## 1. Relative Decline in Consumption

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### Introduction and context
- In the mid-1990s, China’s urban household saving rate stood at 19 percent of disposable income.
- A decade and a half later, the saving rate touched 30 percent.
- The increase in household saving occurred while the economy grew rapidly and expectations of improved livelihoods, higher earnings, and greater prosperity increased.
- China’s growth model became more reliant on exports and investment.
- Rebalancing China’s economy toward consumption will require policies that induce households to save less and spend more.
- This paper examines the role of financial reform—particularly interest rate liberalization and an increase in saving deposit rates—in influencing household saving rates in China.
- Empirical analysis uses a panel dataset covering China’s 31 provincial-level administrative units over the period 1996–2009.

### Main empirical findings
- Panel estimates suggest that household savings respond strongly to a change in the real interest rate:
  - A one percentage point increase in the real rate of return on bank deposits lowers the urban household saving rate by 0.6 percentage points.
- Sub-period comparison:
  - The association between real interest rates and household saving is stronger in 2003–09 relative to 1996–2002.
- Robustness:
  - The estimated relationship is robust to inclusion of variables that proxy for other influences on saving such as life cycle considerations and self-insurance against income volatility.
- Interaction with alternative investment returns:
  - When the return on alternative investment is high (for example when real property price growth is relatively strong), a decline in the real return on bank deposits does not have as negative an impact on household portfolios.

### Key findings on household saving and interest rates (summary statistics and coefficients)
- Urban household saving rate (percent of disposable income): Full Sample (1996-2009) 22.8; 1996-2002 20.0; 2003-09 25.5.
- Real interest rate (Percent, pa): Full Sample 1.4; 1996-2002 2.9; 2003-09 -0.1.
- Empirical association: OLS baseline real interest rate coefficient -0.550*** (0.0826).
- Economic magnitude: a decline in real interest rates from 2.9 percent (average first half) to -0.1 percent (average second half) is associated with an approximately 1½ percentage point increase in the urban saving rate.
- Panel GMM (Arellano-Bond) results: negative effect of the real interest rate on saving is robust overall but is significant primarily in the second sub-period (2003–2009).

### Empirics, controls, and robustness
- Data: provincial annual sample covering all 31 provinces/federal municipalities/autonomous regions for 1996–2009; main variables drawn from China Statistical Yearbook and Urban Household Income and Expenditure Surveys.
- Descriptive variables (Full Sample averages unless noted):
  - Growth rate of disposable income: 10.6 percent (Full Sample), 10.6 (1996-2002), 10.6 (2003-09).
  - Income volatility (coefficient of variation): 13.4 percent (Full Sample).
  - Elderly dependency ratio: 11.2 percent.
  - Child dependency ratio: 30.9 percent.
  - SOE share (fraction of workers employed by SOEs): 68.2.
  - Urban property income share of disposable income: 1.8.
  - Residential property prices: RMB / sq m 2407 (Full Sample), 1666.4 (1996-2002), 2860.9 (2003-09).
  - Real property price growth (y/y): 7.9 percent (Full Sample).
  - Sex ratio (males per 100 females): 103.8.
  - Household size (average residents): 3.5.
- Baseline regressions include growth rate of income and income volatility; results robust to province fixed effects and to inclusion of nominal interest rate and CPI inflation (nominal rate significant, inflation not significant).
- Panel GMM with lagged saving rate confirms robustness; effect concentrated in 2003–2009.
- Additional robustness controls (2003–2009 regressions) that preserve the negative real-rate effect include:
  - Elderly dependency ratio: coefficient positive (aging associated with higher saving); inclusion does not remove real rate effect in many specifications.
  - SOE share of employment: declining SOE share associated with higher saving; inclusion does not remove real rate effect.
  - Property income share: higher property income share associated with higher saving; does not eliminate real rate effect.
  - Property prices: level of residential property prices positively associated with saving; real rate effect persists.
  - Sex ratio and household size: household size negatively associated with saving (smaller households save more); sex ratio not significant.

### Interaction effects and interpretation
- Significant interactions found:
  - Real interest rate * household size = 0.459** (suggests larger households attenuate the negative real-rate saving response).
  - Real interest rate * real property price growth = 0.0201*** (real property price growth weakens the negative relationship between real deposit rates and saving).
- Most other interaction terms (elderly dependency, child dependency, sex ratio, SOE share, property income share, property prices level) are not statistically significant, consistent with households targeting multiple saving motives rather than a single dominant motive.
- Mechanism:
  - Households behave consistent with a target saving / buffer-stock framework: lower real returns reduce actual wealth relative to targeted wealth-to-income ratios; households increase saving out of current income to restore targets.
  - Complementary motives documented: precautionary self-insurance (health, pensions), life-cycle factors (aging, dependency ratios), housing/homeownership and marriage-market signaling motives, and shifts from SOE-provided welfare to private saving.

