Checking SavingsBy Mitchell Chubinsky

Analytical Framework

Checking Savings

Background

The Checking Savings Program

Conclusion

Notes and Sources

BackgroundRecent Trends in the U.S. Personal Saving Rate

Jan-00 May-01 Sep-02 Jan-04 May-05 Sep-06 Jan-08 May-09 Sep-100.00%

1.50%

3.00%

4.50%

6.00%

7.50%

9.00%

Source: U.S. Department of Commerce: Bureau of Economic Analysis via the St. Louis Fed

Personal Saving as a Percentage of Disposable Income

• Although the U.S. Personal Saving Rate has surged in the past few years from alarming lows, it needs to climb even higher.

• In these tumultuous economic times, saving early and often is more important than ever:• Volatile equity, fixed-income and commodity

markets.

• Continued decline of private pension schemes.

• Massive deficits in public pension plans and Social Security.

• Personal saving is the only way to hedge these risks and an uncertain future.

The Current Environment

• It’s clear that individuals should save more; studies have found that many households even feel the same way.

• In many respects, low personal savings is less the consequence of economic factors than behavioral ones.

• The problem, then, is how can we change people’s savings habits?

• A wide body of research has found behavior to be notoriously stubborn; maybe we can’t change it.

Raising the Rate – The Problem

But maybe we don’t have to

change savings habits…

• Instead of trying to influence consumers’ active savings habits, have banks enroll customers in checking accounts that will automatically transfer a percentage of deposits into linked savings accounts.

• Could be pure savings accounts, CDs, govt/agency debt or other risk-free investments.

• The deposit transfer percentage would increase 1% quarterly from 2% to 10% (or higher) over two years, driving a comparable rise in the personal saving rate.

The Solution – Checking Savings

• This account type would be the default for new accounts, but customers would be free to opt-out at any time.

• A rewards program would offer a variety of bonuses for maintaining balances and reaching savings targets:

• Higher interest rates, frequent flyer miles, iTunes downloads, etc.

• Penalties would be imposed for early and frequent withdrawals not for emergency needs or other qualified expenses.

• Housing, educational, medical, etc.

Other Features

The Checking Savings Program

• Economics predicts that individuals will save a portion of their income while employed to finance a healthy level of consumption after retirement.

• People realize that they should save more but have trouble doing so for various behavioral reasons.

The Main IdeaAnalytical Framework

• Bounded Rationality – No one knows for sure what the appropriate savings rate is. The different options and instruments can be overwhelming and confusing.

• Those without economics training may not fully appreciate the time value of money or the fundamental tradeoff between present and future consumption.

• Hyperbolic Discounting – People tend to irrationally discount the future, overconsuming and undersaving in the present.

• Also explains procrastination – I’ll start saving more… tomorrow, when I get a raise, etc.

Behavioral Economic Explanations for Undersaving

• Loss Aversion – People tend to weigh losses far more heavily than equivalent gains. Increased savings can be perceived as a loss of disposable income and current consumption, but it’s really just an intertemporal tradeoff.

• Amplified by hyperbolic discounting – The benefits of saving for a vague and distant future are severely undervalued, given the cut to spending money that you have to live with now.

• Status Quo Bias – There is a strong tendency towards inertia. People infrequently change habits and behaviors, even when it may be in their best interest to do so.

Behavioral Economic Explanations for Undersaving

• Using predetermined deposit transfer rates and investments absolves consumers from having to make the potentially confusing decisions of how and how much to save.

• Also ensures people will save enough, regardless of behavioral biases and irrationally present-minded preferences.

• With enrollment by default and automatic savings transfers, procrastination becomes irrelevant and saving becomes the new status quo.

• Discontinuing participation in the plan would require an active opt-out, which few would pursue.

Why Checking Savings Will WorkAnalytical Framework

• Having a preset transfer rate that gradually increases over time from 2% will help ease people into saving by mitigating the loss aversion.

• Starting at 10% would feel like a huge loss, whereas 2% would be negligible for many.

• Rewards will incentivize and reinforce savings behavior. Offering a variety of bonuses would make the program fun and help expand its appeal across demographics.

• Penalties will serve to force participants to think carefully about withdrawals, and in doing so encourage fiscal responsibility.

Why Checking Savings Will Work

• Personal Saving Rate. Last Updated 11/1/2010.

• http://research.stlouisfed.org/fred2/data/PSAVERT.txt

• This program draws heavily on the ideas and body of research discussed in Richard Thaler and Shlomo Benartzi’s 2004 Journal of Political Economy article “Save More Tomorrow: Using Behavioral Economics to Increase Employee Saving.”

• Thaler, Richard H. and Benartzi, Shlomo. “Save More Tomorrow:

Using Behavioral Economics to Increase Employee Saving.”

Journal of Political Economy. 2004, vol. 112, no. 1, pt. 2.

Notes and Sources