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There are a variety of reasons that would make one expect that US household savings will revert over time to their earlier long run average of around 8-10 percent of disposable income. First, households are presently in the process of repairing balance sheets that have been severely impaired by large declines in housing and equity prices. The Federal Reserve estimates that over the past eighteen months household wealth has declined by US$13 trillion, or close to 100 percent of GDP. Second, households are and will remain for some time liquidity constrained as banks tighten lending standards and as reduced home prices preclude households from withdrawing equity from their homes. Third, rising unemployment and declining wages are now heightening job market insecurity and leading to increased precautionary savings.

A rise in US household savings is a healthy long-run development in that it provides a basis for reducing the large US external imbalance and for increasing domestic investment. However, most of the benefits from improved US household saving are presently being largely offset by a substantial and very worrying deterioration in the US public sector’s savings performance. Illustrative of the prospective decline in US public savings are the recent Congressional Budget Office’s estimates of the impact of the Obama budget on the US long-run public finances. The CBO estimates that even once the economy has fully recovered, the US budget deficit will not decline below 4-6 percent of GDP. The CBO is also projecting that the US public debt will increase at its fastest rate in peacetime from around 41 percent of GDP in 2008 to 82 percent of GDP by 2019.

From a global economic perspective, one would hope that the prospective large increase in US household savings would coincide with a concerted policy effort in surplus countries, like China and Germany, to increase their countries' level of household consumption. Were that to occur, the US could address its serious budget deficit problem without fear of contributing to an inadequate level of global aggregate demand.

Desmond Lachman is a resident fellow at AEI.