Using micro-economics to analyse savings account levy

Treasurer Chris Bowen says he's imposing a new savings account levy on our super-profitable banks, but the banks say they'll just pass it straight on to their depositors. They say it, but can you believe it?

Details of the levy haven't been announced, but we can piece them together. It won't take effect until January 2016, and it's expected to raise almost $750 million in its first 18 months. It will apply to all deposits of up to $250,000 in banks, building societies and credit unions.

It will be imposed at the rate of 0.05 per cent (5? per $100) on the balance in your account at a particular date each year. The proceeds will go into a separate "financial stability fund" until, after 10 years, the fund has accumulated an amount equivalent to 0.5 per cent of the value of all accounts guaranteed under the government's existing "financial claims scheme".

Money in the fund will be invested by the Future Fund guardians or a similar body. It can be taken out only to compensate people who've lost their savings in the unlikely event of their bank going under.

So the levy is like an insurance premium, a user-pays measure that means the banks will be paying for the benefit they receive from having the government guarantee their deposits of up to $250,000. Larger deposits will not be formally government guaranteed.

Needless to say, the banks hate the idea of having to pay for a guarantee they previously didn't have to pay for. And they've tried to gain public support by saying they'd be forced to pass the cost on to their customers.

But that's what businesspeople always say when they're fighting a new impost. As a consequence, they've spent decades inculcating in the public's mind the belief that markets are based on "cost-plus pricing".

The prices a business charges are simply a reflection of the costs the business incurs plus a margin for profit. So when a wicked government imposes a new cost on a firm, it has no choice but to pass it on. But economics teaches that cost-plus pricing is not the way markets work. That's because cost-plus focuses solely on the business's cost of supply, ignoring the role of customers' demand and their "willingness [or unwillingness] to pay".

On the other hand, economists well understand that the initial or legal "incidence" of a tax (the person required by law to write the cheque that pays the tax in to the taxman) isn't likely to be the same as the tax's final or effective incidence (the person who ends up actually bearing the burden of the tax). This is because the firm that bears the legal incidence will use whatever economic power it has to shift the burden of the tax either back to its employees or forward to its customers.

But anyone who has studied any economics knows it is unlikely to be true that all the cost of the deposits tax will be passed on to depositors. Early in an economics course you learn to test such arguments by drawing a diagram with price on the vertical axis, quantity on the horizontal axis and a supply curve sloping up to the right, crossed at some point by a demand curve sloping down to the right. The point where the two curves cross is the market price.

Shift the supply curve up to reflect the extra cost imposed on the firm by the tax and you soon see the increase in the market price is less than the amount of the tax, meaning some part of the tax has been shifted onto customers, but the rest remains borne by the firm as a reduction in its profits.

Why do firms and industries try to fight the imposition of new taxes by claiming they'll simply pass the tax on to their customers? If that's true, why are they getting so upset? Because they fear that, in truth, they'll have to bear some of the burden themselves.

It turns out that how much of the tax they can get away with passing on to customers is determined by the steepness of the slope of the demand curve, which represents the degree of "elasticity" (price-sensitivity) of the demand for the product.

When demand for the product is highly elastic (so that a small price rise causes a big fall in the quantity demanded), firms will have to bear most of the burden of the tax. Only in rare cases where demand for the product is perfectly inelastic (so that the quantity demanded is unaffected by changes in its price) will firms be able to pass on all the tax.

Unfortunately, this neat analysis - like much micro-economic analysis - is highly simplified: based on the assumption of "perfect competition". Among the many unrealistic assumptions of perfect competition, the most pertinent in our case is there are so many small sellers in the market none is able to have any effect on the price.

By contrast, banking is an oligopoly (a small number of big sellers) where each firm does have some degree of pricing power - especially when they act in concert.

But here's the trick. The banks' behaviour since the global financial crisis makes it much more likely the banks will protect their profits by passing on the burden of the deposits tax to their borrowers than to their depositors.

That's because the GFC caused the sharemarket, the ratings agencies and the regulators to pressure the banks to raise less of the funds they need from overseas and more from local depositors. Their competition bid up the "price" of deposits and they passed this increase in their "cost of funds" on to their borrowers by making "unofficial" increases in mortgage interest rates and passing on less than the full cuts in the official interest rate.

Their need to attract deposits remains, so they're likely to pass this small increase in their funding costs on to borrowers, not depositors.

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Economic problems the pollies don't notice

Whoever wins the looming election will inherit a quite uncertain outlook, in which the economy may well slow further and unemployment rise faster over the next few years.

If so, all the politicians' wrangling over "debt and deficit" will be of little relevance and no help. That's the conclusion I drew from Reserve Bank governor Glenn Stevens' surprisingly sombre speech this week, in which he switched from glass half-full to glass half-empty.

If you didn't get that message, it's probably because it was missed in the financial markets' usual obsession with looking for hints about the next move in interest rates and the media's obsession with searching for criticism of the politicians - real or imagined.

Stevens warned that, in our efforts to get economic growth back to its trend rate of about 3 per cent a year - which is necessary to stop unemployment continuing to worsen - "the challenges ahead are substantial". What's more, those challenges will continue for "the next few years".

His speech explained those challenges. You know the basic problem: ensuring the rest of the economy takes up the slack as the stimulus from the mining investment boom tails off.

The first uncertainty is the future path of mining investment spending, which "rose from an average of about 2 per cent of gross domestic product, where it had spent most of the previous 50 years, to peak at about 8 per cent".

Presumably, that means it could eventually fall by a massive 6 per cent of GDP. But over what period? We don't know. All Stevens knows is that "that big rise is now over, and a fall is in prospect, with uncertain timing. It could be quite a big fall in due course."

Spending on the construction of new mines and facilities could stay on a plateau for a while, or it could just keep falling. If it plateaus, it makes no contribution to growth; when it falls, it subtracts from growth.

Meanwhile, what have we got going for us on the upside? Stevens advises that, "at this stage, global growth is sub-par". So, not much help from the rest of the world.

The much awaited fall in the dollar has improved the price competitiveness of our trade-exposed industries, which should allow them to produce more. "It would not be a major surprise if a further decline occurred over time," he says, "though, of course, events elsewhere in the world will also have a bearing on that particular price".

In particular, how soon and how far the Aussie falls will be influenced by how much more "quantitative easing" (creation of money) we see in the developed economies, particularly the US.

And then, of course, there's the stimulus to the non-mining economy from the easing in monetary policy. Since late 2011, the Reserve has cut the official interest rate by 2 percentage points to 2.75 per cent (with another click likely on Tuesday).

So monetary policy is "very accommodative," Stevens tells us, "by historical metrics, at least".

Huh? It turns out that, in our present circumstances, low interest rates don't pack the punch they used to, so we're not going to get as much increase in activity as usual.

Why not? Because, Stevens reminds us, we're not just coping with the aftermath of one boom, but two. The other is the end of the "credit boom".

You'd expect unusually low interest rates to encourage increased spending, particularly on those things that are usually bought on credit: consumer durables, homes and (non-mining) business investment.

But Stevens warns that while "some strengthening in consumption from recent rather subdued growth rates is a reasonable expectation ... we should not expect a return to the sorts of growth seen in the 1995 to 2007 period".

Why not? Because that period, in which consumer spending grew much faster than household income, was a product of the housing credit boom that largely preceded the resources boom. Households borrowed heavily to buy homes, thereby pushing up household debt levels and the prices of homes.

Ever-rising house prices (but also rising share prices) left households feeling ever wealthier, encouraging them to reduce their rate of saving and thus to allow their consumption to grow faster than their income.

In the aftermath of the credit boom - when share prices fell a lot and house prices fell a bit - households felt poorer and became more concerned about their high levels of debt. They thus began increasing their saving and trying to reduce their debts.

The household saving rate has now been steady at about 10 per cent of household disposable income for several years, meaning consumer spending has grown (and, as a matter of arithmetic, could only grow) at the same rate as household income.

Some people think the rate of household saving is unusually high and is the product of low consumer confidence, meaning it should fall when consumers cheer up, causing - again as a matter of arithmetic (because income equals consumption plus saving) - consumption to grow faster than income.

But Stevens says consumer confidence is neither weak nor strong and warns that the present saving rate isn't high, it's just back to normal. As well, "it would seem unlikely that we could bank on a resumption of sustained growth in assets [prices]", thus causing rising wealth to lead people to save less.

