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Why Saving Ratios Have Risen
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WHY SAVING RATIOS HAVE RISEN"
R. Webb Macquarie University
ABSTRACT Th. author eXlmlne. tradltlonll consumer behaviour theory to determine how consumers might be expectsd to respond to chang" In actual and expected price levels, net Wllllth Ind Interest rates. It Is found that actual living behaviour has not conformed to these expectations. The author IUIIII,.ts reuons why this has be.n so and why saving ratios have risen. He concludes that some of the assumption, of traditional theory cannot be justified lind that It omits ••verallmportant determinants of consum·
ptlon Including lags, Imperfect knowledge, Inability to acquire Inflation hedglls, liquidity, debt levels, "forced" saVing, the C1eslr. to maintain real wealth and the price level.
1. Introduction Saving ratios (the ratio of saving 1 to household disposable income) have risen stongly jn many industrialised countries in recent years when inflation rates have been relatively high or accelerating. It will be shown that traditional consumer behaviour theory predicts that it is "irrational" for saving ratios to rise at such times, and hence explanations of why they have risen are required. The objective of this paper is to list factors which may have caused saving ratios to rise. Attention is focused on the above trend rises first occuring in approximately mid 1972. There is no discussion in this paper of the causes of the long-term trend rises in saving ratios observed in some countries. 2. Consumer Behaviour Theory And Actual Behaviour Compared The conventional approach to modelling consumer behaviour is based on the assumption that consumers behave rationally. From this one may infer
'"'This paper Is a condensed verSion of "Why The Saving Ratio Has Risen" appearIng In Macquarle UnIversity, SChool of EconomIc and FInancial StUdies, Research Paper No. 129. The author wishes to acknowledge hIs indebtedness to an anonymous referee for comments on an earlier versIon of this paper.
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the behaviour of rational consumers with respect to rises in the price level, price expectations and real expenditure levels, net wealth and interest rates.
a. Rises in the Price Level Consumer behaviour theory explicitly assumes that rational consumers are not subject to money illusions. The absence of money illusion means that consumption and saving decisions are made· in real terms. However, traditional theory also implicitly assumes that consumers take into account changes in the price level automatically and immediately when undertaking consumption/saving decisions Le., traditional theory implicitly assumes an absence of lags. Rather, the theory assumes that consumers raise their nominal expenditures in the same proportion as the rise in the price level there· by maintaining unchanged real levels of consumption and saving relative to real disposable income. Hence in the absence of changes in the real values of the determinants of nominal consumption with changes in the price level, rational consumers will not change their saving ratios. However, it will be shown below that the implicit assumption that the real values of these determinants do not change with changes in the price level, is unjustified. In addition, evidence continues to accumulate that at least in the short run, some consumers may be subject to money illusion [2], [5), [161, [261, [58], [61). This behaviour which is apparently "irrational" in the sense that it does not conform with how one would expect a rational consumer to react to changes in the price level, requires explanation. (i)
Causes and Consequences of Money Illusion
Evidence of the existence of money illusion raises the question of what are its causes and effects on the saving ratio. Several authors including Branson and Klevorick [2], Deaton (8J and Juster and Wachtel [27], argue that some consumers are subject to money illusion. In each of their views is the notion that money illusion is a short-run phenomenon caused by variable lags in adjusting saving behaviour and price expectations to actual changes in the price level. This view is at variance with the assumption of traditional theory that consumers automatically and immediately take into account price level changes. Money illusion may however, change the saving ratio by means other than lags. When both prices and nominal disposable incomes are rising, consumers may continue to increase their nominal expenditures at the same
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rate as they have in the past. If this past rate is lower than the actual infl· ation rate, the absolute real level of consumption falls, that of saving rises, and the saving ratio rises if nominal disposable income rises at a rate faster than that at which nominal consumption expenditures are rising. In addition, money illusion can change the saving ratio via a wealth effect. Gener· ally, one would expect that the greater the real value of a consumer's stock of net wealth is relative to disposable income, the less the pressure to save. Hence a permanent increase in real net wealth would tend to lower the saving ratio. Consumers whose nominal wealth has risen in an inflation 2 and who are subject to money illusion, may perceive a higher nominal wealth level as a higher real level and if this perceived increased is believed to be permanent, their saving ratios would tend to fall. The effect in this case is to lower rather than raise the aggregate saving ratio. The behaviour of consumers who incur losses in the real value of their wealth in inflations is dealt with below. In the long run, one would expect saving behaviour and expectations to become better adapted to the experience of continuing inflation and for the saving ratio to fall thus reversing the previous rise. This is consistent with the fact that after rising to a peak, saving ratios in some countries including Australia, have started to decline towards their long-run trend levels [241 p. 30, [41] p. 26.
