Lecture Notes: Determinants of Savings

Definition of Savings

• Savings is the portion of disposable income not spent on goods and services.
• Savings is a determinant of Aggregate Demand (AD).
  • Increase in savings leads to a decrease in consumption, shifting AD to the left.

Factors Affecting Savings

Real Disposable Income

• Higher income leads to increased consumption and savings.
• Without income, saving is not possible.
• In developing countries, low-income households save a very small percentage of their income.

Interest Rates

• High interest rates encourage saving due to higher rates of return.
• Low interest rates encourage borrowing and spending, reducing savings.

Consumer Confidence

• Low consumer confidence (fear of recession/job loss) leads to increased saving.
• High consumer confidence encourages spending, reducing savings.

Financial Institutions

• In developing countries, a lack of trustworthy financial institutions reduces savings.
  • Corrupt, unofficial, or unreliable banks discourage saving.

Education

• Lack of education about savings, bank operations, and interest rates can be a barrier to saving.

Tax Incentives

• Government policies can encourage saving, e.g., Individual Savings Accounts (ISAs) offer tax-free returns.
• High tax allowances on savings can increase savings levels.

Age Structure of the Population

• According to economist Modigliani:
  • Middle-aged individuals (30-60 years) save more for retirement/children.
  • Younger individuals (15-30 years) and pensioners are more likely to spend than save.
  • A population with a majority of middle-aged individuals will likely have higher savings.

Conclusion

• Understanding these determinants can help in analyzing the saving behavior in different economies.