Saving
Households dispose of their post-tax income by spending or saving. Saving is a withdrawal from the circular flow of income and it has a pivotal role in determining changes in national income over time.
Decisions to save are
affected by:
Income
In general, saving is a positive function of
income – the greater the income the greater the likelihood of saving.
Expectations
Expectations about the state of the economy affect household decisions to save and spend. In general, positive expectations would tend to reduce savings and increase spending whereas negative expectations would increase savings and reduce spending.
Unemployment
Fear of unemployment will act in the same way as negative expectations, making saving more likely and spending less likely.
Interest rates
Given that interest rates provide a reward to saving, a rise in interest rates will provide an incentive to save. However, when mortgage rates rise, homeowners may be forced to increase their monthly repayments, and this leaves less income available for saving.
Asset prices
Changes in asset prices, such as houses and
shares, can affect confidence and generate wealth effects. In response,
households may change their savings. For example, a rise in house prices
would tend to encourage spending and discourage saving because higher
house prices lead to positive equity for homeowners, and less need to
save for the future.
Savings schemes
Finally, saving may be encouraged by the availability of tax efficient savings schemes, such as the UK’s ISAs (Individual Savings Accounts).
The savings ratio
The household savings ratio shows the proportion of household income that is saved. In the UK, the savings ratio varies between 12% and 4% and is fairly volatile from year to year.
If the savings ratio is too high, there may be insufficient spending in the
economy. This will be beneficial if the economy is growing too quickly,
but is problematic if the economy is growing slowly, or is in recession.
A low savings ratio means that consumer spending may be too high and there
may be insufficient funds for investment. In the short run, low savings
will increase standards of living, but in the long run a low savings
ratio will mean that fewer funds are available for investment, and
economic growth may suffer.
Sudden changes in the savings ratio are an indicator of future changes in spending and AD, and can be a prelude to inflation, or deflation.
A rise in the
savings ratio indicates a fall in consumer confidence, whereas a fall in
the savings ratio indicates a rise in confidence and spending, which can
trigger a rise in the price level.