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FRBSF

WEEKLY LETTER

September 28, 1984

Impervious Saving Behavior
One argument made a few years ago by proponents of large federal tax cuts was that the resu Iti ng
massive federal deficits could automatically be
financed by the private sector. In part, the argument relied on the hypothesis that the fall in tax
rates wou Id create an incentive for the private
sector to increase its saving rate, and that the
increase in private saving would finance the federal deficits and obviate any increase in market interest rates.
Such arguments no longer appear in the financial
press because the reality is that we live in a country
of deficient domestic saving. This deficiency is
easi Iy measured. It is simply the difference
between gross private domestic investment and
gross domestic saving in our national income
accounts. Gross saving is the sum of gross private
saving (personal and business) and the saving of
the government sector.
In the second quarter of this year gross private
savi ng totalled $663 bi II ion. Added to the $54
bi II ion su rplus of state and local governments and
the $167 federal deficit-the "dissaving" of the
federal government, we find that the gross saving
of the entire economy in the second quarter of
1984 amounted to $550 billion, at an annual rate.
In contrast, gross private domestic investment
totalled $626 billion. Domestic investment therefore exceeded domestic saving. The balance of
about $76 billion was made up in essence by
borrowing from abroad. Foreigners can be viewed
as having provided about 12 percent of the funds
needed to finance U.S. private investment in the
second quarter, oras having financed about 45
percent of the federal deficit.

How the private sector sees the government
Before the proponents of large federal tax cuts
made their claims about probable private sector
responses to increased federal deficits and higher
after-tax rates of return, they should have studied
the post-war behavior of gross domestic private
saving. Despite recent economic events such as
changes in federal income tax rates and high real
interest rates, the gross domestic private saving
rate whether measured as a percent of GNP or of
national income has remained relatively stable.

From 1975 to 1983, gross domestic private saving
as a percent of gross national product varied
between 16.5 percent and 18.2 percent. In the last
three years, its rate has moved narrowly between
17.1 and 17.3 percent. The same stability does not
describe the government saving rate. Since 1975,
federal, state and local financial positions combined have yielded a government saving rate (as a
percent of GNP) that has ranged from about zero
in 1979 to negative 4 percent in 1983. Gross domestic private saving, has, then, seemed insensitive to the financial position of the government
sector as well as to the extraordinarily high level of
real interest rates in recent years. (See Chart 1.)
While the gross domestic private saving rate has
been relatively stable, its two componentspersonal saving and business saving have not. As
noted by Edward F. Denison three decades ago,
personal saving and corporate saving often appear
to move in opposite directions. In a sense, the
personal sector appears to incorporate the saving
behavior of the corporate sector in its own decisions to save and to consume. This is not unreasonable. Since the non-business (personal) sector
"owns" the corporate sector, it considers corporate saving, composed of undistributed corporate
profits and depreciation of corporate and noncorporate business, a close substitute for personal
saving. This implies, as noted by Denison, that
personal consumption expenditures are unaffected
by corporate dividend behavior.
The offsetting saving behavior of the personal and
corporate sectors leads to stability in the gross
private domestic saving rate. The relationship is
clearly observable in the two saving rates in just
the last few years (Chart 2). Business saving as a
percentof GNP grew from 12.6 to 13.7 percent
between 1981 and 1983. Personal saving as a
percent of GNP, on the other hand, fell from 4.6 to
3.6 percent from 1981 to 1983. The net effect was
to produce gross private saving rates (as a percent
of GNP) of 17.24, 17.07, and 17.30 percent in
1981,1982 and 1983, respectively.
Domestic private saving has truly been impervious
to the level of real interest rates in recent years and
to the fi nancial status of the federal government,

FRBSF
whose deficits have nearly tripled during the
period from 1981 to 1983. While the personal
sector seems to continue to incorporate the saving
status of the business sector in its own saving
decisions, it appears to have disregarded the financial status of the government sector.

