The Social Science Journal 43 (2006) 553–569

Private saving determinants in European countries:

A panel cointegration approach
George Hondroyiannis a,b,∗
a
Bank of Greece, Economic Research Department, El. Venizelou 21, 102 50 Athens, Greece
b
Harokopio University, Athens, Greece

Abstract
This paper investigates the determinants of aggregate private saving in European countries employing
panel data. The long-run saving function is estimated based on an extended lifecycle hypothesis taking
into account the economic and demographic developments during this period. A long-run saving function
sensitive to dependency ratio, old dependency ratio, liquidity, public finances, real disposable income
growth, real interest rate and inflation is found to exist. The empirical evidence suggests the existence
of a long-run saving function in Europe. The policy implications of such a relationship are presented.
© 2006 Elsevier Inc. All rights reserved.

1. Introduction

The last 30 years the rate of private saving has changed in many European countries. In
particular, in some European countries the average propensity to save has decreased while in
others has showed a marginal increased or remained constant (Table 1). In countries such as
Germany, Greece, Italy, Sweden and U.K. saving rates have declined while in others such as
Austria, Belgium, Denmark, France, Finland, Netherlands, Portugal and Spain saving rates
have increased slightly or remained constant.1
Many economists argue that there are systematic reasons for these developments. Since
saving are related to future consumption, if European households underestimate future con-
sumption and risks they decrease saving. Contrary, if the economic agents are not myopic they
increase saving to buy security for future risks. Additional reasoning relates family relation-
ships, demographic developments and the existing social security system with the evolution

∗
Tel.: +30 210 320 2429; fax: +30 210 323 3025.
E-mail address: ghondroyiannis@bankofgreece.gr.

0362-3319/$ – see front matter © 2006 Elsevier Inc. All rights reserved.
doi:10.1016/j.soscij.2006.08.004
554 G. Hondroyiannis / The Social Science Journal 43 (2006) 553–569

Table 1
Private savings as percentage of GDP in European Union countries
Country 1961–1970 1971–1980 1981–1990 1991–2000 1999 2000
Austria 20.9 21.9 21.3 21.0 19.5 20.0
Belgium 22.0 22.8 25.3 26.3 24.1 23.7
Denmark 18.1 16.1 17.1 19.5 17.2 19.2
Germany 21.1 20.3 20.9 21.1 19.8 19.7
Greece 19.7 29.2 28.5 – 16.9 15.5
Finland 18.3 18.8 17.7 19.3 20.5 18.4
France 21.7 21.7 18.4 20.1 19.7 19.8
Ireland 18.5 22.7 20.7 18.9 17.6 16.1
Italy 23.5 30.2 28.7 23.7 19.1 18.7
Netherlands 23.3 20.1 22.5 25.2 23.4 23.1
Portugal 16.8 22.0 26.7 – 17.8 17.5
Spain – 22.3 21.3 – 19.4 18.8
Sweden – 14.8 17.6 – 17.1 15.6
United Kingdom 16.0 18.4 17.4 16.6 13.1 12.7
Average Euro Zone – 22.6 22.2 – 19.9 19.6
Average European Union 20.5 21.8 21.2 – 18.6 18.2
Source: European Commission, European Economy, Annex, Spring 2000. Luxembourg is not included.

of European saving ratio. In Europe almost all countries experience population ageing that
exercises further economic pressure on the finance of the social security systems and hence
influences saving. Finally, the globalization of capital markets and the release of liquidity
constraints, in many European countries, have improved consumer welfare by enabling more
intertemporal substitution2 and have influenced the European household saving behavior. That
is, the evolution of a “new financial landscape” in Europe, mainly since the introduction of Euro,
have increased the number and the sophistication of financial means increasing substantially
total household loans as percentage of GDP.3
Various studies have analyzed the possible determinants of private saving rates mainly for
individual countries. These studies have estimated the effects of economic and demographic
variables on private saving. Some studies comprise of industrial and developing economies
(Attanasio, Picci, & Scorcu, 2000; Edwards, 1996; Loayza, Schmidt-Hebbel, & Servén,
2000; Masson, Bayoumi, & Samiei, 1995), other of developing economies (Bandiera, Caprio,
Honohan, & Schiantarelli, 2000; Corbo & Schmidt-Hebbel, 1991) and some of country-specific
cases (Ostry & Levy, 1995, for France; Cárdenas & Escobar, 1998; Corbo & Schmidt-Hebbel,
1991, for Colombia; Morandé, 1998, for Chile; López Murphy & Navajas, 1998, for Argentina).
These studies attempt to isolate the key determinants of the private saving rate across a
large number of industrialized and developing economies. However, the econometric find-
ings of the studies have not offered clear evidence regarding the determinants of private saving
behavior, which creates an obvious deficiency that may affect applied research and policy
making.
The paper analyzes, for the first time, the determinants of private saving in a panel of
13 European countries. Given the amount of empirical research on this issue and the wide
range of empirical results, mainly on individual countries, there appears to be no clear
consensus among research on this issue. Methodologically, the statistical inference of this
research relies on univariate time series data of single country over a prolonged period
 G. Hondroyiannis / The Social Science Journal 43 (2006) 553–569 555

