Home > News and media > Comment and opinion > 2010 > 10 > Nudging savers


Nudging savers

Max Steuer

Charlie Bean, the Deputy Governor of the Bank of England, is reported to have urged the ordinary saver to step up his or her rate of consumption, or at least not to reduce it due to lower interest rates. In a much publicised interview he does point out that low interest rates are hard on savers, and one way of keeping up consumption, particularly for those heavily dependent on returns to savings, is to cut into capital. Professor Bean maintains that now is the time to do that. At some future date interest rates will be high and savers will be rewarded. But for now, the Deputy Governor explains, it is in the public interest, as well as in the private interest, for some consumers to spend beyond their income by cutting into past savings. He is not urging those with negative savings to increase their indebtedness by consuming more. However, some consumers already in debt and especially fired up by patriotic feelings might respond to the call for more consumption by doing their part in the national interest.

To be fair to Charlie Bean, the press and television coverage of his interview portrays his comments as more of a call for keeping up consumption than was actually present in his remarks. In the interview he reports that the Governor of the Bank receives many more complaints from those who suffer when interest rates are lowered than from those who loose out when they go up. A possible line the Deputy Governor might have taken was for him to say, look, swings and roundabouts, at another time interest rates will go up, and savers will be on the winning side. He could simply have cautioned that lower interest rates might well last for quite a while, and leave it at that. The slightly surprising extra element, which naturally enough has been causing a stir, is his suggestion that savers might cut into capital "a bit" in order to keep up consumption. He noted that it would be better if business firms spent more on investment rather than hoping for savers to spend more, but firms are unlikely to do so prior to signs of increased consumer spending.   

For many of us who understand that we got into this mess partly through spending more than we earned it seems slightly odd to be told that greater spending now is the cure for some of the ills caused by excessive spending in the recent past. Not only consumers, but firms, banks and government were all somewhat foolhardy in expenditure and risk taking. Now the Deputy Governor of the Bank focuses on certain consumers and exhorts them to spend. The reasoning behind this call to consumption is easy to understand. There is an urgent need to reduce public debt. How urgent and at what rate the debt should be brought down is a complex matter. But almost all parties agree that public debt reduction is a priority. Unemployment is a terrible tragedy for large numbers of people, and the harsh possibility of little reduction in unemployment, not to mention the possibility of even greater unemployment, means that stimulation of the economy is desperately needed. If the economy continues to languish, or worse to slide further into recession, not only will private individuals suffer, tax revenue will decline and welfare expenditure will rise, further damaging the public purse. And where can the needed increase in demand for goods and services, which is what we mean by stimulation, come from? Public expenditure is ruled out. Indeed, the fiscal cuts will in themselves reduce total demand. Exports are a possibility, but with widespread economic decline abroad, this is an uncertain source of demand at best. Business firms will invest if increased capacity is needed, but not just for the sake of it. This leaves the major avenue for taking up the slack in total expenditure to be consumption expenditure in the United Kingdom, at least in the short run. So it is pretty easy to see why the Deputy Governor has taken the line he has taken.

Is it a good idea to urge private individuals to spend more out of their savings? There may be some hoped for symbolic gain in showing that the Bank is behind the Government in its struggles with public debt, and it could be that investors abroad holding United Kingdom bonds might conceivably take some comfort from the thought that the Bank is leaving no stone unturned. But will savers actually respond to this plea and spend more than they otherwise were intending to spend? One is reminded of government sponsored campaigns to Buy British in the days when the quarterly announcement of the balance of payments was the major economic news. There is little evidence that people were significantly influenced by those exhortations in deciding which motor bike to purchase. Economic theory and a fair amount of both scientific and casual evidence suggest that the major determinants of consumer spending are income, life cycle considerations, and projections of future behaviour of the economy. The rational consumer would hardly respond to pleas from the Bank of England unless the state of the macro economy figured very prominently in his or her collection of preferences. These thoughts must leave us with an uneasy feeling that this strategy of urging more consumption is unlikely to have much impact on actual behaviour.  

