9. Saving and Investment in Closed and Open Economies Flashcards
What is the relationship between saving and wealth?
National wealth is a country’s holdings of assets minus its liabilities
–> A country with a high saving rate will accumulate national wealth over time
What is the definition of wealth?
“A person’s Wealth is the amount of her holding of assets (e.g., stocks, houses) minus her liabilities (e.g., mortgages, loans)”
What is the equation for “private disposable income”?
where:
Y = GDP
T = net taxes (i.e., taxes – government transfers – interest payments on debt)
What is the equation for “private saving”?
where:
c = consumption expenditure
(basically private disposable income minus consumption)
How do we calculate the “private saving rate”?
Sd / Yd
(divide private saving by private disposable income)
What do government purchases consist of?
Government investment (Ig)
+
Government consumption (Cg)
What is the equation for “government saving”?
Budget surplus: When T > G
Budget deficit: When T < G
What is “National saving”?
The sum of private saving and government saving
How does a government stimulate saving?
– Tax consumption (e.g., value-add tax—tax
paid by a producer on the difference between
what it receives from the sales minus the costs)
– Provide Tax incentives for saving
– Increase return on saving
– Reduce budget deficits
What is the “uses-of-saving identity”?
Because Y = C + I + G + NX
What is the “National saving rate”?
S / Y
(national saving over total income or GDP)
What is important about saving being “I + NX” (the uses-of-saving identity)?
I + NX
–> This shows that whatever a countries has saved is either used domestically as investment, or abroad as a part of net exports
What is the “net capital outflow identity”?
Net capital outlow = Trade Balance
What is specific about saving and investment in a closed economy?
Saving = Investment
–> The real interest rate keeps the market for saving and investment in equilibrium
What is the equation of “consumption expenditure”?
What is the relationship between “consumption” and “interest rate”?
Negative relation between consumption and interest rate. If the interest rate is high, you are more willing to put your money in the bank.
What is the equation for “desired saving”?
Basically all are fixed, except interest rate (r)
Hence saving is a function of interest rate
Show and explain the “saving-investment” diagram:
–> If interest rate is low, than investment is high, whereas saving is low
–> If interest rate is high, than investment is low, whereas saving is high
Explain the “investment function”?
As real interest rates fall, households and firms are more likely to make investments, and so the desired level of investment in the economy will rise
How will a change in “autonomous expenditure” impact saving?
A rise in autonomous consumption causes saving and investment to fall and the real interest rate to rise in the long run, while a fall in autonomous consumption causes saving and investment to rise and the real interest rate to fall
How will a change in “taxes” impact saving? (fiscal policy)
Changes in taxes – A rise in taxes causes saving and investment to rise and the real interest rate to fall in the long run, while a fall in taxes causes saving and investment to fall and the real interest rate to rise
How will a change in “government purchases” impact saving? (fiscal policy)
Changes in government purchases – A rise in government spending causes saving and investment to fall and the real interest rate to rise in the long run, while a decline in government spending causes saving and investment to rise and the real interest rate to fall
Explain a decline in savings using a diagram
Explain an increase in savings using a diagram
How will a change in “autonomous investing” impact saving? (fiscal policy)
Changes in causes the investment curve to shift, which leads to a change in equilibrium real interest rate
- An increase in business optimism or a change in the tax code that increases autonomous investment causes saving, investment, and the real interest rate to rise
- When businesses become more pessimistic or the government raises taxes on investment, lowering autonomous investment, the investment curve will shift to the left, and so saving, investment, and the real interest rate will fall