of time. Panel studies offer a number of advantages over time series and cross-sectional
analysis. Having multiple years of data increases the sample size and may lead to more
reliable estimates. Also, having multiple observations for each country enables researchers
to include country-specific fixed effects, thereby controlling for a wide range of time-
invariant country characteristics4 whose omission might otherwise bias the estimated saving
function.
In light of this, the study extends this line of research to a sample of European countries
on a country-by-country basis and to panel data modeling to examine the determinants of
private saving, such as demographic changes, government budget, liquidity constraint, real
disposable income changes, real interest rates and inflation. In addition, since our data involves
nonstationarity, a panel cointegration method is applied as an alternative to traditional time
series and cross-sectional regressions.5
The purpose of this paper is to examine empirically the main determinants of private saving
and to extend our understanding of the impact of these factors on private saving determination.
Second, the existence of private saving function is investigated for 13 European countries.
Third, the paper applies the empirical framework on a country-by-country and panel coin-
tegration modeling utilizing the recently developed estimation procedure of fully modified
ordinary least squares (FMOLS) for heterogeneous panels, proposed by Pedroni (1997, 2000).
The utilization of the most recently developed technique of cointegration and FMOLS estima-
tion in heterogeneous panel, has several advantages over the other methods used in the past by
various researchers, since this type of multivariate analysis can clearly estimate heterogeneous
cointegrating relationships in country-by-country and panel bases.
This is accomplished in four steps. First, the stationarity properties of the data and the order
of integration are tested on country-by-country and in panel modeling. The Im, Pesaran, and
Shin (2003), Levin and Lin (1993) and Hadri (2000) test for stationarity in heterogeneous
panel data are applied. Second, the Johansen maximum likelihood technique is applied to
search for cointegration among saving ratio, demographic variables and economic variables.
The Johansen technique controls for endogeneity and focuses on long-run relationships (cointe-
gration) among nonstationary variables. Third, the Pedroni technique for heterogeneous panel
data is applied to search for the existence of cointegration in the panel setting. Finally, the
FMOLS for heterogeneous panel technique is applied to estimate the long-run estimates in
country-by-country basis and in panel modeling (Pedroni, 1997, 2000).
The paper proceeds as follows. Section 2 reviews empirical and theoretical work on esti-
mating saving function. Section 3 deals with methodological issues and the data used in the
empirical analysis. Section 4 presents the empirical results. In Section 5 the conclusions of the
analysis are summarized and the policy implications are discussed.

2. Determinants of private saving

There is a vast literature, both empirical and theoretical, on the determinants of private saving
rates. Various researchers have completed comprehensive surveys on private saving behavior
(Balassa, 1990; Deaton, 1995; Fry, 1995; Gersovitz, 1988; Loayza et al., 2000). This section
deals briefly with the determinants of private sector saving behavior.
556 G. Hondroyiannis / The Social Science Journal 43 (2006) 553–569

2.1. Demographic influences on private saving

According to the lifecycle hypothesis (Modigliani, 1966, 1970) the age structure of the
population can have an influence on the private saving behavior. In societies with a high
proportion of population in the working age, a high rate of private saving should exist as
people save for their retirement. When this working group reaches the retirement age it dissaves
to maintain consumption, causing a decline in the saving ratio. Graham (1987) and Masson,
Bayoumi, and Samiei (1998) find that higher proportions of the young and elderly in relation to
persons of working age are associated with lower saving rates. However, Hurd (1990), Carroll
and Summers (1991) and Haque, Pesaran, and Sarma (1999) question the robustness of the
demographic effects on private saving behavior. They argue that elderly people may not dissave
to the extent that the lifecycle model predicts. Bequests and unpredictable expenses may alter
the saving pattern of the elderly. As supported by Attanasio et al. (2000) “if the negative saving
of the young is large enough at the aggregate level, a strong productivity growth might lead
to a negative correlation between saving rates and growth rates. The precise sign of the long-
run equilibria correlation among saving and growth in a lifecycle model depends upon the
precise shape of the utility function, the demographic structure and other factors.” So higher
proportions of the dependents to persons of working age may be associated either with higher
or lower saving ratio.

2.2. Interest rates and private saving

The effects of interest rate on consumption and consequently saving are ambiguous. Because
of the wealth, intertemporal substitution effects and user cost of durable goods, there is no
presumption as to the direction of the aggregate saving response to an exogenous interest-rate
change. A positive sign in real interest rate indicates an incentive to increase savings when
real interest rate increases that is the substitution and human-wealth effects are greater than the
income effect. Recent reviews, by Balassa (1990) and Fry (1995), conclude that most studies
have found a positive interest elasticity of saving than a negative one, but the coefficients have
generally been small and often insignificant. Bosworth (1993) finds a positive interest-rate
coefficient for a sample of countries, but a negative coefficient in a panel set of countries.
Ogaki, Ostry, and Reinhart (1996) report positive interest-rate effects developing economies
that vary with income but are small in magnitude. Masson et al. (1998) report positive, but less
robust, effects of interest rates on private saving. Bandiera et al. (2000) find that there is no
strong interest-rate effect on saving. When data are pooled, they report a significant, positive,
interest-rate effect on saving, and even then the effect is small.6

