Monday, February 25, 2013

Savings, Production and Net Exports: Part II

When household budgets are reduced, households will have extra spending money as long as household income has not declined.  So even with a stagnant income, low-cost imports can reduce household budgets, thereby freeing up extra spending money.

Such a reduction in household budgets is like a wealth effect in which households can withdraw savings at a rate proportional to the reduction in their budget.  Like any other wealth effect, it can be argued that as households acquire extra spending money, they become more cavalier with savings.

In the US since the early-1980s, the personal saving rate and the interest paid on savings have declined in the long-term.  It should reason that the personal saving rate should be higher as the interest earned on savings declines - whatever cannot be paid through interest must be saved, or at least should be saved.  However, as interest rates on savings declines so does the cost of borrowing.

As the saving rate (green) declines, the cost of borrowing (black) goes down.

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