Savings Rate: Definition, Influences, History in the U.S.

What Is the Savings Rate?

The savings rate is a measurement of the amount of money, expressed as a percentage or ratio, that a person deducts from their disposable personal income to set aside as a nest egg or for retirement.

In economic terms, saving is a choice to forego some current consumption in favor of increased future consumption, so the savings rate reflects a person or group's rate of time preference. The savings rate is also related to the marginal propensity to save.

The cash accumulated can be held as currency or bank deposits, or it can be put into investments (depending on various factors, such as the expected time until retirement) such as a money market fund, or a personal individual retirement account (IRA) composed of non-aggressive mutual funds, stocks, and bonds.

Understanding the Savings Rate

The savings rate is the ratio of personal savings to disposable personal income and can be calculated for an economy as a whole or at the personal level. The Federal Reserve defines disposable income as all sources of income minus the tax you pay on that income. Your savings is disposable income minus expenditures, such as credit card payments and utility bills.

Using this approach, if you have $30,000 left after taxes (disposable income) and spend $24,000 in expenditures, then your savings are $6,000. Dividing savings by your disposable income yields a savings rate of 20% ($6,000 / $30,000 x 100).

A savings rate is determined by the degree of time preference either for an individual or as an average across a group of people. Time preference is the degree to which a person or group of people prefers current versus future consumption. The more someone prefers to consume goods and services now as opposed to in the future, the higher their time preference, and the lower their savings rate will be. Time preference is the fundamental economic cause of the observed savings rate.

A concept related to the savings rate in Keynesian economics is the marginal propensity to save or the proportion of each additional dollar of income that will be saved. However, the marginal propensity to save is concerned with the change in total savings when income changes rather than the observed amount of saving relative to income.

What Influences the Savings Rate?

Anything that influences the rate of time preference will influence the savings rate. Economic conditions, social institutions, and individual or population characteristics can all play a role. Economic conditions such as economic stability and total income are important in determining savings rates. Periods of high economic uncertainty, such as recessions and economic shocks, tend to induce an increase in the savings rate as people defer current spending to prepare for an uncertain economic future.

Income and Wealth Influence Savings

There is a positive relationship between per capita gross domestic product (GDP) and savings, with low-income-earners spending the majority of their money on basic necessities and wealthier individuals buying luxury items while saving more. The relationship does not continue upward indefinitely, however, and tends to level off.

Changes in Market Interest Rates

Changes in the amount of interest the market generates can have an effect on the savings rate. Higher interest rates can lead to lower overall consumption and higher savings because the substitution effect of being able to consume more in the future outweighs the income effect of maintaining current income received from interest payments for most people.

Formal Institutions

Formal institutions matter for savings rates. Institutions such as the effective establishment and enforcement of private property rights and the control of government corruption tend to encourage savings.

In government fiscal policy, the theory of Ricardian equivalence states that private savings tend to increase when public deficit spending increases, as individuals spend less and save more to prepare for increased future taxes to finance the deficit.

Informal Institutions

The savings rate is also influenced by informal institutions, such as how a particular culture views debt or values material possessions. Cultures oriented toward consumerism and conspicuous consumption have lower savings rates. In the United States, consumption spending constitutes approximately 67% to 70% of GDP and the savings rate is around 7%. In China, where the influence of Confucian culture emphasizes temperance, consumption spending is about 38% of GDP and the saving rate is around 46%.

Individual and population characteristics make a difference in savings rates. Savings rates tend to fall lower as populations age and spend their savings rather than adding to them. People with more future-oriented personalities will tend to save more. People descended from populations that historically could obtain a greater return to saving and investment in agriculture, due to things like local climatic conditions, tend to have a lower time preference, which is reflected in higher savings rates.

The U.S. Savings Rate

For years, the savings rate in the United States has declined. In the 1970s and 1980s, personal savings rates were in the 7% to 15% range but declined in the 21st century to a low of 2.2% in July 2005. The savings rate went up in the United States starting in 2008 with the onset of the Great Recession and soared again in 2020 as the Covid-19 pandemic crushed economic activity.

As of November, 2021, the U.S. savings rate has settled back to 6.9. Since the Federal Reserve started tracking the savings rate in the U.S., the highest rate was 34% in April 2020, but most likely that figure was impacted by the pandemic-induced economic crisis and lockdown.

Bottom Line

The government cares about the savings rate since it's an indicator of a nation's health. The savings rate—which shows personal savings compared with the national savings rate which adds in savings by business and government—shows trends in savings, which lead to investments. Household savings can be a source of borrowing for governments to provide funds for public works and infrastructure needs.