Saving, Consumption, and Wealth
National Wealth
Sum of wealth of all households, firms and the government Accumulation of past saving Stock variable
Saving
A flow variable Current income minus current spending
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
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
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
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
Uses of Saving Identity
S = I + current account = I + intl lending
Spvt + Sgvt = I + intl lending
Spvt = I + intl lending - Sgvt
Spvt = I + intl lending + budget deficit
Figure 2.1 The uses-of-saving identity in the United States, 19801996
Sources of Investment Funds
Spvt = I + intl lending + budget deficit
I = Spvt + intl 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 Only exception is a rise in disposable income
If saving rises, consumption must fall
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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 14
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 1998
Labor income = $30,000
LOTTERY!! = $1 million
Labor income = $30,000
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
Dont
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 doesnt 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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