Apart from the factual matter of whether exhortation is an effective tool of economic policy in this context, there is an interesting ethical issue as to whether or not it is ethically appropriate for the Bank of England to go down this route. A recent book by Richard Thaler and Sass Surstein called Nudge makes the case for certain arrangements which technically leave freedom of choice in tact, but nevertheless influence behaviour, or at least are alleged to do so. If the healthy options are presented first at a cafeteria counter rather than the burger and chips, more of the former will be consumed. If potential organ donors have to opt out rather than opt into the donor scheme, more organs will be available for transplant. In all cases of this kind, individuals are free to make the choices they prefer. The form of presentation of options, it is maintained, can significantly influence behaviour. Thaler and Sustein argue that it is perfectly reasonable for the state to sponsor or promote such moves. These nudges are good for the individuals, so it is claimed, and in a fundamental sense there is no coercion and no loss of freedom. When the Deputy of governor of the Bank suggests that savers might consider spending more by dipping into capital he is not taking away their freedom. They can still do what they like. Insisting that a shop which sells cigarettes keep them under the counter does not stop smokers from buying them. It just slightly raises the cost of buying. One has to ask if they sell cigarettes. It is even easier to ignore remarks regarding the appropriate level of spending, but they still are a kind of nudge.

The ethical and freedom of choice issues surrounding the nudge policy vary to a surprisingly large degree depending on the particular circumstances. Suggesting that savers might consume a bit more out of capital raises special ethical issues. What can we assume about the behaviour of those living in whole or in part off savings in the absence of a nudge from the Deputy Governor of the Bank of England? Standard economic theory would suggest that they are doing the best they can according to their lights, their preferences, their circumstances, and what they take to be the present and likely future behaviour of the economy. Defenders of free choice in economic matters do not have to make ridiculous claims to the effect that all savers know exactly how to optimise perfectly. They might go for a weaker version, namely, that some savers are erring on the cautious side and spending too little, others are spending too much, but on average the decisions are about right, given the interests of the individuals making these decisions. On this assumption, if the community of savers responds to the suggestion of Charlie Bean, some will move closer to their best position, others will move away, and on balance the group will loose. No good hearted person, as the Deputy Governor is known to be, would want such a thing.

Perhaps the issue here is solely about information. Savers do not realise how long this regime of low interest rates is gong to last. On balance the community of savers is myopic when it comes to economic matters, or so one might allege. They fail to see that these low interest rates are going to persist for some very significant amount of time into the future. Charlie Bean is simply attempting to improve their information, and so lead them to make better decisions in their own interests. That these better decisions will also benefit the economy is part of the motive for making the suggestions, indeed it may be the major part of the motive. Be that as it may, the argument based on improved information removes much of the possible ethical criticisms regarding the use of a nudge in this case.

Behind all this lurks the paradox of thrift argument. The economy is not quite like what Margaret Thatcher believed it to be, namely, a household writ large.

In short, it is possible that if a lot more spending took place, the economy would recover much faster, and with higher incomes all around, total savings would rise in spite of an initial impetus from reduced savings. Much depends on the speed of the various responses, as well as other complex considerations. Of course, while it might be beneficial for the total economy, any one individual might be better off letting others undertake the initiative in spending. Taking action in the public interest has a free rider problem. For any one individual, it would be better to let other savers dip into capital more than they otherwise had planned to do. 

So what follows from these considerations for the interview by the Deputy Governor? First it is doubtful if many savers will respond to any significant extent. From the point of view of the consequences for the economy, these are likely to be non-existent. If there was to be a response, it might prove ever so slightly harmful to savers, looking at the group of savers as a whole. But if the interview was simply a reminder to savers that low interest rates will be here for some time, we might expect a small improvement in welfare due to better information. The hoo-ha in the media following this interview centred around the surprising sight of a public figure urging more consumption when we have come to realise that as a nation, along with some other relatively well off nations, we have failed to pay our way, have borrowed too much, and have counted on ever rising house prices. On reflection, the Deputy Governor was hardly making a radical suggestion. Only by-the-by was there a small suggestion that some individuals might want to cut into capital in the light of continuing low rates of return to saving. Yet these remarks were seized on in a disproportionate manner. The main message to be drawn from all this is how careful public figures have to be in their statements intended to be taken up by media which naturally enough wants to entertain. Entertaining news is news which is paradoxical, surprising, and with a potential to be made sensational.  

Posted 7 October 2010

Max Steuer is Emeritus Reader in the Department of Economics