How Savings Can Save the Economy

Investopedia · 03 Apr 11.1K Views

Americans are known for a lot of things, but saving isn't one of them. In the two decades between 2000 and 2020, the overall rate of savings amongst Americans trended downwards. In fact, the national savings rate experienced all-time lows during this time period–even turning negative in 2005.1

While most Americans know that saving is important, when the economy hits upon tough times (which it inevitably will, given the cyclical nature of the financial system), having money in the bank in the form of savings can be a godsend. The idea that savings help out in a tough economy isn't an earth-shattering revelation. But you might be surprised to find out just how much a high savings rate can speed up an entire country's economic recovery. However, saving money is always sage advice, no matter the state of the economy.

A Preference for Credit

At the same time that Americans were saving less and less, many Americans were also exhibiting a higher preference for making purchases using some form of credit. While the widespread acceptance of the use of credit in the early 2000s helped fuel significant growth in the U.S., it may have also come at a significant cost. With credit freely available, it could be said that many consumers took to using their credit lines (and home equity) as if it were a savings account.

An example of this is the chain reaction of defaults that occurred during the economic downturn that is now referred to as the Great Recession. This revealed something that is endemic to our credit system: the prevalence of credit defaults. As a collapsing real estate market shoved overextended consumers underwater on their mortgage payments, those same consumers found themselves slashing spending at the last minute and going into default.

As the credit market seized, and consumer credit lines began to shrivel, people started to realize that the credit limits on their accounts weren't the same as cash in the bank. This chain reaction of defaults, in turn, cut economic output and increased job losses. For those whose savings were already depleted, a decrease in total economic output and increased rates of unemployment further impacted them. A small number of consumers and lenders were very quickly able to affect a larger portion of the economy because of the financial system's interconnectedness.

How Savings Help Consumers and the Overall Economy

To be sure, higher savings reserves mean that consumers have cushions that can help absorb overwhelming expenses without digging the hole deeper. But just as importantly, having a higher portion of income allocated to savings means that living expenses are lower–and consumers can adjust their budgets to spend a larger chunk of income on increased mortgage payments or better compensate if they lose their jobs.

That ability to cope with financial hardship ultimately means that the economy recovers much faster. After all, when the bills are being paid, the banks, utilities, and grocery stores can keep their doors open–and their workers employed.

The Risk of Savings

That's not to say that savings are without risk; anyone who held stocks in their retirement accounts at the outset of the Great Recession–in October 2008–can attest to that. Even government intervention can work against savers; stimulus spending and increased inflation can both work against the power of cash savings.

When a government provides an economic stimulus package to its citizens, it typically finances those expenses through additional sovereign debt (which will eventually have to be paid off by future generations). From one perspective, this means that savers are forced to bail out non-savers at some point in the future. Simply printing more money is another way that governments may pay for legislation that includes a federal stimulus. When this happens, there's a higher risk of inflation. Inflation can be said to be the number-one killer of savings.

With inflation, each dollar in your savings account has less real purchasing power. Purchasing power is the value of a currency expressed in terms of the amount of goods or services that one unit of money can buy. When there are high rates of inflation, one unit of currency–for example, one U.S. dollar–is not capable of purchasing the same amount of goods as in a prior period.

While the risks of inflation are real, when there are high rates of personal savings, there is less need for government stimulus. This is because the nation's finances are shored up at the consumer level. As with most economic crises, the national savings rate shot up in the aftermath of the Great Recession. This trend was likely partially the result of those people who could afford to save making the decision to stash their cash in anticipation of tougher times ahead.

The Bottom Line

On both a personal and a national-level, maintaining a solid savings rate is one of the best cures for economic woes. Although that means that Americans will have to live within their means, it also means that we'll be less susceptible to economic downturns in the future. What remains to be seen is whether consumers in the future will remember the lessons of past economic recessions and maintain a more cautious savings level during times when credit flows freely.


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