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JA6. The Impact of a Change in the Savings Rate on the Output

Statement

Please explain in three well-structured paragraphs the impact of a change in the savings rate on the output.

Answer

Saving is a function of money that involves withholding a portion of income for the unknown future. The text will start by defining saving rate, then it it will explain the factors that influence the saving rate, then a simulation of the impact of savings on demand and output will be presented both in the short and long run, then a literature review about the topic will be presented, and finally will draw a conclusion.

Saving rate is the percentage of the disposable income (available to spend) that a household puts aside for future use for retirement, emergencies, future investments, etc; thus, saving has the notion of forgoing current consumption for future greater consumption (Wohlner, 2023). The saved capital (cash) is usually held in banks, retirement and investment pots, and other financial institutions. These institutions use the saved capital to lend to businesses and individuals for investments, consumption, and other purposes.

Saving rate is usually influenced by social, economic, and political factors. People tend to save more during economic uncertainty, high-interest rates, and when they expect future expenses. People may also save less or more if they get encouraged or discouraged by government policies, politicians, and other public figures. Household savings can be a significant reserve of capital that can be used to finance investments or government spending. “Savings stimulate investment, production, and employment and consequently generate greater sustainable economic growth” (Ribaj & Mexhuani, 2021).

On the short run, when the savings rate increases, households spend less and save more; this decreases the demand for goods and services, which leads to a decrease in production and GDP. On the long run, when the savings rate increases, households spend less and save more; this increases the money in the banks which increases the supply of money, and eventually decreases the interest rate. The lower interest rate encourages borrowing and spending, which leads to an increase in demand, investment, production, and GDP (Khan Academy, 2012).

The literature developed some theoretical models to explain the relationship between saving and economic growth, and are presented nicely in Adema & Opschoor (2015). The Solow model suggests that saving is a key factor in economic growth and developed a way to quantify the possible economic growth. The golden rule of capital suggests a way to find the optimal savings rate that maximizes consumption in the long run. Neoclassical models suggest that saving is necessary until accumulating a certain amount of capital that guarantees a steady state; during this period, consumption will go down, until it goes up again after reaching the steady state (Adema & Opschoor, 2015, p.10).

To conclude, saving is a crucial factor in building steady and stable economic growth. Economic, social, and political events affect saving. If saving rate increased, consumption will decrease, capital will start accumulating until reaching a steady state, then consumption will increase again. There may be a negative impact on the short run, but a positive impact on the long run is proven both theoretically and practically.

Word count: 500.

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