(ii) Empirical Testing of the Money Illusion Hypothesis The findings of several studies [2], [5J, [16], [26J, [58J, [61], that the price level yields an independent effect on real consumption expenditures, can be interpreted as evidence of the existence of money illusion. This conclusion mayor may not be correct because money illusion is only one of several ways (discussed below). through which the price level may influence real expenditures.
b. Price Expectations and Real Consumption Expectations of future changes in the price level are a determinant of consumer behaviour and traditional theory predicts that their presence will tend to lower the saving ratio. There is evidence 3 that when inflationary expectations are held, some advance buying does occur. However, it also shows that advance buying does not persist4 . Rather, it is only the first of
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two responses from consumers. In the second stage, continuing inflation invokes resistance to price rises (401 p.24. Consumers refuse to buy goods whose prices they feel are "too high" especially if they are ones whose purchase is postponable sum as durables and non-essential purchases. In effect, additions to saving stocks and additions to durable goods stocks are regarded as close substitutes by some consumers 5 . In this section, we attempt to explain why delayed buying may occur when inflation is anticipated since it is apparently irrational. There are at least three possible explanations. First, according to survey data, rising prices tend to be associated with pessimistic consumer sentimo ent 6. Thus when the inflation rate is accelerating increasingly pessimistic sentiments are generated and the saving ratio rises. Secondly, the reason given in surveys for delayed buying is dissatisfaction with "high" prices which is reflected in a drop in expenditures on durables. In both 1951 and 1957, high and rising prices in the U.S. led to a drop in expenditure on consumer durables (4] p.93. This has also been the experience of many OECD countries in 1973-1976 (401 p.24. This raises several questions: what is meant by the term "prices are too high"; what factors contribute to this sentiment; and why should the impact be reflected in a drop in expenditure on durables. The term "prices are too high", could mean that the absolute prices of all goods have risen by the same proportion relative prices remaining unchanged, while nominal disposable incomes have not risen by the same proportion as the price level i.e., real disposable incomes have fallen. If consumers react to a fall in real disposable income by reducing real consumption, this adjustment might be expected to impinge most heavily on durables purchases because of an alleged higher income elasticity for durables than for nondurables, On the other hand, the term "prices are too high" could mean that the prices of durables have risen relative to the prices of non-durables. This would result in a substitution of purchases of non-durables or increased saving. Or the term may mean that the real acquisition or operating costs of durables have risen relative to real disposable income. Thus the O.P.E.C. oil prices have raised the relative cost of running a car in many countries. Under these circumstances consumers may delay the replacement of durables until these costs have fallen relatively. Additions to savings stocks are substituted for additions to durable goods stocks and the saving ratio rises. Rises in the
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· chase pr,'ces of durables relative to disposable incomes can arise eIfectlve pur
for several reasons including rises in the cost of credit. Because the purchase of many durables is finances by hire purchase credit, the cost of credit must be included in their effective costs. Rises in nominal interest rates assoc· iated with inflation have in some countries, caused interest payments to rise by more than the prices of durables. For example, in the U.K. the typical monthly hire-purchase payment for an average car increased by 40 percent between December 1973 and September 1974 against a much smaller increase in the price of cars (40) p. 24. Another way in which inflation raises the effective real prices of durables relative to disposable income occurs when durables purchases are partly financed from savings stocks. Not only does inflation raise the nominal prices of durables but it also simultaneously reduces the real value of accumulated savings expecialty if those savings earn negative real interest rates. This inflation serves to widen "deposit gaps" and saving to meet these gaps raises the aggregate saving ratio. (Note that the need to meet "deposit gaps" could be a factor temporarily delaying not only durables purchases but also other expenditures as well. There is e.g., evidence that in Australia, housing deposit gaps have risen rapidly relative to average earnings in recent years!. A third possible reason for delayed buying is that even if real prices are expected to rise in the immediate future, consumers may expect them to fall in the more distant future and delay buying until then. For example, some consumers delayed buying colour televisions until after the boom in demand immediately following their introduction into Australia in the expectation of a future fall in their real prices. There are several problems with these three explanations. If delayed buying has contributed to rising saving ratios, it is probably only a short-run influence. There is a floor to the non-replacement of durables, and when replacement occurs it lowers the saving ratio, reversing the previous rise. This may explain the more recent reversals in the rises in saving ratios in some countries. In addition, the influence of expectations depends quantitatively on consumers' perceptions of price level trends and on how or even whether, expectations of future prices increases are formed as a result of increases in the price level. There is evidence [4] p. 93, that for some consumers, price expectations are not a determinant of comsumption expend-