2.3. Financial liberalization and saving

Many researchers have stressed the importance of liquidity constraints on the saving behavior
of the individuals. In the simplest specification, they identify eras before and after liberalization
with dummy variables. Jappelli and Pagano (1994) set out a three-period model to analyze the
role of liquidity constraints in national private saving behavior. To proxy the liberalization
constraints they have used the volume of consumer credit. They apply their model to a panel of
 G. Hondroyiannis / The Social Science Journal 43 (2006) 553–569 557

19 OECD countries and find that liquidity constraints have a significant impact on net national
saving. Also, Ostry and Levy (1995) have employed the volume of consumer credit as a proxy
for financial liberalization and concluded that financial liberalization had lowered saving in
France.7 Bandiera et al. (2000), using principal components, construct 25-year time series
indices of financial liberalization for eight developing countries. They support the idea that
liberalization overall may be associated with a fall in saving. Loayza et al. (2000) have used
the ratio of M2 to GNP as an indicator of financial depth and the private credit flow relative
to income to capture consumers’ access to borrowing. For a sample of 20 industrial and 49
developing economies they conclude that credit availability reduces the private saving rate and
that larger financial depth does not raise saving.

2.4. Government dissaving and saving

The relationship between budget deficits and saving can be broadly classified into two
categories. The first view suggests that if the public does not value government consumption
then saving will decline when the government spending increases independently on the way that
this spending is financed. On the contrary, when the public value public goods, the effect of their
increase depends on the degree of substitutability between public and private goods. Thus, the
second view suggests that higher budget deficits will lower national saving, lower investment
and cause a trade deficit. An increase in the government deficit as a result of lower taxes or higher
government spending can boost consumption and can suggest a coefficient between 0 and −1
for the private saving ratio variable. An extension of this approach is Barro’s view (Barro,
1974) based on the theory of Ricardian Equivalence (RE), which argues that federal deficits
are irrelevant to the level of national saving because increases in private saving will neutralize
federal budget deficits. If Ricardian Equivalence holds, private saving will rise when public
saving fall, implying a negative association between private saving and the government outcome
to GDP ratio. If complete RE holds, then a coefficient of −1 should be expected. Corbo and
Schmidt-Hebbel (1991) use a sample of 13 developing countries to analyze the macroeconomic
consequences of higher public saving. They find a 0.47–0.50% offset on private saving of
changes in government saving which suggests that government saving crowd out private saving.
The magnitude of this effect is below the one-to-one relationship suggested by the simple
Ricardian Equivalence doctrine. According to Bernheim (1987) evidence from industrialized
countries suggests that a unit increase in the government deficit would be associated with a
decrease in consumption of 0.5–0.6. Masson et al. (1995) find for 21 industrial countries a
0.40–0.53 offset coefficient. Finally, Dalamagas (1992a, 1992b) presents empirical evidence
from 52 countries. He found that in countries with high debt-GDP ratios there is absence of debt
illusion. In countries with low-debt ratio there is a positive relationship between consumption
and government deficit indicating that when deficit increases, savings drop.

2.5. Income and private saving

Based on the lifecycle hypothesis, Modigliani (1966, 1970) relates aggregate saving behavior
to the income growth. He argues that a higher growth rate, caused by a population or productivity
growth, would raise aggregate saving as the aggregate income of those having a job relative to
558 G. Hondroyiannis / The Social Science Journal 43 (2006) 553–569

those not working would increase. Attanasio et al. (2000) correlate saving behavior and growth
in a lifecycle model. In their model, if wealth is accumulated in the first part of the lifecycle
and decumulated during retirement, then population and/or productivity growth might lead to
higher aggregate saving if the saving of the young exceeds the dissaving of the old. Carroll
and Weil (1994) and Edwards (1996) find statistical evidence supporting a positive association
between income and saving behavior. Masson et al. (1998) find a direct positive association
between output growth and private saving for most of the specifications examined for a sample
of developing countries. Attanasio et al. (2000) show that growth and saving are mutually
and positively related, but the results are sensitive to the additional controls introduced in the
variable system. Sarantis and Stewart (2001) demonstrate that income growth exerts a positive
influence on saving for some of the OECD countries examined.

2.6. Inflation and private saving behavior

The effects of the inflation rate on private saving are ambiguous and can be associated
with higher or lower saving rates. Higher inflation rates are associated with higher nominal
interest rates and consequently higher measured household income and saving. When inflation
increases, consumers attempt to maintain a target real wealth relative to income by reducing
inflation. Thus inflation is affecting savings through its impact on real wealth. In addition,
higher inflation may lead to higher saving on precautionary grounds to decrease uncertainty in
future income streams. On the contrary, in some economies where income prospects are less
uncertain inflation may be associated with may lower saving. Empirical research has produced
negative or zero coefficients of inflation (Corbo & Schmidt-Hebbel, 1991; Haque et al., 1999;
Masson et al., 1998).