The household sector's apparent conclusion that its level of debt should go no higher makes it unlikely low interest rates will touch off another housing boom, although this "does not preclude prudent levels of borrowing by new entrants to the housing market, or by investors" (as existing borrowers continue paying down their mortgages).

As for non-mining business investment, its healthy growth is "by no means a certainty" and "looks like it is a while off yet".

Doesn't sound to me like a prospect where the highest priority of whoever wins the election should be getting the budget back to surplus.

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We got our cut from the resources boom

Do you realise you've been hearing about the glorious Resources Boom for the best part of a decade? To economists, it constitutes the greatest bit of good fortune to come Australia's way since the Gold Rush. To many of us, however, it hasn't sounded nearly so wonderful.

For one thing, there's that word boom. We know booms can't last. And aren't they supposed to end in bust? For those of us of a certain age, it's not the first commodity boom we've lived through - and the previous ones did end badly.

So a commodity boom is a big improvement in our income that, just as we're starting to get used to it, suddenly disappears, leaving us with a hangover. Great.

And then there's the word resources. It leaves many of us feeling uncomfortable. We were never all that impressed by making our living growing things in the ground and selling them to foreigners, but digging up part of our ground and shipping it overseas seems even more primitive.

Is that the best we can do after 200 years of development? We send our children to school and university for that? How long can we get away with that? Obviously there's a limit to it. Won't it leave us high and dry?

I suspect many of us have drawn perverse satisfaction from the recent pronouncements that the boom has ended. At least the hoopla's over and we're getting back to reality. Time for the reckoning - and the recriminations.

What have we got to show for all that fuss? I'm sure some people must have benefited, but I know I didn't. Surely we should have saved more of that windfall rather than frittering it away on high living? And what do we do for an encore? Haven't we destroyed our manufacturing sector in the process?

These fears are examined in a report by Dr Jim Minifie, of the Grattan Institute, published on Monday. It makes reassuring reading.

If you don't work in mining, or live in Queensland or Western Australia, it's easy to conclude you've seen none of the benefits from this supposedly fabulous boom. But that's because people are conscious only of the benefits that come directly. The trick is that, when we all live and spend in the same economy, the benefits get spread around.

For most of us, the benefits have been indirect, but very real for all that. For instance, many people don't count the high dollar - and its cheaper prices for overseas holidays and other imports - as part of their gain from the boom.

Minifie finds that while people in the mining states did better, those in the non-mining states didn't miss out. Between the 2003 and 2013 financial years, wages rose by 2.7 per cent a year faster than inflation in the mining states and by 1 per cent a year in the non-mining states.

When you switch to looking at income per household, the ratio improves. Household income per person rose by a bit less than 4 per cent a year in the mining states and by 2.4 per cent a year in the non-mining states. Household incomes in the non-mining states grew significantly faster during the boom years than in the previous seven.

Unemployment didn't differ greatly between the mining and non-mining states. They began the period at much the same rate and ended it much the same.

Minifie finds that some regional centres did better than others through the boom, but among centres hit by the high dollar, most still experienced rising employment, thanks to steady economy-wide growth.

Only 14 towns, with a combined population of just 600,000, experienced falls in employment as a share of population, with no town losing more than two percentage points.

We keep hearing that the high dollar has "hollowed out" our manufacturing sector, leaving it incapable of recovering once the dollar comes down. (Tourism and some other industries have been equally hard hit, but no one worries about them.)

Despite a decline in employment in manufacturing, Minifie finds its output didn't fall, mainly because of increased demand from the resources sector. And although its exports fell overall, exports of more sophisticated manufactures grew.

"The experience of other countries that have been through a big shift in exchange rates suggests that Australian manufacturing is unlikely to have suffered permanent damage," he says. "If exchange rates decline, manufacturing is likely to bounce back to [its longer-term rate of growth] within a few years."

Much has been made of Minifie's finding that successive federal governments - Liberal and Labor - saved very little of the higher tax collections they enjoyed as a result of the boom. They gave away most of it in income-tax cuts (thereby improving your standard of living).

But despite the media's efforts to convince you otherwise, the federal budget is not the totality of the economy. Nor did all of the benefits from the boom go solely to the federal government.

The broader picture is that, as a nation, we have saved a high proportion of the proceeds from the boom. Greatly increased saving by households, and increased retention of earnings by companies, have more than outweighed the reduction in saving by governments.

The nation's overall saving rate is now about 3 per cent of national income higher than it was, equivalent to about $50 billion a year. Why are we so easily convinced we're losers?

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How what's hurting most is also what saved us

While many business people see the economy as badly performing and badly managed, our econocrats see it as having performed quite well and better than could have been expected. Why such radically different perspectives on the same economy?

Partly because business people - particularly those from small businesses - view the economy from their own circumstances out: If I'm doing it tough, the economy must be stuffed. By contrast, macro-economists are trained to ignore anecdotes and view the economy from a helicopter, so to speak, using economy-wide statistical indicators.

A bigger difference, however, is that business people are comparing what we've got with what we had, whereas the economic managers are comparing what we've got with what we might have got, which was a lot worse.

Business people know everything was going swimmingly in the years leading up to the global financial crisis of 2008-09, but in the years since many industries - manufacturing, tourism, overseas education, retailing, wholesaling - have been travelling through very rough waters.

The econocrats, however, have a quite different perspective: whereas the rest of us love a good boom, those responsible for managing the economy view them with trepidation. Why? Because they know they almost always end in tears and recriminations.

Particularly commodity booms. As a major exporter of rural and mineral commodities, we've had plenty of these in the past. They've invariably led to worsening inflation, a blowout in the trade deficit and ever-rising interest rates, followed by a recession and climbing unemployment. The latest resources boom was the biggest yet, involving the best terms of trade in 200 years, leading to a once-a-century mining investment boom. It could have - even should have - led to a disaster, but it didn't.

The macro managers' primary responsibility is to maintain "internal balance" - low inflation and low unemployment - which involves achieving a reasonably stable rate of economic growth. No wonder commodity booms make them nervous.

So how have they gone? As Dr Philip Lowe, deputy governor of the Reserve Bank, said in a speech this week, over the three years to March, economic output (real gross domestic product) has increased by 9 per cent, the number of people with jobs has risen by more than half a million and the unemployment rate today is 5.4 per cent, the same as it was three years ago.

Underlying inflation has averaged 2.5 per cent over the period, the midpoint of the medium-term inflation target. "So over these three years we have seen growth close to trend, a stable and relatively low unemployment rate and inflation at target," he says.

And that's not all. The investment boom hasn't led to a large increase in the current account deficit. There hasn't been an explosion in credit. Increases in asset prices have generally been contained. And the average level of interest rates has been below the long-term average, despite the huge additional demand generated by the record levels of investment and high commodity prices.

So "we have managed to maintain a fair degree of internal balance during a period in which there has been considerable structural change, a very large shift in world relative prices, a major boom in investment and a financial crisis in many of the North Atlantic economies", Lowe says.

So how was this surprisingly OK performance achieved? Well, that's the funny thing. The two factors that have done so much to make life a misery for so many businesses - the high dollar and increased household saving - are the very same factors that have been critical to our good macro-economic performance.

The high dollar brought about by the resources boom has reduced the ability of our export industries to compete in the international market and reduced the competitiveness of our import-competing industries in our domestic market, making life very tough for many of them.

For a while, many hoped the dollar's rise would be temporary, but now "there is a greater recognition that the high exchange rate is likely to be quite persistent and firms, including in the manufacturing sector, are adjusting to this", Lowe says.

"Many are looking to improve their internal processes and address inefficiencies. They are focusing on products where value-added is highest and where the quality of the workforce is a strategic advantage. We hear from businesses right across the country that they are looking for improvements and that many are finding them."

But here's the other side of the story. Had we not experienced the sizeable appreciation, he says, it's highly likely the economy would have overheated and we would have had substantially higher inflation and substantially higher interest rates.

"This would not have been in the interests of the community at large or ... in the interests of the sector currently being adversely affected by the high exchange rate." And it's unlikely we would have avoided a substantial real exchange-rate appreciation, with it coming through the more costly route of higher inflation. (The real exchange rate is the nominal exchange rate adjusted for our inflation rate relative to those of our trading partners.)

Next, the rise in the net household saving rate from about zero to 10 per cent of household disposable income since the mid-noughties represents about an extra $90 billion a year being saved rather than consumed by households.

This reversal of the long-running trend for consumption to grow faster than household income explains much of the pain retailers and wholesalers have been suffering. We've had more retail selling capacity than we've needed, forcing shops to fight for their share of business.

