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Volume 5, Number 1 April 27, 2010

Macroeconomic Advisers’

• We think not.

• The argument that the personal saving rate is headed to 7% is based on a long-
term relationship between wealth and saving that is assumed to be stable over time.

• In fact, this long-term relationship shifts for reasons that are well understood.

• The current “position” of this long-term relationship, indeed, suggests no
upward pressure on the personal saving rate.

• Over the next two years, this relationship is expected to shift in such a way as
to suggest only modest upward pressure on the personal saving rate.

• The speed with which the personal saving rate normally adjusts to levels sug-
gested by the shifting long-term relationship suggests little risk to our forecast that
the personal saving rate will be nearly unchanged over the next two years.
We continue to look for above-trend GDP growth this year and next. At 3½% this year and
4% next year (measured Q4/Q4), our projection for GDP growth is roughly ¾ percentage
point above the Blue Chip consensus. Key to our optimistic GDP forecast is robust growth
of consumer spending. We are projecting growth of personal consumption expenditures
(PCE) of roughly 3% this year and next, accounting for more than half of expected GDP
growth. Through 2011, the personal saving rate in our forecast stays within several tenths of
its February level of 3.1%.

Our projection for PCE is derived from a model of consumer spending that has two distinct
parts. The main portion of the model is a life-cycle model that relates service-concept con-
sumption to labor income, transfer income, and wealth.1 This model is well grounded in con- SUITE 900
sumer theory and understands the historical data quite well. The other portion of the model ST. LOUIS, MO 63105
explains expenditures on durable goods as a means to maintain an optimal stock of durable PHONE: 314-721-4747
goods, where “optimal” is determined by the scale of total consumption and the cost of using FAX: 314-721-6383
durable goods. The paths for consumer spending and the personal saving rate in our forecast are
fully consistent with the fundamentals as reflected in this dual model.
Some who expect households’ desire to increase saving (and thereby the saving rate) will result SUITE 1030
in a period of significantly weaker spending growth point to a long-term relationship between WASHIINGTON, DC 20006
the wealth-to-income ratio and the personal saving rate. That simple relationship suggests the PHONE: 202-521-0302
personal saving rate has to rise to nearly 7% given the current ratio of wealth to income. Crit- FAX: 202-449-6715
ical to this argument is the notion that the long-term relationship between saving and wealth
is stable over time. As we argue below, this is not the case; the relationship between saving and
wealth shifts over time for reasons that are well understood. Moreover, the current position of E-MAIL:
Service concept consumption is nearly identical to personal consumption expenditures, but it replaces expenditure on durable goods with VISIT US ON THE WEB:
estimates of consumption of durable goods (depreciation) and the flow of services from the stock of durable goods.

Copyright © 2010 Macroeconomic Advisers, LLC
Figure 1 the relationship suggests no upward pressure on the personal
Saving Rate and Household Wealth saving rate at all. Furthermore, an upward shift in this rela-
Saving Rate
14 tionship over the next two years is expected to exert only mod-
12 $ $ est upward pressure on the personal saving rate, but not near-
$ $$$$$
$$ $ $ $ ly enough to imply a personal saving rate anywhere near 7%.
10 $$$$ $$$$$$$$$$$$$ $$
$$ $ $ $$ $$ $$ $$$$
$$ $$$ $ $$ $
$ $$
$ $$ $$$ $$$ $$$$ $$ $ $$$$
8 $ $ $ $$$$ $$$$
$$$$$ $$$
$ $$$$$$$ $$$ $
$$$$ $$
6 $$ $$$$$ $
$ $$$$$ $
$ $ $$$ $$ Figure 1 plots the wealth-to-income ratio against the personal
$ $ $$ $$ $ $ $
4 $ $$
,$$ $ $ $$
$ $
$$$$ $ $ $$ $
saving rate for quarterly data beginning in 1960. Also shown
$$ $ $
2 2010:Q1 $$ $$
$ $$ on the chart is an observation corresponding to the first two
$ $ $ $ $$ $$$
0 months of this year.2 The line plotted in Figure 1 is a simple
regression of the personal saving rate on a constant and the
3.5 4 4.5 5 5.5 6 6.5 7 wealth-to-income ratio. This is the long-term relationship in
Wealth Ratio
Source: Bureau of Economic Analysis; Flow of Funds; Macroeconomic Advisers, LLC question. On its face, it suggests that if the wealth-to-income
ratio remains near the present level, the personal saving rate
will eventually rise to nearly 7%. If this were to occur over the
Table 1 next two years, it would be difficult for consumer spending to
Dependent Variable: Personal Saving Rate
post the kind of growth we show in our forecast.
Sample: 1960Q1 2009Q4
(Newey-West adjusted t-scores in parantheses) If the long-term relationship shown in Figure 1 were stable,
the current configuration of saving and wealth would be some-
1 2 3 thing to worry about. However, it’s fairly easy to demonstrate
empirically that the relationship is not stable. The first col-
Intercept 27.9 22.7 -15.0 umn of Table 1 shows the regression results that give rise to the
(22.2) (19.6) (-7.2) long-term relationship shown in Figure 1. The second column
DUM85 -2.5 shows the results of simply allowing a shift in the intercept
(-8.3) term in the first quarter of 1985, precisely in the middle of the
sample. The highly significant (and negative) coefficient sug-
Shift Term 1 gests that for any given wealth-to-income ratio, the associated
saving rate is, on average, 2.5 percentage points lower in the
Wealth/Income -4.3 -3.0 -4.3 second half of the sample than in the first.3 This suggests the
(-17.0) (-12.3) (-10.3) simple, two-variable long-term relationship is not stable, and
it is inappropriate to use its prediction at the end of the sam-
ple to forecast the saving rate.
R-squared 0.74 0.88 0.73
Adjusted R-squared 0.74 0.87 0.72
The reason the relationship between saving and wealth shifts
over time becomes clear when one considers the consumer theory that links the two. The
life-cycle model of consumer spending relates service-concept consumption (C) to labor
income (YL), transfer income (YT), and wealth (W) as follows:

The personal saving rate averaged 3.3% over January and February and end-of-Q4 wealth was roughly 5 times disposable personal
This result is robust to selection of the break point. We did the same exercise assuming the possibility of a shift in the intercept term
in every quarter from 1970:Q1 through 2000:Q4. The average t-score across these 124 tests was -6.1, with the smallest (in absolute
value) at -3.1. For each exercise, moreover, the coefficient was negative, ranging in value from -1.6 to -2.9.

2 • Apr. 27, 2010 Macroeconomic Advisers, LLC
Eq. 1 C = β Y γ Y YL + β T YT + β W γ WW .
The β ’s are marginal propensities to consume, and the γ ’s are demographic adjustments
that capture variation in the age profile of the population. This is the long-term relation-
ship we use in our error-correction model of service-concept consumption.

Right away, from Equation 1, it is evident that the relationship between the consumption
rate — the ratio of service-concept consumption to disposable income — and the wealth-
to-income ratio is not necessarily stable. It depends on the age profile of the population (as
reflected in the γ ’s) and the shares of labor and transfer income in disposable personal
income.4 The same intuition holds for the relationship between the personal saving rate
and the wealth-to-income ratio. Simple manipulation of Equation 1 yields:

Y − C 
Eq. 2 100 ∗ 
 β Y γ Y YL + β TYT + β W γ W − 1 W  (
W 
 − 100 ∗ β W ∗   ,
 = 100 ∗ 1 −
 Y   Y  Y 
where Y is disposable personal income.

The left hand side of Equation 2 is not the personal saving rate because what’s subtracted
from disposable personal income in the numerator is not total outlays. However, the dif-
ference between it and the personal saving rate is stationary 5, so we can express the long-
term level for the personal saving rate, s, as
Shift Term
644444444 744444444 8
Eq. 3

s = α + 100 ∗ 1 −
β γ YL + β YT + β γ − 1 W 
( W 
 − 100 ∗ β W ∗   ,

 Y  Y 
where α captures the difference between the left-hand-side of Figure 2
Equation 2 and the personal saving rate.6 Equation 3 reveals Shift Term
what the life-cycle model of consumption suggests about the 48
long-term relationship between the personal saving rate and
the wealth-to-income ratio: its position shifts over time with 46

variation in, among other things, income shares and demo-
graphics. We calculated values for the Shift Term over histo- 44

ry and in our forecast.7 They are displayed in Figure 2.
Notice that in recent quarters, the Shift Term is 4 percentage 42
points lower than it was in the mid- to late-1980’s, account-
ing for 4 percentage points of the roughly 7-percentage-point 40
decline in the trend in the personal saving rate since then.
This begs the question of what has accounted for the decline 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008
Source: Macroeconomic Advisers, LLC
in the Shift Term. Since the mid-1980’s, transfer income has
risen as a share of personal disposable income by roughly 5

This is evident when we divide both sides of Equation 1 by disposable personal income.
The null hypothesis of a unit root (against an alternative of a stationary, constant-mean model) is rejected at the 5% level of signifi-
This difference includes the difference between PCE and service concept consumption as well as non-PCE outlays, both expressed
as ratios to disposable personal income.
To calculate values for the shift term, we use 0.64 for the MPC out of labor income, 1.22 for transfer income, and 0.066 for wealth.
Details of the calculation of the demographic adjustments are available upon request.

