Savings, Personal Wealth and Risk

In this Briefing Paper we examine the underlying determinants of personal savings behaviour to substantiate our view that the recent fall in savings rates does not imply that it must in future bounce back to some more normal level. On the contrary there are good reasons for believing that savings are more likely to go on falling than to rise.
We argue that consumer behaviour should be related explicitly to personal wealth as well as to disposable income. Personal wealth has risen substantially since 1982: the fall in inflation and long-term interest rates has pushed up gilts' prices; the recovery of profits has sparked off a stock market boom; and the value of the housing stock, which is by far the most important asset held by the personal sector, has started to rise again in real terms. This rise in asset values means that, despite a rise in consumption financed by borrowing, the personal sector balance sheet still in a healthy state, particularly when account is taken of the personal savings now held indirectly via pension funds. These have risen rapidly recently, reducing the need for other long-term savings.
The rise in total wealth has increased savers' tolerance of a fall in net liquid assets (bank and building society deposits etc less borrowing). The willingness to hold a smaller (precautionary) stock of net liquid assets may also reflect a perceived reduction in risk. Financial markets have been much more stable over the period since 1975 than over the preceding eight years, and may now be signalling that the period of adjustment to the shocks and disturbances of the 1970s is drawing to an end. The fall in savings is a worldwide phenomenon. As in the UK it is linked to the fall in inflation and may also be connected with the recovery of the world's major stock markets.     

HOUSE PRICES AND THE ECONOMY

UK house prices more than doubled from 1985 until 1989, with house price inflation over the previous year peaking at 34 per cent in the fourth quarter of 1988. The ratio of house prices to average incomes reached levels which surpassed even those experienced during the 1972-73 house price boom. This sharp increase in housing wealth has been a major factor in the fall in the savings ratio over the past three years. This forecast release examines the prospects for future house price movements, discusses the sources of the recent house price boom and finally considers the possible impact on consumer expenditure.     

The asymmetric response of the economy to tax changes before and after 1980

This paper explores the asymmetry in the response of GDP to tax shocks before and after 1980 as first noted in Romer and Romer (2010). I find that there are two main reasons why output responds more strongly to tax shocks before 1980 than after. First, a greater sensitivity of the effect of tax shocks on output to the state of the economy before 1980 explains about half of the difference between periods. Second, before 1980 the effect of tax shocks on households is indirect and lowers total personal income and nondurable goods consumption. After 1980 tax shocks affect personal tax payments directly, causing disposable income and savings to change. This finding affirms Romer and Romer’s hypothesis that households are more likely to consumption smooth. However, I find that households after 1980 consumption smooth in response to a change in their direct tax burden not, as Romer and Romer posit, because they have greater access to financial services.     

Fiscal cost of demographic transition in Japan

This paper quantifies the fiscal cost of demographic transition that Japan is projected to experience over the next several decades, in a life-cycle model with endogenous saving, consumption, and labor supply in both intensive and extensive margins. Retirement waves of baby-boom generations, combined with a rise in longevity and low fertility rates, raise the old-age dependency ratio to 85% by 2050, the highest among major developed countries, and generate a significant budget imbalance, as the government faces rising costs of public pension and health and long-term care insurance. Preserving the current level of the transfers will require a major increase in taxation. Using consumption taxes to balance the government budget, the tax rate reaches the maximal value of 48% in late 2070s. A pension reform to reduce benefits by 20% results in a peak tax rate of 37%, which can be reduced further to 28% if the retirement age is also gradually raised by 5 years.     

Thrifty firms and thriftless households are risks to growth

• ? Structural changes in savings behaviour by households and especially firms in advanced economies in recent years pose threats to global growth. Household savings may have been compressed by high wealth levels, pointing to the risk of a sharp rise in saving and fall in spending if asset prices correct. One positive compared to a decade ago, however, is that US personal saving is less depressed than then.
• ? The bigger risk is arguably on the corporate side, where firms' net savings have risen on average by 2–3 percentage points of GDP since the early 1990s. This has been accompanied by weakening investment, especially in net terms. The reasons behind this are varied – post‐crisis caution, demographic factors and a shift to R&D intensive industry may all have played a role. But a key factor is likely to have been changes in incentives facing executives, leading them to prioritise stock buybacks over investment. This risks creating a long‐term low‐growth feedback loop.

     

The London Business School with Gower Publishing

The Autumn Statement updated the government's spending plans and its forecast from those announced in the Budget in March. On both counts there is very little difference between the Treasury view and our own forecast released in October. The Treasury supports our projection that output and demand will decelerate in 1989, that inflation will peak in the first half of the year at about 7 per cent and fall back to 5 per cent by the end of the year and that the deficit on the current account of the balance of payments will narrow only marginally over the next 12 months. On public spending in 1989–90, our October forecast was close to the unchanged official figures. It was clear to us - though not to most City commentators - that savings on unemployment benefit, debt interest and elsewhere would enable greater spending on programmes within an unchanged planning total. In later years the government has upped its expenditure plans from those announced a year ago, as we had assumed it would. As a result, the Autumn Statement projects significant increases in real public spending from now on. We show that, under a more appropriate inflation forecast, public spending rises nearly 2 per cent next year but falls back in 1990–92. Finally we argue that, unless the Chancellor decides to run an even larger PSDR (public sector debt repayment) than the £12bn built into our forecast - and the Autumn Statement forecast assumes a PSDR in 1989–90 similar to the expected outturn in 1988–9 of £10bn - the scope for tax cuts remains intact.     

