Saving and Capital Formation PDF BSE2701 2024

Saving and Capital Formation BSE2701 Daolu Cai NUS Business School August 29, 2024 Outline Frank-et-Bernanke 8e, Chapter 9 Saving and Capital Formation Macroeconomy and National Savings Savings, Investments and Financial Market...

Saving and Capital Formation BSE2701 Daolu Cai NUS Business School August 29, 2024 Outline Frank-et-Bernanke 8e, Chapter 9 Saving and Capital Formation Macroeconomy and National Savings Savings, Investments and Financial Market Copyright ©2024 Daolu Cai Page 2 / 32 Learning Objectives At the end of this lecture, you will be able to: Explain the relationship between savings and wealth. Analyze financial markets using the tools of supply and demand Copyright ©2024 Daolu Cai Page 3 / 32 Before we begin... 1 CAS https://inetapps.nus.edu.sg/ctr/Session Copyright ©2024 Daolu Cai Page 4 / 32 I am here to support you throughout our course, so please don’t hesitate to reach out with any questions you might have. Feel free to use this form to submit a question, I am happy to help. Link to Submission Form Figure: Use this QR code if you have any questions about this lecture Copyright ©2024 Daolu Cai Page 5 / 32 Saving and Capital Formation Copyright ©2024 Daolu Cai Page 6 / 32 Savings and Wealth Saving is current income minus spending on current needs. The saving rate is saving divided by income. Wealth is the value of assets minus liabilities. Assets are anything of value that one owns Liabilities are the debts one owes. The balance sheet is a list of an economic unit’s (HH or business) assets and liabilities at a specific date. Copyright ©2024 Daolu Cai Page 7 / 32 Example of a Balance Sheet Figure: Balance Sheet Copyright ©2024 Daolu Cai Page 8 / 32 Flow Values Versus Stock Values A flow value is defined per unit of time. Income, Spending, Saving, Wage A stock value value is defined at a point in time. Wealth, Debt The flow of savings causes the stock of wealth to change. Every dollar a person saves adds to his wealth. Liabilities are the debts one owes. The balance sheet is a list of an economic unit’s (HH or business) assets and liabilities at a specific date. Copyright ©2024 Daolu Cai Page 9 / 32 Capital Gains and Losses Wealth changes when the value of your assets changes. Capital gains increase the value of existing assets. Higher value for stock Capital losses decreases the value of existing assets. Car accident damages bumper and front headlight. Change in wealth = Saving + Capital gains - Capital losses. Copyright ©2024 Daolu Cai Page 10 / 32 Savings and Capital Gains, 1975 - 2019 Figure: Savings and Capital Gains Copyright ©2024 Daolu Cai Page 11 / 32 American Household Wealth in the 1990s and 2000s Stock ownership increased in the 1990s. Stock prices rose rapidly. Capital gains on stocks increased household wealth. Stock market declined, 2000 – 2002 Household savings remained low. Value of privately-owned homes increased rapidly Copyright ©2024 Daolu Cai Page 12 / 32 Why do Household Save? Life-cycle saving to meet long-term objectives. Retirement Precautionary saving is for protection against setbacks. Medical emergency, loss of job Bequest saving is to leave an inheritance. Higher income groups is particularly high Copyright ©2024 Daolu Cai Page 13 / 32 The case of China Asian economies tend to save a substantial Chinese households save about 25 percent of disposable income, a very high rate. This is new: was only 10 percent until the late 1980s Life-cycle and precautionary motives are important. Saving of young outweighs dissaving of old. Emerging economy. Limited social safety net. Limited access to financial markets Little opportunity for individuals to borrow, savings are necessary for large purchases. Copyright ©2024 Daolu Cai Page 14 / 32 Saving and the Real Interest Rate Saving Instruments that pay a return. Interest-bearing checking. Mutual funds. Fixed Deposits, CDs Bonds, Stocks Real interest Rate r =i −π r = real interest rate i = nominal interest rate π = inflation Copyright ©2024 Daolu Cai Page 15 / 32 Wealth Distribution in the U.S. The wealth-poor households in the bottom 40 percent of the wealth distribution own only 1.0 percent of the total wealth in the U.S. those in the bottom 80 percent own only 18.3 percent of the total sample wealth. The Wealth-rich top 1 percent of the wealth distribution (the wealth-richest) owns 34.7 percent of the total wealth and that those in the top quintile own 81.7 percent. Savings rate may be depressed by Social Security, Medicare, and other government programs for the elderly. Confidence in a prosperous future lack of ability to save Copyright ©2024 Daolu Cai Page 16 / 32 Macroeconomy and National Savings Copyright ©2024 Daolu Cai Page 17 / 32 National Savings Definition of production and income for the economy. Y = C + I + G + NX (1) Y = aggregate income C = consumption expenditure I = investment spending G = government