In the summer of 2014, when the ECB changed its interest rate on excess bank reserves to -0.1% – a negative policy interest rate for the first time in the history of major central banks –advanced economies implementing unconventional monetary policies entered a new phase.1 Eighteen months later, this action was followed by the Bank of Japan’s decision to adopt negative interest rates. As of the fall 2016, the 19 euro countries, plus Japan, Denmark, Sweden, and Switzerland have adopted negative policy interest rates.
Unconventional actions often face opposition, and the effectiveness of negative interest-rate policies has been challenged. Conventional logic suggests that lowering the policy interest rate stimulates consumption and investment, while discouraging people from saving. Negative interest rates may further lead people to spend now rather than later, which further discourages saving.
Low or negative interest rates may, however, also contribute to higher saving rates because the rate of return per financial instrument is so low that people may try to compensate by increasing their aggregate saving. This scenario can be especially true in an economy with an aging population in which people may want to target their saving to be better prepared for retirement. It can also be strong in an economy in which social security and unemployment benefits are not available.
People may also want to increase their aggregate amount of saving in response to lower interest rates if they face a gloomy and more volatile economic outlook. Therefore precautionary saving behaviour may change depending on economic or policy conditions. Additionally, in a developing economy with financial repression, nominal interest rates tend to be artificially repressed and therefore the real rates of return tend to be low. This situation is made worse when there is high inflation. If this economy has underdeveloped public social-protection programs, citizens have good reason to increase their aggregate saving for precautionary purposes.
So, while the interest rate effect on private saving is commonly assumed to be positive, Nabar (2011) noted that China experienced a combination of rising household saving and declining real interest rates during the 2000s. Using province-level data for the 1996–2009 period, Nabar empirically showed that, when the return to saving declined, household saving rose.1
Income and substitution effects on private saving
In our research, we investigated whether the interest rate has an income (negative) effect or a substitution (positive) effect on private saving by using panel data from 135 countries between 1995 and 2014, controlling for other factors that can affect private saving (Aizenman et al. 2016). We also investigated whether the real interest rate affects private saving differently if the real, or nominal, interest rate is below a certain threshold, and whether the impact of the interest rate on saving was affected by economic, demographical, and policy conditions.
Our baseline estimations supported the positive effect of the real interest rate on private saving, although this is significant only for the full sample, and marginal for the subsample of Asian economies. Given the weakness of the positive effect we suspected that, if the interest rate has any impact on private saving, its effect may be masked by an uncertain economic environment.
Our motive for this investigation was that recent low interest rates have occurred alongside greater uncertainty about future monetary or financial conditions. Therefore, very low interest rates encouraged people to engage in precautionary saving. When we investigated whether the real interest rate affects private saving differently, depending on whether the real, or nominal, interest rate is below a certain threshold, we found evidence that the impact of the real interest rate on private saving changed when the nominal interest rate was below a relatively low level.
Specifically, higher old dependency ratio and financial development can have negative impacts on private saving (a low interest rate would increase private saving), but the impact in absolute value tended to become smaller as the real interest rate fell. Furthermore, high levels of output volatility could make the interest rate effect negative. When the real interest rate was below 1.5%, greater output volatility would lead to higher private saving in developing countries.
Figure 1 illustrates the ratios of private saving in GDP and the real interest rates only for selected Asian economies, emerging market economies, non-emerging market LDCs, and Latin American emerging markets. The dotted line is the threshold of 1.5% for the impact of output volatility for developing countries. In this figure, we can see that Asian developing economies are distributed at lower levels of the interest rate, with all of them, except for Sri Lanka, below the 1.5% threshold. Thus, people in these economies responded negatively to output volatility and less negatively to shocks to old dependency or financial development.
