Session 2. Saving, Investment and Current Account.

The Real Interest Rate.

National Accounting Identity

Saving and Investment

Equilibrium and the Real Interest Rate

What Causes changes in the Real Interest Rate?

Macroeconomics in the Global Economy

 National Accounting (Reminder)
The expenditure approach to measuring GDP:
GDP = C + I + G + NX
C = Private Consumption (Households expenditures excluding newly built
housing)

I = Investment* (Infrastructure, Structures, Equipment, Newly Built Housing,

Change in Inventories)

G = Government Consumption (Purchases of Goods and Services by

Government, excludes Transfers)

NX = Net Exports (Exports – Imports)

* = Includes both Private and Government Investment
Macroeconomics in the Global Economy
 Income and Expenditures (GDP)
The income approach:
National Income (GNI) = GDP + NFP
[NFP = Net Factor Payments]
Private Sector (Households and Companies) receive GNI and they use
it to:
1. Pay Taxes (T)
2. Buy Consumption Goods (C)
The difference is what we refer to as Private Saving
Sprivate= GNI - T - C = (GDP+ NFP) - T - C
Government Saving is the difference between revenues (T) and
government consumption (G)

Macroeconomics in the Global Economy

Sgovernment = T - G
 From Income and Expenditures to
Saving and Investment
National Saving (S) is the sum of private and public saving:
S = Sprivate + Sgovernment = [(GDP+NFP) – C – T] + [ T – G ]=
S = (GDP+NFP) – C – G
(National Saving is the amount of National Income that is not consumed by
the Private Sector or the Government)
Using definition of GDP (C + I + G + NX):
S = (C + I + G + NX+NFP) - C – G = I + (NX + NFP)
We define the sum of NX + NFP as the current account (CA):
S = I + CA
For a closed economy (CA = 0):
S=I
Macroeconomics in the Global Economy
 What Ensures Saving = Investment?

Saving represents a desire to move income from the present to the future.
The rate at which we convert current consumption into future consumption
is the real interest rate. Saving can be seen as the supply of current funds in
financial markets.

Investment implies the need to fund a project that will generate income in
the future via its rate of return. Investment can be seen as the demand for
current funds in financial markets.

Put them together as a model of supply (saving) and demand (investment)

where the equilibrium price is the real interest rate

Macroeconomics in the Global Economy

 Saving and the Interest Rate

Total (National) Saving = Private saving + Government saving

Disposable income - consumption Revenues (taxes)-

Expenditures

Real r
Interest
Rate

Saving is an
increasing function of r

Saving

Macroeconomics in the Global Economy

 Investment function

Real
Investment is a
Interest r decreasing function of r
Rate

Investment

Macroeconomics in the Global Economy

 Saving and Investment: The Equilibrium

The real interest rate is the price that equilibrates saving and investment.
Decreases in Saving or increases in Investment drive up the interest rate.

r
Saving

Equilibrium
Real interest
rate

Investment

Saving, Investment

Macroeconomics in the Global Economy

 When Does Saving Shift?

Consumption/Saving depends on the overall level of resources (income + wealth)

Higher future income, lower taxes, or higher wealth will affect saving patterns.
Expectations about the future matter.

Consumers tend to smooth transitory fluctuations in income through saving. This leads to an
intertemporal allocation of resources over time: e.g. winning a lottery or planning for
retirement leads to a reallocation of income over time to maintain consumption stable. At a
country level, economic crisis or demographic transitions matter for saving patterns.

Do not forget government saving is also part of national saving. Change in fiscal policy will
affect national saving.

Macroeconomics in the Global Economy

 When Does Investment Shift?

Investment depends on the comparison between the return on the available projects and the
real interest rate (opportunity cost of capital).

Improvements in perceived profitability of investment projects will shift investment to the

right.

New technologies or fluctuations in demand are likely to be associated with shifts in

investment.

Macroeconomics in the Global Economy

 Saving and Investment: The Equilibrium

The real interest rate is the price that equilibrates saving and investment.
Decreases in Saving or increases in Investment drive up the interest rate.
Saving curve shifts to the right if:
Current output increases
r Expected future output decreases
Saving Wealth decreases
Taxes increase
Government spending decreases
Demographic transitions (aging)

Equilibrium
Real interest Investment shifts to the right if:
(Expected) productivity increases.
rate
Business confidence increases
Taxes on capital decrease.
Investment

Saving, Investment

Macroeconomics in the Global Economy

 Global Real Interest Rates
7

5
Annual Real Interest Rate (%)

0
84

86

88

90

92

94

96

98

00

02

04

06

08

10

12

14

16

18
-1
19

19

19

19

19

19

19

19

20

20

20

20

20

20

20

20

20

20
Macroeconomics in the Global Economy Source: “Eight centuries of global real interest rates” Bank of England
 Saving Glut
“To be more specific, I will argue that over the past decade a combination of diverse
forces has created a significant increase in the global supply of saving--a global saving
glut--which helps to explain the relatively low level of long-term real interest rates in
the world today” Ben Bernanke, March 10, 2005.

r
Saving (1990s)
Saving (2000s)

World Real interest

rate 1990s
World Real interest
rate 2000s
Investment

Saving, Investment

Macroeconomics in the Global Economy

 Saving Glut + a Deep Recession

Real Interest Rate

Saving (1990s)
Saving (2000s)

Saving (2008-)
Real interest
rate (1990s)

Real interest
rate (2000s)
Investment

Investment (2008-)

Negative real
interest rate
(post 2008)
Macroeconomics in the Global Economy
 Interest Rates Reversal?

5.0

4.0

3.0

2.0

1.0

0.0
1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 2023

-1.0

US 10 Year Real

Macroeconomics in the Global Economy

 Looking Forward
Going forward we might see increases in investment in emerging countries,
possibly combined with increases in consumption in China (lower saving).
Among advanced economies we might see workers reaching retirement and
using their savings to fund their consumption. But we also have aging in many
parts of the world. What will world (real) interest rates do?

r
Saving

Equilibrium
Real interest
rate

Investment

Saving, Investment
Macroeconomics in the Global Economy
 Session 2. Summary
Saving is equal to investment plus the current account. For the World:
Saving = Investment

Saving (Supply of funds ) depends positively on interest rates: If interest

rates increase people save more. Investment (Demand for funds ) depends
negatively on interest rates: If interest rates increase, companies invest less.

The Global Real Interest Rate is the price that ensures that Saving =
Investment

Saving Glut since the mid 1990s caused both a decrease in interest rates and
an explosion of global imbalances.

Macroeconomics in the Global Economy