Revision: Household Saving
Savings, Interest Rates and Unemployment
Two factors that influence the rate at which households save their disposable income
15
15
Household savings ratio (% of disposable income)
Base Interest Rate
Unemployment (Claimant count, seasonally adjusted)
14
Percent
13
14
13
Savings Ratio
12
12
11
11
10
10
9
9
8
8
7
7
6
6
5
5
Unemployment Interest rates
4
4
3
3
2
2
1
1
0
0
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07
Source: Reuters EcoWin
Saving is a decision to postpone consumption – households, businesses and governments can all opt to save
some of their income and decisions about how much to save can have important effects on the economy in both
the short and longer term.
There are many ways in which people can save
•
•
•
•
•
Personal sector saving
Bank and Building Society accounts
Occupational (contributory) pension funds
Personal equity plans
Unit trusts
Measuring saving
(i)
(ii)
Marginal propensity to save (MPS) – the change in savings resulting from a change in income
Average propensity to save (APS) – the proportion of disposable income that is saved (also known
as the savings ratio)
Many factors shape the propensity to save
(i)
(ii)
(iii)
(iv)
(v)
(vi)
(vii)
(viii)
(ix)
(x)
Growth of real disposable income
Expected returns from different savings options
Real interest rate (inflation adjusted)
Risks for different savings options
Tax incentives for different forms of savings
Generosity of welfare provision e.g. state pension
Expectations of changes in equity values and property prices
Confidence about the state of the economy
Real cost of borrowing money (e.g. interest rates on credit cards and mortgages)
Stage of a person's life-cycle e.g. student, someone approaching retirement
Motivations for saving
•
•
•
•
Precautionary saving e.g. fear of unemployment
Desire to hedge against effects of inflation by saving in high-interest-bearing accounts
Building up future spending power
Concern for over-lapping generations
Saving and economic performance
(i)
Saving and economic growth
a. Short run - fall in savings ratio
i. Boosts consumption and AD and increases the value of the multiplier
ii. Injection of demand into the circular flow
iii. Rising consumption may stimulate investment (accelerator effect)
b. Savings and investment
i. Savings flow into the financial system
ii. Provide finance for lending to businesses
iii. Increase in supply of ‘loanable funds’ might cause fall in real interest rates
iv. If higher savings prompt productive investment - boosts LRAS
(ii)
Saving and the balance of payments
a. Fall in savings ratio – boosts consumption ►rise in domestic demand ►increased spending on
imports ► widening of the trade deficit
(iii)
Saving and inflationary pressure
a. Lower propensity to save might lead to some demand-pull inflationary pressure especially if AD
rises above the economy’s potential national output
Globalization and savings
UK companies now have access to much bigger pool of private sector savings from other countries – they can
seek finance through bond markets, equity market and the retail credit market (pre credit crunch!)
The UK very open capital and money markets – capital can come into and out of the economy quickly
Possible inflows of 'hot money' into the economy – affects the value of the exchange rate
Sovereign wealth funds – able to inject fresh capital into businesses through their investments
The domestic economy is now less constrained by the pool of domestic savings
Also makes it easier for the government to fund the budget deficit – so less risk of a “crowding out effect” for
the UK (where rising government borrowing might drive up long term interest rates)
Household Savings Ratio
Savings ratio measured as a % of disposable income
18.0
18.0
16.0
16.0
Poland
14.0
14.0
Japan
12.0
12.0
PERCENT
Germany
10.0
10.0
UK
8.0
8.0
6.0
6.0
4.0
USA
4.0
2.0
2.0
0.0
0.0
92
93
94
Germany
Japan
95
96
97
98
99
Poland
United Kingdom
00
01
02
03
04
05
06
07
08
09
United States
West Germany
Source: Reuters EcoWin
Some possible reasons for the decline in saving
(i)
(ii)
(iii)
(iv)
(v)
Lower unemployment and strong economic growth – decreased consumer uncertainty
Lower inflation rates – leading to a fall in interest rates and less fear of savings being devalued
Strong asset price inflation – perhaps the boom in house prices has changed people’s perceptions
about how much they need to save e.g. to finance their retirement
Easier availability of credit
Micro causes? Behavioural economists might argue that consumers are suffering from myopia –
preferring current consumption to future spending and not appreciating for example the decline in
returns on pension funds and the need to save a higher percentage of income to offset this
There are big differences in savings ratios across countries – e.g. between developed countries and between
advanced rich nations and emerging market countries – what reasons can you suggest for these variations?
In any question on savings - use aggregate demand and supply analysis diagrams to support your answer.