Saving and Wealth
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Transcript Saving and Wealth
Saving, Consumption,
and
Wealth
National Wealth
Sum of wealth of all households, firms and
the government
Accumulation of past saving
Stock variable
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Saving
A flow variable
Current income minus current spending
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National Saving
Private saving
Spvt = Y + NFP + TR + INT - T - C
where GNP = Y + NPF
Government saving
Sgvt = T - TR - G - INT
also called government surplus
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Total Saving
S = Spvt + Sgvt
S = Y+NFP+TR+INT-T-C+T-TR-INT-G
S = Y + NFP - C - G
total income - total spending for current needs
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Developing Uses of Saving
Identity
S = Y + NFP - C - G
substituting in Y = C + I + G + (X - M)
yields S = C + I + G + (X - M) + NFP - C - G
S = I + (X - M + NFP) = I + current account
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A short digression: the current
account
Current account is roughly the trade balance
Current account is equal to the amount of
lending we do abroad
If we export to other countries, we can use
that currency to lend abroad
More details in a future lesson
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Uses of Saving Identity
S = I + current account = I + int’l lending
Spvt + Sgvt = I + int’l lending
Spvt = I + int’l lending - Sgvt
Spvt = I + int’l lending + budget deficit
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Figure 2.1 The uses-of-saving identity in the
United States, 1980–1996
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Sources of Investment Funds
Spvt = I + int’l lending + budget deficit
I = Spvt + int’l borrowing + budget surplus
I = Spvt + trade deficit + budget surplus
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Trade Deficit: Good or Bad?
US had a trade deficit for most years
between 1982 and 1992
This allows us to consume more than we
produce
This allows us to invest more than we save
However, it is not wise to borrow from
abroad for consumption goods
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Private Saving
Income
Taxes
Disposable Income
Consumption
Saving
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Consumption and Saving
Only one decision is made by the household
If consumption rises, saving must fall
–
Only exception is a rise in disposable income
If saving rises, consumption must fall
–
Only exception is a rise in disposable income
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Determinants of consumption
Income
–
–
Increase in income increases both consumption
and saving
Keynesian consumption function
C
= f(Y) = c0 + cY*Y
cY is called the marginal propensity to consume
(MPC)
–
–
What additional consumption is generated by an additional
dollar of income?
Its value is between 0 and 1
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Determinants of consumption
Expected Future Income
–
–
Also called consumer confidence or consumer
sentiment
If you expect a raise next month
consume
more today
save less today
–
If you expect to be unemployed next month
consume
less today
save more today
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Determinants of consumption
Wealth
–
–
Increases in wealth raise current consumption
Increases in wealth lower current saving
Distinguish wealth from income
Stock market movements provide large
changes in wealth
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Example of wealth effect
1996
Labor income =
$30,000
1997
Labor income =
$30,000
1998
Labor income =
$30,000
LOTTERY!! =
$1 million
Income=$30,000
Wealth=$0
C=$29,000
S=$1,000
Income=$1,030,000
Wealth=$1000
C=$230,000
S=$800,000
Income=$30,000
Wealth=$801,000
C=$100,000
S= -$70,000
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Determinants of consumption
Expected real interest rate
–
Two opposing effects
Greater
–
reward for saving
Save more
Don’t
need as much saving to reach a target amount
of wealth in the future
–
–
Save less
Empirical studies
Increases
in real interest rates lead to small increases
in saving, small decreases in consumption
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Determinants of consumption
Taxes on interest earned on savings
–
If tax rate rises
Real
after tax interest rate declines
Savings declines
–
Empirical evidence
IRA accounts
Increases
in certain types of savings vehicles
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Determinants of consumption
Government purchases
–
Increase in G financed by taxation
Disposable
income falls
Consumption falls
Private saving falls
–
Increase in G financed by borrowing
Higher
future taxes (lower future income)
Consumption falls
Private saving rises
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Effect of government spending
(financed by bonds) on national saving
S = Spvt + Sgvt = Y + NFP - C - G
Private saving rises (as expected future
income falls)
Government saving falls
Increase in private saving is less than fall in
government saving
Equivalently, decrease in consumption is
less than rise in government spending
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Effect of government spending
(financed by bonds) on national saving
S = Spvt + Sgvt = Y + NFP - C - G
If G rises, total saving falls
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Determinants of Consumption
Taxes
–
A tax cut raises disposable income today
Consumption
–
increases, saving increases
Future expected taxes are higher
Consumption
decreases, saving increases
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Ricardian Equivalence
S = Spvt + Sgvt = Y + NFP - C - G
–
If two effects offset each other and C doesn’t
rise, then national saving is unchanged
Called Ricardian Equivalence
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Problems with Ricardian
Equivalence
Future and current taxes may not be equal
(uncertainty)
Credit constraints
May avoid the future taxes
Current tax cut and future tax increase may
not be imposed on the same people
How forward looking are consumers?
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Effect of taxes on national saving
S = Spvt + Sgvt = Y + NFP - C - G
If taxes are cut,
Consumption rises
National saving falls
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Life-cycle model of consumption
Enriches our understanding of consumption
behavior
Looks at consumption and saving as
lifetime decisions
Allows us to compare consumption in
countries with different demographic
patterns
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Life Cycle Model
$
Income
Saving
Consumption
Dissaving
Dissaving
18
65
85
age
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Implications of the life-cycle
model
People at different ages will have different
marginal propensities to consume and save
National demographics matter for national
saving
–
–
Baby boom just turned 50; we expect to see an
increase in saving in the near future
The Japanese have long life expectancies, long
retirements, and fast growing income.
These
factors help explain high saving in Japan
(Hayashi)
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