### Policy implications and recommended sequencing
- Objective: lift the return on household saving and broaden saving/investment options to help households meet target accumulation with lower required saving out of current disposable income, thereby potentially boosting consumption and rebalancing the economy.
- Core recommendations for interest rate liberalization within an appropriately-sequenced financial reform agenda:
  - Drain existing liquidity overhang before full deregulation to avoid disorderly outcomes.
  - Increase exchange rate flexibility to minimize liquidity injections via the balance of payments.
  - Expand use of central bank open market operations to influence interbank rates.
  - Strengthen regulatory and supervisory capabilities and close coverage gaps to minimize risks of loosened lending standards and credit surges during liberalization.
  - Begin liberalization by lifting the deposit rate ceiling to allow market forces to guide deposit rates.
  - Broaden household access to saving/investment options by encouraging mutual funds, money market funds, insurance-linked investment products, and development of a full spectrum of securities (equity, corporate fixed income, government bonds across maturities).
  - Gradually remove capital controls to allow cross-border claims and two-way flows, beginning with FDI and long-term flows before relaxing restrictions on short-term portfolio flows.
  - Maintain sequencing: interest rate liberalization should be embedded in broader reforms (liquidity management, regulatory strengthening) and done flexibly to adapt to evolving circumstances.
- Expected macroeconomic effects:
  - Higher financial returns and broader investment choices should reduce the need for high saving out of disposable income by enabling households to meet target accumulation more easily.
  - Combined with effects on corporate saving and investment behavior, an appropriately sequenced set of financial reforms could materially contribute to rebalancing China’s saving-investment imbalance.

### Paper organization (as provided)
- Section II: summarizes recent trends in household saving rates in China and provides a brief overview of previous research.
- Section III: outlines the target saving hypothesis.
- Section IV: presents the empirical analysis.
- Section V: discusses policy implications and the importance of liberalizing interest rates.

### Summary conclusion
- The rise in urban saving rates in China is linked in part to the decline in real interest rates, particularly after 2003.
- Chinese households behave consistent with target-saving / buffer-stock motives and have responded to lower real returns by increasing saving out of current disposable income to restore targeted wealth levels.
- The negative real interest rate—urban saving relationship is robust across multiple specifications and samples and persists after controlling for life-cycle, precautionary, housing, SOE-reform, demographic, and property-related factors.
- Policy action: a sustained increase in interest rates on bank deposits, wider access to alternative investment opportunities, and broader financial reform (appropriately sequenced) could lower required saving out of current income, raise private consumption, and contribute significantly to rebalancing China’s economy.

*Source: _wp11223 - 1. Relative Decline in Consumption; Section V (policy implications and interest rate liberalization) — IMF working paper excerpt*

### 1. Relative Decline in Consumption .....................................................................................

### 1. Relative Decline in Consumption

### Introduction and context
- In the mid-1990s, China’s urban household saving rate stood at 19 percent of disposable income.
- A decade and a half later, the saving rate touched 30 percent.
- The increase in household saving occurred while the economy grew rapidly and expectations of improved livelihoods, higher earnings, and greater prosperity increased.
- Concurrently, China’s growth model became more reliant on exports and investment.
- Rebalancing China’s economy toward consumption will require policies that induce households to save less and spend more.
- This paper examines the role of financial reform—particularly interest rate liberalization and an increase in saving deposit rates—in influencing household saving rates in China.
- The empirical analysis uses a panel dataset covering China’s 31 provincial-level administrative units over the period 1996–2009.

### Main empirical findings
- Panel estimates suggest that household savings respond strongly to a change in the real interest rate:
  - A one percentage point increase in the real rate of return on bank deposits lowers the urban household saving rate by 0.6 percentage points.
- Sub-period comparison:
  - The association between real interest rates and household saving is stronger in 2003–09 relative to 1996–2002.
- Robustness:
  - The estimated relationship is robust to inclusion of variables that proxy for other influences on saving such as life cycle considerations and self-insurance against income volatility.
- Interaction with alternative investment returns:
  - When the return on alternative investment is high (for example when real property price growth is relatively strong), a decline in the real return on bank deposits does not have as negative an impact on household portfolios.

