Save or Spend?

October 6th, 2010

Last week I briefly mentioned the advice given by the Deputy Governor of the Bank of England (BoE) that, in the current economic climate, consumers should spend more and save less. For many people this will sound counter-intuitive to the point of madness and so it deserves greater examination.

While the Bank of England’s economic policies have cushioned those who mortgaged themselves to the hilt, splurged on credit cards and spent all they earned, helping to create the debt bubble in the first place, many are angry that no help has been given to savers who outnumber borrowers by about nine to one.

Prudent savers have been hit hard by the financial crisis and subsequent recession. The measures taken to stabilise the banks and kick-start the economy have resulted in rock-bottom interest rates and rising inflation, both anathema for those trying to build a nest egg for their retirement.

Now they are being urged to sacrifice some of their hard-earned savings in order to give a temporary boost to the country’s output. There are good economic reasons to both spend and save, but the course of action you should adopt depends on your personal circumstances.

For example, savers should be focused on securing their own financial future and this means building a decent retirement fund, using pensions, Isas and other savings. Most people in the UK have neglected to put aside for their retirement. Recent figures from the Office for National Statistics show that nearly 40% of pensioner couples receive an income of less than £5,000 a year.

Everyone should think about having a financial safety net. Government spending cuts, to be announced in this month’s Comprehensive Spending Review, are likely to trigger further job losses. It makes sense to build a financial cushion to ensure that essential bills can be paid if the worst happens.

Analysts recommend savings equivalent to between three and six months’ salary. This will be impossible for many but it demonstrates the time, thought and preparation required to adequately protect yourselves from sudden shocks.

The Deputy Governor of the BoE has fallen into a trap many others who worked in macrofinance before him have fallen into, which is viewing things from the perspective of the whole economy and not from the perspective of the people who make up that economy. People must be viewed as having real cares and concerns in living their lives and not just as economic units.

If you can spend then do so, but for most people saving is still the most prudent thing to do in this economy.

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