A bonus saved still helps economic blues

DOES the huge leap in savings late last year prove Kevin Rudd's first cash splash has failed? Only if you don't know much about recessions.

The national accounts say the amount households saved during the December quarter leapt by $9.5 billion to $15 billion. This caused the saving ratio to leap from 3.5 per cent to 8.5 per cent of household disposable income - its highest since the start of the previous recession in the September quarter of 1990.

Various factors will have helped to produce that surge, not just the $8.7billion in pre-Christmas cash bonuses the Government distributed to pensioners, carers and families.

According to the Reserve Bank's calculations, the fall in interest rates caused interest payments by households to fall from a peak of 15 per cent of household disposable income in the June quarter of 2008 to about 10 per cent in the March quarter.

It's true, however, that the value of the cash bonuses was significant. According to the Reserve, they increased disposable income by about 4.5 per cent in the December quarter. The point is, the cash splash wasn't the only boost to household income during the quarter, and not the only reason households had for increasing their rate of saving.

For a start, people may be saving more because of a "negative wealth effect". Having seen the value of their home fall somewhat and the value of their superannuation savings fall a lot, they may be feeling a lot poorer than they were and feeling a need to rebuild their wealth.

Then there's the growing fear many people have that they may lose their job. That's probably a factor prompting them to tighten their belts and save more in every recession.

But it's likely to be a much bigger factor in this recession since the degree of household indebtedness is very much higher now than it's been in previous recessions.

To economists, using income to repay debt is just a form of saving. It's likely that many people with mortgages have increased their saving by the simple expedient of not reducing their monthly mortgage payments in line with reducing interest rates.

So there's a lot more going on than just people deciding whether or not to spend their cash bonuses.

Even so, it's highly likely that a high proportion of the first cash splash has been saved or used to reduce debt rather than being spent.

Remember that people may end up spending the money before too long. They may not yet have decided what they want to buy, or they may be waiting for some special event.

But the real point is that it's wrong to see any decision by people to save their bonuses as proof the fiscal stimulus has failed.

When governments get in early in a downturn and take action they hope may hold recession at bay, that's fine. But we shouldn't be surprised when the forces behind the downturn prove too powerful.

The norm is for recessions to be drawn-out affairs as we wait for the imbalances in the economy, which helped to cause the recession, to be slowly corrected.

The key (domestically generated) problem is the excessive borrowing of households. And we'll have to wait while households, suddenly anxious to reduce their exposure, slowly chomp their way through that mountain of debt.

The point is that everything the authorities throw their way - whether it's the Reserve cutting interest rates or the Government giving them tax cuts or cash bonuses - brings us closer to the day when households are comfortable with their lower level of debt and are prepared to resume normal spending.

Doesn't sound like failure to me.