But had households spent that extra $90 billion a year on consumption, it's likely there would have been significant overheating. The exchange rate would have been pushed up, the trade balance would be worse and there would have been more borrowing from the rest of the world.

"And both inflation and interest rates would have been higher. I suggest that these are not developments that would have been warmly welcomed by most in the community," Lowe concludes.

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The hidden truth about interest rates

The prize for journalistic innovation of 2012 must surely go to whoever thought of a way to turn a cut in the official interest rate from good news to (the much more valuable) bad news: abandon the media's eternal assumption that everyone's a borrower and let the grey-power lobby bang on about the evils of lower deposit rates.


It's such an improvement on the standard good-into-bad transformation: bleating about the greedy banks not passing on all the rate cut to people with mortgages.

If we keep down this track we can turn all rate stories into bad news: as Reserve Bank board meetings approach you hold the mike up to all the professional urgers predicting death to the economy if rates aren't cut. Then, when the Reserve obliges, you pass the mike to whingeing oldies.

I suppose it's a good thing for the media to discover at long last that interest rates are a two-way street; that though borrowers gain from lower rates, savers lose. And that there are actually a lot more savers than borrowers.

There's just one problem with the newly fashionable bleeding for retired depositors: it doesn't necessarily follow that a cut in the banks' interest rates for people with home loans leads to similar cuts in rates paid to depositors - a point the grey-power lobby didn't bother making clear to a newly sympathetic media.

There are probably few more underreported topics than what's happening to deposit rates. The banks don't mention them in their press releases announcing cuts for borrowers, and the media rarely press the banks to be more forthcoming.

But even if some of the big four banks shave their deposit rates, I doubt they all will. And those that do are not likely to cut them by as much as the 20 basis points they're lopping off mortgage rates.

Why not? Well, if the media had been reporting the whole affair conscientiously, rather than turning it into a comic-book contest between good guys and bad guys, ripoff merchants and impoverished victims, you'd already know why.

The reason the banks haven't been cutting deposit rates the way they've been cutting mortgage rates goes to the heart of their reason for not passing on official rate cuts in full. Since the onset of the global financial crisis in 2008, the banks have been locked in a battle to attract deposits from ordinary Australian savers.

This battle has forced up the rates being paid to depositors. Whereas before the crisis the rates on at-call savings accounts were about 100 basis points below the official interest rate, today they're on par with it. And whereas term-deposit "specials" were below the equivalent rates paid in the wholesale market (bank bills), today they're about 150 basis points above them.

So, savers ought to be the last people complaining about the way events have transpired since the financial crisis changed the rules of the game. They're laughing all the way to the bank.

Indeed, the higher rates being paid to depositors (relative to where the official rate happens to be), are by far the greatest reason the banks have been imposing "unofficial" rate rises on home (and business) borrowers and now are passing on only about 80 per cent of the official rate cuts. The lesser reason is the higher rates they have to pay on their foreign "wholesale" borrowings.

In other words, it's not the banks that are supposedly ripping off poor home buyers, it's the whingeing retirees. The banks' cost of borrowing has increased, and all they've done is pass the higher cost on by cutting mortgage rates by less than the fall in the official rate.

But that doesn't give people with mortgages a licence to feel hard done by. Why not? Because, as the Reserve's deputy governor, Dr Philip Lowe, reminded us yet again last week, the Reserve has cut the official rate by more than it would have, just to ensure home buyers get the desired degree of rate relief. They haven't been short-changed.

On the face of it, the banks have done nothing wrong. They've merely passed on their higher cost of borrowing, leaving their "net interest margin" (the gap between the average rate they charge and the average rate they pay for funds) at about 230 basis points, virtually unchanged from what it was immediately before the crisis.

But it's not that simple. The question we need to ask is the one the media rarely do: why has the banks' cost of borrowing risen so much since the crisis? And why has a deposit-seeking war broken out among them?

Short answer: because the crisis revealed them to be dangerously dependent on foreign wholesale borrowing for their funds. So, the sharemarket and the credit rating agencies have forced them to lift their reliance on "stickier" retail deposits to about 54 per cent of their total funding.

But this means running a bank is now less risky than it was before the crisis. This, in turn, means their risk-adjusted rate of return on capital no longer needs to be as high as it was.

So, the degree of competition among the banks is sufficient to force them to give depositors a much better deal, and sufficient to have them wanting to preserve their profitability (and their chief executives' remuneration packages) relative to the others, but insufficient to force down their rates of return the way the textbook says should happen.

In all the millions of angry words the media have spilt on the topic this year, the hidden truth is that home borrowers have little to complain about and depositors even less - save for the small truth that our banks remain far more profitable than they need to be.

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Economy slowing, not dying

To hear many people talk, the economy is in really terrible shape. Trouble is, we've been waiting ages for this to show up in the official figures, but it hasn't. This week's national accounts for the September quarter are no exception.

You could be forgiven for not realising this, however, because some parts of the media weren't able resist the temptation to represent the figures as much gloomier than they were.

One prominent economist was quoted (misquoted, I trust) as inventing his own bizarre definition of recession so as to conclude the economy was in recession for the first nine months of this year.

Really? Even though figures we got the next day showed employment grew by 1.1 per cent over the year to November, leaving the unemployment rate unchanged at 5.2 per cent? Some recession.

What the national accounts did show - particularly when you put them together with other indicators - is that the economy is in the process of slowing, from about its medium-term trend growth rate of 3.25 per cent a year to something a bit below trend.

That's not particularly good news - it suggests unemployment is likely to rise somewhat - but it hardly counts as an economy in really terrible shape.

The accounts show real gross domestic product growing by 0.5 per cent in the September quarter and by 3.1 per cent over the year to September - which latter is "about trend".

This quarterly growth of 0.5 per cent follows growth of 0.6 per cent in the previous quarter and 1.3 per cent the quarter before that. So that looks like the economy's slowing - although the figures bounce around so much from quarter to quarter it's not wise to take them too literally.

But the accounts contain a warning things may slow further. We always focus on the growth in real gross domestic product, which is the quantity of goods and services produced during the period (and is the biggest influence over employment and unemployment).

But if you adjust GDP to take account of the change in Australia's terms of trade with the rest of the world, to give a better measure of our real income, you find "real gross domestic income" fell by 0.4 per cent in the quarter to show virtually no growth over the year.

Leaving other factors aside, this suggests our spending won't be growing as fast next year, leading to slower growth in the production of goods and services (real GDP) and thus slowly rising unemployment.

Our terms of trade are falling back from their record favourable level because of the fall in coal and iron ore export prices as the first stage of the three-stage resources boom ends. (The second stage is the mining investment boom and the third is the rapid growth in the quantity of our mineral exports.)

For some time the econocrats and other worthies have been reminding us that, when ever-rising export prices are no longer boosting our incomes, we'll be back to relying on improved productivity - output per unit in input - to lift our real incomes each year.

This makes it surprising we've heard so little about the figures showing that GDP per hour worked rose by 0.7 per cent in the quarter and by a remarkable 3.3 per cent over the year. Again, it's dangerous to take short-term productivity figures too literally, but at least they're pointing in the right direction.

They also put a big question mark over all the agonising we've heard about our terrible productivity performance.

This week's figures confirm what we know: some parts of the economy are doing much worse than others. Business investment in plant and construction rose by 2.6 per cent in the quarter and 11.4 per cent over the year - though most of this came from mining, with investment by the rest of business pretty weak.

One area that isn't as weak as advertised is consumer spending, up by 0.3 per cent in the quarter and 3.3 per cent over the year - about its trend rate. The household saving rate seems to have reached a plateau at about 10 per cent of disposable income, meaning spending is growing in line with income.

Investment in home building grew 3.7 per cent in the quarter, suggesting its chronic weakness may be ending, thanks to the big fall in interest rates. Adding in home alterations, total dwelling investment was up 0.7 per cent in the quarter, though still down 6.3 per cent over the year.

The volume (quantity) of exports rose 0.8 per cent in the quarter and 4.7 per cent over the year, whereas the volume of imports rose 0.1 per cent and 3.5 per cent, meaning "net exports" (exports minus imports) are at last making a positive contribution to growth. This suggests we're starting to gain from the third stage of the resources boom, growth in the volume of mineral exports. The greatest area of weakness was spending by governments. Government consumption spending was down 0.4 per cent in the quarter (but still up 3.5 per cent over the year). Government investment spending fell 8.2 per cent in the quarter and 7 per cent over the year even though, within this, investment spending by government-owned businesses was strong.

