Saving up

The deadline for written submissions to the Treasury Select Committee’s inquiry into the effectiveness and impact of post-2008 monetary policy is on Sunday. They put out a call for thoughts a few months ago with a very long list of very open-ended questions some time ago, and the very first one on the list is really interesting.

Their first question concerns “the effectiveness of holding Bank rate near zero and whether extremely low rates can encourage more, rather than less, saving”.

My first thought was that the UK parliament is contemplating following Turkish President Erdogan into the realms of neo-Fisherism. This would be quite a thing.

My second thought was the IPSOS cross-country survey that ING commissioned and analysed a little over a year ago about attitudes to saving in a low or negative rate environment. I found this pretty fascinating stuff. And even if it didn’t deliver a knock-out blow to the conventional notion that lower interest rates discourage rather than encourage savings in aggregate , it did find a considerable minority (14.5%) of UK consumers saved more in response to falling interest rates (although this proportion was much lower than the 27% who indicated that they had reduced saving in response to lower rates). The sample size is small, it lacks a time-series, is democratically rather than plutocratically-weighted. As such it is hard to draw from it sufficient inference to overturn the notion that lower rates would reduce saving/ increase borrowing or the inverse. But still.

 

My third thought though was my kids. I have blogged about the Nangle household bank twice before. My 7 year old ‘target saves’ for big ticket items, using compound interest to his advantage. If I cut rates would he save more or less? As I was on a train I put out a quick ten minute Twitter poll (to test your views on the matter). This is what I got back:

My 7yo who plays the Nangle Bank well, has told me he is saving up for a big ticket item. If I slash rates does he

— Toby Nangle (@toby_n) February 23, 2017

(Although Lorcan did also advise me to ditch this idea altogether.)

Most of the tiny sample of people replying reckoned lower rates = lower saving. This is how stuff tends to work in the real world, right? Lower rates encourage borrowing over saving. But my kids can’t borrow at an interest rate; they can only save at one. They literally ‘save up’ for things rather than debt-finance their spending ambitions. And the interesting thing is that they are not the only ones. In fact, I reckon that I could make the case that the group of people ‘saving up’ in the UK is bigger than it has ever been. And almost all of them are, like my 7 year old, are target savers, accruing savings for a big ticket item.

Two distinct and pretty large cohorts of people who are engaged in saving-up spring to mind.

The first cohort consists of those for whom credit is unavailable by design. This cohort includes highly creditworthy agents seeking to purchase items for which credit is not available (eg, housing, vehicles, plant) due to the lending appetite of lenders, and the macroprudential environment. If you’re a Millennial a few years out of university working in even a highly paid job and like the idea of buying a flat, you are probably in this category. Also in this category are people deemed so uncreditworthy by all lenders that no one will lend to them. Lower rates seem likely to increase savings and reduce borrowing for these agents as they are forced to save up rather than access finance.

Macroprudential regulation has the effect of changing the size of this cohort of agents for whom lower rates means more saving up rather than more consumption. As house prices have risen (partly due to low rates) and macroprudential policy has impeded mortgages from being advanced at ever-higher multiples of salaries, so prospective home-purchasers (first time-buyers and those moving up the housing chain) will be required to save up to a greater extent than in previous times. The chart below from @resi_analyst  shows the level of first time buyer deposit required as a proportion of their disposable income, calculated using the Council of Mortgage Lenders median loan to value and median loan-to-income ratios. It’s an amazing chart. Saving up is clearly a more central aspect today than it may have been in previous times among aspiring homeowners.

First time buyer deposits required as a proportion of disposable income

The second cohort is those for whom credit will never be available no matter the macro prudential environment owing to the thing for which they are saving up. This cohort consists of people who want to generate a specific retirement income that they can look forward to spending. With the private sector defined benefit system a shadow of its former self, and retirement *the biggest lifetime purchase, bigger than a house* this cohort is probably large and growing.

This isn’t market failure, it’s just a thing. No lender is going to lend money to someone on an uncollateralized basis specifically so that the borrower can stop working (forever) and go spend their borrowed money  (although there is a market for heavily-over-collateralized lending designed to be repaid upon death). And so, for these folks, lower rates (and associated bond, dividend and rental yields that come from higher asset prices), will likely increase savings and reduce borrowing. Bottom line: these folks are forced to save up more than they would otherwise as rates fall to generate the same target retirement income. Or they could alternatively invest in riskier assets in the hope of getting higher returns, or adjust down their retirement ambitions through some combination of less time spent in retirement or lower income in retirement.

Savings rates tend to be higher amongst those in the two decades before retirement, in preparation for retirement. This cohort is better paid and so outsized economic influence per individual, and is larger in relation to the general population than it has been. Furthermore, the defined benefit pension system is meaningfully less-inclusive than it has been in previous periods, potentially leading to a change in savings behaviours. As such, we can speculate that the impact of lower rates in forcing higher levels of saving in this cohort is higher today than it would have been in previous times. The chart below is an elementary effort to capture the changing saving habits required over time to purchase a private pension income equivalent to 40% of median salary over time. As interest rates have fallen so required savings rates for ‘saver-uppers’ have increased, and at an economy-wide level the level of saving up is further boosted by the ageing demography.

Level of target savings required to deliver private income of 40% of median income in retirement[1]

There is in addition a third group that is large and unstable in the form of defined benefit pension scheme sponsors, some of which sit in the camp of ‘saver-uppers’ who must save more as rates fall, and some of which sit in the camp of agents that can access borrowing who can save less as rates fall. The potential requirement of a pension fund-sponsor to ‘save-up’ for the retirement of its workers is contingent upon the market’s perception of its expected longevity. Businesses with a long-expected life can borrow from future profits to fund the retirement needs of past and current workers. Businesses with an uncertain life-expectancy will be unable to borrow to fund the short-fall at attractive rates, and will need to increase saving – and increasingly so in a lower rate environment. The shift towards a lower rate environment itself, given the unavoidable system-wide mismatch of pension fund assets and liabilities from an actuarial and accounting perspective, has increased the number of institutions sponsoring defined benefit pension schemes in deficit, a proportion of which have an uncertain life-expectancy.

So where does this leave me? With more questions than answers I’m afraid. How large and important are these different groups in the UK financial landscape, and to what extent are their actions swamped by the opposite actions of others? If they are important, what is the relative importance of: a) the combination of high house prices and macro prudential policy caution; b) the decline of the private sector defined benefit pension system; c) the demographic bulge working its way through the UK’s population pyramid. Is this all just another way of calling long-dated bonds a Giffen Good?

And my 7 year old? What did he do when I cut the Nangle household bank rate? Well in the end I didn’t. In matters of parenthood, as in matters of Eurosystem financial plumbing, it’s worth listening to what Lorcan says.

 

[1] This required level of saving is based on an age-indiscriminate savings rate, that savings are into annuity-purchase products, and that that inflation-linked annuity rates can be proxied by nominal long-dated Gilt yields.