Saving consumption and wealth
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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 S pvt = Y + NFP + TR + INT - T - C

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Saving, Consumption, and Wealth

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Saving consumption and wealth

Saving, Consumption, and Wealth


National wealth

National Wealth

  • Sum of wealth of all households, firms and the government

  • Accumulation of past saving

  • Stock variable


Saving

Saving

  • A flow variable

  • Current income minus current spending


National saving

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

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

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

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

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


Figure 2 1 the uses of saving identity in the united states 1980 1996

Figure 2.1 The uses-of-saving identity in the United States, 1980–1996


Sources of investment funds

Sources of Investment Funds

  • Spvt = I + int’l lending + budget deficit

  • I = Spvt + int’l borrowing + budget surplus

  • I = Spvt + trade deficit + budget surplus


Trade deficit good or bad

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


Private saving

Private Saving


Consumption and saving

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


Determinants of consumption

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


Determinants of consumption1

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


Determinants of consumption2

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


Example of wealth effect

1997

1998

1996

Labor income = $30,000

Labor income = $30,000

Labor income = $30,000

LOTTERY!! = $1 million

Example of wealth effect

Income=$30,000

Income=$1,030,000

Income=$30,000

Wealth=$0

Wealth=$801,000

Wealth=$1000

C=$29,000

C=$230,000

C=$100,000

S=$1,000

S=$800,000

S= -$70,000


Determinants of consumption3

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


Determinants of consumption4

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


Determinants of consumption5

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


Effect of government spending financed by bonds on national saving

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


Effect of government spending financed by bonds on national saving1

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

  • S = Spvt + Sgvt = Y + NFP - C - G

  • If G rises, total saving falls


Determinants of consumption6

Determinants of Consumption

  • Taxes

    • A tax cut raises disposable income today

      • Consumption increases, saving increases

    • Future expected taxes are higher

      • Consumption decreases, saving increases


Ricardian equivalence

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


Problems with ricardian equivalence

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?


Effect of taxes on national saving

Effect of taxes on national saving

  • S = Spvt + Sgvt = Y + NFP - C - G

  • If taxes are cut,

  • Consumption rises

  • National saving falls


Life cycle model of consumption

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


Life cycle model

$

Income

Saving

Consumption

Dissaving

Dissaving

18

65

85

age

Life Cycle Model


Implications of the life cycle model

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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