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Checking Savings

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Raise the Rate Contest Entry

Raise the Rate Contest Entry

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    Checking Savings Checking Savings Presentation Transcript

    • Checking Savings
      By Mitchell Chubinsky
    • Analytical Framework
      Checking Savings
      Background
      The Checking Savings Program
      Conclusion
      Notes and Sources
    • Background
      Recent Trends in the U.S. Personal Saving Rate
      Personal Saving as a Percentage of Disposable Income
      Source: U.S. Department of Commerce: Bureau of Economic Analysis via the St. Louis Fed
    • Although the U.S. Personal Saving Rate has surged in the past few years from alarming lows, it needs to climb even higher.
      In these tumultuous economic times, saving early and often is more important than ever:
      Volatile equity, fixed-income and commodity markets.
      Continued decline of private pension schemes.
      Massive deficits in public pension plans and Social Security.
      Personal saving is the only way to hedge these risks and an uncertain future.
      The Current Environment
    • It’s clear that individuals should save more; studies have found that many households even feel the same way.
      In many ways, low personal savings is less the consequence of economic factors than behavioral ones.
      The problem, then, is how can we change people’s savings habits?
      A wide body of research has found behavior to be notoriously stubborn; maybe we can’t change it.
      Raising the Rate – The Problem
    • Maybe we don’t have to change savings habits…
    • Instead of trying to influence consumers’ active savings habits, have banks enroll customers in checking accounts that will automatically transfer a percentage of deposits into linked savings accounts.
      Could be pure savings accounts, CDs, govt/agency debt or other risk-free investments.
      The deposit transfer percentage would increase progressively to 10% (or higher) over two years, driving a comparable rise in the personal saving rate.
      The Solution – Checking Savings
    • Make this account type the default for new accounts, but allow customers to opt-out at any time.
      A rewards program could offer a variety of bonuses for maintaining balances and reaching savings targets:
      Higher interest rates, frequent flyer miles, iTunes downloads, etc.
      Penalties imposed for early and frequent withdrawals not for qualified emergency, education, medical or other basic living expenses and needs.
      Other Features
      The Checking Savings Program
    • Economics predicts that individuals will save a portion of their income while employed to finance a healthy level of consumption after retirement.
      People seem to realize that they should save more, but have trouble doing so for various behavioral reasons.
      The Main Idea
      Analytical Framework
    • Bounded Rationality – No one knows for sure what the appropriate savings rate is. The different options and instruments can be overwhelming and confusing.
      Those without economics training may not fully appreciatethe time value of money or the fundamental tradeoff between present and future consumption.
      Hyperbolic Discounting – People tend to irrationally discount the future, leading to overconsumption and undersaving in the present, as well as procrastination.
      I’ll start saving more… tomorrow, when I get a raise, etc.
      Behavioral Economic Explanations for Undersaving
    • Loss Aversion – People tend to weigh losses far more heavily than equivalent gains. Increased savings comes at the cost of decreased disposable income and current consumption. This can be perceived as a loss, when it’s really just an intertemporal tradeoff
      Amplified by hyperbolic discounting – The benefits or saving for a vague and distant future are severely undervalued, given the cut to spending money that you have to live with now.
      Status Quo Bias – There is a strong tendency towards inertia. People infrequently change habits and behaviors, even when it may be in their best interest to do so.
      Behavioral Economic Explanations for Undersaving
    • Using predetermined deposit transfer rates and investments absolves consumers from having to make the potentially confusing decisions of how and how much to save.
      Also ensures people will save enough, regardless of behavioral biases and irrationally present-minded preferences.
      With enrollment by default and automatic savings transfers, procrastination becomes irrelevant and saving becomes the new status quo.
      Discontinuing participation in the plan would require an active opt-out.
      Why Checking Savings Will Work
      Analytical Framework
    • Having a preset transfer rate that gradually increases over time will help ease people into saving by mitigating the loss aversion.
      Starting at 10% would feel like a huge loss.
      Rewards will incentivize and reinforce savings behavior. Offering a variety of bonuses would make the program fun and help expand its appeal across demographics.
      Penalties will serve to force participants to think carefully about withdrawals, and in doing so encourage fiscal responsibility.
      Why Checking Savings Will Work
    • Personal Saving Rate. Last Updated 11/1/2010.
      http://research.stlouisfed.org/fred2/data/PSAVERT.txt
      This program draws heavily on the ideas and body of research discussed in Richard Thaler and ShlomoBenartzi’s 2004 Journal of Political Economy article “Save More Tomorrow: Using Behavioral Economics to Increase Employee Saving.”
      Thaler, Richard H. and Benartzi, Shlomo. “Save More Tomorrow: Using Behavioral Economics to Increase Employee Saving.” Journal of Political Economy. 2004, vol. 112, no. 1, pt. 2.
      Notes and Sources