Chapter 4

Saving and
Investment
in Closed and
Open Economies
 Preview

• To understand the relationship between

saving and investment
• To understand how changes in saving and
investment affect a closed economy
• To understand how changes in saving and
investment affect a small open economy
• To understand the difference between large
and small open economies

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 Relationship Between Saving and
Wealth

• A person’s Wealth is the amount of her

holding of assets (e.g., stocks, houses)
minus her liabilities (e.g., mortgages,
loans)
• National wealth is a country’s holdings of
assets minus its liabilities
• A country with a high saving rate will
accumulate national wealth over time

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 Private Saving

• Private saving equals private disposable

income minus consumption expenditure
• Private disposable income:

YD  Y  T
where
Y = GDP
T = net taxes (i.e., taxes – government transfers –
interest payments on debt)

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 Private Saving (cont’d)

• Private saving:

SP  Y  T  C
where
C = consumption expenditure

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 Private Saving (cont’d)

• Private saving rate is the proportion of

private disposable income that is saved:

SP / YD

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 FIGURE 4.1 Three Measures of the Saving
Rate in the United States, 1955-2013

Source: Federal Reserve Bank of St. Louis, FRED Database. http://research.stlouisfed.org/fred2/

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 Government Saving

• Government purchases consist of:

– government investment (IG)
– government consumption (CG)

G  CG  IG

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 Government Saving (cont’d)

• Government saving:

SG  T  CG
• For simplicity:

SG  T  G
• Budget surplus occurs if T>G, and budget deficit
(dissaving) occurs if T<G

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 National Saving

• National saving is the sum of private saving and

government saving:

S Y C G
• National saving rate:

S /Y

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 Policy and Practice: Government
Policies to Stimulate Saving

• Governments stimulate saving through:

– Tax consumption (e.g., value-add tax—tax
paid by a producer on the difference between
what it receives from the sales minus the costs)
– Provide Tax incentives for saving
– Increase return on saving
– Reduce budget deficits

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 Uses of Saving

• Uses-of-saving identity:

S = (C  I  G  NX )  C  G
= I  NX
• Or as the net capital outflow identity:

S  I = NX

Net Capital Outflow = Trade Balance

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 Uses of Saving (cont’d)

• A trade surplus occurs if NX>0

• A trade deficit occurs if NX<0
• The trade balance is reported periodically in the
balance of payment accounts, which is a
bookkeeping system for recording all receipts and
payments between a nation and foreign countries

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 Macroeconomics in the News: Balance
of Payments Accounts

• The Bureau of Economic Analysis (BEA), a

division of the U.S. Department of
Commerce, produces quarterly data on the
balance of payments accounts
• The BEA releases data around two and a
half months after the end of the quarter
and revises data every year in June to
incorporate accurate information
• You can find this data on the BEA Web site
at www.bea.gov

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 The Link Between Saving and Wealth

• The uses-of-saving and net capital outflow

identities show that:
– Saving is linked to wealth
– Saving an either finance investment or net exports
– An increase in net foreign assets (American-owned
assets minus foreign-owned U.S. assets) increases
wealth
• Americans have had very low private saving
rates in recent years. Does it mean that
personal wealth has not increased in the United
States? No.

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 FIGURE 4.2 Ratio of U.S. Wealth to
Income, 1955-2013

Source: Federal Reserve Bank of St. Louis, FRED Database. http://research.stlouisfed.org/fred2/

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 Application: How the United States Became
the Largest Net Debtor in the World

• Up until the 1980s, the United States was the

largest net creditor in the world
• By 2012, net foreign debt was over $3.9 trillion, or
25% of GDP
• How did the United States go from being the
largest net creditor in the world to the largest net
debtor?
• The net capital outflow identity provides an
answer.

