What a Penny Saved Costs

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Americans are finally saving again. However, economists don't agree on how much they should save.

Benjamin Franklin taught that a penny saved is a penny earned -- but it is also a penny not spent. And in a recessionary period like today, economists say that more pennies need to be spent to prop up the economy. That would argue for a lower saving rate during down times. During prosperous times, meanwhile, saving pennies could help boost the amount of money that could ultimately be invested.

But individuals don't look at saving that way. During periods of slow growth in the 1970s and 1980s, the U.S. personal saving rate -- defined as disposable income minus spending -- topped 10% as job loss and tight credit led consumers to rein in spending. Starting in the late 1990s, soaring stocks made Americans feel richer, and the saving rate declined to 2%. Savings jumped for a bit following the 2001 recession, but plummeted afterwards as housing prices rose, again making Americans feel that it wasn't especially important to save. The personal saving rate averaged just over 0.5% in 2007.

Now that Americans are trying to rebuild wealth lost during the housing and market turmoil, the saving rate is starting to climb again. It was 2.8% in November and is expected to top 4% in the coming months as consumers retreat due to their declining net worth.

The big question is whether personal savings will grow to such an extent that it will damp consumption and growth, says William Cline, a senior fellow at the Peterson Institute for International Economics. The matter is particularly pressing for the U.S. economy, where consumer spending powers more than 70% of gross domestic product.

"It depends critically on how households treat losses on houses and stocks -- as permanent or temporary," says Mr. Cline.

For individuals, an appropriate saving rate depends largely on circumstances. Those nearing retirement, of course, have the biggest incentive to save. Everyone else should have six months to a year of liquid savings in case of job loss, say personal finance experts.

The savings impulse has numerous benefits for the overall economy, including reducing the amount a nation has to borrow. The government could boost the nation's total saving rate -- which includes that by businesses, individuals and governments -- by running a budget surplus. But that would be counterproductive at a time when more spending is necessary to stimulate business investment and create jobs.

Other nations routinely save more than the U.S. Partly, though, that may reflect cultural differences. France, Germany and many other nations in the euro zone have savings rates at or above 10%, due in part to a deeper memory of home fronts wrecked by war. That relative frugality hasn't helped them grow any faster than the U.S., or made them any more immune from recession, though the higher savings could provide an important cushion as unemployment rises.

In China, the household saving rate is between 20% and 30%, but that reflects the structure of the economy, more than strength. China doesn't have government pensions, so families must save more for their retirement.

The sharpest critics of the low U.S. saving rate say the country's lack of a cash cushion makes it too dependent on China, Japan and the Middle Eastern oil states, which buy the debt that finances U.S. spending. Greater U.S. savings would diminish the country's reliance on foreign creditors.

Lawrence Summers, President-elect Barack Obama's chief economic adviser, has long warned against a "financial balance of terror," in which U.S. creditors could batter the U.S. economy by selling dollars and other U.S. assets and driving up U.S. interest rates to disastrous levels. But they are held in check by the realization that if they do so, the value of their dollar holdings would plummet.

Other economists note that the U.S. can get by with a lower saving rate because U.S. companies are especially efficient at deploying the capital at their disposal. "The U.S. has tended to get more growth out of lower savings than most economies," said Mr. Cline. That theory will be tested in the current economic downturn, when credit is hard to come by.

Write to Sudeep Reddy at sudeep.reddy@wsj.com