Precautionary Saving and Social Insurance
- Precautionary savings is a reference to the money that certain households save. It is called precautionary because the money is saved for when income levels are too low to support expenses and the household needs to access additional funds in order to preserve its current lifestyle. Precautionary savings is often employed by low-income households that are worried about money and do not expect any outside source of funds to help in the future. It can lead to slow wealth accumulation for such households.
- Social insurance refers to public programs--in this case programs run by the federal government--to provide money from taxes to low-income households. These plans differ widely based on how and why they were created and can change over time, but their primary design is to help such households by allowing them to avoid the worst effects of poverty and covering necessary expenses. The same type of households that practice precautionary savings are the households affected by social insurance.
- Some economists focus on the detrimental effects of social insurance on precautionary savings. If households already have a source of guaranteed income through the social insurance, then saving is no longer precautionary and households begin to save less. Not only can this put the household at high risk if the program benefits are discontinued and encourage unhealthy reliance on such funding, but it also lowers the amount of money in banks. This means that the banks cannot use as much money for lending and investment activities, and the economy can suffer.
- Social insurance, when used correctly, can help households save even more money, eventually elevating their income level and nullifying the need for such funding programs. Also, social insurance can encourage the expenditure of money that would otherwise be saved, which is another potential way to grow the economy.