Save or Spend: What's Better for the Economy?

Are Americans saving too much? It’s a quandary that seems at odds with financial responsibility. Put money in the bank, your parents once told you, or else.

As it turns out, the economy doesn’t play by your parents' rules. Spending is a necessary component of economic growth, accounting for roughly two-thirds of the gross domestic product. If American piggy banks get too heavy, growth – or, in this case, recovery – can stall.

Americans are certainly borrowing less – the Fed reported Friday that the amount of consumer credit outstanding contracted another $14.8 billion in September, following drops of $12 billion in August and $19 billion in July. Revolving credit, which includes credit-card debt, is falling faster than non-revolving credit like car loans and mortgages, as consumers either pay down debt or find they can’t access as much credit as they once could.

Personal savings as a percentage of disposable income climbed to 3.3% in September, up from 2.8% in August, according to the Department of Commerce. Of course, many Americans have a lot more saving to do in order to repair their balance sheets after years of spending borrowed cash. But the unemployment rate, which reached 10.2% last month, may remain stubbornly high until consumers unlock their wallets and create some demand for goods and services.

SmartMoney asked five economists and academics to get at what the economy needs consumers to do most – save or spend. Here’s what they had to say on which is better for the economy, a savings account or a spending spree:

Truman Bewley, Professor of Economics at Yale University:
“In a time like now, when we don’t have enough spending, it’s better for the economy that people spend,” Bewley says. But you’re not likely to see patriotic Americans rushing to the mall to try to stimulate the economy: “The consumer spends money for their own reasons, they’re not going to do it because they’re helping or hurting the economy,” he says.

Dan Seiver, Professor of Finance at San Diego State University:
“From a short-run perspective, having consumers hitting the malls again is good for the economy,” Seiver says, “but we have had for many years this problem of consumption spending being too high a percentage of GDP.” Americans have been spending borrowed dollars, and a return to an economy that’s less dependent on the consumer is a painful but necessary process, he says.

John Canally, Economist at LPL Financial:
“There’s dangers in doing too much of both,” Canally says. “Japan saved too much and they got in trouble, and we spent too much and got into trouble,” he says. Right now, consumers need to pay down debt and repair their balance sheets, and other sectors of the economy like exports or business spending can compensate for reduced consumer spending for a year or two, Canally says.

Keith Hembre, Chief Economist at First American Funds:
“The challenge is to grow both simultaneously. And in order to do that we need to look outside the U.S. for some help in terms of demand,” Hembre says. Ideally, consumer spending would grow slowly while other sectors, like exports, pick up more quickly, allowing the economy to rebalance itself to rely a little less on consumer spending, he says.

David Wyss, Chief Economist at Standard & Poor’s:
“There’s a long run versus short term issue here,” Wyss says. In the short term, spending would create demand and help drive down the unemployment rate, but “in the long run you’re actually better off saving more, because that keeps interest rates low, it allows more investment and stronger long-term growth,” he says. But are Americans willing to change their habits? With the savings rate now at only 3.3%, “so far, the evidence seems to be that we don’t have to worry about Americans saving too much,” Wyss says.