3 December 2010
The limitations of credit granting and the caution of households cause so-called procautionary saving behaviour in households: the uncertainty of income from work motivates households to gather savings. This behaviour can possibly have significant consequences on the long-term economic growth and trend fluctuations. For example, increased procautionary saving during the latest financial crisis contributed to the lowered consumption of households.
However, currently available research results are contradictory as for the importance of procautionary savings behaviour for economic growth and trend fluctuation. In his doctoral dissertation, Tomi Kortela (Lis.Soc.Sc. Economics) studied three different situations in which the procautionary saving of households can be considered to significantly influence the national economy.
Do credit shocks affect aggregate consumption?
One argument to support the public-sector recovery package in the U.S. was that the banking crisis led to a decrease in credit offerings, which caused credit-limited consumers to reduce consumption. The research reviews the scale in which changes in credit offerings can influence the aggregate private consumption.
The research shows that the number of consumers whose consumption is mainly dependent on the level of crediting in the U.S. is so low that this group of people cannot cause major changes in the aggregate consumption. This means that changes in credit offerings do not affect the aggregate consumption, at least not through households.
Changes in credit offering are more likely to impact companies which may have to make personnel cuts. This, in turn, leads to an increased uncertainty of the households' expected work income, which increases procautionary saving.
How extensive is procautionary saving in Finland?
If households maintain assets mainly because they feel uncertain about work-related income, procautionary saving constitutes a key motivation for financing investments and accumulating capital. In this case, such factors as changes in the social security payments can have a key impact on saving and economic growth. However, there are contradictory research results about the magnitude of this motivational factor, and there are, to our knowledge, no estimates whatsoever of the magnitude of this factor in Finland.
Kortela's research presents a new method for measuring the magnitude of the procautionary motive. The research shows that the magnitude of this motive is significantly dependent on the level of risk aversion in households and the so-called subjective discount interest. The reliable measurement of these parameters from the given data is difficult and, therefore, the magnitude of this factor cannot be reliably estimated. However, using generally used parameter values, it can be estimated that approximately 20 percent of households' assets are kept for procautionary reasons.
Social security and inability to work
The costs of the social security system are generated by two separate sources: social security distorts the economic behaviour of households, and the higher taxation rates needed to finance the social security system distort the incentives for working and saving. In an alternative system without any social security systems, households would have to prepare for possible unemployment independently, through savings.
Kortela's research indicates that the U.S. social security system against unemployment lowers households' aggregate consumption by 2.5 percent. In this amount, reduced procautionary saving accounts for 2/3 and the higher tax rates for 1/3 of the costs. However, the social security system does increase welfare, because households' (procautionary) savings would not provide sufficient protection against inability to work. Nevertheless, the research shows that the best way to increase welfare is to aim at a well-functioning private insurance system. This would enable an increase in private consumption, up to 7 percent higher than the current level.
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Tomi Kortela's dissertation "The intertemporal choice of households under incomplete markets in general equilibrium" belongs to the field of Economics.
Contact information: +358 2 333 6438, tomi.kortela[at]utu.fi
Kortela's picture: http://www.utu.fi/vaittelijat/kortela_tomi.jpg
Read the dissertation: http://info.tse.fi/julkaisut/vk/Ae6_2010.pdf