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# Saving, Consumption, and Wealth - PowerPoint PPT Presentation

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

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

• Accumulation of past saving

• Stock variable

• A flow variable

• Current income minus current spending

• Private saving

Spvt = Y + NFP + TR + INT - T - C

where GNP = Y + NPF

• Government saving

Sgvt = T - TR - G - INT

also called government surplus

• 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

• 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

• 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

• 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

Sources of Investment Funds 1980–1996

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

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

• I = Spvt + trade deficit + budget surplus

• 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 1980–1996

Consumption and Saving 1980–1996

• 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 1980–1996

• 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 consumption 1980–1996

• 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 consumption 1980–1996

• 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

1997 1980–1996

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 consumption 1980–1996

• 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 consumption 1980–1996

• 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 consumption 1980–1996

• 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

• 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 saving

• S = Spvt + Sgvt = Y + NFP - C - G

• If G rises, total saving falls

Determinants of Consumption national saving

• Taxes

• A tax cut raises disposable income today

• Consumption increases, saving increases

• Future expected taxes are higher

• Consumption decreases, saving increases

Ricardian Equivalence national saving

• 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 national saving

• 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 national saving

• S = Spvt + Sgvt = Y + NFP - C - G

• If taxes are cut,

• Consumption rises

• National saving falls

Life-cycle model of consumption national saving

• 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

\$ national saving

Income

Saving

Consumption

Dissaving

Dissaving

18

65

85

age

Life Cycle Model

Implications of the life-cycle model national saving

• 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)