All told, the public sector made a negative contribution to GDP growth of 0.5 percentage points in the quarter, and a positive contribution of just 0.3 per cent over the year - obviously the consequence of budgetary tightening at both federal and state levels.

This degree of contraction isn't likely to continue. But a strong reason for accepting the economy is slowing somewhat is the news from the labour market.

Don't be fooled by the monthly farce in which unemployment is said to jump one month and fall the next. If you're sensible and use the smoothed "trend estimates" you see unemployment steady at 5.3 per cent since August.

Even so, the economy hasn't been growing fast enough to employ all the extra people wanting work, causing the working-age population's rate of participation in the labour force to fall by 0.4 percentage points to 65.1 per cent.

And we know from the labour market's forward-looking or "leading" indicators - surveys of job vacancies - that employment growth is likely to be weaker in coming months.

That's hardly good, but it ain't the disaster some people are painting.

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Punters turn away from share investment

The return of the prudent consumer is being accompanied by the return of the risk-averse consumer. Households aren't only saving more of their incomes, they're saving more through banks and less through shares.

In the days when the public was less economically literate, many people had no conception of saving other than putting money in the "savings accounts" offered by banks. After a season in which we thought that was for mugs, saving through bank accounts is back.

In truth, the main way Australians saved was to take on a huge home mortgage, then pay it off over the next 25 or 30 years. By the time most people retired, most of their savings were embodied in the unencumbered value of their home.

And their outright ownership of their home was a big part of the reason they were able to scrape by happily enough on little but the age pension. Although the value of the pension has been rising in line with real wages for decades, ours is the first generation convinced it couldn't possibly live on the pension alone.

So it's probably just as well that, starting in the mid-1980s, employees have been compelled to save via superannuation. Super is now the chief rival to paying off a home loan as the main way Aussies save over their working lives.

Remember when John Howard was encouraging us to become "a nation of shareholders"? That was at a time when government-owned businesses such as the Commonwealth Bank and Telstra were being privatised and non-profit outfits such as AMP and the NRMA were being "demutualised", so many households acquired tiny shareholdings of this and that.

And, having taken the plunge, many then acquired shares in the more usual way. Well, owning shares directly is no longer fashionable. Of course, working households' indirect ownership of shares via superannuation increases as each pay day passes.

But, as the Reserve Bank observes in an article in last week's quarterly Bulletin, households have shifted their "portfolios" away from riskier financial assets, such as shares, and towards less risky assets, such as deposits. I'll be drawing from that article.

I've no doubt much of households' saving has taken the form of reducing debts and getting ahead on their mortgage repayments. There was a time when Aussies' highest financial goal was to repay the mortgage as early as possible. That goal is coming back into its own with the return of the prudent consumer.

I guess the chief motivation was a desire to be unencumbered but, as a tax-effective investment strategy, repaying the mortgage has always scored highly - exceeded only by negatively geared property or share investments.

Which brings us back to risk - and risk aversion. Between 2003 and 2007, the proportion of household financial assets held in shares (both directly and via super) increased from 35 per cent to 45 per cent.

Much of this increase came from capital gain. Total return on shares averaged about 20 per cent a year over this period, compared with average deposit rates of about 5 per cent. But then came the fall in wealth caused by the global financial crisis and the mild recession of 2008-09.

Between 2008 and 2011, there were net outflows from households' direct holdings of shares of $67 billion, while holdings of deposits rose by $225 billion.

It's likely people were reacting, on the one hand, to the large capital losses in the sharemarket, but also to the market's volatility, which has doubled since 2007.

But, on the other hand, people would have been reacting to the advent of much higher interest rates offered on bank term deposits as, in the aftermath of the global crisis, the banks bid up those rates in their competition to replace now-riskier overseas funding with more stable, "stickier" funding from domestic deposits.

Over the past 30 years, the average annual real return on Australian shares (including capital growth and dividends) has exceeded the average annual real return on deposits by about 5.5 percentage points.

Since 2008, however, that's been reversed, with a return on shares of minus 5 per cent versus 2.5 per cent on deposits.

The share of households' financial assets held directly in equities has more than halved from 18 per cent before the crisis to 8 per cent at the end of last year. In contrast, the share of deposits has increased from 18 per cent to 27 per cent.

That this shift has been driven mainly by households' greater aversion to risk is confirmed by the changed answers people are giving to relevant questions in the survey of consumer sentiment and other reputable surveys.

In theory, households have shifted to a less risky risk/return trade-off and, by doing so, are willing to live with lower returns over the longer term. But whether the "equity premium" - the much higher rate of return on shares relative to fixed-interest securities - will stay as high as it's been in the past is open to doubt.

The equity premium has always looked much healthier over long periods than it has over many shorter periods, meaning people in or approaching retirement shouldn't be too mesmerised by it and should be favouring more stable returns.

So the shift from shares to deposits may well be explained partly by the baby boomers' rapidly approaching retirement.

The big super funds have also shifted their mix away from shares to some extent, though they've done so by less than the self-managed super funds, suggesting they're more wedded to "equity" than they ought to be.

Why might that be? Well, part of the problem is that the dividend imputation system means share returns are more favourably taxed than fixed-interest returns. Not good.

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Why we've become good savers

Who would believe it? Australia is turning into a nation of savers. We've already lifted our rate of saving - we save more than people in other developed countries - and we're likely to increase our saving rate further.

Who would believe it? Australia is turning into a nation of savers. We've already lifted our rate of saving - we save more than people in other developed countries - and we're likely to increase our saving rate further.

This the surprising message in this year's budget statement 4 - otherwise known as Treasury's sermon. The facts and figures that follow come from there.

Expressed as a proportion of gross domestic product, gross national saving fell significantly from the mid-1970s until the early 1990s. Between 1992-93 and 2004-05, it was fairly steady at 21 per cent. It began to rise in 2005-06 - well before the global financial crisis - and since the crisis it's shot up to reach almost 25 per cent last year.

This is well above the average for the developed economies of less than 19 per cent. Now, their saving rates are down because they're still trying to put the Great Recession behind them and it's arguable that some part of our increased saving since the crisis is also a passing reaction to the uncertainty it continues to cause. But we were well above them before the crisis.

The nation's rate of saving is the sum of the saving done by the three sectors of our economy: the households, the companies and the governments.

Households save when they spend less than all their income on consumption. Companies save when they retain part of their after-tax profits rather than paying all of them out in dividends. Governments save when their revenue exceeds their recurrent spending.

Most of the reason for the increase in national saving - and most of the reason for expecting it to increase further - rests with households.

The household saving rate declined steadily from the mid-1970s to the mid-noughties but then it increased significantly and is now 11.5 per cent of GDP, up from a low of just under 6 per cent in 2002-03.

One reason for this turnaround is the maturing of the compulsory superannuation system. Award-based super was introduced in 1985 but the scheme really got going in 1992, when they began phasing up employer contributions to 9 per cent of ordinary-time wages by 2002.

The value of Australia's super savings is now as much as $1.3 trillion, equivalent to 95 per cent of annual GDP (compared with the average for the developed countries of 68 per cent). Treasury estimates the scheme now makes a gross contribution to national saving of 1.5 percentage points.

Treasury says the more recent increase in household saving is likely to reflect a combination of increased consumer caution following the crisis and a return to more sustainable rates of consumption growth.

To the extent it's a return to more normal rates of growth in consumer spending, it's likely to be lasting. To the extent it's just caution, retailers and others can hope it will go away as all the upheaval stemming from the global crisis is resolved, people become more confident and lower somewhat the rate at which they're saving.

Now, no one can say how much of our higher household saving rate comes from lasting ''structural change'' and how much comes from passing caution. Until more of history unfolds, we can only make guesses.

But my guess is most of it is structural and not much of it is passing. In any case, I can't see the global economy becoming a much more placid place any time soon. Europe's weakness could roll on for a decade.

I think the econocrats are holding out false hope to retailers and others with their talk of ''the cautious consumer'', implying the tough times will end as soon as shoppers cheer up. It would be better to encourage the retailers to get on with adjusting to the new world they live in.

Treasury says the fall in household saving up to the mid-noughties primarily reflected a prolonged, but essentially one-off, structural adjustment to financial deregulation from the early '80s and the transition to a low-inflation (and hence low nominal interest-rate) environment from the early '90s.

Easier access to credit and lower rates led to greater borrowing, rising house prices, high levels of confidence and - thanks to big capital gains - people reducing their saving rate and allowing their consumption spending to grow faster than their incomes.

