Introductory Macroeconomics Lecture 13: Savings and Capital Formation 2024 PDF

Introductory Macroeconomics Lecture 13: Savings and Capital Formation Jonathan Thong Daniel Minutillo 2nd Semester 2024 1  This Lecture Beginning of topics in long run macro Savings and capital formation –...

Introductory Macroeconomics Lecture 13: Savings and Capital Formation Jonathan Thong Daniel Minutillo 2nd Semester 2024 1  This Lecture Beginning of topics in long run macro Savings and capital formation – basic saving and investment concepts – equilibrium real interest rate – examples: shocks to determinants of saving and investment BOFAH chapter 4 2 Basic Savings and Investment Concepts 3  Saving and the Saving Rate Saving current income less spending on current needs – household saving * income: wages, interest, dividends, transfer * spending: consumption of goods and services, depreciation, taxes – firm * income: sale of goods and services, transfers * spending: payment of wages, raw materials, rent, dividend, taxes – government * income: tax from households and firms * spending: government purchases of goods and services, transfers Saving rate: saving divided by income 4  Key Motives for Saving Life-cycle saving: savings against predictable events – saving for long-term objectives e.g., deposit on a house, retirement – borrowing (student loans, a mortgage) is a form of dissaving – but paying off outstanding loans is then itself a form of saving Precautionary saving: savings against unpredictable events – saving for unexpected events such as job loss, medical emergency Bequests: saving for the next generation 5 Life-cycle Theory of Consumption and Saving 6 Household Saving Rate 7  National Saving (in a Closed Economy) Recall the national income accounting identity Y = C +I +G Private savings S is disposable income less consumption S = (Y − T ) − C = I + G − T National savings N S is private saving S plus public saving T − G NS = S + T − G = I In a closed economy, national savings equals investment 8  Stocks and Flow Flow variables are measured per unit of time e.g., your wage per fortnight your household saving per fortnight GDP, consumption investment, etc per year Stock variables are measured at a point in time e.g., the value of your assets the value of your liabilities your net wealth, assets minus liabilities the physical capital stock 9  Stocks and Flow The change over time in a stock is a flow Stockt+1 − Stockt = Flowt Iterating backwards, the stock at t is the cumulation of all the past flows (plus an initial condition) Stockt = Flowt−1 + Flowt−2 + · · · + Stock0 A key example of this link between stocks and flows is the link between capital and investment 10  Capital and Investment Let Kt denote physical capital, It denote investment and δ denote the depreciation rate per unit time Kt is a stock, value of plant and equipment etc at a point in time It is a flow, expenditure on plant and equipment etc per unit time δKt is a flow, value of depreciated capital per unit time Net capital accumulation is then Kt+1 − Kt = It − δKt or equivalently Kt+1 = (1 − δ)Kt + It 11 Equilibrium Real Interest Rate 12  Saving and Investment Simple model of saving and investment in a closed economy Supply curve S(r), increasing in the real interest rate r (save more when return to saving r is higher) Demand curve I(r), decreasing in the real interest rate r (fewer investment project are profitable when r is higher) Equilibrium real interest rate r∗ where supply equals demand S(r∗ ) = I(r∗ ) 13 Equilibrium Real Interest Rate 14  Discussion S(r), I(r) curves represent schedules of amounts supplied/demanded at each hypothetical r Represent behavioural assumptions, not accounting identities – conceptually different to symbols S, I used earlier Also note confusion that arises if financial ’investment’ is used as synonym for ’saving’ – ’investing’ in financial assets is ’saving’ so akin to S(r) not I(r) – I(r) is expenditure on productive physical capital, plant and equipment etc, key idea is there is less of this when r is higher Being clear on language and terminology is important! 15  Aside: Keynes and the Classics This is a classical model, for understanding long run trends By contrast, Keynes replaced ’S(r)’ curve with an ’S(Y )’ curve to emphasise the effect of income on savings, something like S(Y ) = (1 − c)(Y − T ) − C̄ Keynesian approach is for understanding short run fluctuations Much more on this in Intermediate Macroeconomics. 16 Examples: Shocks to Determinants of Saving and Investment 17  Example: New Technology Suppose there is a technological breakthrough (e.g., nuclear fusion or AI) such that businesses are willing to invest more at any given r Whole I(r) curve shifts out along unchanged S(r) curve Bids up market clearing real interest rate, equilibrium amounts of investment and savings are both higher 18 Example: New Technology 19  Example: Ageing Population Suppose population has more retirees (i.e., more people dissaving in the final period of their lifecycle consumption), less savings at any given r Whole S(r) curve shifts in along unchanged I(r) curve Bids up market clearing real interest rate, equilibrium amounts of investment and savings are both lower 20 Example: Ageing Population 21  Learning Outcomes 1 Understand and explain basic concepts in relation to savings, including its definition, the savings rate, and motives for savings. 2 Understand and explain basic concepts in relation to investment, including the relationship between stocks and flows and how to derive a mathematical expression for net capital accumulation. 3 Understand and explain how the real interest rate in determined in a simple classical loans market model. 4 Critically assess the applicability of a simple classical loans market model to different time horizons. 5 Understand and explain how shocks to the determinants of savings and investment will alter the real interest rate and quantities of savings and investment in equilibrium. 22  New Formula(s) and Notation Capital Transition Equation Kt+1 − Kt = It − δKt K capital stock δ depreciation rate, \delta 23  Next Lecture Overview of economic growth – main idea, growth over long horizons – supply-side fundamentals: capital, labour, productivity – the aggregate production function BOFAH Chapter 13 and 14 – Google “partial derivatives using the power rule” 24