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itures. This is contrary to the rationality assumption of conventional consumer theory and requires explanation. One possible reason is that the period to which the above findings relate are based on U.S. data for the late 1950's a period when inflation rates were low by current standards. When prices are rising slowly, say 2 percent a year, not everybody perceives that prices have risen and hence some consumers may not anticipate future price rises. But even if price increases are anticipated, some consumers may feel that the incentive to speed up purchases is not strong enough to warrant a change in their behaviour. It is unlikely however, that many consumers are unaware of the acceleration in inflation rates experienced recently and do not anticipate future price level rises. Thus there may be a threshold inflation rate and if the actual inflation rate is lower than the threshold rate consumers may not alter their behaviour but when the threshold rate is exceeded, behaviour may change. c. Net Wealth
Net non-human wealth is probably a determinant of real consumption expenditure and there is a growing body of empirical literature which supports this view [12] pp. 1312-1314. In this section the role of wealth and of liquid assets in particular, is discussed. (iJ Assets
On the assets side of consumers' balance sheets, the real value of assets may change due to inflation. The rationality assumption leads one to expect that consumers would prefer to hold assets whose real value remains intact in times of inflation. Conversely, one would expect a rejection of assets whose real values depreciate. One would not expect a rational consumer to accumulate more of the latter type of assets. There is evidence that some consumers do prefer to hold non-depreciating assets {38J p. 35. There is however, very strong evidence which shows that this does not typify the behaviour of many, if not most consumers. An DECO study [41] pp.4045, of the financial behaviour of the private household sectors of five major countries using flow-of-funds accounts of households, concluded that there has been a rapid growth in consumers' holdings of liquid assets during the 1970's in relation to both total asset formation and disposable income. Because nominal interest rates on some liquid assets have not adjusted fully to inflation and because some are denoted in unchanged nominal monetary
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terms, their real value has diminished. Since the continued acquisition of this type of liquid asset or more generally, of any asset whose real value diminishes as a result of inflation is prima facie irrational, this behaviour requires explanation. First, some consumers are unable to acquire inflation hedges because the absolute deposits and repayments are so large as to prevent them from buy· ing such assets e.g., some land and real property. This restricts the number of outlets for their saving to things like liquid assets. Hence it cannot be concluded that behaviour of these consumers is irrational. Secondly, theory assumes that consumers have perfect knowledge but many consumers may not have consciously thought in terms of negative real interest rates, diminishing real asset values, etc. The continued accumulation of depreciating assets may reflect ignorance. Again, it cannor be said that this behaviour is irrational. Thirdly, some savers are "captive" in that they deliberately choose to acquire Iiquid assets. The liquidity feature is important for people nearing retirement since liquid assets are used to finance consumption during retirement. The recognition that the real value of their assets is declining might even induce these consumers to increase their saving ratios to offset this decline. Fourthly, Forsyth [15] has advanced the hypothesis that consumers have a desired ratio between their liquid asset stocks and their disposable incomes, that this is disrupted by inflation and that the saving ratio rises to re-establish the desired ratio. This hypothesis predicts that the lower the actual liquid asset ratio is (the ratio of liquid assets to disposable incomel, the higher the saving ratio will be. Plots of these Australian data do not however, form any discern able pattern but this may reflect the influence of other variables {62l.
riO Liabilities Inflation generally diminishes the real value of indebtedness denoted in constant nominal terms. The rationality assumption leads one to expect that consumers would be willing to increase real indebtedness relative to disposable incomes if they expect its real value to decline and if real interest rates on the debt are negative. Hence one would expect to observe an acceleration of real expenditures financed by indebtedness in times of inflation thereby lowering the saving ratio. One would neither expect consumers to be reluctant to incur more debt nor to observe a fall in indebtedness relative to disposable income in periods of inflation. However, an OECD study [41]
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pp. 40·45, of the financial behaviour of the private household sectors of five major countries concluded that "". the recent unexpectedly large rises in saving ratios and financial surpluses as a percentage of disposable income was largely a result of declines in borrowing rather than a reflection of accelerating financial asset formation" [41} p.44. There are at least two explan· ations for this apparently irrational behaviour. Firstly, private households' borrowing propensities rose sharply in the 1972·3 boom. This has been attributed to a ..... rapid growth of nominal incomes, easy monetary conditions with relatively low real interest rates, and the related prospect of beating inflation through growing indebtedness... " [411 p. 44. However, the reversal of these conditions in 1974 may have resulted in consumers' disinclination to finance current consumption through indebtedness. Secondly, the fall in indebtedness relative to dispos· able incomes may have resulted from the feeling that existing debt levels were too high given the risks of unemployment and diminishing real income prospects during the following recession [41) p.44. If these are the reasons for such behaviour, once again it cannot be said that consumers have be· haved irrationally.
