Intertemporal Choices in Financial Capital Markets

Rates of saving in America have never been especially high, but they seem to have dipped even lower in recent years, as the data from the Bureau of Economic Analysis in this figure show. A decision about how much to save can be represented using an intertemporal budget constraint. Household decisions about the quantity of financial savings show the same underlying pattern of logic as the consumption choice decision and the labor-leisure decision.

Personal Savings as a Percentage of Personal Income

Personal savings were about 7 to 11% of personal income for most of the years from the late 1950s up to the early 1990s. Since then, the rate of personal savings has fallen substantially, although it seems to have bounced back a bit since 2008. (Source: http://www.bea.gov/newsreleases/national/pi/pinewsrelease.htm)

The discussion of financial saving here will not focus on the specific financial investment choices, like bank accounts, stocks, bonds, mutual funds, or owning a house or gold coins. The characteristics of these specific financial investments, along with the risks and tradeoffs they pose, are detailed in the Labor and Financial Markets tutorial. Here, the focus is saving in total—that is, on how a household determines how much to consume in the present and how much to save, given the expected rate of return (or interest rate), and how the quantity of saving alters when the rate of return changes.