1. Saving Interest Rates
2. Savings Interest Rate
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Interest rates determine the amount of interest payments that savers will receive on their deposits.

• An increase in interest rates will make saving more attractive and should encourage saving.
• A cut in interest rates will reduce the rewards of saving and will tend to discourage saving.

However, in the real world, it is more complicated. The link between interest rates and saving is not clear because many factors affect saving.

In 2009, the household saving ratio increased from 0.5% to over 8% – despite a cut in interest rates from 5 to 0.5%. This was because the impact of the recession encouraged saving. The fear of unemployment and recession was greater than the effect of lower interest rates

Income and substitution effect of higher interest rates.

• If interest rates fall, the reward from saving falls. It becomes relatively more attractive to hold cash and/or spend. This is the substitution effect – with lower interest rates, consumers substitute saving for spending.
• However, if interest rates fall, savers see a decline in income because they receive lower income payments. A pensioner relying on interest payments from saving may feel he needs to save more to maintain their target income from savings.

Usually, the substitution effect dominates. Lower interest rates make saving less attractive. But, for some, the income effect may dominate, and people may respond to lower interest rates by saving more to maintain their standard of living.

Alternatively, a lower interest rate may encourage other forms of saving and investment. With very low bank rates, it has encouraged people to look for better yields in the stock market. This is one reason why the stock market did well in the great recession of 2008-2013 – savers have been buying shares to get a better rate of interest rate than they can in a bank and on bonds.

Jul 01, 2018 The link between interest rates and saving is not clear because many factors affect saving. In 2009, the household saving ratio increased from 0.5% to over 8% – despite a cut in interest rates from 5 to 0.5%. The interest payable on the investment is either on a monthly basis or quarterly basis, this interest may be reinvested. Tax Deductible Fixed Deposits have a nomination facility. Banks offer slightly higher interest rates to senior citizens on these Fixed Deposits. This increased interest rate exists for Tax Saving Fixed Deposits. The Surprise Savings booster is calculated using the average completed transfer amount per customer for the full month of January, 2021. The interest is calculated using a $26,000 average Online Savings Account balance at 0.60% Annual Percentage Yield (APY).

Base rates and bank rates

Usually, a cut in Central Bank base rates leads to an equivalent fall in bank rates. However, in the aftermath of the credit crunch, bank rates didn’t fall as much as base rates. In the UK, bank rates (e.g. Libor were higher). Therefore, the cut in base rates didn’t have as much impact. After the impact of the credit crunch diminished the UK saw a fall in Libor rates, and bank rates came closer to base rates.

(instant access saving rates starts Jan 2011.)

• Before the crisis, 1-year fixed rate saving bonds were very close to the Bank of England base rate.
• However, 1-year saving rates in 2009 only fell to 3% in 2009, meaning savers were protected from the full cut in base rates.
• However, since the Funding for Lending scheme was introduced in 2012, saving rates have fallen for both 1-year fixed and interest rates on instant access saving.
• The fall in the savings ratio in late 2012 / early 2013, may be related to the fall in bank saving rates, which are being passed on to consumers.

Relative interest rates

• It is also important to consider interest rates relative to other countries. If UK rates fall, but are still higher than other major economies, this could lead to an inflow of hot money as investors take advantage of the relatively higher interest rates. If UK rates are lower than Europe, some investors may move their money out of the UK and into European banks.
• Confidence in the exchange rate is also important. If the Pound is deemed, a ‘safe haven’ currency. (e.g. during Euro crisis of 2011), this could cause higher demand for Sterling deposits.

Real interest rates

Real interest rates measure the interest rate – inflation rate. If interest rates are 5%, and inflation 3%, the real interest rate is 2%. Savers are increasing their real wealth. However, if we have negative interest rates, (interest rates of 0.5% and inflation of 3%), then savers will see a fall in the real value of their savings.

Other factors affecting saving

Saving ratio and interest rates

In 2009, the saving ratio rose sharply – despite a cut in interest rates.

The saving ratio (percentage of income saved) depends on several factors, including:

• Confidence. A big factor is economic confidence. If households are pessimistic about the economic outlook, they will tend to save more and concentrate on paying off their debts. For example, in 2007, we have falling house prices and rising unemployment. Both of these factors reduce spending and encourage saving.
• Financial conditions. In the aftermath of the credit crunch, credit was hard to get. Therefore, borrowing fell, and people concentrated on saving.
• Wealth. People’s saving is often tied up in assets, such as houses. The housing market has a big impact on saving in the UK. Rising house prices encourage equity withdrawal and higher spending. Falling house prices have the opposite effect.
• Real wage growth (nominal wages-inflation) a period of negative real wage growth (2009-17) saw a fall in the savings ratio as consumers maintained spending by borrowing and eating into their savings.

Interest rates and exchange rate

Higher interest rates also make it more attractive to save money in the UK, as opposed to other countries. Therefore, higher rates will cause ‘hot money flows’ and may cause the value of the £ to rise.

• Interest rates determine the amount of interest payments that savers will receive on their deposits.
• An increase in interest rates will make saving more attractive and should encourage saving.
• A cut in interest rates will reduce the rewards of saving and will tend to discourage saving.

Example of interest rate changes

• £20,000 Loan at an interest rate of 7%
• Annual interest rate payment will be 0.07 * 20,000 = £1,400
• If interest rates rise to 9%
• Annual interest rate payment will rise to 0.09 * 20,000 = £1,800
• The rise in interest rates will cost households an extra £400 a year. This will discourage borrowing.

