financial discussions with the girl next door

US Savings Rates – Permanent Income Hypothesis October 18, 2009

Filed under: Uncategorized — girlnextdoorfinance @ 1:41 pm

A few weeks ago I wrote about the US savings rate, since we were reading articles for one of my classes about that topic.

Today I’m reviewing the articles and my notes for the class, because we have an exam later this week. As I was re-reading my summaries of the articles, it occurred to me that in the next few years, the US savings rate is probably going to drop drastically.

In Economics there is an idea called the Permanent Income Hypothesis, which basically says that most people will estimate their total income for their entire life, divide that income by the number of years they expect to live, and spend that amount of money each year. Whether people actually think about it that way is debatable, but here’s what it comes down to: Basically, it means that young people will go into debt (usually for education or to start businesses), then through the middle years people will pay down debts and save money for the future, then in retirement people will draw down their savings. Sounds pretty familiar, right?

Well, it just occurred to me that as baby boomers retire in the coming years, we will see a huge drop in the overall savings rate in America. As this huge generation retires, they will stop contributing to savings and start withdrawing. Since they are much larger as a generation than the generation currently in their middle years (who, according to the Hypothesis, will be the ones doing most of the saving), the average savings rate will fall drastically EVEN IF those in their middle years are saving a significant portion of their incomes. Maybe in coming years, we should focus on savings rates for age cohorts rather than the overall savings rate. The rates are going to sound much more dismal than they really are, since such a large proportion of our population in the US will be retiring and no longer contributing to savings. So, take heart, those of you who worry about things like savings rates! Keep in mind that it will sound much worse than it really is for the next few decades!

And I hope somebody other than me finds this stuff interesting :)


One Response to “US Savings Rates – Permanent Income Hypothesis”

  1. I find it interesting! There’s no such thing as too much information, especially when trying to be frugal. Don’t want to be part of the Permanent Income hypothesis statistic, so I’m living well below my means… Everybody needs to save even if it’s five bucks a month.

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