3. Methodological issues and data

Following a modified specification of the lifecycle model of saving behavior proposed by

Modigliani and extended by Jappelli and Pagano (1994) a linear saving function is estimated
employing as explanatory variables economic and demographic variables. Therefore, in the
empirical study the following specification for the long-run saving behavior is employed:
SADYit = α0 + α1 DEPit + α2 DPRit + α3 CLAIMSit + α4 GBit + α5 LDYit
+ α6 RINTERit + a7 LCPIit + uit , (1)
where i is the country i, SADYt the saving to disposable income ratio at time t, DEPt the
dependency ratio at time t, DPRt the old-age dependency ratio at time t, CLAIMSt the liquidity
constraint at time t, GBt the government balance to GDP ratio at time t, LDYt the real
disposable income growth at time t, RINTER the real interest rate at time t, LCPIt the inflation
rate at time t and ut is an error term. The first two independent variables, dependency and old-
age dependency ratios are used to determine the demographic characteristics of the country.
Inflation is used in the specification as proxy for macroeconomic uncertainty. A positive sign
suggests that an increase in macroeconomic uncertainty (for example changes in nominal
 G. Hondroyiannis / The Social Science Journal 43 (2006) 553–569 559

incomes and future economic policies) will induce people to save a higher fraction of their
income.
The empirical analysis has been carried out using annual data for the period 1961–1998 for
13 European countries. The 13 European countries are: Austria, Belgium, Denmark, Finland,
France, Germany, Greece, Ireland, Italy, Netherlands, Spain, Sweden and United Kingdom.8
DEPt is the dependency ratio (i.e., the number of young individual aged between 0 and 19 years
to the working population aged between 20 and 65 years). DPRt is the old-age dependency ratio
defined as the ratio of elderly (population above 65 years old) to the working age population
(those aged between 20 and 65 years). RINTERt is the real deposit interest rate defined as
the nominal interest rate minus inflation. CLAIMSt is the liquidity constraint defined as the
private sector domestic credit as percent of nominal GDP. GBt is the central government
fiscal surplus(+)/deficit(−) as percent of nominal GDP. LDYt is the growth rate of real
disposable income and LCPIt is the rate of inflation. All data except for the two demographic
variables are obtained from International Financial Statistics cd-rom and AMECO cd-rom.
The demographic data are collected from the World Development Indicators cd-rom published
by the World Bank.
In the empirical analysis we test for the existence of a long-run relationship among the
variables (estimation of Eq. (1)). Testing for the existence of statistical relationship among the
variables is done in four steps. The first step is to verify the order of integration of the variables
of the individual country since the cointegration tests are valid only if the variables have the
same order of integration. Standard tests for the presence of a unit root based on the work of
Dickey and Fuller (1979, 1981), Perron (1988), Phillips (1987), Phillips and Perron (1988)9
and Kwiatkowski, Phillips, Schmidt, and Shin (1992)10 are used to investigate the degree of
integration of the variables used in the empirical analysis.
The next panel unit root tests are employed to examine the order of integration of the
variables in the panel data setting. The Levin and Lin (LL) (1993), Im et al. (IPS) (2003) and
Hadri (2000) tests for the presence of a unit root in panel data are employed. The LL test
allows for heterogeneity in the constant term while the IPS test allows for heterogeneity in
both the constant and slope terms of the ADF test. Both of them examine the null hypothesis
that there is a unit root against the alternative hypothesis that a unit root does not exists in
panel data. The Hadri (2000) test is panel equivalent to the Kwiatkowski et al. (1992) statistics
for the time series case and tests the null hypothesis of stationarity against the alternative of
nonstationarity. The test is distributed as N(0, 1) and is appropriate for panel data with high T
(number of periods) and relatively small N (cross-section units).
The second step involves testing for cointegration in the individual country and in the panel
data. The Johansen maximum likelihood approach (Johansen, 1988; Johansen & Juselius, 1990,
1992) for the multivariate model is used for each individual country. The Johansen-Juselius
estimation method is based on the error-correction representation of the VAR Model with
Gaussian errors.
Next panel cointegration tests are employed. Kao (1999), Kao and Chiang (2000) and
Pedroni (1997, 1999, 2000) developed several test to examine the existence of cointegration in
a multivariate framework. The proposed statistics test the null hypothesis of no-cointegration
versus the alternative of cointegration. However, pooling time series has resulted in a substantial
sacrifice in terms of the permissible heterogeneity of the individual time series. It is important
560 G. Hondroyiannis / The Social Science Journal 43 (2006) 553–569

in the process of pooling time series data to permit as much heterogeneity as possible among
individual time series. Testing for cointegration among the variables should permit for as much
heterogeneity as possible among the individual countries of the panel. If pooled results rely on
homogeneous panel cointegration theory then common slope coefficients are imposed. Pesaran
and Smith (1995) show that if a common estimator is used when there are differences among
the individual countries then the variables are not cointegrated.
Pedroni (1997, 1999, 2000) developed several tests for no-cointegration in dynamic panel
allowing for heterogeneity among the individual countries. The estimated tests permit for het-
erogeneity in cointegrating vectors and the dynamics of the underlying error process across
the cross-sectional units and are estimated as residuals tests. Seven tests are used to examine
whether the error process of the estimated equation is stationary (Table 4). The first four statis-
tics are based on pooling along within-dimension. The null hypothesis associated with the first
four statistics is that ρi = 1 against the alternative that ρi ≤ 1 for all cross-sectional units (homo-
geneous panel).11 Specifically, the four statistics test the null hypothesis of no-cointegration
for all cross-sectional units versus the alternative of the existence of cointegration for all cross-
sectional units. The next three statistics are based on pooling along between-dimension. The
null hypothesis tested is the same as in the previous case while the alternative is equal to ρi < 1
for all i (existence of cointegration) so it permits distinct slope values (heterogeneous panel).
Evidence of cointegration rules out the possibility that the estimated relationship is
spurious.12 So long as the four variables have common trend, causality must exist in at least
one direction and information for the endogeneity of the variables is revealed.
The final step of the analysis is to estimate the cointegrating vectors. The cointegrating
vectors for each individual country and for the dynamic panel are estimated following the fully
modified OLS estimation technique for heterogeneous panels (Pedroni, 1997, 2000). Pedroni
(2000) follows a semiparametric correction to the OLS estimator for panel data as developed
by Phillips and Hansen (1990) for time series data. This semiparametric correction eliminates
the second-order bias caused by the fact that the independent variables are endogenous.

