Introduction to Consumer Choices

5.2. Applications of the Model of Intertemporal Choice

The theoretical model of the intertemporal budget constraint suggests that when the rate of return rises, the quantity of saving may rise, fall, or remain the same, depending on the preferences of individuals. For the U.S. economy as a whole, the most common pattern seems to be that the quantity of savings does not adjust much to changes in the rate of return. As a practical matter, many households either save at a fairly steady pace, by putting regular contributions into a retirement account or by making regular payments as they buy a house, or they do not save much at all. Of course, some people will have preferences that cause them to react to a higher rate of return by increasing their quantity of saving; others will react to a higher rate of return by noticing that with a higher rate of return, they can save less in the present and still have higher future consumption.

One prominent example in which a higher rate of return leads to a lower savings rate occurs when firms save money because they have promised to pay workers a certain fixed level of pension benefits after retirement. When rates of return rise, those companies can save less money in the present in their pension fund and still have enough to pay the promised retirement benefits in the future.

This insight suggests some skepticism about political proposals to encourage higher savings by providing savers with a higher rate of return. For example, Individual Retirement Accounts (IRAs) and 401(k) accounts are special savings accounts where the money going into the account is not taxed until it is taken out many years later, after retirement. The main difference between these accounts is that an IRA is usually set up by an individual, while a 401(k) needs to be set up through an employer. By not taxing savings in the present, the effect of an IRA or a 401(k) is to increase the return to saving in these accounts.

IRA and 401(k) accounts have attracted a large quantity of savings since they became common in the late 1980s and early 1990s. In fact, the amount of IRAs rose from $239 billion in 1992 to $3.7 trillion in 2005, then to over $5 trillion in 2012, as per the Investment Company Institute, a national association of U.S. investment companies. However, overall U.S. personal savings, as discussed earlier, actually dropped from low to lower in the late 1990s and into the 2000s. Evidently, the larger amounts in these retirement accounts are being offset, in the economy as a whole, either by less savings in other kinds of accounts, or by a larger amount of borrowing (that is, negative savings). The following Clear It Up further explores America's saving rates.

A rise in interest rates makes it easier for people to enjoy higher future consumption. But it also allows them to enjoy higher present consumption, if that is what these individuals desire. Again, a change in prices - in this case, in interest rates - leads to a range of possible outcomes.

Clear It Up

How does America's saving rates compare to other countries?

By international standards, Americans do not save a high proportion of their income, as Table 6.10 shows. The rate of gross national saving includes saving by individuals, businesses, and government. By this measure, U.S. national savings amount to 17% of the size of the U.S. GDP, which measures the size of the U.S. economy. The comparable world average rate of savings is 22%.

Country	Gross Domestic Savings as a Percentage of GDP
China	51%
India	30%
Russia	28%
Mexico	22%
Germany	26%
Japan	22%
Canada	21%
France	21%
Brazil	15%
United States	17%
United Kingdom	13%

Table 6.10 National Savings in Select Countries