### Interpretation and mechanisms
- Households appear to save to meet a multiplicity of needs: retirement consumption, purchase of durables, self-insurance against income volatility, and health shocks.
- Households act as though they have a target level of saving in mind.
- An increase in financial rates of return raises the return on saving and makes it easier for households to meet their target saving.
- Financial reform that boosts interest rates could therefore have a strong effect on reducing current tendencies to save out of disposable income.
- As financial development proceeds and alternative investment opportunities become more readily available, portfolio diversification may further enable households to meet their target saving more easily, potentially contributing to lower saving rates out of current disposable income.

### Paper organization (as provided)
- Section II: summarizes recent trends in household saving rates in China and provides a brief overview of previous research.
- Section III: outlines the target saving hypothesis.
- Section IV: presents the empirical analysis.

*Source: _wp11223 - 1. Relative Decline in Consumption (IMF working paper excerpt)*

### Section  V  discusses  policy  implications  and  the  importance  of  liberalizing  interest  rates

### _wp11223 - Section  V  discusses  policy  implications  and  the  importance  of  liberalizing  interest  rates

### Key findings on household saving and interest rates
- Urban household saving rate (percent of disposable income): Full Sample (1996-2009) 22.8; 1996-2002 20.0; 2003-09 25.5.
- Real interest rate (Percent, pa): Full Sample 1.4; 1996-2002 2.9; 2003-09 -0.1.
- Empirical association: a statistically significant negative correlation between real interest rates and urban saving rates. OLS baseline: real interest rate coefficient -0.550*** (0.0826).
- Economic magnitude: a decline in real interest rates from 2.9 percent (average first half) to -0.1 percent (average second half) is associated with an approximately 1½ percentage point increase in the urban saving rate.
- Panel GMM (Arellano-Bond) results: the negative effect of the real interest rate on saving is robust overall but is significant primarily in the second sub-period (2003–2009).
- Interpretation: evidence favors a “target saving” / buffer-stock framework where declining real returns erode actual wealth relative to targeted wealth-to-income ratios and induce households to raise saving out of current disposable income to replenish the shortfall.

### Empirics, controls, and robustness
- Data: provincial annual sample covering all 31 provinces/federal municipalities/autonomous regions for 1996–2009; main variables drawn from China Statistical Yearbook and Urban Household Income and Expenditure Surveys.
- Descriptive variables (Full Sample averages unless noted):
  - Growth rate of disposable income: 10.6 percent (Full Sample), 10.6 (1996-2002), 10.6 (2003-09).
  - Income volatility (coefficient of variation): 13.4 percent (Full Sample).
  - Elderly dependency ratio: 11.2 percent.
  - Child dependency ratio: 30.9 percent.
  - SOE share (fraction of workers employed by SOEs): 68.2.
  - Urban property income share of disposable income: 1.8.
  - Residential property prices: RMB / sq m 2407 (Full Sample), 1666.4 (1996-2002), 2860.9 (2003-09).
  - Real property price growth (y/y): 7.9 percent (Full Sample).
  - Sex ratio (males per 100 females): 103.8.
  - Household size (average residents): 3.5.
- Baseline regressions include growth rate of income and income volatility; results robust to province fixed effects and to inclusion of nominal interest rate and CPI inflation (nominal rate significant, inflation not significant).
- Panel GMM with lagged saving rate confirms robustness; effect concentrated in 2003–2009.
- Additional robustness controls (2003–2009 regressions) that preserve the negative real-rate effect include:
  - Elderly dependency ratio: its coefficient positive (aging associated with higher saving); inclusion does not remove real rate effect in many specifications.
  - SOE share of employment: declining SOE share associated with higher saving; inclusion does not remove real rate effect.
  - Property income share: higher property income share associated with higher saving; does not eliminate real rate effect.
  - Property prices: level of residential property prices positively associated with saving; real rate effect persists.
  - Sex ratio and household size: household size negatively associated with saving (smaller households save more); sex ratio not significant.
- Interactive effects:
  - Significant interactions found for:
    - Real interest rate * household size = 0.459** (suggests larger households attenuate the negative real-rate saving response).
    - Real interest rate * real property price growth = 0.0201*** (real property price growth weakens the negative relationship between real deposit rates and saving).
  - Most other interaction terms (elderly dependency, child dependency, sex ratio, SOE share, property income share, property prices level) are not statistically significant, consistent with households targeting multiple saving motives rather than a single dominant motive.