Not internalizing government financial behavior
The debate over the effect of the federal government deficit on the real economy centers on the
degree to which taxpayers recognize any current
and future costs associated with paying for government expenditures with the sale of bonds rather
than through immediate taxation. At the local
community level, one might argue that taxpayers
quickly recognize that bond issuance will involve
a future financial burden to the local residents.
These residents would alter their saving behavior
in recognition of the future financing burden. In a
sense, bond finance may be viewed as deferred
taxation. A similar argument applied to federal
deficits has gained popularity recently among
some academic economists. However, it is difficult
to observe any major change in private domestic
saving behavior in response to the outbreak of
large federal deficits.
The stability of the gross private saving rate in the
face of federal budget deficits amounting to 5-6
percent of GNp, and expected to remain in the 3-4
percent range for the next several years, is inconsistent with recent arguments promoted by some
academics that current federal deficits, entailing
future principal and interest servicing costs, are
equivalent to and interpreted by consumers as
future taxes. Their argument presupposes that
consumers realize that the only real "tax cut" is a
government spending cut. Since they recognize
this equivalence, according to the argument, they
would not have interpreted recent personal income tax cuts as real tax cuts. Instead, they would
have recognized the need to obtain additional
interest-earning assets in order to pay forthe future
costs of servicing the increased federal deficit and
saved all of the tax cut. The result should be a rise
in the gross private saving rate. Chart 1 shows that
in 1969 and 1975, for example, fhe gross private
saving rate and the government saving rate moved
in opposite directions, as suggested by the theory.
Recent facts, however, do not support this argument. Between 1981 and 1983, the gross private
saving rate averaged 17.20 percent compared with
an average saving rate of 17.18 percent of GNP
between 1975 and 1980. The tax cut and resulting

federal deficitsdo not appearto have disturbed the
general stability ofthe gross private saving rate.

The saving gap
The apparent insensitivity of the gross private
saving rate to changes in after-tax rates of return
means that gross domestic saving likely will fall
short of gross private domestic investment if the
federal government goes substantially into deficit.
The resulting shortfall may be called the "domestic
saving gap." This gap totalled about $34 billion in
1983 and was closed by importing foreign capital,
observable in our large and growing current
accou nt deficit.
The existence of both large federal deficits and
large current account deficits has sometimes led to
the claims thatthe former "causes" the latter. This
is not necessarily true. The current account deficit
could decline significantly, that is, the saving gap
could close, even in the face of large federal deficits if domestic private investment would decline
-the textbook case of "crowding out." Eliminating the domestic saving gap therefore requires
either a fall in domestic investment or a reduction
in the federal deficit.
But is the current saving gap necessarily pernicious, something to be avoided? Not necessarily.
What we observe in the United States is that
capital investment is more cyclical and more
interest-sensitive than private saving. Hence, the
saving gap is altered by cyclical swings in investment. For example, between 1978 and 1982, the
ratio of gross private domestic investment to GNP
fell from almost 18 percent to 13.5 percent, while
the gross private saving rate was 17.3 and 17.1
percent.
The cyclical recovery beginning in late 1982
coupled with the reduction in after-tax interest
costs of business capital investment and the resulting pick-up in investment led to the emergence of
a saving gap and the need for the
to import
capital tofinancewhat has turned outto be almost
a capital investment boom in 1984. The saving
gap currently reflects the very strong cyclical
growth in business capital investment as well as
the deficit status of the federal government. But
unlike earlier recoveries, the saving gap is not
expected to decline because the government saving rate is not expected to become less negative as
itdid between 1975 and 1979.

u.s.

Chart 1
Saving and Real Interest Rates

Chart 2
Saving Rates as a Percent 01 GNP

Percent

Percent

6

19
Real Interest

..-: Gross Private!

~

Rate

Saving Rate ''"\..

17

15

13

.

.

.41'.,.. . , I:...G.•

~
la";

•

Government~....:

.

Saving Rate"
11

4

1'/'1' ",-"

<f(""""/.. .\

\.l
"If

Percent

20

15
2

,..-•

.". .. •
.....
•
•

I

,

•
•
•
•

o

":.

•

•
•
•
•

'.

10

.,
5
Personal Saving Rate

·4

•
1960
1965
1970
1975
1980
1985
Real interest rate defined as the l-yearTreasury bill rate less the

9

oL.L.J..J...L.L..L.L..LJU-JU-L.LJ..J.J..J...L.L..LJU-JU
1960

1965

1970

1975

1980

1985

annual rate of change in the GNP price deflator.