purchases of goods and services NX = net exports Copyright ©2024 Daolu Cai Page 18 / 32 Closed Economy In a closed economy NX ≡ 0 Y =C +I +G (2) National savings (S) is current income (GDP or Y) less spending on current needs. Y −C −G =I (3) S =I (4) Copyright ©2024 Daolu Cai Page 19 / 32 US National Savings Figure: Balance Sheet Copyright ©2024 Daolu Cai Page 20 / 32 Private Saving Private saving is household plus business saving. Household’s total income is Y. Households pay net taxes (T) from this income. Government transfer payments increase household income. Transfer payments are made by the government to households without receiving any goods in return. Interest is paid to government bond holders T = Taxes - Transfers - Government interest payments. Private saving is after-tax income less consumption. SPrivate = Y − T − C (5) Copyright ©2024 Daolu Cai Page 21 / 32 Public Saving and National Saving Public saving is the amount of the public sector’s income that is not spent on current needs. Public sector income is net taxes. Public sector spending on current needs is G. SPublic = T − G (6) Recall: SPrivate = Y − T − C (7) National Saving (S) SPrivate + SPublic = (Y − T − C ) + (T − G ) (8) S = (Y − C − G ) (9) Copyright ©2024 Daolu Cai Page 22 / 32 Three Components of National Saving Of the three components of national saving, business saving is the most important. Copyright ©2024 Daolu Cai Page 23 / 32 Savings, Investments and Financial Market Copyright ©2024 Daolu Cai Page 24 / 32 The Investment Decision Two important costs: Price of the capital goods. Real interest rates, the Opportunity cost of the investment. Value of the marginal product of the capital is its benefit. Net of operating and maintenance expenses and of taxes on revenues generated. Technical innovation increases benefits. Lower taxes increase benefits. Higher price of the output increases benefits. Copyright ©2024 Daolu Cai Page 25 / 32 Saving, Investment, and Financial Markets Supply of savings (S) is the amount of savings that would occur at each possible real interest rate (r). upward-sloping curve Demand for investment (I) is the amount of savings borrowed at each possible real interest rate. downward-sloping curve Financial Market adjusts to surpluses and shortages as any other market does. → Equilibrium Principle holds. Copyright ©2024 Daolu Cai Page 26 / 32 Demand for Investment and Supply For Savings Real Interest Rate S 1 Demand for investment (I) is the amount of savings borrowed at each possible real interest rate. downward-sloping curve ∗ r 2 Supply of savings (S) is the amount of savings that would occur at each possible real interest rate (r). I upward-sloping curve 0 Q∗ S, I Copyright ©2024 Daolu Cai Page 27 / 32 Equilibrium Demand for Investment and Supply For Savings Real Interest Rate S 1 Financial Market adjusts to surpluses and shortages as any other market does. → Equilibrium Principle holds. r∗ 2 Changes in factors other than real interest rates will shift the savings or investment curves. → New I equilibrium. 0 Q∗ S, I Copyright ©2024 Daolu Cai Page 28 / 32 Effect of New Technologies on The Equilibrium Real Interest Rate S 1 New technology raises marginal productivity of capital. r new 2 Increases the demand for investment funds. I → I 0 r∗ 3 Higher interest rate. Higher level of I 0 savings and investment. 4 Movement up the savings supply I curve. 0 Q ∗ Q new S, I Copyright ©2024 Daolu Cai Page 29 / 32 Effect of Government Budget Deficit on The Equilibrium Real Interest Rate S’ S 1 Increase in government budget r new reduces the supply of savings. 2 shift for supply of savings from r∗ S → S0 3 Higher interest rate. lower level of savings and investment. I 0 Q new Q ∗ S, I Copyright ©2024 Daolu Cai Page 30 / 32 Practice Question For Final Exam (Answers will be provided during Tutorial with the TA) 1 We have information on the market for investment and savings for a small open economy: Demand for savings (in trillions): I = 0.4 − 4r and supply of savings: S = −0.04 + 2r 2 Plot the demand for savings 3 Plot the supply for savings 4 At the interest rate of r = 0.05 (or 5%), what is the quantity demanded for savings and what is the quantity supplied for savings? 5 Does the market clears at the interest rate of r = 0.05? 6 Would the interest rate have to go up or down to clear the market? 7 Find the equilibrium interest rate and quantity of savings. Copyright ©2024 Daolu Cai Page 31 / 32 Write Down a Few Takeaways from Today’s Lecture Individuals and households save for a variety of reasons, including life-cycle motives, such as saving for retirement; emergency (precautionary savings); and the idea of leaving an inheritance. In the absence of international borrowing or lending, the supply of and demand for national saving depends on the saving decisions of households and businesses and the government fiscal policy. Copyright ©2024 Daolu Cai Page 32 / 32