• Saving is disposable income that is not spent
• There are many ways in which money can be saved ranging from accounts in bank and building society accounts to savings in pensions and the stock market
• The savings ratio is the % of disposable income saved rather than spent e.g. if a person has an annual income of £25,000 and saves £2500 of this, then the savings ratio is 10%
• A high savings ratio (other factors remaining equal) lowers consumption and aggregate demand

What factors affect how much of their income people save?

• Real Interest Rate: The nominal interest rate adjusted for inflation. A positive real interest rate incentivises saving
• Price Expectations: If consumers expect prices to fall (i.e. deflation) they may choose to save more now
• Availability of Credit: Borrowing is dis-saving as it allows spending > current income
• Unemployment / Job Security: When unemployment is rising, many people save more as a precaution as job security declines
• Consumer Confidence: When consumer confidence is strong, people are more willing to borrow and save less
• Taxation of Savings: Interest on many types of saving is taxed, some savings schemes are tax-free or low tax
• Trust in Savings Institutions: Deposit guarantees can encourage more saving in commercial banks

Evaluating the importance of saving for an economy

Decisions by people and by businesses about how much to save have a powerful effect on economic performance – here are some reasons:

1. Corporate savings provide a cushion during a recession when demand and profits fall. Business savings can be used as finance for takeovers and for capital investment projects
2. Savings by families flow into financial institutions

• Banks need deposits as capital from which they can lend. Many small businesses have complained about the difficulty in getting loans in the aftermath of the global financial crisis
• Savings flow into pension funds – these can be reinvested in stock markets providing funds for businesses that need to raise capital to finance expansion plans.

Savings provide a source of household wealth and a buffer against uncertain times allowing people to smooth out their consumption when times are tough. They allow people to reduce debts and save to allow a reasonable standard of living during retirement.

The Paradox of Thrift

• The paradox of thrift is an important idea from Keynesian economics. Saving is regarded as positive because it provides the funds to finance the capital investment needed to promote long-term growth
• But if many people start saving more at the same time, this causes a drop in consumer demand and an even deeper recession
• What might be rational and virtuous for an individual might be damaging for the economy as a whole