Why do we care about national savings?
Posted May 27, 2008on:
In another of our warm up posts for discussing productivity we are going to discuss why national savings are important.
As Fred states in this comment, savings are effectively deferred consumption. The incentive to defer consumption is based on individuals wish to “smooth consumption” over time (which relies on their time discount rate and expectations of future income) and the return available on these savings. Now the reason that it is possible to make money off your savings is because these savings are used by other agents in the economy who have the ability to pay you back later on – fundamentally these savings are used to invest.
Going back to our good friend supply and demand we know that the supply of funds for capital investment is a function of the interest rate and peoples willingness to smooth consumption while the demand for capital investment is a function of the interest rate and the expected return from the investment. As savings increase in the interest rate (for those who care, assume that the substitution effect dominates the income effect of a higher interest rate) and investment decreases with the interest rate (or at least the expectation of the equilibrium interest rate) we know that there will be an interest rate that makes supply and demand equal.
Fundamentally, the government may want to increase national savings if they believe that current national capital accumulation is sub-optimal for some reason – as in some sense savings=investment. Again I’m going to ask a question which I would love for everyone to have a go at answering – why may the government believe that the current rate of capital accumulation is sub-optimal?