Economics Essay Why is it necessary to increase savings in the Australian economy? Outline the government policies that might be used to increase savings. Savings is an integral part of the modern economy as it can help finance higher levels of investment for businesses and governments, or create a potential boost in productivity in the long term. It can be defined as the proportion of an individual, business or government income that is not spent, or paid in taxes. Firstly, the trends in the current savings will be discussed, as well why it is so low. From there, the effects of low savings will be examined, while finally the government policies to increase savings will be analysed. After this, the negative implications of savings would be clearly evident; and hence, why Australia’s economy should increase them. To begin, the household’s savings ratio in Australia over the last decade has been steadily decreasing. From a historical high of over 10% in 2008, the savings ratio fell to under 3.5% as of 2018. This can be attributed mainly towards the GFC (Global Financial Crisis) in 2008, where there was a significant downturn in the economy. Because of this, there was a record high level of household savings (over 10%) due to the contracting economy. After this event, the savings ratio gradually decreased from this high to the 3.5% that was recorded last year. The low, and gradually decreasing savings ratio can be attributed in part to the low interest rates set by the RBA. The cash rate has been set at a constant 1.5% since August of 2016, which contrasts the high rate at 4.75% in 2011.This very low interest rate promotes increased consumption in the economy, as the return on saving money is quite low. Similarly, the cost of borrowing money is quite low as well, so consumers are more likely to spend more of their income than save it (with financial institutions). Hence, consumers have been saving less since 2016; contributing to the overall downward trend of household savings since the GFC. Another reason for low savings in the Australian economy is low wage growth. Since July of 2017, the wage growth has remained in the low 2% range; with 2.0% in July 2017, to a negligible rise of 0.2% as of January 2019. Because the APC is currently quite high (due to the low cash rate mentioned previously), individuals are currently saving a smaller proportion of their income. With low wage growth, this low savings trend will continue. However, if there was an increase in wage growth, savings would also increase as MPS is generally high for middle income earners (which are the most popular in the workforce). Since there has not been an increase in wage growth however, the savings ratio has still stayed quite low. Additional reasons for the currently low savings rate include: increased house prices (and hence increased consumption due to the wealth effect – which in turn lowers savings), government debt (budget deficit following the GFC, with public debt around 20% of the GFC) and the generally low population of Australia as a country. The combination of these factors and the more significant examples mentioned above have combined to produce a low savings rate in the Australian economy. A negative effect of low savings in the Australian economy is increased inflationary pressure, and hence a decrease in the purchasing power of currency. This is because low savings will increase economic growth in the short term, which will lead to increased inflationary pressures. This is caused by an increase in aggregate demand due to the economic growth, which will eventually exceed the aggregate supply. Thus, the price of goods and services in high demand will increase; thereby causing inflation/inflationary pressure. Because of this increase in prices, the purchasing power of currency will also decrease; as the same income will buy a smaller number of goods and services, as the price of them has increased. Therefore, it is necessary to increase savings in the Australian economy; so that inflation and the low purchasing power of money can be avoided. Another adverse effect of low savings is decreased economic growth in the long term. This can be attributed to the fact that low savings causes financial institutions to have less money to use for investment (as defined by the circular flow of income). Because of this, firms will not be able to purchase more or advance their current capital goods; due to the lower investment. In turn, this will cause the productive capacity of the economy to decrease in the long term. Consequently, economic growth will slow down quite quickly in the long term. Hence, savings should be increased in the economy, so that economic growth can be sustained in the long term. Furthermore, low savings will also cause an increase in the CAD (Current Account Deficit). This is due to the fact that Australia has many capital-intensive industries such as the mining sector, which require constant investment. Since low savings causes low investment, the Australian economy will have to borrow more money from overseas to finance these investments. This will increase debt servicing costs (interest payments) overseas. As a result, CAD will increase. This means increased overseas investment (both portfolio and direct) which will in turn increase equity servicing costs; as foreign countries have greater equity in Australian businesses. All of this will increase our foreign debt (which will also lower economic growth in the long term, as more money is going overseas), and worsen Australia’s external stability (ability to repay loans). This in turn lowers investor confidence from overseas, and depreciates the value of the Australian dollar. All of these negative effects will stem from low savings in the Australian economy; thus, it is necessary to increase savings. A government policy used to combat low savings in the economy is fiscal policy. This is where the government engages in fiscal consolidation; whereby the economy moves to a budget surplus, which will then be used to pay off foreign and public debt. Currently, public debt is projected to be paid off by 2030, which will mean that it has lowered from 20% of the GDP in 2019 to 0% in 2030. Fiscal consolidation can be achieved in a number of ways, the most effective of which is increasing taxation. This will increase the government’s revenue; which will then allow money to be allocated to pay off foreign debt. With the current projections, fiscal consolidation looks to be an effective government policy to increase the savings in the economy. Another government policy used to increase savings is monetary policy. This is where the government (through the RBA) increases the cash rate. By doing this, the cost of borrowing money increases, and the return on saving money also increases. Hence, there is a greater incentive for households to save money. However, this policy is widely considered as the least important, and last policy to be used to increase savings. Nevertheless, it is still a valid strategy used by the government to increase savings in the economy. Finally, micro-economic reform (MER) can be used to increase savings in the Australian economy. The government mainly does this currently through superannuation (a long term form of savings) which was introduced in 1992. Superannuation involves compulsory employer contributions (additional to salary) at 9.25% of total income (which increased recently from 9%). This number is forecasted to increase to 12% by 2025, which will naturally increase savings for individuals. In addition to this contribution, voluntary contributions to superannuation can be added as tax incentives; since they are taxed at 15%, much lower than PAYG tax. Overall MER has been proven to be an effective government policy to increase savings in the economy. To conclude, it is vital that the currently low savings rate in the economy is increased from its gradually decreasing trend of late. This low trend can be attributed to the low cash rate since 2016 (1.5%), low wage growth as well as few less important factors. Savings must be increased so that Australia can avoid inflation/low purchasing power, low economic growth in the future and an increase in Australia’s CAD. Some government policies used to counter low savings include; fiscal policy, monetary policy and micro-economic reform. If the government can employ these strategies effectively, Australia’s economy will undoubtedly see an increase in savings in the near future.