This adjustment process is likely to have been a significant driver of change in household saving. From the second half of the noughties, however, households began to slow their accumulation of debt and, as a result, the household saving rate began to rise.

With this process now likely to have been completed, households as a whole can be expected to consolidate their financial position over coming years by returning to more normal levels of saving and borrowing.

That's a quick explanation of why we've gone back to being good savers. But why expect our saving rate to go on rising? Partly because our (largely foreign-owned) mining companies are retaining a high proportion of their huge after-tax profits (which they're using to help finance their investment in additional production capacity).

Partly because the federal politicians (and their state counterparts) are struggling to get their budgets back into operating surplus, meaning governments are shifting from dissaving to saving.

But mainly because the compulsory super scheme will soon begin phasing up the contribution rate from 9 per cent of wages, reaching 12 per cent in 2019-20. Treasury estimates this will make a further gross contribution to the national saving rate of 1.5 percentage points of GDP over the next 25 years, with most of that expected to occur over the next decade.

Just as every punter knows in their gut that deficit and debt are always and everywhere a bad thing (it ain't true), so everyone knows saving is always a good thing. But what's so good about it?

The main reason people save is to smooth their consumption over time. For instance, you consume less while you're working so you can have a higher standard of living when you're retired. You can even use saving to pass some of your income on to the next generation. And saving makes you more resilient by providing a buffer against unexpected adverse events.

At a national level, borrowing less and saving more makes us more resilient to possible external shocks. And it helps moderate inflation pressure and so allows interest rates to be lower.

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Is Australia living beyond its means?

It has become fashionable to say the US is ''living beyond its means''. But can the same accusation be levelled at Australia? It was a claim we used to hear often when people worried about the big deficits we were running on the current account of the balance of payments.

During the 1960s, the current account deficit averaged the equivalent of 2 per cent of gross domestic product. By the '80s, however, it was averaging 4 per cent, rising to 4.25 per cent during the '90s and noughties.

But though few people have noticed, in recent years the deficit has been falling. And for 2011 it was just 2.25 per cent.

Why the decline? And what does this tell us about whether we are or aren't living beyond our means?

It gets down to what's happening to the nation's levels of saving and investment. And James Bishop and Natasha Cassidy provide a detailed account of trends in national saving and investment in the latest Reserve Bank bulletin. Most of the facts and figures I'm using are from their article.

The nation's annual investment spending occurs in three categories: households investing in the construction of new homes, companies investing in new equipment, buildings and other structures, and governments investing in infrastructure.

The money to pay for all that investment spending has to come from somewhere and, for the most part, it's provided by the nation's savers.

Households save when they spend less than all their income on the consumption of goods and services. Companies save when they retain part of their after-tax profits rather than paying them all out to shareholders in dividends. Governments save when their raise more in revenue than they need to pay for their recurrent spending.

If Australians saved more than we wanted to invest in a period, we'd lend our excess saving to foreigners. If we want to invest more than we've saved in a period, we call on the savings of foreigners to make up the difference. We either borrow their money or we sell them Australian assets.

In fact, we almost always want to invest more than we save, and the amount we need to acquire from foreigners is called the current account deficit.

The level of our national investment spending has stayed reasonably steady over the years, somewhere below the equivalent of 30 per cent of GDP. Business investment accounts for more than half of this.

You might expect business investment to be particularly high at present because of the huge spending on new mines and natural gas facilities. But while mining investment has been exceptionally strong, other business investment spending has fallen sharply in recent years. This may be due to the effect of the high dollar on the profits of trade-exposed industries.

Public investment spending - covering such things as transport, hospitals, educational facilities and state-owned utilities - declined significantly as a share of GDP during the '90s. This partly reflected efforts to balance budgets and reduce government debt but also the trend to having the private sector, rather than the public sector, provide infrastructure such as expressways.

But this decline was reversed during the noughties, public investment reaching 6 per cent of GDP in 2010. Initially this recovery was underpinned by infrastructure spending by state governments, though in later years it was driven by the federal government's stimulus spending on school buildings and public housing. The latter has fallen off very recently, of course.

Households' investment spending on new housing usually fluctuates between 4 and 6 per cent of GDP. But it was particularly strong in the noughties and has fallen back in very recent years.

Putting these disparate trends together, national investment has actually fallen as a share of GDP in the past year or two, dropping to 27 per cent in 2011.

Australia's level of investment has almost always been significantly higher than the average for the developed economies, our 27 per cent at present comparing with their 19 per cent.

On the face of it, our desire to invest heavily in the further development of our economy hardly qualifies as a case of living beyond our means.

As the authors remind us, investment is a key driver of the productivity of labour. And when we spend on expanding the nation's capacity to produce goods and services, we're ensuring a higher material standard of living in future. The income we generate should easily cover the cost of servicing our foreign borrowings.

But it ain't quite that simple. Well-directed investment is a virtue, no doubt. But if we're having to borrow from foreigners because we're not doing enough saving of our own, that could be a problem.

Are we saving as much as we should be? Don't forget, saving equals income minus consumption. So if we're consuming too much, we won't be saving enough. But how much is enough?

As a nation we are saving - at present, a bit under 25 per cent of national income (GDP) - so we can't be accused of borrowing to finance consumption, which is surely the most obvious case of living beyond your means.

But, equally obviously, we could be saving more than we do, so are we saving enough?

Looking at the components of national saving, saving by companies has been slowly trending up over the decades and at present is at a record level of about 14 per cent of GDP.

Government saving was very weak in the '70s and '80s but, following the deep recession of the early '90s, strengthened to about 5 per cent of GDP during most of the noughties.

It's now back to zero, however, in consequence of the 2008-09 recession the pollies keep saying we didn't have.

The rate of household saving fell steadily through the '70s, '80s and '90s but began increasing sharply in the mid-noughties and is now back up to about 10 per cent of GDP, its highest since the '80s. Pulling the components together, national saving is now back up to almost 25 per cent of GDP, also its highest since the '80s. And this is about 6 percentage points higher than the average for the developed countries.

Why has our current account deficit almost halved to 2.25 per cent of GDP in the past year or two? Because national investment is down a bit on the one hand, while national saving is up a bit on the other.

The charge that we're living beyond our means has never been less applicable.

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Nice set of figures should shut up the gloomsters

Something strange is happening to the Australian psyche at present. A lot of people are feeling down about the economy. They're convinced it's pretty weak, and any bit of bad news gets a lot of attention.

But most of the objective evidence we get about the state of the economy says it is, under the circumstances, surprisingly strong. Consider the national accounts we got this week.

They show the economy - real gross domestic product - grew by 1 per cent in the September quarter, more than most economists were expecting. And not only that, the Bureau of Statistics went back over recent history, revising up the figures.

Originally we were told the economy grew by a rapid 1.2 per cent in the June quarter, but now we're told it grew by an even faster 1.4 per cent. Originally we were told the economy contracted by 1.2 per cent in the March quarter because of the Queensland floods and cyclone, but now we're told the contraction was only 0.7 per cent.

Those figures hardly fit with all the gloominess. So how fast is the economy travelling, on the latest numbers? We're told it grew by 2.5 per cent over the year to September, but that figure includes the once-off contraction in the March quarter, which is now ancient history.

We could do it the American way and say we grew at an ''annualised rate'' of 4 per cent in the September quarter (roughly, 1 per cent x 4), but that's too high because this quarter (and the previous one) includes a bit of ''payback'' (or, if you like, catch-up) as the Queensland economy got back to normal after its extreme weather.

(There's likely to be more catch-up in the present quarter as the Queensland coalmines finally pump out all the water and resume their normal level of exports, suggesting the Reserve Bank is reasonably safe to achieve its forecast of 2.75 per cent growth over the year to December.)

So the best assessment is that at present the economy is growing at about its ''trend'' (long-term average) rate of 3.25 per cent a year. If so, everything's about normal.

Ah yes, say the gloomsters, but all the growth's coming from the mining boom. Before we check that claim, let's just think about it. If we were viewing our economy in comparison with virtually every other developed economy, we'd be thanking our lucky stars for the mining boom.

But not us; not in our present mood. We're feeling sorry for ourselves because, for most of us, the benefits of the boom come to us only indirectly. (The other thing we ought to be thankful for apart from our luck is 20 years of clearly superior management of our economy. In stark contrast to Europe and the US, we have well-regulated banks and stuff-all public debt.)

It's true the greatest single contributor to growth in the September quarter was the boom in investment in new mines. New engineering construction surged 31 per cent in the quarter and total business investment spending rose by almost 13 per cent.

