RDP 2006-07: Household Saving and Asset Valuations in Selected Industrialised Countries Appendix C: The Relationship of Household Saving to Wealth Building

As noted in Appendix B, the household saving rate as measured in the national accounts is computed as a residual item, representing the difference between all sources of after-tax income and consumption. While this definition of household saving may indicate flows into household wealth – and therefore the soundness of household balance sheets – it does not take into account the sale of, or changes in, the market valuation of existing household assets (also referred to as ‘holding gains’), which can be considerable. In this respect, the convention of Juster et al (2004) can be adopted, whereby saving can be broken down into an ‘active’ component (the national accounts notion of the saving ratio) and a ‘passive’ one (capital gains on existing assets). Indeed, over the second half of the 1990s, personal savings declined to record lows as wealth grew to record highs in several countries. This fact can be attributed to the effects of valuation changes in wealth, which rose to record highs in the late 1990s.[28]

The relationship between household saving and the change in household wealth can be summed up rather succinctly. Following on the presentation of Perozek and Reinsdorf (2002), the wealth accumulation identity can be written as follows:

where Wt is wealth at time t; it represents nominal interest, dividend and rental rates of return; Inline Equation is the percentage change in the price of assets from time t − 1 to time t; Yt is income from sources other than wealth holdings; Tt is net tax paid; and Ct is consumption expenditure on goods and services.

In words, wealth in any given period can be expressed as last period's wealth (adjusted for income accruing from pre-existing wealth in addition to valuation changes) plus income net of taxes and consumption. This can be rewritten more intuitively as:

with the first right-hand term representing capital gains on assets and the second right-hand term representing the national accounts concept of saving. In this sense, the national accounts definition of saving accounts for the ‘active’ component – that is, the difference between income exclusive of capital gains and consumption – but ignores the ‘passive’ component.


More recently, survey findings of Kennickell (2006) for the United States indicate that holding gains on assets explain a very large fraction of the change in net worth in the flow of funds accounts, with holding gains accounting for about 92 per cent of the change in the net worth of the household sector in the fourth quarter of 2004. [28]