Saving adds to a household’s wealth Dissaving reduces it Indeed, a household’s wealth is the sum of the value of all past saving less all past dissaving We can think of saving as a choice to postpone consumption Because interest rates are a payment paid to people who postpone their use of wealth, interest rates are a kind of reward paid to savers Will higher interest rates encourage the behavior they reward? The answer is a resounding “maybe.” Just as higher wages might not increase the quantity of labor supplied, higher interest rates might not increase the quantity of saving The problem, once again, lies in the fact that the income and substitution effects of a change in interest rates will pull in opposite directions Consider a hypothetical consumer, Tom Smith Let us simplify the analysis of Mr Smith’s choices concerning the timing of consumption by assuming that there are only two periods: the present period is period 0, and the next is period Suppose the interest rate is 8% and his income in both periods is expected to be $30,000 Mr Smith could, of course, spend $30,000 in period and $30,000 in period In that case, his saving equals zero in both periods But he has alternatives He could, for example, spend more than $30,000 in period by borrowing against his income for period Alternatively, he could spend less than $30,000 in period and use his saving—and the interest he earns on that saving—to boost his consumption in period If, for example, he spends $20,000 in period 0, his saving in period equals $10,000 He will earn $800 interest on that saving, so he will have $40,800 to spend in the next period Attributed to Libby Rittenberg and Timothy Tregarthen Saylor URL: http://www.saylor.org/books/ Saylor.org 701