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Let's say our government runs an advertising campaign, encouraging its citizens to reduce spending money on consumer items, and instead save more money.

Let's say the campaign is successful, and that happens.

How does this affect economic activity?

On one hand the factory and shop owners appear to produce less, and thus hire less people, but on the otherhand, there is more money available to build new factories etc.

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And who said that in this site only expert-level questions are on-topic? –  Alecos Papadopoulos Nov 19 '14 at 17:38
    
The invitation to the private beta, which we all got via mail, said that this is going to be the case at least for the private phase. –  FooBar Nov 22 '14 at 0:49

5 Answers 5

Such a "planned" and sought-after re-allocation of given income from consumption to saving, is justified only if the savings in an economy are sub-optimal (or we think so), in the sense of hurting the investment rate, which in turns hurts the (human and physical) capital infrastructure.

Think about the extremes: consume all that you produce, save nothing (as a society). Your capital base will erode, leaving in the end only the other factor of production, labor, an orphan, without the necessary capital to produce, leaving perhaps only land for the society to return to a non-industrial agricultural state.

So it is a matter of intertemporal (re)allocation of resources in order to guarantee that the economy survives, and then that it does a bit better than just surviving.

The conundrum: if businesses see consumption declining, why would they rush to make new investments even though now the "price" of these investments is lower, due to increased savings and so to increased availability of funds?

I would invoke here "Say's Law": Supply finds its own demand. (see the controversies over it). For me, this law is better interpreted in the context of heterogeneity: no matter what overall consumer spending does, there is always some fields where consumer desire goes unfulfilled. Entrepreneurs try to identify these fields, and invest there (this has a Schumpeterian flavor).

The above discussion does not mean that we will not observe phenomena like increased unemployment. After all, investing in new fields requires re-allocation of productive resources, and this is not easily nor quickly done. And there is always the case that the "savings drive" may overshoot, and the economy will be led to a lengthy recession, Japan some 20 years ago being the classic modern example (in fact in Japan, the government tried actively to persuade the citizens to raise their consumption, but it failed).

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@FooBar So is the burn out of the sun. And a million other things. So this is not a very useful comment. –  Alecos Papadopoulos Nov 19 '14 at 17:38

As stated the Government successfully runs a campaign and people stop spending and start saving.

Part of the answer depends on how they save, and the other part depends on how manufacturers react. However it´s worth observing that in most countries only a minority of people can do this - the 60-70% of people in the USA for example who live pay cheque to pay cheque can´t realistically save anything.

If the savers simply leave their money in their bank accounts, or switch it to a savings account, it is incorrect to assume there is more investment. In fact nothing changes on the investment side. Banks can´t lend more money, because their customers stop spending it. It just sits there in their bank accounts. Capital reserves, and in some countries central bank reserves control the amount of bank lending, not deposits. People spend less, less is bought, we can presume that either less is produced, or producers lower their prices as a result. In the latter case, there could be no change whatsoever.

However, people may start buying investments, and in that case there may be more investment. It again depends on which financial instruments they´re buying. Money market funds for example would channel that money into short term commercial debt, angel investments into startup companies, corporate bonds into companies, government treasuries into government debt. If they bought bank capital (i.e. newly issued bank shares), then the banks would be able to lend more - as the increased capital would act to increase the amount they could lend. Since banks can lend at a multiple of their capital, that is actually the most efficient (in terms of the amount of money required) way to increase lending.

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The whole point of saving is that you consume less NOW in order to consume more LATER. That is certainly true at a personal level.

Moreover, that is true at a national level. More savings this year means less consumption this year. The danger of savings is that if the money goes under the proverbial "mattress," instead of being invested, less consumption this year will mean less GDP this year, and will not be compensated by more consumption in future years. If the savings are invested, total future consumption will rise by whatever the rate of return is on the investments.

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It's dangerous to reason from local effect to global ones, as large scale systemic behaviours can often be very counter-intuitive. For example, let's say I put off consumption now, and as a consequence of the lack of demand for that item, its manufacturer goes bankrupt, and the object is no longer produced, or its price rises as a result of the reduction in supply. Or in the background, the money I've saved under the mattress gets replaced by a treasurer that essentially prints cash money on demand, and consequently it gets devalued by monetary expansion. –  Lumi Mar 28 at 16:28
    
@Lumi: As I understand it, this was originally cast as a micro economics question, and I answered it as such. Yes, it could have macro implications, and if it does, it means that the global economy has gotten "too hot to handle," and may be vulnerable to "ultimate" failure. –  Tom Au Mar 28 at 16:46
    
I think the real issue is that without considering the mechanisms involved in what we call "saving" it's very hard to draw conclusions about the actual results of postponing consumption (beyond dietary considerations of course.). I think this is fairly well understood by actual governments, f.ex. ww2 campaigns for people to save were invariably accompanied by exortions to "buy war bonds" or similar. –  Lumi Mar 28 at 18:45

Why Save? "In the long run we are all dead!" - K.

Your interesting question brings more questions. Because the short answer is: it depends.