But though most of that remarkable boost is explained by mining, there was also a healthy increase in manufacturing investment.

And here's a point some people have missed: the second biggest contribution to growth in the September quarter (a contribution of 0.7 percentage points) came from the allegedly cautious consumer.

Consumer spending grew by 1.2 per cent in the quarter and by 3.8 per cent over the year to September. That's actually above its long-term trend. And consumer spending was strong in all the states, ranging from rises of 0.8 per cent in Victoria, 0.9 per cent in Western Australia (note) and 1.1 per cent in NSW, to 1.9 per cent in Queensland (more catch-up).

Although households are now saving about 10 per cent of their disposable incomes, this saving rate has been reasonably steady for the past nine months. So consumer spending is growing quite strongly because household income is growing quite strongly.

It's noteworthy that, according to Treasury, non-mining profits rose by 4.7 per cent in the quarter. And according to Kieran Davies, of the Royal Bank of Scotland, non-mining GDP grew by a solid 0.7 per cent in the quarter, just a fraction below trend.

So the notion that mining (and WA and Queensland) might be doing fine but everything else is as flat as a tack is mistaken. It's true, however, that some industries are doing it tough. Consumers are spending at a normal rate, but their spending has shifted from clothing and footwear and department stores to restaurants, overseas travel and other services.

Home-building activity declined during the quarter - a bad sign. The continuing withdrawal of the earlier budgetary stimulus meant that government spending fell by 2.5 per cent during the quarter. Public spending was a drag on growth in all states bar WA and Queensland (more catch-up).

Our terms of trade - export prices relative to import prices - improved by 2.7 per cent in the quarter (and by 13 per cent over the year to September) to be their best on record. But that's likely to be the peak, with key export prices falling somewhat in the present quarter.

The volume of exports rose by 2 per cent in the quarter, but the volume of imports rose by 4.3 per cent, mainly because of imports of capital equipment. So ''net exports'' (exports minus imports) subtracted 0.6 percentage points from overall growth in real GDP during the quarter.

Ah yes, say the gloomsters, but all this is old news - the September quarter ended more than two months ago. The economy must have slowed since then. After all, look at this week's news of a rise in the unemployment rate to 5.3 per cent in November.

It does seem true the labour market isn't as strong as the strength of economic activity would lead us to expect. This could indicate a degree of caution on the part of employers. But the rise in unemployment is slow and small, and if it's only up to 5.3 per cent we're still doing very well by the standard of the past 20 years.

As for the tempting line that everything's gone bad since the strong growth in the September quarter, just remember: that's what the gloomsters said when they saw the good growth figures for the previous quarter. Turned out to be dead wrong.

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Thrift paying big dividends on current accounts

The nation's econocrats have been pondering the resources boom for years, but one thing they've been expecting isn't coming to pass: we're not getting huge deficits on the current account of the balance of payments.

Last week's figures showed a deficit of just $5.3 billion for the June quarter, about half what it was in the March quarter. This included a surplus on the balance of (international) trade in goods and services of

$7.5 billion - the fifth quarterly surplus in a row - offset by a deficit on net income payments (our payments of interest and dividends to foreigners less their payments to us) of $12.8 billion.

Switching to the year to June, the current account deficit was $33.6 billion, down from $53.3 billion the year before. Expressed as a proportion of gross domestic product, this was an amazingly low 2.4 per cent, down from 4.1 per cent the year before.

So why were the econocrats expecting bigger deficits? Because most of the money to finance the surge of investment in new mines and natural gas facilities would have to come from foreigners, thereby adding to the surplus on the capital account of the balance of payments which, with a floating currency, is always exactly balanced by a deficit on the current account.

And why haven't the big deficits come to pass? Because household saving has been a lot greater than the econocrats were expecting. The more the nation saves, the less it has to call on the savings of foreigners to finance its investment spending.

Last financial year's current account deficit is down because saving is up while the mining investment boom is only just getting started.

As that boom gets under way, the current account deficit is likely to grow. This year's budget forecast a deficit of 4 per cent of GDP for this financial year, rising to 5.25 per cent in 2012-13. Even so, those figures are smaller than the econocrats had been expecting before they realised how much more households were saving.

Last week's national accounts showed households saving a net (that is, after allowing for the year's depreciation in the value of household assets) 10.5 per cent of household disposable income. This is unlikely to be an aberration; it's more likely to be a reversion to our earlier thrifty habits.

If you're more used to thinking about the current account deficit in terms of exports and imports, I should explain that these days economists tend to look on the other side of the coin, which shows saving and investment.

The current account deficit equals the capital account surplus, which represents the net inflow of foreign financial capital to the Australian economy. As we've seen, we call on the savings of foreigners to finance that part of our investment in new physical capital than can't be financed by our own saving.

This net inflow of foreign financial capital allows us to import more goods and services than we export, including imports of capital equipment.

The net capital inflow also helps us finance our net payments of interest on the nation's net foreign debt and our net payments of dividends on net foreign equity investment in Australia's businesses - though the ultimate justification for our foreign borrowing is the profits we make from our physical investments.

The nation's annual investment spending includes not just business investment in equipment and structures, but also public investment in infrastructure and households' investment in the construction of new homes.

Similarly, the nation's annual saving includes not just the amount saved by households, but also the saving companies do when they retain part of their after-tax profits rather than paying them all out in dividends and the saving governments do when they raise more in revenue than they need to cover their recurrent spending.

According to an article in the federal Treasury's latest Economic Roundup, in the decade or so before the first stage of the mining boom began in 2003, the current account averaged 3.7 per cent of GDP. During the first stage it averaged 5.7 per cent, but since the global financial crisis it's averaged 3.3 per cent.

Before the mining boom, gross national investment spending (that is, before allowing for the annual depreciation of assets) averaged 24.3 per cent of GDP. Since the start of the mining boom it's averaged 27.9 per cent.

Had the level of gross national saving stayed unchanged, that would have increased the average current account deficit by 3.6 percentage points. In fact, national saving has increased from 22.2 per cent to 24.5 per cent.

While households have been saving a lot more in the period since the global financial crisis, federal and state governments have fallen into operating deficit, meaning they've gone from saving to dissaving. As they get their budgets back to operating surplus in the next year or two they'll be adding to rather than subtracting from national saving.

Company profits have been high in recent years and many companies have been saving a fair bit. Mining companies, in particular, have been reinvesting a lot of their after-tax profits in expanding their activities. (To the extent that those retained earnings are owned by foreign shareholders, and were initially counted in the balance of payments as capital outflows, their reinvestment is counted as foreign capital inflow, even though the actual dollars never left the country.)

Australia's persistent current account deficit has always reflected a high rate of national investment rather than a low rate of national saving. Although our household saving rate was quite low during the decade or so to the mid-noughties, our overall, national rate of saving has been around the average for the developed economies.

Point is, should our current account get a lot bigger in the next few years, it will be because the mining construction boom involves a lot more investment spending, not because we're saving less.

We've done much hand-wringing lately about ''the cautious consumer'' (especially when we imagined consumer spending was weak, which we learnt last week it isn't), but the fact that increased household saving has stopped the strong growth in household income translating into booming consumer spending has some big advantages.

If we can avoid a consumption boom occurring at the same time as an investment boom, the Reserve Bank won't need to increase interest rates as much to control inflation and this, in turn, will avoid adding upward pressure to the Aussie dollar.

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Baby boomers' wealth effect hits the retailers

Back in the early Noughties, when the property market was booming, a lot of baby boomers began contemplating their future and realised they hadn't saved nearly enough to allow them to continue in retirement the privileged lives they'd always enjoyed. They decided they'd have to start saving big time.

So what did they do? Went out and bought a negatively geared investment property, of course. Their notion of saving was to borrow to the hilt, then sit back and wait for the lightly taxed capital gains to roll in.

If you're wondering why the retailers are doing it tough at present, don't blame it all on the mug punters' conviction that Armageddon starts next July 1 with the carbon tax. Part of the explanation rests with the baby boomers learning the hard way that saving actually requires discipline.

Glenn Stevens, governor of the Reserve Bank, has reminded us of the way real consumer spending per person grew significantly faster than household disposable income for the decade to 2005. Over the period our rate of household saving steadily declined until we were actually dis-saving.

And this from a nation that hitherto had saved quite a high proportion of income. Why the change? Well, Stevens is no doubt right to explain it primarily in terms of our return to low inflation and low nominal interest rates, combined with a deregulated banking system now more than eager to lend for housing.