### Mechanism and interpretation
- Income vs. substitution: standard intertemporal interpretation would pit income and substitution effects; results are consistent with the income effect dominating but better explained by target saving / buffer-stock behavior in a rapidly changing environment (reforms to social safety nets, labor-market uncertainty, housing privatization, limited non-bank saving vehicles).
- Target saving model intuition: lower real returns reduce actual wealth relative to target wealth-to-income ratios; households respond by increasing saving out of current income to restore target.
- Complementary motives documented: precautionary self-insurance (health, pensions), life-cycle factors (aging, dependency ratios), housing/homeownership and marriage-market signaling motives, and shifts from SOE-provided welfare to private saving.

### Policy implications and recommended sequencing
- Objective: lift the return on household saving and broaden saving/investment options to help households meet target accumulation with lower required saving out of current disposable income, thereby potentially boosting consumption and rebalancing the economy.
- Core recommendations for interest rate liberalization within an appropriately-sequenced financial reform agenda:
  - Drain existing liquidity overhang before full deregulation to avoid disorderly outcomes.
  - Increase exchange rate flexibility to minimize liquidity injections via the balance of payments.
  - Expand use of central bank open market operations to influence interbank rates.
  - Strengthen regulatory and supervisory capabilities and close coverage gaps to minimize risks of loosened lending standards and credit surges during liberalization.
  - Begin liberalization by lifting the deposit rate ceiling to allow market forces to guide deposit rates.
  - Broaden household access to saving/investment options by encouraging mutual funds, money market funds, insurance-linked investment products, and development of a full spectrum of securities (equity, corporate fixed income, government bonds across maturities).
  - Gradually remove capital controls to allow cross-border claims and two-way flows, beginning with FDI and long-term flows before relaxing restrictions on short-term portfolio flows.
  - Maintain sequencing: interest rate liberalization should be embedded in broader reforms (liquidity management, regulatory strengthening) and done flexibly to adapt to evolving circumstances.
- Expected macroeconomic effects:
  - Higher financial returns and broader investment choices should reduce the need for high saving out of disposable income by enabling households to meet target accumulation more easily.
  - Combined with effects on corporate saving and investment behavior, an appropriately sequenced set of financial reforms could materially contribute to rebalancing China’s saving-investment imbalance.

### Summary conclusion
- The paper argues that the rise in urban saving rates in China is linked in part to the decline in real interest rates, particularly after 2003.
- Chinese households behave consistent with target-saving / buffer-stock motives and have responded to lower real returns by increasing saving out of current disposable income to restore targeted wealth levels.
- The negative real interest rate—urban saving relationship is robust across multiple specifications and samples and persists after controlling for life-cycle, precautionary, housing, SOE-reform, demographic, and property-related factors.
- Policy action: a sustained increase in interest rates on bank deposits, wider access to alternative investment opportunities, and broader financial reform (appropriately sequenced) could lower required saving out of current income, raise private consumption, and contribute significantly to rebalancing China’s economy.

*Source: _wp11223 - Section  V  discusses  policy  implications  and  the  importance  of  liberalizing  interest  rates*