Figure 1 Private saving and the real interest rate for Asia and others
The triangle charts in Figure 2 are helpful for tracing the patterns of output volatility, old dependency, and financial development, all of which had interactive effects with the real interest rate. The real interest rate had a negative impact (income effect) on private saving if any output volatility, old dependency, or financial development was above the threshold. We can see that on average, emerging market economies had an average level of financial development above the threshold. Other conditions, however, were below the threshold, which applies to the group of ex-China Asian emerging market economies, and, to a lesser extent, Latin American emerging market economies, and non-emerging market LDCs. Both China and Hong Kong stand out from the emerging market group with their high levels of financial development, which contributed to these two countries facing the negative impact of the real interest rate. Hong Kong also has an average old dependency ratio above the threshold, providing an example in which the real interest rate had an income effect on an aging-population economy.
Figure 2 Triangle charts
(a) Emerging markets
(b) Non-emerging market LDCs
(c) Latin American emerging markets
(d) Ex-China Asian emerging markets
(f) Hong Kong
Notes: In each triangle, three vertices measure output volatility, old dependency ratios, and financial development with the origin normalized to represent the minimal level and each vertex normalized to represent the maximal level.
A contractionary stimulus
A low-interest rate environment gave rise to different effects on private saving across country groups in different economic environments. This means that low-interest rate policies adopted by advanced countries to stimulate their economies may yield contractionary effects on developing countries by encouraging saving and reducing consumption. This is relevant to Asian economies, often characterised by well-developed financial markets and many with aging populations. Our findings suggest that these factors cause the income income effect on private saving to dominate.
Advanced economy monetary or financial conditions can have spillover effects on emerging market economies (Aizenman et al., 2016a and 2016b). This means that, in emerging market economies, unconventional monetary policies can push interest rates lower. Low interest rates could then contribute to higher private saving. That means that an active low-interest rate policy in advanced economies can contribute to keeping global imbalances perennial.
Aizenman J, Y-W Cheung, and H Ito (2016), “The Interest Rate Effect on Private Saving: Alternative Perspectives” NBER Working Paper No. 22872.
Aizenman, J, M Chinn, and H Ito (2016a), “Monetary Policy Spillovers and the Trilemma in the New Normal: Periphery Country Sensitivity to Core Country Conditions,” Journal of International Money and Finance 68: 298–330. Also available as NBER Working Paper No. 21128.
Aizenman, J, M Chinn, and H Ito (2016b), “Balance Sheet Effects on Monetary and Financial Spillovers: The East Asian Crisis Plus 20,” NBER Working Paper No. 22737 (October).
Aizenman, J and I Noy (2015), “Public and Private Saving and the Long Shadow of Macroeconomic Shocks.” Journal of Macroeconomics 46(C): 147-159. Also NBER Working Paper No. 19067
Loayza, N, K Schmidt-Hebbel and L Servén (2000a), “Saving in Developing Countries: An Overview,” The World Bank Economic Review 14(3): 393–414
Loayza, N, K Schmidt-Hebbel and L Servén (2000b), “What Drives Private Saving across the World.” Review of Economics and Statistics 82(2): 165-181.
Masson, P R, T Bayoumi and H Samiei (1998), “International evidence on the determinants of private saving,” The World Bank Economic Review, 12.
Nabar, M (2011), “Targets, Interest Rates, and Household Saving in Urban China,” IMF Working Paper.
Skinner, J (1988), “Risky Income, Life-Cycle Consumption, and Precautionary Savings.” Journal of Monetary Economics 22(2):237–55.
Zeldes, S P (1989), “Consumption and Liquidity Constraints: An Empirical Investigation.” Journal of Political Economy 97(2):305–46.
 Denmark had previously lowered its benchmark rate to a negative figure in mid-2012. Another exception is Switzerland, which levied negative interest rates on Swiss franc deposits from non-residents in 1972 to curb rapid capital inflows. This policy lasted until 1978.
 Many studies have investigated the determinants of saving, including Masson et al. (1998), Skinner (1988), Zeldes (1989), Loayza et al. (2000a, 2000b), and Aizenman and Noy (2015).