But there has to be more to it. For most of the decade in question we fought each other for the best house in the block, forcing house prices up and up. At much the same time, the sharemarket was rising strongly as we and the rest of the developed world enjoyed the last phase of the over-confident Great Moderation that ended so abruptly with the coming of the global financial crisis.

Over the 35 years to 1995, the nation's real private wealth per person grew at the rate of 2.6 per cent a year, pretty much in line with the growth in real gross domestic product per person.

Over 10 years to 2005, however, real household financial assets (including our superannuation and direct shareholdings) grew by 5.3 per cent a year per person. The corresponding growth in non-financial assets (most of which is the value of our homes) was 7.5 per cent.

Put the two together and our total assets grew by 6.7 per cent a year. (Our debts grew, too, of course. The ratio of debt to total assets rose from 11 per cent in 1995 to 17.5 per cent in 2005.)

So what was it that gave us the confidence during this period to let our consumer spending rip and stop saving any of our household income? One almighty ''wealth effect''. Capital gain was king.

Everywhere we turned we could see ourselves getting wealthier, year after year. The value of our homes rising inexorably, the value of our super swelling nicely. With all that going for us, who needed to save the old-fashioned way? No wonder negative gearing - of share portfolios as well as residential property - was so popular.

As Stevens says, that period of debt-fuelled wealth accumulation had to end sometime. We would come to terms with the new world of lower nominal interest rates and readily available credit, loading ourselves up with as much debt as we needed (or a bit more) and calling it a day.

The recovery in household saving began well before the global financial crisis. Even so, there's no reason to doubt the crisis did much to accelerate our return to rates of household saving - 11.5 per cent at last count - not seen since the 1980s. For one thing, it reversed the wealth effect.

In principle, the behaviour of people of all ages should be affected by the knowledge of what's happening to the market value of their wealth. In practice, however, you'd expect it to have the greatest effect on those approaching retirement - the baby boomers - or even the already retired.

Consider it from their perspective. In the months leading up to and during the global financial crisis of late 2008, they observed it smash the sharemarket and take a huge bite out of their super savings. The market has recovered a fair bit since then but it hasn't regained its earlier peak and could hardly be said to be booming.

As for house prices, the boom is long gone and prices are, in market parlance, ''flat to down''. There's no reason to believe they'll be taking off again any time soon.

Many boomers have responded to this marked change in their prospects by postponing their retirement. A government-funded survey regularly asks workers over 45 when they expect to retire. In 2009, almost 60 per cent were expecting to retire at 65 or later, up from 50 per cent two years earlier.

With little prospect of much in the way of capital gains, it's a safe bet the baby boomers are leading the way in the nation's return to a higher rate of saving.

But that doesn't spell the death of retailing. As a matter of arithmetic, it's only when households are increasing their rate of saving - as they are now - that consumer spending has to grow very much more slowly than household income is growing.

Once households have reached a rate of saving they're happy with - no matter how high that rate - consumption can resume growing at the same rate as income.

But who knows? It may not be until the second half of next year that the punters - including the baby boomers - realise how much Tony Abbott & Co conned them about the depredations of the carbon tax.

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Putting away dollars makes sense once again

Our top econocrats make a lot more speeches these days, but sometimes they say things that represent a clear advance in our understanding of what's happening with that mysterious animal we call the economy. Glenn Stevens, governor of the Reserve Bank, gave such a speech this week.

One device economists use to get a handle on economic developments is to distinguish between those that are ''cyclical'' and those that are ''structural''. Cyclical developments are a product of the economy's present position in its eternal movement through the business cycle of boom and bust. That is, they may be important now, but they won't last.

Structural developments, by contrast, come from deeper, underlying and long-running economic and social forces. They usually move more slowly, but they're more permanent.

The main message the econocrats have been trying to get to us is that the present resources boom isn't just another short-lived commodity boom but is bringing about a long-lasting change in the structure of our economy.

But this week Stevens identified a quite different structural change occurring at the same time as the mining construction boom. We're in the middle of a profound shift in the attitudes of Australian households towards how much of their income they spend on consumption and how much they save.

For many years households used to save a high proportion of their disposable incomes: 10, 12 even 15 per cent. Taking all households together, their mortgage and other debt stood at less than 50 per cent of annual household disposable income. Everyone's ambition was to pay off their mortgage as early as possible.

But, as Stevens points out, all that started to change in the mid-1990s. Over the 10 years to 2005, the trend rate of growth in real household disposable income (here, meaning income after tax and net interest payments) was 2 per cent a year per person. That's a very healthy rate of income growth - more than double the rate seen in the previous two decades.

Even so, household consumption spending grew over the same period at the even faster real, per-person rate of 2.8 per cent a year. How can our spending grow at a faster rate than our income? By us steadily cutting the rate of our saving.

We even got to the point where our consumption spending exceeded our income. How is that possible? By ''dissaving'' - running down past savings or by borrowing.

But from about 2005, before the global financial crisis in late 2008, all that began changing.

Over the five years to the end of 2010, real household disposable income per person grew at the even faster rate of 2.9 per cent. Why? Because of the flow through the economy of the very much higher export prices we've been getting.

But here's the thing: as our rate of income growth has accelerated, our rate of consumer spending has slowed down. In per-person terms, real consumption today is no higher than it was three years ago.

So what's changed? We've stopped saving less and started saving more. Why? Well, it's obviously not primarily because we're worried about higher interest rates, the risk of problems in Europe and America causing another global financial crisis or we're all afraid the world will end when the carbon tax starts next July.

Those worries are clearly part of the present, short-term, cyclical explanation for our caution as consumers, but they can't explain a structural trend that began about six years ago.

For that you have to look deeper. As we've seen, it's possible for your spending to grow faster than your income for a protracted period as you run down past savings and borrow. But you can't keep doing it forever. Eventually, your debts get so great that you (or your bankers) call a halt.

You realise having so much debt is dangerous, so you hold back your spending and increase your saving - often by paying off some of the debt. The ratio of household debt to annual disposable income shot up to about 150 per cent, but in the past few years it's levelled off.

The point to realise is that this new trend represents a return to normal behaviour after a protracted period of abnormal behaviour. We used to save 10 or 12 per cent of our incomes, and now we've got back to saving that much. We used to want to pay off our mortgage ASAP, and now we're back to wanting that to.

What happened in the middle was households making a protracted but essentially once-only adjustment to two major developments: financial deregulation, which made banks much keener to lend to households using newer, more flexible deals, and the return to low inflation and low nominal interest rates, which allowed people to borrow a lot more for the same monthly payments.

With hindsight it's clear we'd long wanted to spend more on better housing so, when the opportunity arose, we did. In the process of everyone wanting to move to a better house at pretty much the same time, however, we greatly bid up the price of houses and acquired a lot of debt.

But now we've adjusted to the new world of lower interest rates and higher levels of debt. We're not getting in any deeper, so have moved back to more normal levels of saving.

While we were watching the value of our homes going up and up we felt richer and so didn't feel we needed to save from our incomes. We stepped up our consumption. But now house prices have levelled off and so we've held back our consumption and returned to saving for the future the normal way.

Point is, the period of consumption spending growing faster than income has ended and is unlikely to return. At present, our efforts to increase our rate of saving mean consumption is growing a lot more slowly than our income is growing.

But as soon as we get our rate of saving back to where we want it to be, we can maintain that rate while consumer spending returns to growing at the same speed as income. With the saving rate already back to 11 per cent, you'd think we must be pretty close to reaching that point. If so, consumer spending could resume a reasonable rate of growth once our present short-term worries lift.

Message for retailers: the party times will never return, but the present tough times won't last.

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Surge in savings masks current account rise

One little-noticed consequence of the resources boom has been a big rise in the current account deficit on our balance of payments with the rest of the world. But when we get the latest figures on Tuesday we're unlikely to see any evidence of that. Why not? Because of the surge in household saving.

The current account deficit occurs because our imports and payments of interest and dividends to the rest of the world almost always exceed our exports and receipts of interest and dividends from the rest of the world.

Over the past 30 years the current account deficit has averaged about 4 per cent of gross domestic product. Since the start of the resources boom in 2003-04, however, the current account deficit has been nearer 5 or 6 per cent of GDP.

You might expect that, with the resources boom meaning the world is paying us much higher prices for our exports of coal and iron ore, the current account deficit would be smaller rather than larger. But it hasn't worked out that way.

Why not? Because the higher export prices represent an increase in the nation's real income, and when that extra income is spent by individuals and firms, much of the additional spending goes on imports.