d. Interest Rates Consumer behaviour theory predicts that the aggregate saving ratio is an increasing function of the money rate of interest assuming that the real interest rate is positive e.g., (18] p. 203. Conversely, negative real yields could be expected to lower the saving ratio. However, consumers continue to amass savings on which real yields are negative. Several explanations of this apparently irrational behaviour may be advanced. First, some savers may be subject to "interest rate illusion" Le., they look at nominal and not real yields. Alternatively, if they do look at real yields they may believe that real yields are positive whereas in fact they are negative. The former situation could reflect ignorance of the fact that infl· ation can result in negative real yields. The latter situation could arise in times of accelerating inflation rates when there is a lag in adjusting anticip· ated inflation rates to actual rates. If actual inflation rates exceed expected rates and if nominal interest rates reflect expected inflation rates, real inter· est rates would be negative.
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Secondly, the upward shift in nominal interest rates associated with inflation has depressed some financial asset prices notably of fixed·interest securities. The losses on the capital values may have resulted in a wealth effect which discouraged consumption and encouraged saving. Thirdly, higher nominal interest rates may have resulted in higher repayments relative to disposable income, on debt incurred in the past. This could apply in countries where interest rates charged on housing mortgages are varied to reflect changing market rates. Most householders regard rises in mortgage repayments as rises in an "unavoidable" commitment. If such payments rise faster than disposable incomes, there is "forced" saving which raises the saving ratio. Calculations show that in Australia, housing loan repayments to permanent building societies as a proportion of disposable income, have risen in recent years (1970: 9.9%; 1971: 12.2%; 1972: 11.4%; 1973: 14.0%; 1974: 16.5%; 1975 first half: 15.7%). On the other hand, some contractual saving e.g., with insurance companies, remains temporarily unchanged in nominal terms while nominal disposable incomes are rising, thus lowering the real value of this saving and the saving ratio. Fourthly, higher nominal interest rates may have contributed to the unwillingness of consumers to borrow, and as we have already seen the rise in saving ratios in five major OECD countries was largely the result of declines in borrowing (41] p.44. As mentioned earlier rising interest rates raise the effective cost of buying goods whose purchase is financed by instalment credit. The repayment of debt may entail a higher level of saving than that which a consumer is prepared to undertake. Thus instead of buying, consumers save and the saving ratio rises. Fifthly, it is possible that saving is interest inelastic and empirical studies generally tend to show that the acquisition of financial assets by households does not respond greatly to rises in interest rates 152] p.22. In addition to econometric studies, surveys support the thesis that financial asset acquisitions by some households are essentially interest inelastic, the rate of return ranking markedly lower than other factors, liquidity and safety of principal being the predominant factors especially for small savers [52) p. 22. 3. Conclusions The rises in saving ratios do not appear to reflect irrational behaviour as defined. Traditional consumer theory is not wrong in the sense that its
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predictions of how rational consumers will behave do not conform with ob· served behaviour. The reason why traditional consumer theory is unable to explain why saving ratios have risen is because it omits from consideration variables which are determinants of saving ratios such as lags, the desire for liquidity, imperfect knowledge, debt levels, "forced" saving, inability to acquire inflation hedges, uncertainty, the desire to maintain real values of wealth, the effects of changes in the price level and others. Nor does it take into account the relative importance attached to eam determinant by different consumer groups.
FOOTNOTES 1.
In the Australian National Accounts, saving is a residual derived by deducting consumption expenditure from household disposable income. However, consumption therein is not defined in the physical sense Le., as the physical consumption of goods and services. In particular, expenditure on durables is treated as consumption. Such treatment implicitly assumes that all of the services rendered by duro able goods are provided in the year of purchase.
2.
Inflation will not induce an increase in the net nominal wealth of all consumers. The effect depends on the form and composition of the individual consumer's balance sheet.
3.
A maior source of studies on consumers' reactions to expectations of price increases is the University of Michigan Survey Research Centre. The results of some of the Centre's early studies are summarised in [4] p.93.
4.
Some evidence of a two stage response may be found in the University of Michigan Survey of Consumer Sentiment. See [40) p.24.
5.
Evidence of such behaviour can be found in Mueller and lean [33] p. 377, who report that consumers alternate between adding to savings stocks and durable goods stocks, the latter being built up by wholly or partly running down savings stocks.
6.
See !orexample, (23) p.29, [41 p. 93, and [291.
