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Saving and growth under borrowing constraints explaining the "high saving rate" puzzle

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Author Info
Yi Wen
Abstract

Fast-growing economies tend to have extremely high saving rates. Empirical evidence suggests that this positive correlation holds largely because high growth leads to high saving, not the other way around. Such empirical evidence is inconsistent with the permanent-income hypothesis, but consistent with standard neoclassical growth theory, since high productivity growth raises the rate of returns to investment, hence stimulating saving through high real interest rates. However, fast-growing economies have not just high saving rates, but also low interest rates. Why would households save excessively to finance firms? investment when the interest rate on their savings is so low? This paper shows that precautionary saving under borrowing constraints can solve the puzzle. Borrowing constraints make an individual?s marginal propensity to consume negatively dependent on her permanent income, so that high growth can lead to substantially increased saving without high interest rates. In other words, precautionary saving is able to support a large spread between the deposit rate and the rate of returns to capital; consequently, fast-growing economies can exhibit not only astonishingly high saving rates despite low deposit rates, but also undiminished rates of return to capital despite large investment-to-output ratios.

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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2009-045.

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Date of creation: 2009
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Handle: RePEc:fip:fedlwp:2009-045

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Keywords: Saving and investment ; Consumer behavior;

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