But it's always easier to see the factors driving the current account deficit if we explain it in terms of saving and investment rather than exports and imports.

How is it possible for us to go on year after year having our recurrent payments to the rest of the world exceeding our recurrent receipts? It's possible only if we can cover the difference by having someone in the rest of the world lend us that difference (or by accepting foreign ''equity'' investment in Australian businesses).

These capital transactions are recorded in the capital account on the balance of payments. So it turns out that if we're running a deficit on the current account this has to be exactly matched by a surplus on the capital account.

And the capital account surplus represents the amount by which the nation's investment in new housing, business plant and structures, and public infrastructure during a period exceeds the nation's saving during that period.

Households save by spending less than all their income on consumption. Companies save by retaining some of their after-tax profits rather than paying them all out as dividends. And governments save when they raise more in taxes than is needed to cover their recurrent spending.

The amount we save pays for the amount we invest. So when a nation's physical investment spending during a period exceeds the amount it has saved during that period - as it always does in Australia - it has to cover the gap by calling on the savings of foreigners.

Looked at this way, the resources boom increases the current account deficit because it leads the mining companies - many of which are foreign-owned - to greatly increase their investment in the construction of new mines, natural gas facilities and so forth.

In the first stage of the resources boom - before the global financial crisis interrupted - there was an increase in national saving, but a greater increase in national investment, thus causing the current account deficit to be 1 or 2 percentage points of GDP higher.

Then there was the period of the crisis - particularly in 2009 - when national saving increased but national investment fell, thus causing the current account deficit to narrow to about 3 per cent.

But now we've got the economy recovering from the mild recession induced by the crisis. We have seen a bit of growth in investment in new housing, stronger growth in companies' investment in ''non-dwelling construction'' (mainly continuing construction of new mines), though no growth in companies' investment in new machinery and equipment, and very strong growth in governments' investment in infrastructure, particularly the state governments.

So national investment spending is up on the crisis period. But national saving is up by more. As we saw in this column last week, the household saving ratio has shot up to 10 per cent of household disposable income (equivalent to about 6 per cent of GDP).

Corporate saving is quite high, as companies use retained earnings to repay debt and improve their gearing. Yet governments have gone from saving to dissaving as their revenues have been hit by the delayed effect of the downturn while their recurrent spending has been swollen by stimulus measures.

Putting these three components together, national saving is well up on what it was before the crisis struck. Whereas gross national saving had coasted along each year at about 20 per cent of GDP (here, ''gross'' means before making a deduction for the annual depreciation in the value of the stock of the nation's physical capital), now it is up to about 25 per cent.

So, though national investment is up a bit on what it was during the crisis, national saving is up a lot - mainly thanks to the remarkable increase in household saving. This suggests the current account deficit, which got down to 3 per cent of GDP during the crisis, has taken a step lower to 2 per cent. It averaged 2 per cent in the June and September quarters of last year and, when we see the balance-of-payments figures on Tuesday and the national accounts on Wednesday, they're likely to show the current account deficit stayed at about 2 per cent in the December quarter.

Two conclusions. First, the fact that the increase in the current account deficit during the noughties occurred because of higher investment rather than reduced saving (which actually increased a bit), suggests that the foreign debt we are racking up is financially sustainable. In the main, we're borrowing from foreigners to expand our capacity to sell more coal, iron ore and natural gas to foreigners.

Second, the expectation that the resumption of the resources boom will lead to many more years of outsized current account deficits arises because we know there's a huge amount of investment in mining construction to come, with much of the funding for that investment coming from foreigners.

But this expectation assumes no change in the nation's saving habits. So to the extent that our households continue saving a lot more of their incomes than they used to, we can have the mining construction boom with lower-than-expected current account deficits and less increase in our foreign debt.

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Urge to splurge fades as savers born again

The punters, pollies and shock jocks who tell us we're groaning under the weight of the rapidly rising cost of living need to answer a question: if so, how come households are managing to save 10 per cent of their disposable income?

It has drawn remarkably little comment, but the household saving ratio - saving as a proportion of household disposable (that is, after-tax) income - is the highest it has been in more than 20 years.

You wonder why the retailers are doing it so tough? That's why. With wage rates increasing and more people in jobs, household income has been growing quite strongly. But in recent years we've been much less inclined to rush out and spend every cent that comes our way.

That's what saving is: the bit that's left over when you don't spend all your income on consumption. In fact, economists define saving as ''deferred consumption''.

Most of us think of saving as putting money in bank accounts. We've been doing more of that lately, but it's not the main way we save. Historically, the main way Australians have saved is by borrowing a shed-load of money to buy a house, then paying it off over the next 25 years. Your savings are embodied in the proportion of the house that's owned by you rather than the bank - your ''equity'' in the house.

The household saving ratio was at 15 per cent in the early 1980s, but then it fell for more than two decades to reach a low point of minus 2 per cent in the early noughties. We were ''dissaving'' - consuming more than we earnt.

How's that possible? By running down past savings or by borrowing.

Since the mid-noughties, however, the saving ratio has shot up to 10 per cent. You could be forgiven for not knowing this because much of the increase has suddenly appeared as a result of the Bureau of Statistics' revisions to the national accounts.

The bureau doesn't measure saving independently, just takes it as the residual when it compares two huge numbers: for household income and for household consumption. So any errors in measuring those two big numbers will be reflected in the figure for saving, making it volatile and subject to revision as better information comes to hand.

Since 2004 household disposable income has grown strongly, averaging 7.3 per cent a year in nominal terms (that is, before allowing for inflation). Over the same period, household consumption has grown by 5.4 per cent a year.

Dr Philip Lowe, an assistant governor of the Reserve Bank, expressed the figures differently in a speech he gave this week. In quite a few of the years during the decade and a half to 2005, household consumption increased by more than a dollar for every extra dollar of household disposable income received.

Since then, however, only about 65¢ in every extra dollar of income has been spent. (Small prize if you realised this measure is that old Keynesian workhorse, the ''marginal propensity to consume''.)

The evidence that something has changed in our attitude to saving can be seen in other indicators. One example comes from the annual survey of Household, Income and Labour Dynamics in Australia.

In the surveys between 2000 and 2005, there was a clear trend of fewer and fewer households with mortgages reporting they were ahead of schedule in their repayments (a way of saving). But this downtrend slowed in about 2005 and then in 2009 - the most recent year for which results are available - there was a marked increase in the share of people saying they were ahead of schedule.

Similarly, over the past couple of years there has been an increase in the proportion of households who say they pay their credit card balance in full each month. It has gone from about 60 per cent to almost 65 per cent.

Then if you look at the Westpac-Melbourne Institute monthly survey of consumers you find there has been a marked increase in the number of households saying the wisest thing to do with their savings is to pay down debt or build up bank deposits.

Correspondingly, there has been a decline in the perceived attractiveness of more risky investments.

A final bit of evidence comes from the estimates of how much equity households are adding to the housing stock. Until the late 1990s, it was normal for the value of newly constructed homes each year to be significantly greater than the increase in the amount we all owed on our housing.

Why? Because, while the people buying the newly-built homes would usually borrow most of the cost of the home, other, established home owners would be trying to pay back their mortgages as quickly as they could (mainly by keeping their monthly mortgage payments higher than the bank's minimum requirement).

In other words, the proportion of the nation's total amount of housing that wasn't owed to banks would increase each year. Economists call this ''equity injection''.

But during the early part of the noughties this changed and the household sector was withdrawing equity. Now here's the point: in recent years things have changed again and we've returned to the usual pattern of increasing equity.

So what's going on? Why did we stop saving and why have we started again? Over the decade to 2005, there was a large run-up in household debt and a related rise in the (gross) value of household assets such as homes and shares, while our rate of saving declined.

This seems to have been a period of adjustment to the fall in nominal interest rates (caused by our return to low inflation) and financial innovation (banks keener to lend for housing, with new products such as home-equity loans and reverse mortgages).

Lower nominal mortgage rates allowed us to borrow more, which many of us did at much the same time, thus bidding up house prices in the process. Some of us even increased our mortgage to pay for an overseas trip.

But it seems this period of adjustment to new possibilities was largely completed by the mid-noughties and we've gone back to our usual preference for paying off the mortgage as soon as we can.

And then this episode of ''structural adjustment'' seems to have been reinforced by the global financial crisis, which has led some households to rethink their spending and borrowing decisions. Some people are a lot more cautious and a lot less sure that house and share prices can only ever go up.

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