Example of saving rate changes

• £7,000 savings at 4%.
• Annual interest payments received will be 0.04 * 7,000 = £280
• If interest rates rise to 6%
• Annual interest payments received will be 0.06 * 7,000 = £420
• The saver gains an extra £149 a year

Related

Saving is income not spent, or deferred consumption. Methods of saving include putting money aside in, for example, a deposit account, a pension account, an investment fund, or as cash.^[1] Saving also involves reducing expenditures, such as recurring costs. In terms of personal finance, saving generally specifies low-risk preservation of money, as in a deposit account, versus investment, wherein risk is a lot higher; in economics more broadly, it refers to any income not used for immediate consumption. Saving does not automatically include interest.

Saving differs from savings. The former refers to the act of not consuming one's assets, whereas the latter refers to either multiple opportunities to reduce costs; or one's assets in the form of cash. Saving refers to an activity occurring over time, a flow variable, whereas savings refers to something that exists at any one time, a stock variable. This distinction is often misunderstood, and even professional economists and investment professionals will often refer to 'saving' as 'savings'.^[2]

In different contexts there can be subtle differences in what counts as saving. For example, the part of a person's income that is spent on mortgage loan principal repayments is not spent on present consumption and is therefore saving by the above definition, even though people do not always think of repaying a loan as saving. However, in the U.S. measurement of the numbers behind its gross national product (i.e., the National Income and Product Accounts), personal interest payments are not treated as 'saving' unless the institutions and people who receive them save them.

Saving is closely related to physical investment, in that the former provides a source of funds for the latter. By not using income to buy consumer goods and services, it is possible for resources to instead be invested by being used to produce fixed capital, such as factories and machinery. Saving can therefore be vital to increase the amount of fixed capital available, which contributes to economic growth.

However, increased saving does not always correspond to increased investment. If savings are not deposited into a financial intermediary such as a bank, there is no chance for those savings to be recycled as investment by business. This means that saving may increase without increasing investment, possibly causing a short-fall of demand (a pile-up of inventories, a cut-back of production, employment, and income, and thus a recession) rather than to economic growth. In the short term, if saving falls below investment, it can lead to a growth of aggregate demand and an economic boom. In the long term if saving falls below investment it eventually reduces investment and detracts from future growth. Future growth is made possible by foregoing present consumption to increase investment. However, savings not deposited into a financial intermediary amount to an (interest-free) loan to the government or central bank, who can recycle this loan.

In a primitive agricultural economy, savings might take the form of holding back the best of the corn harvest as seed corn for the next planting season. If the whole crop were consumed the economy would convert to hunting and gathering the next season.

Interest rates[edit]

Classical economics posited that interest rates would adjust to equate saving and investment, avoiding a pile-up of inventories (general overproduction). A rise in saving would cause a fall in interest rates, stimulating investment, hence always investment would equal saving.

But John Maynard Keynes argued that neither saving nor investment was very responsive to interest rates (i.e., that both were interest-inelastic) so that large interest rate changes were needed to re-equate them after one changed. Further, it was the demand for and supplies of stocks of money that determined interest rates in the short run. Thus, saving could exceed investment for significant amounts of time, causing a general glut and a recession.

Saving in personal finance[edit]

Saving Interest Rates

Within personal finance, the act of saving corresponds to nominal preservation of money for future use. A deposit account paying interest is typically used to hold money for future needs, i.e. an emergency fund, to make a capital purchase (car, house, vacation, etc.) or to give to someone else (children, tax bill etc.).

Within personal finance, money used to purchase stocks, put in an investment fund or used to buy any asset where there is an element of capital risk is deemed an investment. This distinction is important as the investment risk can cause a capital loss when an investment is realized, unlike cash saving(s). Cash savings accounts are considered to have minimal risk. In the United States, all banks are required to have deposit insurance, typically issued by the Federal Deposit Insurance Corporation or FDIC. In extreme cases, a bank failure can cause deposits to be lost as it happened at the start of the Great Depression. The FDIC has prevented that from happening ever since.

In many instances the terms saving and investment are used interchangeably. For example, many deposit accounts are labeled as investment accounts by banks for marketing purposes. As a rule of thumb, if money is 'invested' in cash, then it is savings. If money is used to purchase some asset that is hoped to increase in value over time, but that may fluctuate in market value, then it is an investment.

Saving in economics[edit]

In economics, saving is defined as after tax income minus consumption.^[3] The fraction of income saved is called the average propensity to save, while the fraction of an increment to income that is saved is called the marginal propensity to save.^[4] The rate of saving is directly affected by the general level of interest rates. The capital markets equilibrate the sum of (personal) saving, government surpluses, and net exports to physical investment.^[5]

See also[edit]

Notes[edit]

Savings Interest Rate

1. ^'Random House Unabridged Dictionary.' Random House, 2006
2. ^'Savings Rate'. Investopedia. Retrieved 27 August 2014.
3. ^'Revision Guru'. www.revisionguru.co.uk. Retrieved 2016-10-12.
4. ^'The Concept and Measurement of Savings: The United States and Other industrialized Countries'(PDF). Federal Reserve Bank of Boston. Federal Reserve Bank of Boston. Retrieved 2016-10-11.
5. ^'Principles of Macroeconomics - Section 5: Main'. www.colorado.edu. Retrieved 2016-10-12.

References[edit]

• Dell'Amore, Giordano (1983). 'Household Propensity to Save', in Arnaldo Mauri (ed.), Mobilization of Household Savings, a Tool for Development, Finafrica, Milan.
• Modigliani, Franco (1988). 'The Role of Intergenerational Transfers and the Life-cycle Saving in the Accumulation of Wealth', Journal of Economic Perspectives, n. 2, 1988.

Further reading[edit]

• Kotlikoff, Laurence J. (2008). 'Saving'. In David R. Henderson (ed.). Concise Encyclopedia of Economics (2nd ed.). Indianapolis: Library of Economics and Liberty. ISBN978-0865976658. OCLC237794267.

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