4. Empirical results

Initially, the ADF, PP and KPSS tests examine the nonstationarity for the eight variables,
saving ratio, dependency ratio, age dependency ratio, private sector domestic credit as percent
of disposable income, budget balance as percent of GDP, real disposable income growth, real
interest rate and inflation used in the analysis in levels and first differences on individual country
basis.13 The combined results from all the tests (ADF, PP, KPSS) suggest that all the series
except for real disposable income growth, real interest rate and inflation under consideration
appear to be I(1) processes while real disposable income growth, real interest rate and inflation
are I(0).14
Next, panel unit roots are used to examine if the series are I(1). The IPS, Levin–Lin and
Hadri unit root tests for each variable for the panel data are estimated. The results are presented
in Table 2. The null hypothesis of nonstationarity (IPS and LL tests) is not rejected at different
levels of significance for all series except for real disposable income growth, real interest rate
and inflation. Employing the Hadri test, the null hypothesis of stationarity is rejected for all
 G. Hondroyiannis / The Social Science Journal 43 (2006) 553–569 561

Table 2
Panel unit root tests
Variable Unit root tests
IPS Levin–Lin ρ-statistic Hadri
Private savings ratio (SADY) 0.42 −1.75 2.90***
Dependency ratio (DEP) −0.27 −1.42 4.94***
Old-age dependency ratio (DPR) 0.81 −0.62 5.57***
Liquidity constraint (CLAIMS) 0.44 1.05 4.56***
Government deficit as percentage of GDP (GB) −0.33 2.21 2.78***
Real interest rate (RINTER) −2.66*** −6.46*** 1.56
Real disposable income growth (LDY) −7.56*** −47.73*** 1.69
Inflation (LCPI) −1.75** −7.81*** 0.37
Notes. ** and *** indicate rejection of the null hypothesis at 5% and 1% levels of significance, respectively.

variables except for real disposable income growth, real interest rate and inflation. Therefore,
the results from the three tests suggest that all series except real disposable income growth,
real interest rate and inflation appear to be nonstationary in the panel data set.
Since all the variables except for real disposable income growth, real interest rate and
inflation in the individual country basis are integrated of the same order, it is appropriate to
look for a relationship among the variables. Table 3 summarizes the results of cointegration
analysis among the variables using the Johansen maximum likelihood approach employing
the trace statistic. In the VAR estimation, real disposable income growth, real interest rate
and inflation are treated as stationary variables. To determine the lag length of the VAR, three
versions of the system were initially estimated: a four-, a three- and a two-lag version. Then, an
Akaike Information criterion (AIC), a Schwarz Bayesian Criterion (SBC) and a likelihood ratio

Table 3
Johansen and Juselius cointegration test based on trace of the stochastic matrix (savings ratio, dependency ratio, old
dependency ratio, claims, budget balance, net disposable income growth, real interest rate and inflation) (sample:
13 European countries during 1961–1998)
Country r=0 r≤1 r≤2 r≤3 r≤4
**
Austria 102.6 39.2 17.7 6.1 0.5
Belgium 110.0** 60.1** 27.8 6.6 1.2
Denmark 101.5** 61.6** 31.3** 2.8 0.1
Finland 216.6** 98.2** 51.0** 5.1 0.8
France 81.0** 43.1 16.5 8.4 1.4
Germany 84.6** 39.8 17.2 5.7 0.5
Greece 89.8** 43.9 25.1 11.4 3.5
Ireland 109.5** 66.8** 37.4** 12.2 0.1
Italy 154.8** 77.0** 39.7** 9.6 0.1
Netherlands 129.2** 55.3** 27.5 9.0 0.3
Spain 115.0** 59.2** 27.2 4.9 0.1
Sweden 153.3** 88.5** 39.8** 4.0 0.1
United Kingdom 107.4** 47.3 20.9 10.4 1.5
Notes. r indicates the number of cointegrating relationships. Maximum eigenvalue and trace test statistics are
compared with the critical values from Johansen and Juselius (1990). The 5% critical values are 68.5 for r = 0, 47.2
for r = 1, 29.7 for r = 2, 15.4 for r = 3 and 3.8 for r = 4. ** indicates rejection of the null hypothesis at 95% critical
value.
562 G. Hondroyiannis / The Social Science Journal 43 (2006) 553–569

Table 4
Panel cointegration tests for heterogeneous panel (dependent variable: savings ratio)
Statistics Value
Panel ν-statistic 14.36***
Panel ρ-statistic −20.83***
Panel t-statistic: nonparametric −6.26***
Panel t-statistic: parametric −846.99***
Group ρ-statistic −26.42***
Group t-statistic: nonparametric −7.13***
Group t-statistic: parametric −7.23***
Notes. All statistics are from Pedroni (1999). *** indicates rejection of the null hypothesis of no-cointegration at
1% level of significance.

