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Savings

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Savings

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  1. Savings Prof. Michael Smitka Washington and Lee University

  2. Savings • What determines savings? • Motives • Present vs future consumption • But no specific reason to believe we really trade off consumption today against more goodies tomorrow • Need more precise motives! • Precautionary motive • Rainy day needs are constant? Surely not huge… • Until you get into a severe recession

  3. “Sticky Behavior” • How do we plan our consumption behavior? • Look at those around us… Hence we look backward at how others did?OR: • Project current income into the future… Hence we look backward at how others did? • But all with the aim of providing for the future • With sticky behavior, an unanticipated rise in income thus tends to be saved • In particular, growth raises savings rates • but this is ad hoc / makes light of efforts to optimize

  4. Lifetime or Permanent Income • Sticky behavior assumes we can’t see what’s happening around us, and that non-precautionary savings is unplanned • Alternatively, we deliberately choose to save using (rational?) expectations about the future • We want steady consumption over our lifetime • Though we can jazz the model up to reflect family formation • But income is low when young and old, then: • We dissave (or would like to!) when (i) young or (ii) retired • We save otherwise.

  5. Income vs. Consumption Income (rises then falls) Consumption (steady) Savings Retirement... Dissavings Dissavings 20 80 (death!) 50 30 40 60 70

  6. $ Temp income decline or consumption spurt ===> savings is the margin over which we adjust Income is red line consumption is blue line saving Dissaving age 20 40 60 80

  7. Implications • Savings rise: • When the core savings age bracket is rising as a share of the population • When there are unexpected increases in income • Due for example to a short-term tax rebate • Or when economic growth lifts retirement targets • When (expected) longevity increases • Private savings fall with “social security” • Total savings likely shifts far less

  8. Other interpretations • Another approach is to posit target consumption over the course of a lifetime • These might include: • Buying a house • Funding children’s education • Paying for their wedding • Retirement • In effect, a variation of the “lifetime” model

  9. Advantages of a “target” • Individual targets can shift independent of other movements (income, etc) • It helps in particular to model the impact of changes in asset prices • A rise in housing prices lowers savings if most of the population already owns a house • A fall in the stock market boosts savings • It also seems to fit how people actually plan

  10. Present vs. Future ConsumptionDo interest rates matter? • We trade off in financial markets • S today becomes (1+i)S tomorrow (i=interest) • When “i” rises real wealth rises: we can consume the same amount today and more tomorrow! • From micro theory: • A change in “i” thus has an income effect: we don’t need to save as much to make (say) a down payment. • It also has a substitution effect: the better “price” makes us save more by making future consumption cheaper. • Empirically they cancel: “i” doesn’t affect S

  11. Interest rates: addendum • However, consumption of durables is sensitive to interest rates in the US • Lots of people borrow / buy and then save • Repaying a loan means consumption is less than income • Hence you save to repay a loan • But when interest rates are high, the monthly payment on a mortgage rises steeply • People are priced out of the market • If no one is borrowing, consumption is lower and S • Alternatively, only those repaying loans are left, so S

  12. Japan • These various approaches successfully predict Japan’s rising savings rate during the high growth era of 1955-1973 • The “target” approach helps us understand why savings didn’t fall in 1973-74: inflation eroded assets so families had to redouble their efforts • The “target” approach helps us understand the 1987-91 bubble, too...

  13. Realism: AddendaWe can always add complexity: sample data

  14. This and the previous chart are from Mark Aguiar and Erik Hurst (2008). “Deconstructing Lifecycle Expenditure.” University of Michigan Retirement Research Center, Working Paper WP 2008-173.