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Economic Analysis and Policy
Vol. 07 No. 01, March 1977
WHY SAVING RATIOS HAVE RISEN"
R. Webb Macquarie University
ABSTRACT Th. author eXlmlne. tradltlonll consumer behaviour theory to determine how consumers might be expectsd to respond to chang" In actual and expected price levels, net Wllllth Ind Interest rates. It Is found that actual living behaviour has not conformed to these expectations. The author IUIIII,.ts reuons why this has be.n so and why saving ratios have risen. He concludes that some of the assumption, of traditional theory cannot be justified lind that It omits ••verallmportant determinants of consum·
ptlon Including lags, Imperfect knowledge, Inability to acquire Inflation hedglls, liquidity, debt levels, "forced" saVing, the C1eslr. to maintain real wealth and the price level.
1. Introduction Saving ratios (the ratio of saving 1 to household disposable income) have risen stongly jn many industrialised countries in recent years when inflation rates have been relatively high or accelerating. It will be shown that traditional consumer behaviour theory predicts that it is "irrational" for saving ratios to rise at such times, and hence explanations of why they have risen are required. The objective of this paper is to list factors which may have caused saving ratios to rise. Attention is focused on the above trend rises first occuring in approximately mid 1972. There is no discussion in this paper of the causes of the long-term trend rises in saving ratios observed in some countries. 2. Consumer Behaviour Theory And Actual Behaviour Compared The conventional approach to modelling consumer behaviour is based on the assumption that consumers behave rationally. From this one may infer
'"'This paper Is a condensed verSion of "Why The Saving Ratio Has Risen" appearIng In Macquarle UnIversity, SChool of EconomIc and FInancial StUdies, Research Paper No. 129. The author wishes to acknowledge hIs indebtedness to an anonymous referee for comments on an earlier versIon of this paper.
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the behaviour of rational consumers with respect to rises in the price level, price expectations and real expenditure levels, net wealth and interest rates.
a. Rises in the Price Level Consumer behaviour theory explicitly assumes that rational consumers are not subject to money illusions. The absence of money illusion means that consumption and saving decisions are made· in real terms. However, traditional theory also implicitly assumes that consumers take into account changes in the price level automatically and immediately when undertaking consumption/saving decisions Le., traditional theory implicitly assumes an absence of lags. Rather, the theory assumes that consumers raise their nominal expenditures in the same proportion as the rise in the price level there· by maintaining unchanged real levels of consumption and saving relative to real disposable income. Hence in the absence of changes in the real values of the determinants of nominal consumption with changes in the price level, rational consumers will not change their saving ratios. However, it will be shown below that the implicit assumption that the real values of these determinants do not change with changes in the price level, is unjustified. In addition, evidence continues to accumulate that at least in the short run, some consumers may be subject to money illusion [2], [5), [161, [261, [58], [61). This behaviour which is apparently "irrational" in the sense that it does not conform with how one would expect a rational consumer to react to changes in the price level, requires explanation. (i)
Causes and Consequences of Money Illusion
Evidence of the existence of money illusion raises the question of what are its causes and effects on the saving ratio. Several authors including Branson and Klevorick [2], Deaton (8J and Juster and Wachtel [27], argue that some consumers are subject to money illusion. In each of their views is the notion that money illusion is a short-run phenomenon caused by variable lags in adjusting saving behaviour and price expectations to actual changes in the price level. This view is at variance with the assumption of traditional theory that consumers automatically and immediately take into account price level changes. Money illusion may however, change the saving ratio by means other than lags. When both prices and nominal disposable incomes are rising, consumers may continue to increase their nominal expenditures at the same
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rate as they have in the past. If this past rate is lower than the actual infl· ation rate, the absolute real level of consumption falls, that of saving rises, and the saving ratio rises if nominal disposable income rises at a rate faster than that at which nominal consumption expenditures are rising. In addition, money illusion can change the saving ratio via a wealth effect. Gener· ally, one would expect that the greater the real value of a consumer's stock of net wealth is relative to disposable income, the less the pressure to save. Hence a permanent increase in real net wealth would tend to lower the saving ratio. Consumers whose nominal wealth has risen in an inflation 2 and who are subject to money illusion, may perceive a higher nominal wealth level as a higher real level and if this perceived increased is believed to be permanent, their saving ratios would tend to fall. The effect in this case is to lower rather than raise the aggregate saving ratio. The behaviour of consumers who incur losses in the real value of their wealth in inflations is dealt with below. In the long run, one would expect saving behaviour and expectations to become better adapted to the experience of continuing inflation and for the saving ratio to fall thus reversing the previous rise. This is consistent with the fact that after rising to a peak, saving ratios in some countries including Australia, have started to decline towards their long-run trend levels [241 p. 30, [41] p. 26.