test (Sims’ test) were used to test whether all three specifications are statistically equivalent.
All tests reject the null hypothesis that all the specifications are equivalent. In particular, the
tests suggest a different lag structure for each country. In the most cases the appropriate lag
structure was equal to 2.
The tests provide evidence to reject the null of zero cointegrating vectors in favor of one
cointegrating vector at 5% level for all the countries.15 On the basis of the results, the long-run
relationship among the variables and therefore the existence of private saving function finds
statistical support in each individual country over the period under examination.
Next, the panel tests are estimated. Table 4 summarizes the results of cointegration analysis
among the variables using the Pedroni statistics. All the tests strongly reject the null hypothesis
of no-cointegration using both the panel and group versions of the Phillips-Perron and ADF
tests. Thus, all the statistics provide evidence of cointegration to support the existence of
saving function in the panel. In particular, all the country-by-country and panel cointegration
test results suggest that there is a cointegrating relationship among the variables in the sample
of 13 European countries.16 Therefore, we can conclude that Eq. (1) finds statistical support
on a country-by-country basis and in the panel.
Having established that the variables are structurally related the long-run saving equations
are estimated using the fully modified OLS (FMOLS) for heterogeneous cointegrated panels
(Pedroni, 1997, 2000).17 The results are presented in Table 5. From the estimated equations, six
main points can be concluded. First the demographic variables are significant and have positive
sign in the panel and in most of the countries. Therefore, we can conclude that an upward shock
in fertility and in old dependency ratio will increase private saving. This result goes against
the lifecycle hypothesis. The positive effect of demographic variables can be explained along
with the precautionary-saving motive. In most of the countries in the European Union, the
established social security systems are under financial pressure. The level of reimbursement
from the existing social security systems does not satisfy the individuals, and they realize the
need for more own provision by private saving. This result coincides, for some countries, with
the findings of Haque et al. (1999), Attanasio et al. (2000) and Sarantis and Stewart (2001)
who report similar findings for the demographic variables.
Second, an increase in the liquidity constraints has a negative effect on private saving, sug-
gesting that the relaxation of the credit constraints leads to a decrease in private saving rate.
The liquidity constraint is statistically significant for about half of the countries and in the
 G. Hondroyiannis / The Social Science Journal 43 (2006) 553–569
Table 5
Long-run estimates (fully modified ordinary least squares) (dependent variable: savings ratio)
(a) Country DEP DPR CLAIMS GB RINTER LDY LCPI
Austria −0.22 (−0.75) 1.08 (2.13)**
−0.05 (−0.93) 0.01 (0.02) 0.28 (1.29) ***
0.35 (2.61) 0.65*** (3.05)
Belgium 0.71*** (6.64) 1.56*** (4.69) −0.02 (−0.90) −0.07** (−2.00) 0.22 (1.12) 0.32*** (3.33) 0.27 (1.52)
Denmark 0.33 (0.67) 1.75** (1.96) −0.05 (−0.63) 0.39 (1.29) −0.32 (−0.90) 0.10 (0.49) −0.29 (−0.66)
Finland −0.14 (−0.78) 0.42 (1.20) −0.02 (−0.99) 0.48*** (7.89) 0.14 (0.53) 0.20*** (3.27) 0.27 (1.11)
France 0.26*** (2.81) 0.88*** (8.28) −0.01 (−0.10) 0.34*** (5.39) 0.10 (1.09) 0.05 (0.98) −0.16*** (−4.01)
Germany −0.12 (−1.47) 0.40** (1.91) −0.09*** (−4.32) 0.97*** (3.76) 0.39 (1.51) −0.01 (−0.02) 0.23 (1.17)
Greece 1.37*** (3.53) 2.56*** (3.80) −0.29*** (−3.54) −0.46** (−1.92) 0.02 (0.05) 0.45*** (3.26) 0.68*** (2.72)
Ireland −0.80 (−2.46) −0.37 (−0.14)
***
−0.09*** (−2.12) 0.17 (0.56) 0.35 (1.69) 0.39*** (3.29) 0.60*** (3.10)
Italy 0.39*** (5.92) 0.09 (0.84) −0.07*** (−3.65) −0.02 (−0.57) 0.01 (0.19) 0.18*** (4.25 −0.09 (−1.66)
Netherlands 0.29*** (3.27) 2.81*** (3.28) −0.07*** (−2.31) −0.08 (−0.62) 0.10 (0.61) 0.23*** (3.31) 0.19 (1.36)
Spain 0.42*** (4.36) 1.93*** (4.82) −0.01 (−0.02) 0.11 (0.92) −0.02 (−0.31) 0.27*** (4.00) −0.21*** (−2.84)
Sweden 0.42 (0.96) 0.56*** (3.02) −0.15*** (−2.25) 0.36*** (3.56) 0.31 (1.43) 0.17 (1.46) 0.60*** (4.88)
United Kingdom 0.14*** (2.28) 1.01*** (7.56) −0.07*** (−12.97) 0.20*** (4.26) 0.05 (0.97) 0.07 (1.46) −0.05 (−0.91)
(b) Panel 0.24*** (6.93) 1.13*** (12.02) −0.08*** (−9.63) 0.18*** (6.25) 0.13*** (2.57) 0.21*** (8.79) 0.21*** (2.45)
Notes. Figures in brackets are t-statistics. ** and *** indicate significance at 5% and 1% levels, respectively.