Part A - Diagnostic What phase of the business cycle are you in? You first need to make a diagnostic of the shape and timing of the economy your are analyzing. The timing of the business cycle is of prime importance. In a downturn it may affect negatively, while in an era of overheating it might be a good thing to calm things down. Has the government surpluses? Is the economy growing? Are people optimist about the future?

It is a closed economy or a globalized one? A globalized but stagnant-growth economy could see an outflow of capital, if "agents" see more investments opportunities abroad. This is a key question. Where those new factories will be built. The economy is not a zero sum game but wealth will not be equally distributed. In a closed system, or if the wolrd economy is your level of observation, more savings could increase investments in productive assets and result in an increase of productivity.

Who are the consumers? What is the demographics young/old population? It will have an impact on the response both in terms of consumption and investing. We could argue that a young population will be more adventurous in new projects. Is it a risk/loss averse culture? Are the consumers into hedonic consumerism, where entertainment and instant gratification is more important than distant benefits? Is the population in favor of buying local products, or prefer cheap imports? If you cut consumption of local products you might hurt your domestic market, or maybe they will cut imports first? Are your consumers poor or rich?

Are there good institutions in place? Do people trust the government/ each other? Is there a lot of corruption? Is there efficient financial markets to invests the savings in? In India, gold is a popular forms of savings.

What is the economic struture, the dominant type of industries? Oil is a dominant sector in Norway, which command a large share of gdp, exports and governmental revenues. By reducing the consumption you will affect less the vigor of the economy. A country with a large industrial business to business (B2B) economy may profit from more investments.

Do the economy needs more savings? If you assume we are at the dawn of the thirs industrial revolution, in which IT leads our civilization into a new era, maybe you don't need that much more savings. The tech-savy "creative class" mostly need a computer and an internet connection to launch a business. You do not need the same large investments in machinery as in the 1st and 2nd revolutions, where pooling capital and sharing risks was a condition for developping for example the railroad systems.

Once you have made a diagnostic of the situation you can look at the effects:

Part B - Possibles Outcomes:

1- How much can consumers save? As Lumi observed, most people live on a tight budget (In fact via credit they spend more than their annual income).A small increase in savings will probably have a minimal impact both on consumption and investments levels. 1b) What are they going to save on? Spending cuts will affect the basket of goods and services that they usually consume.

If there is a sales tax, a decrease in consumption will diminish the revenues of the government (hopefully only in the sort run), and if the government must also cut back its spending we could perhaps see an amplification of the action, and a contraction of the economy. Why would business invests if both government and consumers stops spending?

1c) How much consumers are willing to save/sacrifice? This has to do with time preferences, and perhaps the inflation levels, the interests rates, other cultural traits like attitude towards savings...

2- Where will the savings be invested?? Short vs long run? This depends on multiple factors (see diagnostic). It also depends on the incentives. In your question you only refer to advertisement, but the government can implement other incentives and it will direct where the money go. For example incentives for retirements savings. Are they sophisticated investors? How much knowledge do they have about financial markets?

2a) Downturn, optimisim, risk/loss aversion, and forecasts: Will they be willing to take risks? If not, we can expect people to buy secure assets for example bonds.

2b) What are they saving for? Saving for a wedding or to start a company will have a different impact. China has experienced what the Austrian School calls "malinvestments", people just bought real estate properties. Apparently there are appartments towers completly empty even empty brand new towns.

2c) Invest in... Education? Housing? Stock Markets? Investment in education could have long term positive effects (hopefully). In housing it could lead to a bubble... Sotck markets, facilitate outflow of capital, and offshoring of manufacturing.

2d) Save for... Retirements, or decrease in working hours or travels. What if people having more savings decide to work less? Early retirment, or more part time jobs? How would this impact the productivity? Debts are a forced incentive to postpone retirment age.

3- Will the savings translate in productive investments? more cash = hoarding, possibly merge and acquisition waves? Will they lead to an increase productivity or more complacency due to reduced competitivity?

Conclusion: What is the total effect?

It really depends on the situation. For individuals there are great benefits to have a little cushion to face unexpected situations, it also opens the way to new opportunities. But will they/ can they seize them? For the government it may mean less revenues in the short run, and must therefore be ready for it. For companies it depends to which purpose the money will be used for.

Reducing consumer spending, might contract the personal goods/services sector, leaving with less diversity in the end. Or if people take the opportunity of having more available money to invest in order to launch new businesses it might just do the opposite.

At the moment, the strategy is to facilitate access to credit and to promote high levels (almost unsustainable) of consumption. A supply-side economy needs a high level of C.

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Let's say the campaign was free.

According to the common introductory model: $C+I+G+X-IM=Y_1$

  • G stays the same (program is free).
  • C goes down.
  • I goes up the by an amount equal to the decrease in C because Savings=Investment.

Net result: No change in GDP for that year.

Every model I have ever seen suggests that broadly increased investment leads to better production in the following year. We have more hammers, more manufacturing of widgets, etc. This means $Y_2>Y_1$, and either $C_2$, $I_2$, $G_2$ or $X_2-IM_2$ must be larger to compensate.

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But I != consumer savings –  serakfalcon Mar 20 at 15:08

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