuring this year given the severity of the deterioration in our export markets, but it will help ensure that the recession is milder than would otherwise have been the case. It will also help bring forward the time when households feel comfortable in increasing their spending again on a sustainable basis.

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