Demography and the U.S. current account deficit

We examine whether aging in the trading partners of the U.S. has affected their demand for foreign (i.e., U.S.) assets enough to materially affect the U.S. current account balance. There is reason to think that demography may be at work in international capital flows because the standard life-cycle model of consumption behavior predicts that a household's age will influence its saving behavior. Moreover, simple national accounting identities link a country's current account balance to its savings–investment imbalance. Thus, differences in national age-profiles should affect the current account. To test this theory's plausibility and significance, I simulate a multi-region overlapping generations model that is calibrated to match the demographic differences among the major industrialized countries over the past 50 years. In the model, it is found that these differences can explain some of the observed long-term capital movements in the G-7. In particular, the model does a good job of predicting the size and timing of U.S. current account deficits.     

Evidence on the Demand for Mortgage Debt by Owner-Occupants

This paper explores the relationship between household mortgage debt burdens and housing consumption, periodic income, nonhousing wealth, the income tax position of the household, expected mobility, and other micro-level characteristics that proxy for household risk preferences and life cycle effects. We use 1985 and 1989 American Housing Survey data to estimate mortgage debt level equations simultaneous with house value equations, controlling for the contemporaneous nature of these two choices. We find that larger debt levels are positively associated with greater value residences and with the level of household income. Numerous household level demographic characteristics are also systematically related to mortgage demand. Of particular interest are our findings that the use of mortgage debt is affected significantly by the rate of tax savings on mortgage interest deductions and by the expected mobility of the household.     

THE AUTUMN STATEMENT

The Treasury's forecasts, published with the Autumn Statement, are close to those we presented in October. For domestic demand the main difference is that the Treasury has consumption growing by 3 per cent next year whereas we had forecast a growth of only 2 percent. Behind this difference lies a significant different in policy assumptions. In October we estimated that there was no scope for tux cuts, yet the Treasury's forecast assumes that there will be net cuts in taxation (over and above indexation) of £11/2bn in the next Budget. In this Forecast Release we show that the main differences are (a) that the government has raised its forecasts of sales of assets and council houses arid (b) that it expects more North Sea Oil Revenue than we do. The latter forecast depends critically on what happens to the exchange rate.
We present a revised forecast based on the new information in the Autumn Statement and incorporating the £1 1/2bn tax cuts. It is very close to the Treasury's forecast.
We also discuss the relevance of changes in North Sea oil revenue to fiscal policy and we suggest that it is misleading to treat it on a par with other sources of revenue. We then show that the suggested tax cuts of £11/2bn in the next Budget are effectively £4bn less than was indicated last March. Finally we argue that the Chancellor's claim to have kept within his Planning Totals for spending in the last three years has only been achieved by increased asset sales.     

Inflation ond Personal Saving

What are the consequences of the decline in the personal savings ratio? Professor Victor Morgan argues that contrary to claims by the government, amongst others, the decline in the savings ratio could have serious consequences for inflation.     

To cut or not to cut? The Chancellor's Budget dilemma

This article analyses the Chancellor's options for the forthcoming Budget and, in particular, the case for tax cuts. James Nixon, John O'Sullivan and Andrew Sentance argue that there is no case for large reductions, with public borrowing still running at an unsustainable rate and reasonable prospects for growth next year. The case for a modest reduction is more finely balanced. Against a background of public spending restraint, a small tax reduction can be seen as an insurance policy against a much weaker economy next year.     

Ageing's raging savings debate

• ? Demographic changes have played a crucial role in pushing savings rates up and real rates down in the advanced economies. Despite some voices to the contrary, we think such forces will remain in place for many years to come.
• ? For such a predictable process, it's amazing that the economic implications of ageing are so hotly debated. Ageing affects everyone's lifetime savings decisions and has an impact on macroeconomic variables through several direct and indirect channels, the strength of which varies over time.
• ? The impact of ageing on savings depends on interpreting two distinct long‐term drivers. On the one hand, aggregate savings may start to fall as the baby‐boomer “bulge” in advanced economies transitions from the peak period of saving to the phase of lower saving in retirement.
• ? On the other hand, rising life expectancy should lead individuals to save more during their working lives or wait longer to retire. Greater labour market participation by those close to the official retirement age suggests that rising life expectancy is already leading many to remain in the workforce for longer – a trend that is likely to continue.
• ? Accounting for ageing and rising life expectancy together, we find there will be no major decline in savings even as the elderly's share of the population rises further.
• ? The impact on future real interest rates will, if anything, be negative. Comprehensive studies have reached a similar conclusion, taking into account the impact of demographic changes on savings, investment and other factors affecting real interest rates.
• ? Ageing populations may be complicating the escape from low global inflation. Crosscountry evidence suggests older populations may prefer lower inflation. As societies in advanced economies continue age, there is a downside risk to the long‐term outlook for inflation and bond yields.

