October 28, 2005 (GDP Byte)
Savings Rate Goes Negative as Consumption Drives Growth
October 28, 2005
By Dean Baker
GDP grew at a solid 3.8 percent annual rate in the third quarter, driven primarily by another quarter of strong consumption growth. The 3.9 percent annual rate of consumption growth far outstripped income growth, pushing the savings rate down to negative 1.1 percent. This is the first quarter ever in which households were reported to have a negative savings rate. The other major factor spurring the economy was a 10.2 percent surge in defense spending, which added 0.47 percentage points to the growth rate. Investment grew at a relatively weak 6.2 percent annual rate.
The increase in consumption was driven largely by strong auto sales in the quarter, which increased at a 17.6 percent annual rate, adding 0.62 percentage points to GDP growth. Non-auto consumption growth was more moderate, with services growing at a 3.2 percent annual rate and non-durables at 2.6 percent annual rate. Consumption growth will almost certainly be far slower in the fourth quarter, as car sales fall back from their record levels in the third quarter.
The 1.2 percentage point drop in the savings rate from the previous quarter was driven in part by one-time losses of rental property associated with Hurricane Katrina. But, even without this effect, the savings rate still would have been negative 0.6 percent. With slower car sales, the savings rate will presumably rise in the fourth quarter, but the low level of recent savings rates are striking regardless of how the data are adjusted. The savings rate averaged more than 8 percent from the sixties to the eighties. The current demographics, with almost the entire baby boom cohort in its peak savings years, are heavily tilted toward saving. The fact that households are net borrowers should raise serious concerns about how well prepared baby boomers will be for retirement.
The investment data in this report is especially discouraging. When savings start to return to more normal levels and consumption slows, it will be necessary to have strong double-digit investment growth to sustain the economy (consumption spending is almost 7 times as large as investment spending). This is the third consecutive quarter that investment growth has been in the single digits, and recent data on durable goods orders indicate that it may be slowing further in the near future.
The data show both real imports and exports to be virtually flat for the quarter. Some of this may be attributable to shipping disruptions caused by Katrina. While the real trade balance changed little in the quarter, the nominal deficit hit a new record of 5.73 percent of GDP ($721.7 billion) due to the sharp run-up in oil prices. Most forecasts show the deficit rising still higher in 2006, which will be a further drag on growth.
Housing continued to be a strong positive factor, growing at an 8.9 percent annual rate and adding 0.28 percentage points to the growth rate. Inventories fell for the second consecutive quarter (partly due to a strike at Boeing), subtracting 0.55 percentage points from the growth rate. Firms will presumably start adding to their inventories again in the fourth quarter, which will give a boost to growth.
The overall GDP price index rose by 3.1 percent, while the core (excluding food and energy) index grew at a 2.5 percent annual rate. This is consistent with other data showing that surging energy prices were not yet affecting the prices of other items in the 3rd quarter, although the rising prices of many intermediate goods suggest that the core index may show higher inflation in the months ahead. Output growth in the non-farm sector implies productivity growth will be approximately 2.4 percent for the quarter, somewhat of a bounce back from last quarter's 1.8 percent.
On the whole, the data show the economy moving further out on an unsustainable path of negative savings, large trade deficits, and severe overbuilding in the housing sector. There is some evidence that the housing market is weakening, which would bring this cycle to an end, but it is certainly too early to be confident in the direction of the market at this point.
Dean Baker is Co-Director of the Center for Economic and Policy Research in Washington, D.C.
CEPR’s GDP Byte is published quarterly upon release of the Bureau of Economic Analysis' report on the Gross Domestic Product.