What’s it:Private savings equal to the sum of household and business savings. And savings from the private and public sectors are equal to national savings.
Private savings are crucial to a nation’s overall savings and investment picture. They represent the domestic supply ofloanable fundsin a country. They contribute to the accumulation of capital, which, in turn, can foster economic growth.
When individuals and businesses save, they make funds available for investment in businesses, infrastructure, and other productive activities. Hence, high savings means more money for investment in the economy.
Private savings formula
The economist defines private savings in the following mathematical formula
- Private savings = household savings + business sector savings
In aggregate, the formula for savings from the private sector is:
- S = Y – T – C
Where
- S = Private savings
- Y = Aggregate income represented byGDP
- C = Consumption
- T = Tax revenue
As explained by economists, money is used for two objectives, namely savings and consumption. In other words, we can explain savings as the remaining money after being reduced by consumption. The second formula above explains it, namely private savings, which is the income earned by the private sector after being reduced by taxes paid and the consumption of goods and services.
Difference between private saving and government saving
Private savings are another component of national savings. In other words, national savings are equivalent to private savings plus public savings (government savings).
By definition, private savings are the sum of the household sector savings with business sector savings. The household sector savings refer to the portion of income that individuals or households choose to save rather than spend on consumption. It includes funds held in various forms, such as bank accounts, retirement funds, or other investment vehicles.
Business sector savings is the sum of undistributed corporate profit and capital consumption allowances. We call undistributed corporate profit retained earnings in accounting. Meanwhile, capital consumption allowances are the amount of money that businesses must reinvest in to maintain existing productivity, which is equivalent to the depreciation of capital assets.
Meanwhile, government savings, often referred to as public savings, is the difference between government revenue and government expenditure over a specific period. Government saving is determined by the fiscal policies and budget decisions the government makes. It includes taxes collected and government spending on various programs and services.
Government saving is a reflection of the fiscal stance of the government. A budget surplus indicates that the government is saving, while a deficit implies that it is borrowing or using reserves.
A budget surplus can contribute to national savings and reduce the need for government borrowing. A deficit, on the other hand, may lead to increased government debt.
The link between private sector savings, public savings, and external sectors
Let’s take back the formula S = Y – T – C. Then, let’s describe the aggregate income (Y) by recalling the GDP formula using the expenditure approach.
In calculating the GDP using expenditure approach, economists formulate aggregate income (Y) ashousehold consumption(C) plus business investment (I), government income (G), and net export (export (X) minus imports (M)). Or mathematically, we write:
- Y = C + I + G + (X-M)
Then, let’s replace Y in the private savings formula with the formula above. So, we get:
- S = Y – T – C
- S = C + I + G + (X-M) – T – C
- S = I + (G – T) + (X – M)
- S-I = (G – T) + (X – M)
Government expenditure minus tax revenue (G-T) represents the fiscal balance or public savings. Exports minus imports (X-M) refers to thetrade balanceor net exports. Net private savings (S-I) is the remaining savings after deducting investment.
The last formula above explains how a country finances its domestic investment. When the economy experiences a fiscal deficit (G <T) and atrade deficit(X <M) – or “twin deficit”-, net private savings (S-I) are negative. It means domestic private savings are insufficient for domestic private investment (S <I). Hence, the country must borrow from abroad. Foreign capital should be inflow, and the capital account should be a deficit.
Factors affecting private savings
Some factors can contribute to the decrease or increase in private savings. Theyinclude:
- Current and expected income and wealth;
- Public saving;
- Interest rates and inflation;
- External factors (terms of trade and foreign saving); and
- Demographic factors
Take income and wealth, for example. Individuals with lower incomes may find it challenging to allocate significant earnings to savings after covering essential living expenses. Thus, income level is positively correlated with the level of savings by the household.
Meanwhile, wealth is closely related to income, assets owned, and debt. Assuming the income and asset value unchanged, heavy debt burdens, such as credit card debt or loans, can limit the income available for savings. Interest payments on debts may take precedence over saving for the future.
- Loanable Funds Market: Concept and How it Works
- Household Savings: Meaning, Formula, Importance, Key Factors
- National Savings: Formula, Its Importance, How To Calculate It
