A key determinant of the severity of the recession in the global economy and in Australia will be the extent to which households in the US and Australia boost their level of savings in order to cut their debt levels.

Some are claiming that we are about to see a massive cut in household debt in Australia and that this will drag the economy down into a very severe recession if not depression. This note looks at the main issues. The key points are as follows:

– Household savings rates are set to move higher in the years ahead as households seek to cut debt in the face of a tighter credit environment, economic uncertainty and a loss of wealth. A return to pre 1980s levels for household savings rates in the US and Australia is quite likely.

– However, lower interest rates & government measures to boost household finances will help ease this adjustment, heading off the economic calamity that some predict.

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