Moreover, while the model is generally true, it doesn't eliminate business cycles, which are caused by factors outside the elements of the theory. But even in these cases, the correlation between savings and output would still be positive, even if weak. The financial sector could be inefficient, or the efficiency of capital (output per unit of capital) could be low. Of course, a higher savings rate does not guarantee correspondingly higher GDP. ![]() "All correlations are positive," says Thornton, "suggesting that a higher saving rate in the current quarter is associated with faster (not slower) economic growth in the current and next few quarters." Louis Fed economist Daniel Thornton bolsters this line of reasoning in a report titled " Personal Saving and Economic Growth." Contrary to intuition, a higher savings rate actually correlates with higher GDP growth both several quarters out and also in the current quarter. The United States experienced much faster average GDP growth in the decades when the savings rate was higher.Īs I explained in that previous article, consumption is the using up of resources, while saving is the accumulation of resources - namely, capital. But this has not turned out to be the case. One would think that, since 70% of GDP is made up of consumption, a lower savings rate would lead to higher GDP growth. But, as the illustration suggests, higher wages also lead to increased savings, all else being equal, which reinforces the virtuous cycle. And, of course, more consumption, almost by definition, means higher GDP growth. Higher wages for the median worker provide more buying power to those who spend the highest percentage of disposable income on consumption. The only addition I would make to the above flow chart would be to include the higher wages that are correlated with increased investment. This is a modified version of the Harrod-Domar Model of economic growth, as illustrated here: More consumption leads to higher GDP growth. More valuable workers command higher wages. Investment leads to increased productivity and output capacity. ![]() ![]() In a previous post (see here), I wrote about the often-ignored engine of organic economic growth that is private savings.
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