Macro Focus Apr. 27, 2010 • 3
percentage points (from about 13% then to roughly 18% now). Over the same period, the
labor-income share has declined by about 3 percentage points (from about 63% to 60%)
and the other-income share (mainly asset income) has decline by about 2 percentage points
(from about 24% to 22%). The MPC out of transfer income (about 1.22) is about twice
that out of labor income (about 0.64), so the change in the composition of income lowers
the Shift Term; i.e. lowers the long-term level in the personal saving rate for any wealth-to-
income ratio.

Equation 3 makes clear that when one estimates a simple linear relationship between the
personal saving rate and the wealth-to-income ratio, one assumes that α + Shift Term can
be represented by a constant. While this may be appropriate for α (it is stationary), it is
not for α + Shift Term , as is evident in Figure 2. In light of this, we estimated Equation
3 while restricting the coefficient on the shift term to equal 1. The results appear in col-
umn 3 of Table 1. Notice that the coefficient on the wealth-to-income ratio is identical to
that of the initial regression, so the only real difference between this “shift-adjusted” long-
term relationship and the simple, two-variable long-term
Figure 3 relationship that has some analysts worried is this equation
Personal Saving Rate and Predicted Levels
Percent allows the position of the long-term relationship to shift
H F over time for reasons that are well understood and ground-
Predicted level from
ed in consumer theory.
simple, two-variable
long-term relationship

Figure 3 shows the personal saving rate over history and in
our current forecast. Also charted are the predicted values
from the simple, two-variable long-term relationship (col-
4 umn 1 of Table 1) and the shift-adjusted long-term rela-
2 tionship (column 3 of Table 1). The simple, two-variable
Predicted level from relationship currently is predicting a long-term level for
0 shift-adjusted long-term
relationship MA forecast the saving rate of about 7%, with little change to this pre-
1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008
diction in the forecast. This is the prediction that has
Source: Bureau of Economic Analysis; Macroeconomic Advisers, LLC
some analysts worried. The shift-adjusted long-term rela-
tionship currently is predicting a long-term level of rough-
ly 3%, suggesting no upward pressure on the personal saving rate at all. By the end of 2011,
the prediction rises to about 5%, or 1½ percentage points above our forecast. However,
given the normal speed with which the personal saving rate adjusts to the shift-adjusted
long-term level, the personal saving rate would be expected to rise to only 3.6% by the end
of 2011, nearly identical to our forecast. 8

The simple, two-variable relationship between the personal saving rate and the wealth-to-
income ratio that has some worried about the path of saving and consumption over the next
couple of years is not stable. This lack of stability results from the fact that it treats as sta-
tionary variables such as income shares and demographics that are known to be trended.
When the simple, two-variable relationship is supplemented with these variables, it ration-
alizes the current low level of the personal saving rate.
We estimated the normal speed of adjustment by regressing the change in the personal saving rate on one lag of the difference
between the shift-adjusted long-term level and the actual saving rate. To arrive at the value of 3.6% by 2011:Q4, we simulated this
dynamic equation.

4 • Apr. 27, 2010 Macroeconomic Advisers, LLC
Furthermore, for reasonable projections of demographics, income shares, and the wealth-
to-income ratio, the projected long-run level of the personal saving rate suggests little risk
to our forecast of only a modest increase in the personal saving rate over the next couple of

Finally — and this is key — what really matters for the outlook for GDP is the evolution
of consumer spending, not consumer saving. The personal saving rate could rise more than
in our forecast in a way that would not jeopardize our forecast of consumer spending; i.e.,
asset income could rise rapidly, providing a boost to personal income but not to consumer
spending (because asset income is not in the consumption function).

We are confident that the fundamentals for consumer spending are properly reflected in our
projection for consumer spending. If our forecast of consumer spending proves correct,
what happens to the personal saving rate is of secondary importance.

The forecasts provided herein are based upon sources believed by Macroeconomic Advisers, LLC, to be reliable and are devel-
oped from models that are generally accepted as methods for producing economic forecasts. Macroeconomic Advisers, LLC,
cannot guarantee the accuracy or completeness of the information upon which this Report and such forecasts are based. This
Report does not purport to disclose any risks or benefits of entering into particular transactions and should not be construed
as advice with regard to any specific investment or instance. The opinions and judgments expressed within this Report made
as of this date are subject to change without notice.

Macro Focus Apr. 27, 2010 • 5