### REFERENCES

### _wp11223 - REFERENCES

### Academic articles and working papers
- Aziz, J. and L. Cui. 2007. “Explaining China’s Low Consumption: The Neglected Role of Household Income.” IMF Working Paper series, 07/181 (Washington: International Monetary Fund).
- Banerjee, A., Xin Meng, and N. Qian. 2010. “The Life Cycle Model and Household Savings: Evidence from Urban China.” mimeo, Yale University (New Haven: Yale University).
- Batini, N., P. N’Diaye and A. Rebucci. 2005. “The Domestic and Global Impact of Japan’s Policies for Growth.” IMF Working Paper Series, 05/209 (Washington: International Monetary Fund).
- Blanchard, O. and F. Giavazzi. 2006. "Rebalancing Growth in China: A Three-Handed Approach," CEPR Discussion Paper 5403.
- Cai, Fang, J. Giles, and Xin Meng. 2006. “How Well Do Children Insure Parents Against Low Retirement Income? An Analysis Using Survey Data From Urban China.” Journal of Public Economics, 90, 12, pp. 2229-2255.
- Camerer, C., L Babcock, G. Loewenstein, and R. Thaler. 1997. “Labor Supply of New York City Cabdrivers: One Day at a Time” Quarterly Journal of Economics, 112, 2, pp. 407-441
- Carroll, C. 1997. “Buffer-Stock Saving and the Life Cycle/Permanent Income Hypothesis.” Quarterly Journal of Economics, 112, 1, pp. 1-55.
- Carroll, C. 2001. “A Theory of the Consumption Function, With and Without Liquidity Constraints.” Journal of Economic Perspectives, 15, 3, pp. 23-45.
- Chamon, M. and E. Prasad. 2010. “Why Are Saving Rates of Urban Households in China Rising?” American Economic Journal: Macroeconomics, 2, 1, pp. 93-130.
- Chamon, M., Kai Liu, and E. Prasad. 2010. “Income Uncertainty and Household Savings in China.” IMF Working Paper, 10/289 (Washington: International Monetary Fund).
- Feyzioğlu, T., N. Porter, and E. Takáts. 2009. “Interest Rate Liberalization in China.” IMF Working Paper, 09/171 (Washington: International Monetary Fund).
- Geng, N. and P. N’Diaye. 2011a. “Determinants of Corporate Investment in China: Evidence from Cross Country Firm-Level Data.” IMF Working Paper (forthcoming) (Washington: International Monetary Fund).
- Geng, N. and P. N’Diaye. 2011b. “Financial Development, Corporate Investment and Savings in China.” IMF Working Paper (forthcoming) (Washington: International Monetary Fund).
- Giles, J. and Ren Mu. 2007. “Elderly Parent Health and the Migration Decision of Adult Children: Evidence from Rural China.” Demography, 44, 2, pp. 265-288.
- Giles, J. and K. Yoo. 2007. “Precautionary Behavior, Migrant Networks, and Household Consumption Decisions: An Empirical Analysis Using Household Panel Data from Rural China” Review of Economics and Statistics 89, 3, pp. 534-551.
- Guo, K.and P. N’Diaye. 2010. “Determinants of China’s Private Consumption: An International Perspective”. IMF Working Paper, 10/93. Reprinted in Arora V. and R. Cardarelli, eds. Rebalancing Growth in Asia. Economic Dimensions for China. IMF: Washington DC. 2011.
- Gu Baochang, Wang Feng, Guo Zhigang, and Zhang Erli. 2007. “China's Local and National Fertility Policies at the End of the Twentieth Century.” Population and Development Review 33, 1, pp. 129-147
- Horioka, C. and Junmin Wan. 2007. “The Determinants of Household Saving in China: A Dynamic Panel Analysis of Provincial Data.” Journal of Money, Credit and Banking 39, 8, pp. 2077-2096.
- Kraay, A. 2000. “Household Saving in China.” World Bank Economic Review 14, 3, pp. 545-570.
- Kuijs, L. 2006. “How Will China’s Saving - Investment Balance Evolve?” World Bank Policy Research Working Paper 3958 (Washington: World Bank).
- Laxton, D., P. N'Diaye, and P. Pesenti. 2006. “Deflationary Shocks and Monetary Rules: an Open-Economy Scenario Analysis.” NBER Working Paper 12703 (Cambridge: National Bureau of Economic Research).
- Modigliani, F. and Shi Larry Cao. 2004. “The Chinese Saving Puzzle and the Life-Cycle Hypothesis.” Journal of Economic Literature, 42, 1, pp. 145-170.
- Pesenti, P. 2008. “The Global Economy Model (GEM): Theoretical Framework”. Federal Reserve Bank of New York, NBER and CEPR, mimeo.
- Wei, Shang-Jin and Xiabo Zhang. (forthcoming) “The Competitive Saving Motive: Evidence from Rising Sex Ratios and Savings Rates in China.” Journal of Political Economy.

### IMF, international institutions, and policy briefs
- IMF. 2009. Global Crisis: Asian Context. Asia and Pacific Regional Economic Outlook, Spring. http://www.imf.org/external/pubs/ft/reo/2009/APD/eng/areo0509.pdf
- IMF. 2011. People’s Republic of China: Staff Report for the 2011 Article IV Consultation. www.imf.org/external/pubs/ft/scr/2011/cr11192.pdf.
- Lardy, N. 2008. “Financial Repression in China.” PIIE Policy Brief, 08-8 (Washington: Peterson Institute for International Economics).
- Lardy, N. and P. Douglass. 2011. “Capital Account Liberalization and the Role of the Renminbi.” PIIE Working Paper, 11-6 (Washington: Peterson Institute for International Economics).
- Naughton, B. 2007. The Chinese Economy: Transitions and Growth. MIT Press.

### Other entries
- Geng, N. and P. N’Diaye. 2011a. “Determinants of Corporate Investment in China: Evidence from Cross Country Firm-Level Data.” IMF Working Paper (forthcoming) (Washington: International Monetary Fund).
- Geng, N. and P. N’Diaye. 2011b. “Financial Development, Corporate Investment and Savings in China.” IMF Working Paper (forthcoming) (Washington: International Monetary Fund).

*References as listed in _wp11223 - REFERENCES*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2011/_wp11223.pdf_