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Question from Past Macroeconomics Qualifying ExamEdit

Spring, 2004 - Question one - at George Mason University

Many economists and policymakers are convinced that one of the most important macroeconomic problems confronting the U.S. economy is the long-lasting low savings rate:

  • a. Do you think that this is a serious problem? Why or why not?
  • b. Provide at least three reasons that may explain why the U.S. savings rate is so low.
  • c. What policies do you think can be implemented to stimulate the U.S. savings rate?

AnswerEdit

  • a. Theoretically the low savings rate would be a missing source of investment funding new capital accumulation. One of the sources of investment funding is money from abroad. With the increased investment from abroad comes equity ownership of capital by foreign citizens. Without politics, this seems to be a benign circumstance (what does it matter what political intity a capital investor subscribes to, the money still spends). With politics, the situation might get more complicated. As far as low savings rates domestically, this reflects higher consumption and an increased return on capital encouraging technological advancement. There are two sides of the coin. A lower aggregate savings rate might follow the "Keynesian savings paradox," and actually trap the economy on lower rates of growth.


alternative: a. "Low" is a relative term. The U.S. savings rate is relatively low by historical (time-series) and across-country (cross-sectional) comparisons. If circumstances or structures have changed, or the U.S. is special, the low rate may not be cause for concern; it may just be an appropriate equilibrium for its time and place. I think this is more the case than not.


  • b. 1) The capital gains are not included in income or savings so that the rates is actually lower than it seems
~ 2) Credit availability decreases the need for precautionary savings
~ 3) subjective discount rates domestically are higher than subjective discount rates abroad, as a result savings abroad (with advanced capital markets) is compatatively advantageous) and crowds out domestic investment.


alternative: b. Advances in technology are now occurring with such a speed that the phenomenon of technological advancement is widely remarked-upon, understood, and expected to continue. If Americans today have the expectation of strong future growth driven by technology, they may be less willing than their ancestors to forgo present consumption for a potential additional increase in future output.
Another possible reason for lower savings may be improved capital markets. It is possible that in the past, many Americans were unable to borrow all that they desired to borrow against their future income. With home equity loans, readily available credit cards, and other innovations, possibly we are now seeing a savings rate more in line with true individual desires.
Those are two arguments for change over time; there is also an argument to be made that the U.S. is special among nations today. By providing a standard international currency, Americans are at an advantage in international trade. If the Chinese government accepts paper money in return for television sets, there will be a current account deficit (at least as it is commonly measured), which may count as American dissaving. In reality, the Chinese get something they want in large part for its own sake -- dollars -- in return for the TVs. So it is possible that this part of the lower savings rate is an illusion of accounting.


  • c. One policy which could stimulate domestic savings rates is to tax foreign investment. We could also include the equity as part of the savings, so that the ratio actually reflects the higher level of intertemporal substitution (this would also have to include all retirement savings plans offered by companies).


alternative: c. Don't count the trade deficit as dissaving; that would be one quick and painless method. The government could tax or restrict home equity loans, possibly painting them politically as newfangled tools to separate fools from money. The government could further increase incentives to save for retirement, or potentially twiddle with Social Security, turning it into an actual savings mechanism rather than a bookkeeping trick.

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