William De Vijlder

Interest rates are very low and often negative in many countries of the eurozone. This raises the concern that eventually we would be confronted with the paradox of thrift whereby the households’ saving rate increases. This would imply that monetary policy becomes powerless to boost growth. The relationship between interest and savings is a very complex one and empirical research does not provide conclusive answers. Recently, one observes somewhat of an increase in the eurozone. It remains to be seen whether that is the start of a trend.

The paradox of thrift or of saving has been made popular by John Maynard Keynes. It means that when people decide to increase their savings, which may make sense at the individual household level, it has a negative impact in the aggregate because it slows down consumption and hence economic growth.

With rates being very low and often negative, there is concern that we would be confronted with this paradox. This would imply that monetary policy becomes powerless to boost growth.

Before discussing the repercussions of low to negative interest rates, it is useful to distinguish a number of concepts.

The household saving rate is defined as gross household saving divided by gross disposable income.

Gross saving is the part of the gross disposable income which is not spent as final consumption expenditure. Therefore, the saving rate increases when gross disposable income grows at a higher rate than final consumption expenditure.

Saving rates can be measured on either a gross or net basis. Net saving rates are measured after deducting consumption of fixed capital (depreciation).

Household savings can be used for household capital formation (essentially the purchase and renovation of dwellings) and for financial savings.

The impact of low and declining interest rates

Declining and low interest rates can impact household savings and the household savings rate via various channels.

Faster economic growth will lead to an increase in employment and hence household income. This should boost the volume of household savings.

Low rates reduce the opportunity cost of spending money today, rather than tomorrow. This is called the substitution effect. It reduces the savings rate.

The income effect has the opposite effect: a decline in interest rates implies lower financial income out of a given size of financial assets. As a consequence, households may decide to save more and spend less.

Households may also spend less, save more, take a mortgage to buy a house because rates are low. This implies a substitution between consumption and capital formation.

Finally, declining interest rates may boost property prices and equity markets. This can support consumer spending via a wealth effect, and hence weigh on the volume of savings.

The consequences of lasting negative real rates

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, one 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.