Private savings equal to the sum of household and business savings. And, savings from private sector plus from public sector are equal to national savings. They represent the domestic supply of loanable funds in a country. Hence, high savings means more money for investment in the economy.
Private savings formula
Private savings = household savings + business sector savings
In aggregate, the formula for savings from private sector is
S = Y – T – C
Where
- S = Private savings
- Y = Aggregate income represented by GDP
- C = Consumption
- T = Tax revenue
Imagine an economy as an individual. And, remember, in economics, economists assume the money is used for only two purposes, namely savings and consumption. The formula above says to us that the actual amount of savings is the income individuals get after deducting the taxes paid and the consumption of goods and services.
In calculating the GDP expenditure approach, the formula of aggregate income (Y) equals to the sum of household consumption (C), business investment (I), government income (G), plus export (X) minus imports (M).
So, we can convert the formula above into:
S = Y – T – C = C + I + G + (X-M) – T – C = 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 the trade balance or net exports. Net private savings (S-I) is the remaining savings after deducting investment.
Let’s draw conclusions from the last equation. When the economy experiences a fiscal deficit (G <T) and a trade deficit (X <M) – or “twin deficit”-, net private savings (S-I) is negative. It means domestic private savings are not sufficient for domestic private investment (S <I). Hence, the country must borrow from abroad. Foreign capital should inflow, and the capital account should be a deficit.
