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Saving, Capital Formation and Financial Markets Saving, Capital Formation and Financial Markets Xi Wang UMSL, Summer MB MC Learning Objectives Slide 2 1. Explain the relationship between savings and wealth Chapter 9: Saving and Capital Formation Capital and 9: Saving Chapter 2. Recognize and work with the components of national saving 3. Understand the reasons people save 4. Discuss the reasons firms choose to invest in capital 5. Analyze financial markets using the tools of supply and demand Copyright c 2004 by The McGraw-Hill Economic Growth Slide 2 Companies, Inc. All rights reserved. MB MC Why do Individuals and Nations Slide Save, And Why do we care? 3 Individuals save Formation Capital and 9: Saving Chapter To meet future expenditures (life cycle motive) To protect against an economic emergency (precautionary motive) Nations save To produce new capital goods – to promote growth and higher standards of living in the future National Saving equals savings by households, businesses and governments Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. MB MC Savings and Wealth Slide 4 Saving of an economic unit equals current Formation Capital and 9: Saving Chapter income minus spending on current needs Saving Rate of any economic unit is its Saving divided by its income Wealth: The value of assets minus liabilities Assets: Anything of value that one owns either financial (cash, stocks, bonds, etc.) or real (real estate, jewelry, consumer durables like cars, etc.) Liabilities: The debts one owes (credit card balances, loans, mortgages, etc.) Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. MB MC Savings and Wealth Slide 5 By comparing an economic unit’s assets andFormation Capital and 9: Saving Chapter liabilities economists calculate that unit’s wealth – also called Net Worth. This comparison is done using a list of assets and liabilities as on a particular date – called the unit’s Balance Sheet. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. MB MC Mr. A’s Balance Sheet Slide 6 Chapter 9: Saving and Capital Formation Capital and 9: Saving Chapter Assets Liabilities Cash $ 80 Student loan $3,000 Checking account 1,200 Credit card balance 250 Shares of stock 1,000 Car (market value) 3,500 Furniture (market value) 500 ______ Total $6,280 $3,250 Net worth $3,030 •Earnings ($300/wk) - Expenditures ($280/wk) = Saving ($20/wk) •Saving Rate = $20/$300 = 6.7% •Wealth ($3,030) = Assets ($6,280) - Liabilities ($3,250) Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. MB MC Savings and Wealth: Flows and Slide Stocks 7 Savings is a Flow Formation Capital and 9: Saving Chapter A measure that is defined per unit of time (e.g., Mr. A saves $100/month; Mrs. B saves $50/wk, etc.) Wealth is a Stock A measure that is defined at a point in time (e.g., Mr. A’s wealth was $3030 on Jan 1, 2008) Bathtub analogy Every dollar a person saves adds to his/her wealth The flow of saving causes the stock of wealth to change. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. MB MC Savings, Capital Gains and Losses Slide 8 Capital Gains - increase in the value of Formation Capital and 9: Saving Chapter existing assets - may decrease the urge to save. Eg., higher value of a stock. Capital Losses - decrease in the value of existing assets - may increase the urge to save. Eg., decrease in house prices. Capital gains and losses are not part of savings. They are part of wealth. Change in Wealth = Saving + Capital gains - Capital loss Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. MB MC Mr. A’s Balance Sheet After An Slide Increase in the Value of His Stocks 9 Chapter 9: Saving and Capital Formation Capital and 9: Saving Chapter Assets Liabilities Cash $ 80 Student loan $3,000 Checking account 1,200 Credit card balance 250 Shares of stock 1,500 Car (market value) 3,500 Furniture (market value) 500 ______ Total $6,780 $3,250 Net worth $3,530 Mr. A enjoyed a Capital Gain of $500 (his stock value increased from $1,000 to $1,500. Therefore his Assets increased by $500 while his liabilities remained unchanged. So his Wealth increased by $500. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. MB MC Who Saves? Slide 10 Households, Businesses and Governments. Formation Capital and 9: Saving Chapter Household S is also called Personal S Private S = Household S + Business S Public S = Govt. S Total S = Private S + Public S Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. MB MC Household Saving Rate inSlide 11 the United States, 1960 - Chapter 9: Saving and Capital Formation Capital and 9: Saving Chapter 2006 Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. MB MC Low and Declining Household Slide Savings in the US 12 Household savings declined since mid 1980sFormation Capital and 9: Saving Chapter In 2006 we saved about 0.4% of disposable income US rates are low compared to other countries Low household saving can be offset by savings of businesses or government National savings has also declined although less significantly than household savings Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. MB MC US National Saving Rate, 1960Slide - 2010 13 1960: National saving was 21% of GDP; 2010: Formation Capital and 9: Saving Chapter National Saving is 11% of GDP Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. MB MC The Three Components of National Slide Saving, 1960- 2006 14 Chapter 9: Saving and Capital Formation Capital and 9: Saving Chapter Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. MB MC US Savings – A Global PerspectiveSlide 15 Krugman Macroeconomics 2ed Macroeconomics Krugman Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Household Saving $ Household Saving Rate Business Saving $ Government Saving $ National Saving Rate MB MC Low Household Savings:Slide 21 National savingsUS determines a country's abilityFormation Capital and 9: Saving Chapter to invest in new capital goods Household savings has been low Business saving has been significant In the 1990s, government saving increased From 1960 to 2002, national saving rate was fairly stable Since 2002, federal government’s large deficits have contributed to a decline in the US national saving rate Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. MB MC The Bull Market of the Slide 22 How did Americans increase their wealth 1990s Formation Capital and 9: Saving Chapter during the 1990s, while household savings fell? More households acquired stocks and they enjoyed enormous capital gains as stock prices rose. Capital gains on stocks increased household wealth May have decreased household savings Stock market declined, 2000 – 2002 Household savings remained low Value of privately-owned homes increased rapidly from 2000 - 2006 Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. MB MC Slide The Bull Market of the 23 1990s Formation Capital and 9: Saving Chapter Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. MB MC Reasons: Why has Household Savings Slide Fallen? 24 Aging of the US population – increased fraction of the population with higher Formation Capital and 9: Saving Chapter propensities to consume Financial Innovations (derivatives) and deregulation of the financial sector – facilitated novel ways of borrowing and hence reduction in precautionary saving Capital Gains from booming stock and housing markets – Wealth effect Low interest rates – stimulating consumption through inter-temporal substitution; So Why? Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Other Reasons? Income Inequality Slide 25 Can polarization of incomes explain a rising consumption–income ratio? Formation Capital and 9: Saving Chapter Frank (2005) argues that household consumption is increasingly about positional goods – houses, cars – creating a consumption arms-race, which leads to escalating consumption relative to income. *** (next page)(Catch-up With Jones) Given the polarization of earnings in the US since the 1980s, the norms in this race are increasingly set by the super income-rich. May explain why Income Polarization leads to low S-Y ratio MB MC Which Would You Choose? Slide 26 Positional Good: World A - You will live in aFormation Capital and 9: Saving Chapter 4,000-square-feet house and others will live in 6,000-square-feet houses; OR, World B - You will live in a 3,000-square-feet house, others in 2,000-square-feet houses. Once you choose, your position on the local housing scale will persist. Non Positional Good: World C - You have 4 weeks/year of vacation time and others have 6; OR, World D, in which you would have 2 weeks of vacation, others 1 week. Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. MB MC Bonus Question: Low Household Slide Saving – A Problem? 27 From a Macroeconomic perspective – not necessarily a problem. Formation Capital and 9: Saving Chapter Microeconomic Perspective – yes a problem The low household saving rate signals a problem of growing inequality in wealth among U.S. households, how? Savings patterns tend to increase this inequality as rich families save more and get richer while poor families save little and get poorer, how? Copyright c 2004 by The McGraw-Hill Companies, Inc. All rights reserved. MB MC Private Savings-Investment Identity Slide 28 Recall the basic accounting identity: Formation Capital and 9: Saving Chapter Y = C + I + G + NX, where, Y = Real income or expenditures; C = Consumption; I = Investment; G = Government Expenditure; NX = Net exports Assume G = 0 and NX = 0, closed economy and no govt.
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