Savings is current income minus current spending on goods and services.
Savings rate is the amount of savings as a proportion of income.
Example: Earning 600perweek,spending520, savings is 80.
Savings rate = 80/600 = 13.3 percent.
Wealth (net worth) is equal to assets minus liabilities.
Assets: anything of value that someone owns, either financial or real.
Liabilities: debts that someone owes to other parties.
Balance sheet lists assets and liabilities to determine net worth (wealth).
Net worth = assets minus liabilities.
Savings contributes to wealth.
Flow: A measure defined per unit of time (e.g., saving 20 per week).
Stock: A measure defined at a point in time (e.g., wealth of 3030 on 30th March 2023).
Flows change stocks.
Wealth can change due to changes in asset values.
Capital gain: increase in asset value.
Capital loss: decrease in asset value.
Change in wealth = savings + capital gains - capital losses
Why People Save
Three reasons why people save:
Lifecycle savings: long-term objectives (retirement, school fees, home).
Precautionary savings: for unexpected setbacks (job loss, health).
Bequest savings: to leave money to heirs or charity.
Reasons for declining saving rates in Australia:
Aged pension and compulsory superannuation.
Home ownership with small deposits and increased availability of mortgages.
Falling unemployment and improved labor market prosperity.
Good stock and housing market performance (capital gains).
Higher household savings rates during Covid-19.
Household savings have fallen due to the rise in the cost of living.
People save by making financial investments (savings deposits, bonds, stocks).
They receive interest on their financial investment, which increases their wealth.
Relevant interest rate for savings decisions is the real interest rate (r).
r = i(nominalinterestrate)−\pi (inflation rate).
The real interest rate is the “reward” for saving.
A higher interest rate makes savings more attractive.
National Savings
Macroeconomics focuses on the savings and wealth of a country (national savings or aggregate savings).
Savings represents current income minus spending on current needs.
Applies to three sectors: firms, households, and the government.
Firms: Income from sales, expenditure on wages, materials, interest, rent, dividends, and tax, the rest is business savings.
Households: Income from wages, interest, rent, and dividends. Expenditure on consumption, depreciation of assets and tax payments. the rest is household savings.
Government: Income from taxes. Expenditure on transfer payments and government purchases. The rest is government savings.
Y equals total income.
I is not part of current needs because investment is for the future.
CandG include current needs expenditure.
National savings (NS) = Y – C – G.
National Income Identity: Y = C + I + G + NX,whereY can refer to production (GDP) or income, or output.
Assume exports equals imports so NX = 0.
Then, Y = C + I + G.
National savings divided into private and public savings.
T = taxes from the private sector to the government, minus transfer payments and interest payments made by the government to the private sector (net taxes).
NS = Y – C – G + T – T
NS = (Y – T – C) + (T – G)
S_{private} = Y – T – C
S_{public} = T – G
National savings NS = S{private} + S{public}
Government Budget Deficit when T – G < 0, decrease in public savings.
Government Budget Surplus when T – G > 0, increase in public savings.
Investment and Capital Formation
National savings provides resources for investment.
Investment is the creation of new capital goods and housing.
Critical to increasing productivity and improving living standards.
Investment usually takes place via financial markets where people borrow funds for their investment.
Investment decision determined by cost-benefit principle.
Is the expected cost of the investment less than the expected benefit of the investment (equal to the value of the marginal product it provides).
Cost side: price of capital goods and the real interest rate.
Real interest rate: real cost of paying back debt to borrow funds to purchase capital goods and measures the opportunity cost of investment.
Benefit side: the value of the marginal product of new capital.
Savings, Investment, and Financial Markets
In a closed economy, national savings funds investment.
Financial markets: the supply of savings is attributed to the households, firms and the government.
The demand for savings is by firms that want to borrow money to buy new capital.
The supply of savings funds the demand for savings.
In equilibrium: National Savings = Investment.
Demand and supply model to analyze financial markets.
The equilibrium amount of savings and investment in the economy.
The prevailing real interest rate.
The savings-investment model has national savings and investment on the horizontal axis.
The vertical axis is the real interest rate.
The supply of national savings (NS) is an upward-sloping curve.
Increases in the real interest rate increases savings.
Savings are demanded by firms wishing to invest in new capital goods.
Borrowing money in the financial market or Using their own accumulated profits.
The demand for savings is the investment curve (I).
Curve shows the quantity of investment in new capital that firms would choose if they borrowed in financial markets at each value of the real interest rate.
Downward sloping because a higher real interest rate raises the cost of borrowing and decreases a firm’s willingness to invest.
In equilibrium, the desired level of investment (demand for savings) and desired level of national savings (supply of savings) are equal.
Where the two curves intersect gives us the economy’s level of savings and investment and the real interest rate that will ‘clear’ the market for savings, r*.
The real interest rate acts as the “price” for savings.
NS = I
If NS > I, excess supply of savings which would push down the real interest rate.
If NS < I, excess of demand for savings which would push up the real interest rate.
A change in the real interest rate causes movement along the curve.
A change in other factors causes the curves to shift.
Factors that will cause the demand for investment to change:
New technology.
Investment tax credit policy.
Anything that changes the marginal product of the investment (i.e. the returns to the investment) will shift the demand for investment funds
Anything that decreases the marginal product of the investment will reduce the demand for investment funds, at every interest rate level.
Anything that increases the marginal product of the investment will increase the demand for investment funds, at every interest rate level.
An increase in demand for investment will shift the curve to the right whereas a decrease shifts it to the left.
New technology creates profit opportunities and increases the marginal product of capital.
Increase in the marginal product of capital at any given level of the real interest rate, makes firms eager to invest.
Increase in demand for savings and the investment curve to shift to I1. In turn, the real interest increases from r* to r1 so that NS = I1
The real interest rate increase reflects an increase for the demand for funds by investors.
Quantity of savings increases because of the incentive of higher returns (hence NS* becomes NS1).
Factors that will cause the supply of savings to change:
Changes in the government’s level of spending (budget).
Any other factor that changes savings in the economy will shift the supply of savings.
Anything that makes households, businesses or governments choose to change their saving rate will shift the supply curve.
An increase in the supply of savings shifts the curve to the right whereas a decrease in the supply of savings shifts it to the left.
The Government increases its savings, and hence has a government budget surplus T – G > 0
Increases the supply of savings and will shift the savings curve to the right.
Real interest rate would fall from r* to r1.
A government budget deficit implies (T – G < 0)$$.
Would reduce the supply of savings and will shift the savings curve left, from NS to NS1.
Real interest rate would increase from r* to r1.
The higher interest rate makes investment less attractive so it decreases.
National savings also falls.
The Government’s borrowing crowds out private investment.