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In economics, household savings refer to money left after the household pays taxes and spends on the consumption of goods and services. It is vital for the economy’s long-term growth as it is the primary source of domestic loanable funds, besides savings from business and public sectors.
Savings from the household sector form the domestic savings of a country (or national savings). It is equal to public savings and private savings. Public savings are the excess money from the government sector, meanwhile private savings come from the private sector (household and business).
In the capital markets, the money moves from household sectors to the business sector, for instance, through investing it into corporate debts or stocks. Companies can use it to funds capital investment. For this reason, household savings are essential to increase the productive capacity of business sectors.
Calculating household savings rates
The savings rate shows how much households save their income rather than being consumed for goods and services. To calculate it, we divide household savings by disposable income.
For example, when someone saves about Rp500,000 of the total disposable income of Rp5,000,000, the savings rate is 10%.
Household savings rate = (Household savings/Personal disposable income ) x 100%
Savings rates vary between household income groups. Higher-income households will have a higher savings ratio than lower-income earners. They save more because they have fulfilled the most desirable needs.
Disposable income is a key determinant of household savings. The personal tax rate is also the other factor.
Meanwhile, other determining factors include real interest rate (inflation-adjusted interest rate), credit availability, household wealth, and income expectations. Debts and existing liabilities are also the other factors since they reduce money left for the household.
- Income. High-income households usually allocate more income to savings than consumption. Conversely, because they cannot fulfill the most desirable items, low-income households consume more than they save.
- Interest rate. High real interest rates make savings more attractive. Why the real interest rate? The high nominal interest rate will be useless if inflation is also high. When it is lower than the inflation rate, the actual returns cannot offset the decline in the purchasing power of money. Hence, households are reluctant to save.
- Future income expectation. Households increase consumption rather than saving when they are optimistic about their future income. It commonly occurs during economic expansion.
- Wealth. Increased asset value encourages households to consume more. As the assets value rise, households find reaching their wealth accumulation target without saving more.
- Tax. Higher personal taxes reduce disposable income, hence decreasing money allocation for consumption and saving.
Why is household savings important?
Household savings are a supply source of domestic funds for capital investment. Households save their money into various types of assets, such as deposits, stocks, and bonds. In return, they receive interest income, dividends, or capital gains.
On the other side, to increase production, the companies require money to purchase new equipment and other capital assets. They then raise funds, for instance, by issuing bonds.
Supply-demand of the money takes place in the financial market. As the household invests in the corporate bonds, money flowing to the business sector. Now, with money, companies can invest and increase their productive capacity.
Investment in capital assets is essential for economic growth. It is a key driver in increasing the productive capacity of the economy. Higher production capacity leads the economy to produce more goods and services, without causing inflationary pressures.
Savings also allow households to accumulate wealth. In addition to income, wealth is a crucial determinant for consumption. An increase in household consumption drive up aggregate demand stimulates a growing real GDP.
Savings also become a pillow when times are hard. By saving, households sacrifice current consumption for future consumption. For this reason, saving allows households to support their well-being.