(ii) Empirical Testing of the Money Illusion Hypothesis The findings of several studies [2], [5J, [16], [26J, [58J, [61], that the price level yields an independent effect on real consumption expenditures, can be interpreted as evidence of the existence of money illusion. This conclusion mayor may not be correct because money illusion is only one of several ways (discussed below). through which the price level may influence real expenditures.
b. Price Expectations and Real Consumption Expectations of future changes in the price level are a determinant of consumer behaviour and traditional theory predicts that their presence will tend to lower the saving ratio. There is evidence 3 that when inflationary expectations are held, some advance buying does occur. However, it also shows that advance buying does not persist4 . Rather, it is only the first of
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two responses from consumers. In the second stage, continuing inflation invokes resistance to price rises (401 p.24. Consumers refuse to buy goods whose prices they feel are "too high" especially if they are ones whose purchase is postponable sum as durables and non-essential purchases. In effect, additions to saving stocks and additions to durable goods stocks are regarded as close substitutes by some consumers 5 . In this section, we attempt to explain why delayed buying may occur when inflation is anticipated since it is apparently irrational. There are at least three possible explanations. First, according to survey data, rising prices tend to be associated with pessimistic consumer sentimo ent 6. Thus when the inflation rate is accelerating increasingly pessimistic sentiments are generated and the saving ratio rises. Secondly, the reason given in surveys for delayed buying is dissatisfaction with "high" prices which is reflected in a drop in expenditures on durables. In both 1951 and 1957, high and rising prices in the U.S. led to a drop in expenditure on consumer durables (4] p.93. This has also been the experience of many OECD countries in 1973-1976 (401 p.24. This raises several questions: what is meant by the term "prices are too high"; what factors contribute to this sentiment; and why should the impact be reflected in a drop in expenditure on durables. The term "prices are too high", could mean that the absolute prices of all goods have risen by the same proportion relative prices remaining unchanged, while nominal disposable incomes have not risen by the same proportion as the price level i.e., real disposable incomes have fallen. If consumers react to a fall in real disposable income by reducing real consumption, this adjustment might be expected to impinge most heavily on durables purchases because of an alleged higher income elasticity for durables than for nondurables, On the other hand, the term "prices are too high" could mean that the prices of durables have risen relative to the prices of non-durables. This would result in a substitution of purchases of non-durables or increased saving. Or the term may mean that the real acquisition or operating costs of durables have risen relative to real disposable income. Thus the O.P.E.C. oil prices have raised the relative cost of running a car in many countries. Under these circumstances consumers may delay the replacement of durables until these costs have fallen relatively. Additions to savings stocks are substituted for additions to durable goods stocks and the saving ratio rises. Rises in the
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· chase pr,'ces of durables relative to disposable incomes can arise eIfectlve pur
for several reasons including rises in the cost of credit. Because the purchase of many durables is finances by hire purchase credit, the cost of credit must be included in their effective costs. Rises in nominal interest rates assoc· iated with inflation have in some countries, caused interest payments to rise by more than the prices of durables. For example, in the U.K. the typical monthly hire-purchase payment for an average car increased by 40 percent between December 1973 and September 1974 against a much smaller increase in the price of cars (40) p. 24. Another way in which inflation raises the effective real prices of durables relative to disposable income occurs when durables purchases are partly financed from savings stocks. Not only does inflation raise the nominal prices of durables but it also simultaneously reduces the real value of accumulated savings expecialty if those savings earn negative real interest rates. This inflation serves to widen "deposit gaps" and saving to meet these gaps raises the aggregate saving ratio. (Note that the need to meet "deposit gaps" could be a factor temporarily delaying not only durables purchases but also other expenditures as well. There is e.g., evidence that in Australia, housing deposit gaps have risen rapidly relative to average earnings in recent years!. A third possible reason for delayed buying is that even if real prices are expected to rise in the immediate future, consumers may expect them to fall in the more distant future and delay buying until then. For example, some consumers delayed buying colour televisions until after the boom in demand immediately following their introduction into Australia in the expectation of a future fall in their real prices. There are several problems with these three explanations. If delayed buying has contributed to rising saving ratios, it is probably only a short-run influence. There is a floor to the non-replacement of durables, and when replacement occurs it lowers the saving ratio, reversing the previous rise. This may explain the more recent reversals in the rises in saving ratios in some countries. In addition, the influence of expectations depends quantitatively on consumers' perceptions of price level trends and on how or even whether, expectations of future prices increases are formed as a result of increases in the price level. There is evidence [4] p. 93, that for some consumers, price expectations are not a determinant of comsumption expend-