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 FIGURE 4.3 Net Foreign Assets in the
United States, 1975-2012

Source: Bureau of Economic Analysis. www.bea.gov/international/index.htm/iip

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 FIGURE 4.4 U.S. National Saving,
Investment, and the Trade Balance, 1960-
2013

Source: Federal Reserve Bank of St. Louis, FRED Database. http://research.stlouisfed.org/fred2/

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 Saving, Investment, and Goods Market
Equilibrium in a Closed Economy

• To further understand the link between

saving and investment in the long run when
all prices are flexible, we first assume:

– The goods market is in equilibrium

– A closed economy (NX=0)

Y C I G

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 Saving, Investment, and Goods Market
Equilibrium in a Closed Economy (cont’d)

• Subtracting C and G from both sides of the

above equation, then:

S Y C G  I
Saving = Investment

• The real interest rate keeps the market for

saving and investment in equilibrium

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 Saving

• Consumption expenditure:

C  C  C(Y  T , r )
+ -
where
C = autonomous consumption
Y-T = disposable income

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 Saving (cont’d)

• Assume the following variables as exogenous:

G G
T T
K K
LL

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 Saving (cont’d)

• Long-run aggregate output becomes:

Y  F (K, L )  Y
• And so desired saving becomes:

S  Y  C  C(Y  T , r )  G

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 FIGURE 4.5 The Saving-Investment
Diagram: Equilibrium in the Goods Market

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 Investment

• As real interest rates fall, households and firms are

more likely to make investments, and so the desired
level of investment in the economy will rise
• The investment function:

I  I  I(r )
—
where I = autonomous investment

TH có stock price: không tính vào Investment mà là 1 dạng của saving.

Investment là của firms khi purchase cho machine, equipment, or furniture
trong quá trình sx

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 Goods Market Equilibrium

• In the saving-investment diagram, r* keeps the

goods market in equilibrium
• If r>r*, then desired investment is less than
desired saving
• If r<r*, then desired investment is greater than
desired saving

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 Response to Changes in Saving and
Investment in a Closed Economy

• We will look at how the economy respond to

changes in saving and investment through:
1. Changes in Autonomous consumption
2. Changes in Fiscal Policy
3. Changes in Autonomous Investment (does not
depend on real interest rate)

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 Changes in Saving: Autonomous
Consumption

• A rise in autonomous consumption causes saving

and investment to fall and the real interest rate to
rise in the long run, while a fall in autonomous
consumption causes saving and investment to rise
and the real interest rate to fall

auto C S I r vice versa

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 FIGURE 4.6 Response to Change in
Saving (a)

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 FIGURE 4.6 Response to Change in
Saving (b)

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 Changes in Saving: Effects of Fiscal
Policy

• Changes in taxes
– A rise in taxes causes saving and investment to
rise and the real interest rate to fall in the long
run, while a fall in taxes causes saving and
investment to fall and the real interest rate to
rise

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 Changes in Saving: Effects of Fiscal
Policy (cont’d)

• Changes in government purchases

– A rise in government spending causes saving and
investment to fall and the real interest rate to rise in the
long run, while a decline in government spending causes
saving and investment to rise and the real interest rate to
fall

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 Changes in Saving: Effects of Fiscal
Policy (cont’d)

• Changes in government saving

– Increases in government budget deficits
(government dissaving) cause saving and
investment to fall in the long run and real
interest rates to rise

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 Policy and Practice: Crowding Out and
the Debate Over the 2009 Fiscal Stimulus
Package
• In 2009, the Obama administration proposed and
Congress passed a $787 billion fiscal stimulus
package to promote economic recovery from the
recession that started in 2007
• Although this fiscal stimulus package had potential
benefits in terms of increasing employment and
output, huge government budget deficits and
government dissaving would generate a leftward
shift of the saving curve, which would lead in the
long run to a crowding out of investment and
higher real interest rates

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 Changes in Autonomous Investment

• Changes in I causes the investment curve to

shift, which leads to a change in equilibrium
real interest rate
– An increase in business optimism or a change in the
tax code that increases autonomous investment
causes saving, investment, and the real interest rate
to rise
– When businesses become more pessimistic or the
government raises taxes on investment, lowering
autonomous investment, the investment curve will
shift to the left, and so saving, investment, and the
real interest rate will fall

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 FIGURE 4.7 Response to a Rise in
Investment

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