Why do Norwegians increase their savings when the interest rate is cut?

A nice paper showing an interesting result. It shows the Norway’s savings rate increased post crisis despite rate cuts. One would imagine consumption to go up post rate cuts and savings to declinme. We see just the opposite. Why?

Well, the reason is net financial wealth of Norweigians was negative pre-crisis as they ahd high debt on their books. So the rate cuts actually led to sort of rise in incomes as EMIs etc declined.

Since 2008 Norwegian household saving has increased in a period when interest rates have been low (see Figure 1a). In 2007, the saving rate was below 1 percent while it increased to 8.7 percent in 2012. In the same period, the real interest rate averaged 1.2 percent which is low compared to the historical average of approximately 3.5 percent. At fi rst glance, it might seem strange why saving has increased, as low interest rates should induce households to shift consumption from the future to today. However, a negative relationship between saving rates and real interest rates is not a new phenomena. The correlation coecient of annual saving rates and the real interest rate in the time period 1978-2012 is {0.24 indicating that historically the relationship has been negative (see Figure 1b). The negative correlation between saving rates and the real interest rate was in particular strong during the 1980s (correlation coecient of {0.62).

We have also seen this negative relationship recently with a correlation coefficient of {0.18 during the 2000s. In the 1990s, the correlation went in the opposite direction with a positive correlation coefficient of 0.62 between saving rates and the interest rate. I aim to shed light on the relationship between interest rates and saving rates in Norway. The main message is that the financial position of Norwegian households is important when predicting the response in saving and consumption to an interest rate  decrease. Norwegian households on average have negative net financial wealth. Hence, the low interest rate has reduced interest rate payments which can be viewed as a transitory income increase to debt holders. In a life-cycle model where households wish to smooth consumption, only a small fraction of the transitory income gift will be consumed, while most of the reduced interest payments will be saved for consumption in future periods. Hence, the life-cycle model predicts an increase in saving from the reduction in interest rates.

I guess this should apply to most developed econs where debt levels were high and pre-crisis savings rate really low. The author does not mention this but it also explains why the effect of stimulus has not been as large as policymakers wanted.

Just like we think of Ricardian equivalence we also need to think of this monetary equivalence kind of condition.  Moreover, the context is really important as pre-crisis things were really complex and weird. So just assuming  normal crisis solutions to work may not apply when you have high debt and low savings before the crisis.

Nice bit..

2 Responses to “Why do Norwegians increase their savings when the interest rate is cut?”

  1. Misaal Shah Says:

    Interesting read.

  2. Ashwin Says:

    Really good to read….simple and easily understantable….this how interesting economic phenomena and sometimes weird ecomic behaviours are.

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