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itures. This is contrary to the rationality assumption of conventional consumer theory and requires explanation. One possible reason is that the period to which the above findings relate are based on U.S. data for the late 1950's a period when inflation rates were low by current standards. When prices are rising slowly, say 2 percent a year, not everybody perceives that prices have risen and hence some consumers may not anticipate future price rises. But even if price increases are anticipated, some consumers may feel that the incentive to speed up purchases is not strong enough to warrant a change in their behaviour. It is unlikely however, that many consumers are unaware of the acceleration in inflation rates experienced recently and do not anticipate future price level rises. Thus there may be a threshold inflation rate and if the actual inflation rate is lower than the threshold rate consumers may not alter their behaviour but when the threshold rate is exceeded, behaviour may change. c. Net Wealth
Net non-human wealth is probably a determinant of real consumption expenditure and there is a growing body of empirical literature which supports this view [12] pp. 1312-1314. In this section the role of wealth and of liquid assets in particular, is discussed. (iJ Assets
On the assets side of consumers' balance sheets, the real value of assets may change due to inflation. The rationality assumption leads one to expect that consumers would prefer to hold assets whose real value remains intact in times of inflation. Conversely, one would expect a rejection of assets whose real values depreciate. One would not expect a rational consumer to accumulate more of the latter type of assets. There is evidence that some consumers do prefer to hold non-depreciating assets {38J p. 35. There is however, very strong evidence which shows that this does not typify the behaviour of many, if not most consumers. An DECO study [41] pp.4045, of the financial behaviour of the private household sectors of five major countries using flow-of-funds accounts of households, concluded that there has been a rapid growth in consumers' holdings of liquid assets during the 1970's in relation to both total asset formation and disposable income. Because nominal interest rates on some liquid assets have not adjusted fully to inflation and because some are denoted in unchanged nominal monetary
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terms, their real value has diminished. Since the continued acquisition of this type of liquid asset or more generally, of any asset whose real value diminishes as a result of inflation is prima facie irrational, this behaviour requires explanation. First, some consumers are unable to acquire inflation hedges because the absolute deposits and repayments are so large as to prevent them from buy· ing such assets e.g., some land and real property. This restricts the number of outlets for their saving to things like liquid assets. Hence it cannot be concluded that behaviour of these consumers is irrational. Secondly, theory assumes that consumers have perfect knowledge but many consumers may not have consciously thought in terms of negative real interest rates, diminishing real asset values, etc. The continued accumulation of depreciating assets may reflect ignorance. Again, it cannor be said that this behaviour is irrational. Thirdly, some savers are "captive" in that they deliberately choose to acquire Iiquid assets. The liquidity feature is important for people nearing retirement since liquid assets are used to finance consumption during retirement. The recognition that the real value of their assets is declining might even induce these consumers to increase their saving ratios to offset this decline. Fourthly, Forsyth [15] has advanced the hypothesis that consumers have a desired ratio between their liquid asset stocks and their disposable incomes, that this is disrupted by inflation and that the saving ratio rises to re-establish the desired ratio. This hypothesis predicts that the lower the actual liquid asset ratio is (the ratio of liquid assets to disposable incomel, the higher the saving ratio will be. Plots of these Australian data do not however, form any discern able pattern but this may reflect the influence of other variables {62l.
riO Liabilities Inflation generally diminishes the real value of indebtedness denoted in constant nominal terms. The rationality assumption leads one to expect that consumers would be willing to increase real indebtedness relative to disposable incomes if they expect its real value to decline and if real interest rates on the debt are negative. Hence one would expect to observe an acceleration of real expenditures financed by indebtedness in times of inflation thereby lowering the saving ratio. One would neither expect consumers to be reluctant to incur more debt nor to observe a fall in indebtedness relative to disposable income in periods of inflation. However, an OECD study [41]
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pp. 40·45, of the financial behaviour of the private household sectors of five major countries concluded that "". the recent unexpectedly large rises in saving ratios and financial surpluses as a percentage of disposable income was largely a result of declines in borrowing rather than a reflection of accelerating financial asset formation" [41} p.44. There are at least two explan· ations for this apparently irrational behaviour. Firstly, private households' borrowing propensities rose sharply in the 1972·3 boom. This has been attributed to a ..... rapid growth of nominal incomes, easy monetary conditions with relatively low real interest rates, and the related prospect of beating inflation through growing indebtedness... " [411 p. 44. However, the reversal of these conditions in 1974 may have resulted in consumers' disinclination to finance current consumption through indebtedness. Secondly, the fall in indebtedness relative to dispos· able incomes may have resulted from the feeling that existing debt levels were too high given the risks of unemployment and diminishing real income prospects during the following recession [41) p.44. If these are the reasons for such behaviour, once again it cannot be said that consumers have be· haved irrationally.