563
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panel. Jappelli and Pagano (1994) and Loayza et al. (2000) report similar results of the influ-
ence of credit constraints on private saving. Third, an increase in government surplus leads
to a decrease in private saving ratio in four countries while in the rest and in the panel an
increase in government surplus increases private saving ratio. This finding is similar to that of
Dalamagas (1992a, 1992b). He showed that in countries with high debt to GDP ratio there is
a negative relationship between surplus and private saving, while the Ricardian Equivalence
in the most of the cases does not apply. In other countries where debt to GDP is historically
low, there is a positive relationship between surplus and private saving since individuals are
rather myopic and have debt illusion. This value is statistically less than 1 for all the countries
and in the overall panel. Fourth, the real interest rate has a statistically significant positive
effect on the private saving rate in the panel. This suggests that the intertemporal substitution
effect is greater than the wealth effect. Fifth, growth of real disposable income has a statis-
tically significant positive effect on the private saving rate for most of the countries and in
the panel. This result suggests that as individuals’ incomes grow faster or individual agents
become richer, their private saving rate increases. Finally, for the most of the countries and
in the panel, inflation, which is a proxy for macroeconomic uncertainty, has a statistically
significant positive effect on private saving behavior. This result suggests that in periods of
high inflation, individuals prefer to save a larger fraction of their income for precautionary
motives.18
In short, the estimated private saving function implies that in the panel of 13 countries sav-
ing function is affected positively by changes in demographic developments, budget balance,
growth of real disposable income, real interest rate and inflation and negatively by changes
in liquidity constraint. The coefficients are not the same in magnitude across the panel and
sometimes have different sign. However, the panel estimation provides more precise esti-
mates of the parameters of private saving function in this sample of 13 European countries
(Baltagi, 2001). Table 6 briefly summarizes the determinants of private savings and lists the
signs.
From the empirical analysis, four conclusions can be drawn. First, all the country-by-country
and panel cointegration estimations suggests that there is a long-run saving function. Second,
an upward shock in demographic variables will increase private saving implying the need of
individuals for their own provision by private saving due to the existing financial pressure
on the social security systems. Third, a decrease of liquidity constraints, resulting from an
increase of financial liberalization decreases private savings. Fourth, an increase in growth of

Table 6
Summary results: determinants of private savings
Explanatory variable Variable category Sign
Dependency ratio (DEP) Demographics +
Old-age dependency ratio (DPR) Demographics +
Liquidity constraint (CLAIMS) Financial depth −
Government deficit as percentage of GDP (GB) Fiscal policy +
Real interest rate (RINTER) Rates of return +
Real disposable income growth (LDY) Income +
Inflation (LCPI) Uncertainty +
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real disposable income and real interest rate and inflation increase private saving while the sign
of government constraint depends on the magnitude of debt to GDP ratio.

5. Conclusions

This paper provides an empirical model that estimates the private saving function using panel
cointegration techniques for 13 European countries. The private saving function is estimated
for 13 European countries, namely Austria, Belgium, Denmark, Finland, France, Germany,
Greece, Ireland, Italy, Netherlands, Spain Sweden and U.K. on a country-by-country basis and
using panel data modeling for the 1961–1998 period.
The study examines the stationarity properties of the data, employing individual along with
panel unit root tests. Multivariate Johansen cointegration tests are employed along with panel
cointegration tests to ensure that problems of power in finite samples do not distort Johansen’s
tests. Finally, the private saving function is estimated employing the recently developed esti-
mation procedure of the fully modified OLS for heterogeneous panels (Pedroni, 1997, 2000).
The analysis supports the findings of a private saving function which depends on demo-
graphic and economic variables, for each country individually and for the panel as a whole.
The empirical results suggest that for the whole panel, private saving should be considered as
endogenous variable affected positively by changes in dependency ratio, old-age dependency
ratio, government budget constraint, growth of real disposable income, real interest rate and
inflation and negatively by the liquidity constraint. The results suggest that deregulation of the
capital markets resulted in a decrease of private saving while the existing financial pressure
on social security systems resulted in an increase of private saving. This last result may imply
that private saving make up public pensions in the provision of retirement income. In the
future, it is possible that there is need for private saving to complement public pension in the
provision of retirement income since today social security systems are hardly sustainable and
population ageing is on an upward trend in most European countries. Pension systems reform
will change this trend, but it is possible that there will be side effects on capital markets and
budget surplus. However, social security system reform resulting in a decrease in government
surplus will have different effects on private saving among the European countries. The
empirical results indicate that a decrease in government balance will decrease the saving
ratio in economies with low debt to GDP ratio. Contrary, in the debt-ridden countries such as
Greece and Belgium, a decrease of budget surplus will increase private saving.
Recent developments, that is the total liberalization and development of European financial
markets coupled with the currency changeover to Euro, are expected to further affect the
development of credit markets, mortgage markets and consumer credit arrangements. The
adoption of the single currency has reduced transaction costs, leading to a restructuring of
the financial sector across countries. The major changes, since the introduction of Euro, in
fiscal and financial policies may give more opportunities to consumers to reallocate their
portfolio decisions cross-border and to reduce home bias in portfolios inducing further savings.
Social security restructuring combined with pension reforms are key fiscal policy issues for
Continental Europe, which may affect future savings. In addition, unified tax treatment of
different assets is one of the most important issues, which has to be solved to implement
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further financial integration among the European countries. Financial integration is important
in an ageing Europe, since the existence of new financial products, may increase, decrease or
leave unchanged, savings.19 Consumers may increase or substitute for existing savings since
they are able to enter capital markets directly or indirectly through institutional investors,
buying new products or changing the composition of their portfolio.
Another implication of the empirical analysis is that policies that spur development can
be effective in raising private saving rates in Europe. Inflation has a positive influence on
private saving. However, it can not be argued, that inflation reduction could have adverse
effects on private saving as lower inflation might raise growth and this might have positive
effect on private saving. In a Europe of low inflation, high economic growth, well-financed
social security systems and fiscal stability, the evolution of “new financial landscape” permits
consumers to enter capital markets, provide more opportunities for financial investments, alter
significantly the composition of their portfolio of risky and nonrisky assets and hence, in the
future, might increase savings.

