The Economic Effects of Raising National Saving

Publication Date: October 2005

Publisher: Library of Congress. Congressional Research Service

Author(s):

Research Area: Banking and finance; Economics

Type:

Abstract:

Raising the share of income we save is a frequent aim of public policy. That may be particularly apparent in debates about the size of the federal budget deficit, but concerns about the low household saving rate have also prompted policymakers to consider ways to encourage individuals to save more. How much individuals save will directly affect their future economic well-being, but from a macroeconomic perspective, the source of saving -- be it households, business, or government -- makes no difference. This report presents standard economic analysis of the macroeconomic effects of raising saving.

An increase in saving means a reduction in spending. In the short run, that is likely to result in slower economic growth than would otherwise have been the case. When the saving rate rises, demand for financial assets rises as well. The increase in demand for assets puts upward pressure on their prices and that results in a decline in their yields and so interest rates fall. The decline in interest rates sets in motion a chain of events that tends to reduce the extent to which incomes might fall in response to an increase in the saving rate.

Domestically, lower interest rates reduce the cost of financing expenditures on durable goods as well as business fixed investment, and thus increase some private sector demand. Lower interest rates can also have an effect on the balance of trade. A decline in U.S. interest rates, relative to foreign rates, is likely to reduce foreign purchases of U.S. assets. While an increase in saving may initially cause income to fall relative to what it otherwise would have been, in time any decline in income is likely to be offset by rising investment demand and an increase in net exports.

If there is a one-time permanent increase in the rate of investment, each worker will have more capital with which to work, and there will be a one-time rise in the capital-labor ratio, and thus a one-time rise in labor productivity. The one-time increase in labor productivity will temporarily raise the growth rate of output.

If financial capital flows easily between countries, then even a small decline in U.S. interest rates would be likely to have a large influence on the demand for dollardenominated assets. In that case, the net outflow of capital from the U.S. economy would minimize the decline in interest rates. The smaller the decline in interest rates is, the smaller any stimulus to domestic spending will be. In that case, more of the short-term contractionary effect of an increase in saving would be offset by rising net exports than by increased domestic investment.

This report will not be updated.