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What Determines The Level Of Saving In An Economy April 30, 2008

Filed under: economy — financialponderings @ 1:56 pm
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In economics saving is the decision by consumers to put aside money rather than consume goods and services. The propensity to save depends on various factors such as interest rates, consumer confidence and expectations of the future. The level of saving can have a big impact on the performance of an economy. Low saving rates can cause higher economic growth in the short term, but lead to lower levels of investment making future economic growth more difficult. These are the most important factors for determining the level of savings in an economy.

Access to Credit. If bank loans, mortgages and credit is easily and cheaply available then it will encourage consumers to borrow. For example, in the period 2002-2007, there was a period of easy credit were banks were keen to lend at a low cost. However, the credit crisis of 2007-08, made banks reluctant to lend, this was especially the case for subprime lending. As banks withdraw the availability of credit, saving ratios will increase

Interest rates. A rise in interest rates makes saving more attractive because of the interest earned from savings. The base rate is the main determinant of saving as base rates indirectly influence the commercial savings rates. However, commercial banks may offer additional incentives for saving by offering attractive deposit accounts. Also important is the level of real interest rates. This is the level of interest rates minus inflation. If interest rates are lower than the inflation rate then there is little incentive for people to save.

Confidence about Future economic prospects. If people are confident about the future, they will be more willing to borrow money. However, if they fear being made unemployed then they will start saving and cut back on borrowing. Therefore saving ratios are often cyclical. Falling in times of economic growth and rising in times of recession.

Attitudes to Saving. Saving ratios can vary from one country to another quite significantly. This can reflect cultural changes about saving. For example, China has a relatively high savings ratio and the US a relatively low savings rate. This reflects a difference in attitude between consumption and saving.

House Prices. When house prices are rising consumers see a rise in housing equity. This causes people to be more optimistic and willing to borrow money. Falling house prices create negative equity so it is much harder for people to borrow.

In the short term, savings ratios can change because of changes in interest rates and economic confidence. In the longer term saving ratios are determined by the access and availability of credit and savings accounts. Also social and cultural attitudes to debt and saving are important.

Auther: Richard Pettinger

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