Saving, Consumption,
and
Wealth
National Wealth
Sum of wealth of all households, firms and
the government
 Accumulation of past saving
 Stock variable

2
Saving
A flow variable
 Current income minus current spending

3
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
4
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
5
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
6
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
8
Figure 2.1 The uses-of-saving identity in the
United States, 1980–1996
9
Sources of Investment Funds

Spvt = I + int’l lending + budget deficit

I = Spvt + int’l borrowing + budget surplus

I = Spvt + trade deficit + budget surplus
10
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

11
Private Saving
Income
Taxes
Disposable Income
Consumption
Saving
12
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
13
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
15
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

16
Example of wealth effect
1996
Labor income =
$30,000
1997
Labor income =
$30,000
1998
Labor income =
$30,000
LOTTERY!! =
$1 million
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
 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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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
20
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

21
Effect of government spending
(financed by bonds) on national saving

S = Spvt + Sgvt = Y + NFP - C - G

If G rises, total saving falls
22
Determinants of Consumption

Taxes
–
A tax cut raises disposable income today
 Consumption
–
increases, saving increases
Future expected taxes are higher
 Consumption
decreases, saving increases
23
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
24
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?

25
Effect of taxes on national saving

S = Spvt + Sgvt = Y + NFP - C - G
If taxes are cut,
 Consumption rises
 National saving falls

26
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

27
Life Cycle Model
$
Income
Saving
Consumption
Dissaving
Dissaving
18
65
85
age
28
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)
29