saving, consumption, and wealth. 2 national wealth sum of wealth of all households, firms and the...

Saving, Consumption, and

Wealth

2

National Wealth

Sum of wealth of all households, firms and the government

Accumulation of past saving Stock variable

3

Saving

A flow variable Current income minus current spending

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National Saving

Private savingSpvt = Y + NFP + TR + INT - T - C

where GNP = Y + NPF

Government savingSgvt = 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 - Gtotal 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 SavingPrivate Saving

Taxes

Consumption Saving

Disposable Income

Income

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Consumption and SavingConsumption 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 consumptionDeterminants 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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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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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 effectExample of wealth effect

1996

Labor income = $30,000

1998


1997


LOTTERY!! = $1 million

Income=$30,000 Income=$1,030,000 Income=$30,000Wealth=$0 Wealth=$1000 Wealth=$801,000

C=$29,000 C=$230,000 C=$100,000S=$1,000 S=$800,000 S= -$70,000

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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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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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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 savingEffect 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 savingEffect of government spending (financed by bonds) on national saving


If G rises, total saving falls

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Determinants of ConsumptionDeterminants 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 EquivalenceRicardian 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 EquivalenceProblems 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 savingEffect of taxes on national saving


If taxes are cut, Consumption rises National saving falls

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Life-cycle model of consumptionLife-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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Dissaving

Dissaving

Saving

Life Cycle ModelLife Cycle Model

$

age18 65 85

Income

Consumption

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Implications of the life-cycle modelImplications 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)

saving, consumption, and wealth. 2 national wealth sum of wealth of all households, firms and the...

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