Notes
1. For an extensive discussion over savings in Europe, see, among others, Khaled and
Thirlwall (1999) and Börsch-Supan and Brugiavini (2001). Data, not presented in Table 1
due to space limitations, show that savings ratio rises at a decreasing rate as per capita
income increases and levels off at around 20–25% of national income.
2. Intertemporal substitution is the process of maximizing consumer’s utility by allocating
resources across time.
3. Total households’ loans, that is consumption and housing loans, as percentage of GDP
in the Euro area were increased from 30.5% in 1997 to 36.8% in 2001 and 38% in 2002.
4. Specific country characteristics, which do not alter over time, such as religion, education,
etc. might affect savings.
5. Panel cointegration modeling is applied to estimate the long-run relationship between
savings and the other macroeconomic variables. For more details see Section 3.
6. Many empirical studies report that the response of savings to interest rate is not different
to zero for developing countries where the population may not be able to borrow even
at black market rates. In addition, this result may imply that interest rate is an effective
policy tool, only in conjunction with financial markets.
7. The main deregulation and liberalization of financial system occurred in France in the
second half of the 1980s to improve the efficiency of the allocation of financial resources.
The creation of new financial instruments provided the private sector access to a broader
range of financing, while the unification of the credit market favored the expansion of
the French financial system.
8. Luxembourg and Portugal are excluded since there are no available data for the total
period.
9. This version of the test is an extension of the Dickey-Fuller test, which makes a semi-
parametric correction for autocorrelation and is more robust in the case of weakly
autocorrelated and heteroskedastic regression residuals.
 G. Hondroyiannis / The Social Science Journal 43 (2006) 553–569 567

10. The KPSS procedure assumes the univariate series can be decomposed into the sum
of a deterministic trend, random walk and stationary I(0) disturbance and is based on a
Lagrange Multiplier Score Testing Principle. This test reverses the null and the alternative
hypothesis. A finding favorable to a unit root in this case requires strong evidence against
the null hypothesis of stationarity.
11. The following equation is estimated: uit = ρui(t − 1) + eit where uit are the estimated resid-
uals.
12. When the regression analysis reveals the existence of a relationship, otherwise not
expected, then such regression is called spurious.
13. A time series is stationary if its mean and variance do not vary systematically over time.
14. The unit root tests are not reported but are available from the author upon request.
15. In some countries there is more than one cointegrating vectors. From theory it seems
likely that there will be additional long-run relationships between the demographic
and economic variables. In addition, the Larsson, Lyhagen, and Lothgren (2001) test
for panel cointegration is employed. The test is obtained by estimating the average
of the N individual trace statistics and then standardizing. The test follows standard
normal distribution. The test indicates the existence of three cointegrating vectors.
However the other long-run relationships for the individual countries and for the
panel are not examined since the purpose of the study is to estimate a private saving
function.
16. The Pedroni (1999) panel cointegration statistics are calculated using Chiang and Kao
(2002) NPT 1.3 program.
17. The FMOLS is estimated using a routine kindly provided by Pedroni.
18. Although, it may be concluded that inflation stabilization could have an adverse effect on
saving, it should be emphasized that price stabilization affects saving through indirect
channels that are likely to more than compensate for any negative direct effect of inflation.
In this context, lower inflation raises growth and this might in turn increase saving. In
addition, the macroeconomic stability implied from a fiscal discipline policy will have
a positive effect on national saving (Loayza et al., 2000).
19. Private savings as percentage of GDP, since the currency changeover to Euro, remained
almost constant. In particular, provisional figures indicate that the private savings to GDP
ratio for the Euro area (excluding Luxembourg) increased to 20.8% in 2004 compared
to 20.1% in 2002 and 19.6 in 2001.

Acknowledgments

The views expressed in this paper are those of the author and not of the Bank of Greece.
The author wishes to thank two anonymous referees for their helpful comments in a previous
version of this paper; Chiang and Kao who offer the NPT 1.3 as public program and Peter
Pedroni for providing his program for the estimation of FMOLS. The author also wishes to
acknowledge useful comments and suggestions by Stephen Hall. All errors and deficiencies
are the responsibility of the author.
568 G. Hondroyiannis / The Social Science Journal 43 (2006) 553–569

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