     

Real option value over a housing market cycle

This paper analyzes how the dynamics of house prices are affected by the option to rebuild or enlarge existing dwellings. The nonlinear functional form for option value and zoning limits provides identification of changes in option value over the cycle. For homes with high development potential, our results show that about 40% of the price increases during the boom years after the fall of the Berlin Wall were related to increased option value. In the subsequent bust about 50% of their price decline was associated with decreased option value. For dwellings with low redevelopment potential 12% of the decline in real value can be attributed to changing option value.     

浅议我国现行个人所得税制改革

个人所得税作为调节居民收入分配的一个重要税种,在我国经济生活中起着至关重要的作用。个税调整直接关系百姓钱袋子,在通胀形势下成为关注热点。随着我国经济的增长,居民可支配收入也在逐年增多,但是作为调节贫富收入差距的"个人所得税"这一税收杠杆却滞后于我们经济的变化,这些问题不仅严重影响了税收调节经济的功能,而且对社会稳定也极为不利。本文在阐明了我国个人所得税制改革中存在的相关问题后,有针对性的提出了相关学者的政策建议。     

The potential effect of US baby-boom retirees on stock returns

Empirical studies demonstrated that US baby boomers consumption and savings patterns have affected economic aggregates over the past decades, among them equity returns. Boomers’ retirement is expected to mitigate the demand for equities until 2050, but its impact varies with the specific population age structure along decades. This paper employs a dynamic asset pricing model with optimum consumption and portfolio rules to estimate aging effects on S&P500 returns between 1950 and 2050. Calibration for demographic and economic data between 1950 and 2005 yields model estimates that significantly explain the moving average of S&P500 returns. Further, taking into account the present value of expected demographic effects until 2050 suggests that the S&P500 was fairly priced at the heart of the financial crisis, on April 2009, but overpriced thereafter.     

COUNTING THE COST OF HIGHER BASE RATES

It is a brave Chancellor of the Exchequer who raises interest rates when inflation is at record low levels and there are few signs of overheating. But Kenneth Clarke is clearly trying to give substance to his commitment - made in June's Mansion House Speech - to pursue stable monetary and fiscal policies. In that speech, the Chancellor told his City audience that the government had "not created the conditions for the strongest recovery in Europe in order to throw it away by creating yet another boom followed by bust".
There is widespread agreement with the Chancellor's objectives. But the difficult question for economic management is how high interest rates will need to go in order to contain inflation and keep the economy on course. In this Forecast Release, we examine this question as well as assessing the likely impact of the first rise in base rates for five years.     

Monetary and real causes of investment booms and declines

The 1900s have marked two major investment booms in the United States. The boom of the 1920s was followed by the Great Depression of the 1930s, in which investment demand fell sharply. The second boom, of the 1950s and 60s, has been followed by a period of lagging investment. The economics literature reflects two disparate schools of thought on long-term investment behavior: the accelerator theory and the monetarist theory. This paper develops an investment function that interrelates monetary and real variables. Analysis of the investment function identifies several powerful non-monetary forces that can trigger investment booms with subsequent collapse due to overexpansion. Money is shown to be a critical element in sustaining a boom, but monetary contraction during the succeeding decline appears to be a symptom rather than essential cause of investment stagnation. The results thus point toward an integration of the monetarist and accelerator theories.     

个人所得税对居民消费影响研究的文献综述

1994年至今,个人所得税已经历四次重大改革,个税改革是税制改革的重点内容。本文将从个人所得税对居民消费影响的理论研究和实证研究方面,对现有个人所得税的研究文献进行梳理总结,并进行述评,总结现有文献研究存在的不足之处,以期为进一步研究个人所得税对居民消费影响研究提供依据和方向。     

The London Business School with Gower Publishing

Last year the Chancellor followed "the path of prudence and caution", cutting taxes by £4bn and budgeting for a public sector surplus of £3bn. This year - rather more compellingly - he is travelling the same route. Against the background of a record current account deficit and rising inflation, Mr. Lawson has tightened fiscal policy, cutting taxes in 1989–90 by nearly £2bn - less than is needed to offset real fiscal drag. His main priority, reaffirmed in the Budget speech, is to tackle inflation and, to this end, he chose not to revalorize excise duties. This was reinforced by a reduction in national insurance contributions, which not only benefits the low paid in relative terms, but also sharpens the incentive to supply labour at the bottom end of the wage spectrum. But this reform of national insurance is not cheap. Even though it is not practicable to implement the changes until October, the cost in 1989–90 is estimated at £1bn, rising to £2.8bn in 1990–1. This is equivalent, in PSDR terms, to a 2 per cent cut in the basic rate of income tax arid, in our post-Budget forecast, precludes further tax cuts in 1990. Unless there is an unexpectedly large rebound in personal savings, the Chancellor is likely to find himself in his present position in a year's time: presiding over a large budget surplus but unable to reduce it significantly for fear of rekindling inflation or aggravating the current account deficit. Simply writing declining numbers for the PSDR into the MTFS offers no genuine guidance on medium-term fiscal policy and may even be positively misleading to financial markets.