In part, the present situation is not unlike what
occurred after the Civil War, when rapid U.S.
economic growth and a declining price levelled
to massive importation of foreign capital. From
1861 to 1899, the United States was more often
than not a financial capital importer. Only in nine
years during this period did the United States
experience a capital outflow. And not until the
end of the 19th century did the United States turn
from importing to exporting financial capital. This
comparison of saving behavior in the 19th century
with that in 1984 is meant simply to emphasizethe
fact that rapid economic growth and low inflation
is often accompanied by capital importation,
particularly if rates of return on real and financial
investments are higher than they are abroad,
which now appears to be the case.
The stability of the gross domestic private saving
rate in the United States means that a significant
pick-up in capital investment would lead to a
cyclical shortfall of private domestic saving available to finance private investment. The private
saving gap can be filled either by saving in the
government sectors or by importing of foreign
capital. In the long-run, it makes a considerable
difference how the private saving gap is closed.
Interest payments on the federal debt to foreign
bond holders represent a real future tax burden to
U.5. citizens. One cou Id argue thaHhe heavy
importation of foreign capital is financing current
government consumption and not private invest-

ment and hence the deficit represen.ts the mortgaging of future income to pay for this excess
consumption.

Tax policy implications
Changes in neither the personal income tax structure nor real after-tax interest rates have affected
the U.S. gross domestic private saving rate. As a
result, a large and possibly structural, that is, noncyclical, domestic saving gap has emerged, resulting in U.S. dependence on foreign capital to
finance both capital formation and the deficit of
the federal government.
Shou Id aggregate tax pol icy be changed to reduce
the saving gap? This is obviously a sensitive and
politically charged question, but we can conjecture that as the tax cut seems to have had no effect
on the gross private saving rate, so a personal tax
increase would most likely leave it unchanged. If
the corporate tax rate is left unchanged, it is possible, although quite conjectural, that a tax increase on consumers alone might help close the
saving gap without greatly affecting the growth of
capital investment. That is, a tax increase on consumers might contribute to lowering the federal
deficit without changing the gross private saving
rate. Such achange intax policy would recognize
the insensitivity of the gross private saving rate to
changes in taxes and real interest rate and the
sensitivity of capital investment to both.

Joseph Bisignano

Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of San
Francisco, or of the Board of Governors of the Federal Reserve System.
Editorial comments may be addressed to the editor (Gregory Tong) or to the author .... Free copies of Federal Reserve publications
can be obtained from the Public Information Department, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco
94120. Phone (41S) 974-2246.

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BANKING DATA-TWELFTH FEDERAL RESERVE DISTRICT
(Dollar amounts in millions)

Selected Assets and Liabilities
Large Commercial Banks
Loans, Leases and Investments 1 2
Loans and Leases 1 6
Commercial and Industrial
Real estate
Loans to Individuals
Leases
U.s. Treasury and Agency Securities 2
Other Securities 2
Total Deposits
Demand Deposits
Demand Deposits Adjusted 3
Other Transaction Balances 4
Total Non-Transaction Balances 6
Money Market Deposit
Accounts-Total
Time Deposits in Amounts of
$100,000 or more
Other Liabilities for Borrowed MoneyS

Weekly Averages
of Daily Figures

Amount
Outstanding
9/12/84
182,490
163,448
48,660
60,908
29,734
5,047
11,876
7,165
192,998
47,172
29,290
12,644
133,182

-

37,985

-

41,120
21,923
Period ended
9/10/84

Change from 12/28/83
Percent
Dollar
Annualized

Change
from
9/05/84

-

-

214
314
30
85
84
24
86
13
359
162
40
240
43

-

-

6,465
8,093
2,697
2,009
3,083
16
631
998
2,001
2,065
2,041
131
4,197

-

1

2

3
4

S
6

23
39
15

-

-

13

-

1,612

-

5.7

4
1,710

-

2,955
1,084

-

10.8
6.6

Period ended
8/27/84

Reserve Position, All Reporting Banks
Excess Reserves (+ )/Deficiency (-)
Borrowings
Net free reserves (+ )/Net borrowed( -)

-

5.1
7.3
8.2
4.7
16.2
0.4
7.0
17.1
1.4
5.8
9.1
1.4
4.5

60
68
7

Includes loss reserves, unearned income, excludes interbank loans
Excludes trading account securities
Excludes U.S. government and depository institution deposits and cash items
ATS, NOW, Super NOW and savings accounts with telephone transfers
Includes borrowing via FRB, TI&L notes, Fed Funds, RPs and other sources
Includes items not shown separately