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

  • Yi Wen
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Empirical evidence suggests that fast-growing economies tend to have not only high saving rates but also low interest rates. This evidence is difficult to reconcile with standard explanations about the positive linkages between saving and growth. These explanations rely either on high saving to explain high growth or on high growth to explain high saving; but in either case, they must imply and depend on high interest rates to induce high saving rates. Hence, the real puzzle is why households would save excessively to finance firms’ investment when the interest rate on their savings is so low. This paper shows that if households face idiosyncratic wealth-income risk and are borrowing constrained, an otherwise-standard growth model can imply that fast-growing economies have not only high saving rates but also low interest rates. Precautionary saving under borrowing constraints can make an individual’s marginal propensity to consume negatively dependent on her permanent income, so that high income growth can lead to substantially increased saving without high interest rates. The predictions of the model are consistent with the experience of Japan (in the 1960-1970s) and China (in the past 30 years).

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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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