Part 3 - The paradox of saving: individual rationality, macroeconomic headache

What do you mean with individual rationality?

Nominal government bond yields are negative in many eurozone countries, even for longer maturities. Taking into account inflation, real interest are even more negative. This has a negative impact on financial income. Certain households may start to wonder how they will make ends meet after having retired.

To put it differently, negative interest rates may create a mismatch between assets and liabilities, the former being lower than the latter. This is the situation that certain Dutch pension funds are in and which may lead to a cut in the pay-out upon retirement. One can argue that it is a manifestation of the challenge facing households wherever real interest rates are negative.

Whether negative rates will lead to an increase in the savings rate will, amongst other things, depend on the extent to which households consider that rates will remain negative for many years to come. Empirical research doesn’t provide a clear answer. However, on does observe that in recent quarters the savings rate has increased somewhat in the eurozone, in France and, particularly, in Germany. Whether it is the start of a trend remains to be seen.

Why is it a macroeconomic headache?

Potentially it is a headache because, to the extent that the savings rate increases and this does not correspond to an increase in household investments, the effectiveness of monetary policy declines.

This would force an inflation-targeting central bank to cut rates more, further into negative territory, do buy more assets (QE), etc. Although it could increase certain asset prices, it lowers their expected return and it could end up increasing the risk aversion of household. In turning to safe assets, it would make it even more difficult to have enough assets to cover future liabilities.

What to do then?

Work directly on demand, hence the emphasis by Mario Draghi on the role of fiscal policy.