28 February 2011 – Chart of the Week




Macro Chart of the Week: Oil Spikes and Savings Rates

When oil prices surged into triple digits in 2008, the spike helped tip the US economy into its worst recession in decades. With oil again approaching $100 a barrel, some economists are bracing for a double dip. However, US households can absorb the shock without necessarily curtailing their overall spending. Instead, they can save less, at least temporarily, which is exactly what they appear to be doing.

As originally developed by Nobel laureate Milton Freidman, the permanent income hypothesis holds that households tend to make their consumption decisions based on their long-term income expectations. A sudden short-term increase in income from, say, a temporary payroll tax cut is unlikely to be followed by a short-term boost to spending. Instead, the theory goes, the windfall will be saved.

A similar dynamic can be seen after sudden spikes in energy costs. During an economic slowdown, job losses or extended job uncertainty can dampen spending, particularly among more vulnerable households, which an oil price spike can exacerbate. In contrast, households tend to ride out the cyclical turbulence of energy costs and maintain their spending patterns when the economy is expanding and job security is high. The savings rate can provide a buffer.

During the last recession and using a 12-month rolling average, the amount that Americans were diverting from income into savings more than doubled between December 2007 and June 2008 (the blue line in the chart). Since then, total savings have continued to increase but the pace has slowed down. In the latest data for January 2011, the amount of income being saved is about the same as a year ago, still positive but no longer climbing.

Meanwhile, energy expenditures are the mirror image of the savings data. Given the different sources for the data sets, the correlation since 2000 of -0.62 shows a relatively strong inverse relationship. Again with a one-year moving average, annual household spending on gasoline and other energy jumped early in the recession as oil prices soared (the orange line), but then collapsed after oil prices plunged. More recently, as oil prices started going back up, energy expenses are again taking a bigger bite out of the household budget.

To judge by this data, the recent ebb and flow in US household savings is largely a reflection of price swings in energy prices. At this point in the cycle, the labor market is healing, however fitfully, and income growth trends remain reasonably strong. While the oil price spike is an unexpected factor in the global economy, thus far US households appear to be absorbing higher energy prices by saving less and holding consumption steady.



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