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At the beginning of the year, you will have examined the five sector model of the economy.  (If you can’t remember what that model looks like, now would be a good time to have another look at it!)  The five sector model will help us to identify the factors that can affect the level of saving in the economy.

The first, and most obvious, factor affecting our willingness to save is our income.  If our income is more than sufficient to meet all of our needs and wants, then we will have surplus funds left over at the end of each pay cycle.  These funds can then be directed into a savings account.

After we receive our income, the majority of it will be spent.  Economists refer to the percentage of our income which is used in this way as the marginal propensity to consume (MPC).  Put simply, this suggests that if we earn one more dollar, economists would like to know how much of that money we will end up spending.  The MPC can be calculated if we know the household savings ratio.  If we save 10% of our income, then it follows that we must spend 90% of it.  (Some economists prefer to list this as 0.90 – this is the same figure expressed in a different way.)  The key is that our MPC plus the household savings ratio will always equal 100%.  As such, anything which affects our MPC will also affect our saving levels.

For example, when consumers are confident, they are more likely to spend their money.  This means that there won’t be as much money left over each month to save.

Two other factors deserve special mention.  The government levies income tax in Australia.  When income tax rates change, it will affect our disposable income.  If income tax rates increase, then we won’t have as much money to save.  On the other hand, when income tax rates fall, it is possible that we will save more of our money.  You should note that any money that you earn from your savings is subject to income tax.  Any decision by the government to alter the way in which savings are taxed will also have an effect on whether or not we choose to channel some of our money into this area.

Finally, interest rates will have a significant impact on our willingness to save money.  When interest rates increase, it suggests that we will receive a higher financial return on the money that we do save.  This will make saving a more attractive option, and so we are more likely to save more money during periods of high interest rates.  We can see this trend develop between 2004 and 2007.  At that time, interest rates increased slowly (including three increases in 2006).  At the same time, the long term downward trend in the household savings ratio was arrested.

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