d. Interest Rates Consumer behaviour theory predicts that the aggregate saving ratio is an increasing function of the money rate of interest assuming that the real interest rate is positive e.g., (18] p. 203. Conversely, negative real yields could be expected to lower the saving ratio. However, consumers continue to amass savings on which real yields are negative. Several explanations of this apparently irrational behaviour may be advanced. First, some savers may be subject to "interest rate illusion" Le., they look at nominal and not real yields. Alternatively, if they do look at real yields they may believe that real yields are positive whereas in fact they are negative. The former situation could reflect ignorance of the fact that infl· ation can result in negative real yields. The latter situation could arise in times of accelerating inflation rates when there is a lag in adjusting anticip· ated inflation rates to actual rates. If actual inflation rates exceed expected rates and if nominal interest rates reflect expected inflation rates, real inter· est rates would be negative.
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Secondly, the upward shift in nominal interest rates associated with inflation has depressed some financial asset prices notably of fixed·interest securities. The losses on the capital values may have resulted in a wealth effect which discouraged consumption and encouraged saving. Thirdly, higher nominal interest rates may have resulted in higher repayments relative to disposable income, on debt incurred in the past. This could apply in countries where interest rates charged on housing mortgages are varied to reflect changing market rates. Most householders regard rises in mortgage repayments as rises in an "unavoidable" commitment. If such payments rise faster than disposable incomes, there is "forced" saving which raises the saving ratio. Calculations show that in Australia, housing loan repayments to permanent building societies as a proportion of disposable income, have risen in recent years (1970: 9.9%; 1971: 12.2%; 1972: 11.4%; 1973: 14.0%; 1974: 16.5%; 1975 first half: 15.7%). On the other hand, some contractual saving e.g., with insurance companies, remains temporarily unchanged in nominal terms while nominal disposable incomes are rising, thus lowering the real value of this saving and the saving ratio. Fourthly, higher nominal interest rates may have contributed to the unwillingness of consumers to borrow, and as we have already seen the rise in saving ratios in five major OECD countries was largely the result of declines in borrowing (41] p.44. As mentioned earlier rising interest rates raise the effective cost of buying goods whose purchase is financed by instalment credit. The repayment of debt may entail a higher level of saving than that which a consumer is prepared to undertake. Thus instead of buying, consumers save and the saving ratio rises. Fifthly, it is possible that saving is interest inelastic and empirical studies generally tend to show that the acquisition of financial assets by households does not respond greatly to rises in interest rates 152] p.22. In addition to econometric studies, surveys support the thesis that financial asset acquisitions by some households are essentially interest inelastic, the rate of return ranking markedly lower than other factors, liquidity and safety of principal being the predominant factors especially for small savers [52) p. 22. 3. Conclusions The rises in saving ratios do not appear to reflect irrational behaviour as defined. Traditional consumer theory is not wrong in the sense that its
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predictions of how rational consumers will behave do not conform with ob· served behaviour. The reason why traditional consumer theory is unable to explain why saving ratios have risen is because it omits from consideration variables which are determinants of saving ratios such as lags, the desire for liquidity, imperfect knowledge, debt levels, "forced" saving, inability to acquire inflation hedges, uncertainty, the desire to maintain real values of wealth, the effects of changes in the price level and others. Nor does it take into account the relative importance attached to eam determinant by different consumer groups.
FOOTNOTES 1.
In the Australian National Accounts, saving is a residual derived by deducting consumption expenditure from household disposable income. However, consumption therein is not defined in the physical sense Le., as the physical consumption of goods and services. In particular, expenditure on durables is treated as consumption. Such treatment implicitly assumes that all of the services rendered by duro able goods are provided in the year of purchase.
2.
Inflation will not induce an increase in the net nominal wealth of all consumers. The effect depends on the form and composition of the individual consumer's balance sheet.
3.
A maior source of studies on consumers' reactions to expectations of price increases is the University of Michigan Survey Research Centre. The results of some of the Centre's early studies are summarised in [4] p.93.
4.
Some evidence of a two stage response may be found in the University of Michigan Survey of Consumer Sentiment. See [40) p.24.
5.
Evidence of such behaviour can be found in Mueller and lean [33] p. 377, who report that consumers alternate between adding to savings stocks and durable goods stocks, the latter being built up by wholly or partly running down savings stocks.
6.
See !orexample, (23) p.29, [41 p. 93, and [291.
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