Saving

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Depositing change in a piggy bank is a frequently used savings strategy. Piggy bank2.jpg
Depositing change in a piggy bank is a frequently used savings strategy.

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.

Income is the consumption and saving opportunity gained by an entity within a specified timeframe, which is generally expressed in monetary terms.

Consumption (economics) purchase and use of goods and services

Consumption, defined as spending for acquisition of utility, is a major concept in economics and is also studied in many other social sciences. It is seen in contrast to investing, which is spending for acquisition of future income.

A deposit account is a savings account, current account or any other type of bank account that allows money to be deposited and withdrawn by the account holder. These transactions are recorded on the bank's books, and the resulting balance is recorded as a liability for the bank and represents the amount owed by the bank to the customer. Some banks may charge a fee for this service, while others may pay the customer interest on the funds deposited.

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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" (for example, Investopedia confuses the two terms in its page on the "savings rate"). [2]

Stock and flow

Economics, business, accounting, and related fields often distinguish between quantities that are stocks and those that are flows. These differ in their units of measurement. A stock is measured at one specific time, and represents a quantity existing at that point in time, which may have accumulated in the past. A flow variable is measured over an interval of time. Therefore, a flow would be measured per unit of time. Flow is roughly analogous to rate or speed in this sense.

Investopedia is an American website based in New York City that focuses on investing and finance education along with reviews, ratings and comparisons of various financial products such as brokerage accounts.

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.

Mortgage loan loan secured using real estate

A mortgage loan or, simply, mortgage is used either by purchasers of real property to raise funds to buy real estate, or alternatively by existing property owners to raise funds for any purpose, while putting a lien on the property being mortgaged. The loan is "secured" on the borrower's property through a process known as mortgage origination. This means that a legal mechanism is put into place which allows the lender to take possession and sell the secured property to pay off the loan in the event the borrower defaults on the loan or otherwise fails to abide by its terms. The word mortgage is derived from a Law French term used in Britain in the Middle Ages meaning "death pledge" and refers to the pledge ending (dying) when either the obligation is fulfilled or the property is taken through foreclosure. A mortgage can also be described as "a borrower giving consideration in the form of a collateral for a benefit (loan)".

The national income and product accounts (NIPA) are part of the national accounts of the United States. They are produced by the Bureau of Economic Analysis of the Department of Commerce. They are one of the main sources of data on general economic activity in the United States.

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.

To invest is to allocate money in the expectation of some benefit in the future.

In economics and accounting, fixed capital is any kind of real, physical asset that is used in the production of a product but is not used up in the production. It contrasts with circulating capital such as raw materials, operating expenses and the like. It was first theoretically analyzed in some depth by the economist David Ricardo.

Economic growth increase in production and consumption in an economy

Economic growth is the increase in the inflation-adjusted market value of the goods and services produced by an economy over time. It is conventionally measured as the percent rate of increase in real gross domestic product, or real GDP.

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.

Bank financial institution

A bank is a financial institution that accepts deposits from the public and creates credit. Lending activities can be performed either directly or indirectly through capital markets. Due to their importance in the financial stability of a country, banks are highly regulated in most countries. Most nations have institutionalized a system known as fractional reserve banking under which banks hold liquid assets equal to only a portion of their current liabilities. In addition to other regulations intended to ensure liquidity, banks are generally subject to minimum capital requirements based on an international set of capital standards, known as the Basel Accords.

In economics, a recession is a business cycle contraction when there is a general decline in economic activity. Recessions generally occur when there is a widespread drop in spending. This may be triggered by various events, such as a financial crisis, an external trade shock, an adverse supply shock or the bursting of an economic bubble. In the United States, it is defined as "a significant decline in economic activity spread across the market, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales". In the United Kingdom, it is defined as a negative economic growth for two consecutive quarters.

In macroeconomics, Aggregate Demand (AD) or Domestic Final Demand (DFD) is the total demand for final goods and services in an economy at a given time. It is often called effective demand, though at other times this term is distinguished. This is the demand for the gross domestic product of a country. It specifies the amounts of goods and services that will be purchased at all possible price levels.

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

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.

Classical economics or classical political economy is a school of thought in economics that flourished, primarily in Britain, in the late 18th and early-to-mid 19th century. Its main thinkers are held to be Adam Smith, Jean-Baptiste Say, David Ricardo, Thomas Robert Malthus, and John Stuart Mill. These economists produced a theory of market economies as largely self-regulating systems, governed by natural laws of production and exchange.

In economics, overproduction, oversupply, excess of supply or glut refers to excess of supply over demand of products being offered to the market. This leads to lower prices and/or unsold goods along with the possibility of unemployment.

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

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

In economics, saving is defined as post-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

Notes

  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.

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