If the United States attempted to save more, would it also invest more? If so, would the increase be largely in foreign investment or in domestic investment? This paper tries to explore what evidence can be brought to bear on these questions by exploring the links between particular components of saving and investment in an income determination framework.
Artus, Jacques R., “Persistent Surpluses and Deficits on Current Account Among Major Industrial Countries,” in Europe and the Dollar in the World-Wide Disequilibrium, ed. by J. A. Sargent (Alphenaandenrijn, Netherlands, 1980).
Barro, Robert J., The Impact of Social Security on Private Saving: Evidence from the U. S. Time Series; with a reply by Martin Feldstein, American Enterprise Institute for Public Policy Research (Washington, 1978).
Boskin, Michael J., “Taxation, Saving, and the Rate of Interest,” Journal of Political Economy, Vol. 86, Part 2 (April 1978), pp. S3-S27.
Buiter, Willem H., and James Tobin, “Debt Neutrality: A Brief Review of Doctrine and Evidence,” in Social Security versus Private Saving, ed. by George M. von Furstenberg (Cambridge, Mass., 1979), pp. 39-63.
David, Paul A., and John L. Scadding, “Private Savings: Ultrarationality, Aggregation, and ‘Denison’s Law’,” Journal of Political Economy, Vol. 82, Part I (March/April 1974), pp. 225-49.
Dornbusch, Rudiger, and Paul Krugman, “Flexible Exchange Rates in the Short Run,” Brookings Papers on Economic Activity: 3 (1976), pp. 537-75.
Feldstein, Martin, and Charles Horioka, “Domestic Saving and International Capital Flows,” Economic Journal, Vol. 90 (June 1980), pp. 314-29.
Fellner, William John, Towards a Reconstruction of Macroeconomics: Problems of Theory and Policy, American Enterprise Institute for Public Policy Research (Washington, 1976).
Howrey, E. Philip, and Saul H. Hymans, “The Measurement and Determination of Loanable-Funds Saving,” Brookings Papers on Economic Activity: 3 (1978), pp. 655-85.
Jaffee, Dwight M., and Kenneth T. Rosen, “Mortgage Credit Availability and Residential Construction Activity,” Brookings Papers on Economic Activity: 2 (1979), pp. 333-76.
Kindleberger, Charles P., “Germany’s Persistent Balance-of-Payments Disequilibrium Revisited,” Banca Nazionale del Lavoro, Quarterly Review, Vol. 29 (June 1976), pp. 118-50.
Lederer, Walther, “The Effects of International Capital Movements on Domestic Production, Investment and Saving,” in The Government and Capital Formation, ed. by George M. von Furstenberg (Cambridge, Mass., 1980).
McKinnon, Ronald I., “Exchange Rate Instability, Trade Imbalances, and Monetary Policies in Japan and the United States” (unpublished, Stanford University, December 1978).
von Furstenberg, George M. (1980 a), “The Effect of the Changing Size and Composition of Government Purchases on Potential Output,” Review of Economics and Statistics, Vol. 62 (February 1980), pp. 74-80.
von Furstenberg, George M. (1981), “Saving,” in How Taxes Affect Economic Behavior, ed. by Henry J. Aaron and Joseph A. Pechman. It is scheduled to be published by the Brookings Institution in 1981.
Mr. von Furstenberg, Chief of the Financial Studies Division of the Research Department, was formerly Professor of Economics at Indiana University and a Senior Staff Economist of the U.S. President’s Council of Economic Advisers.
Equating the real interest rate on saving to the real net user cost of capital rate relevant for fixed investment is purely illustrative in Chart 1. No rate of return variables survived in the final empirical estimates reported later in this paper.
If technological progress is either absent or purely labor augmenting, the natural growth rate of an economy is equal to the growth rate, n, of (augmented) labor inputs in the steady state. Net investment per head (per unit of labor input), i, is then i = nk + k, where k is capital per head. Assuming that k = f (kd — k), f’ > 0, where the desired amount of capital per head, kd, varies (inversely) with the real interest rate and other factors, a decline in r changes i more in the short run (k > 0) than in the long run (k = 0). In the long run, i = nk = nkd is raised by the decline in r only to the extent capital deepening has raised k. Hence, the investment schedule shown in Chart 1 changes with the time allowed for adjustments to take place. A decline in the natural growth rate, however, reduces net investment per head in both the short run and the long run.
Analogously, private saving per head, s, is
Harberger (1980) reports estimates ranging from 7.8 per cent (1947–57) to 12.7 per cent (1955–66) for the United States. The estimates of 6.3 per cent for Canada (1965–69) and 7.1 per cent for India (1955–59) contrast with 12.0 per cent estimated for Colombia (1967).
Using the rudimentary functions specified in footnote 2, with g now denoting the potential output gap rate, ∂(kd – k)/∂g < 0 and hence k < 0 and net investment per head is depressed when the gap widens cyclically. On the saving side, ∂(wd – w)/∂g < 0 on permanent income grounds, since a transitory rise in the output gap that is associated with a temporary depression of private incomes below trend leads to little change in consumption compared with saving.
Since cyclical deviations are expected to be transitory, their effect is weaker on investment than on saving. Because a reversal of the cyclical decline is expected, the capital stock desired for future years may be little affected, and only investment that can quickly be put in place and started up may be discouraged or deferred by a cyclical decline.
The potential output series used later in this paper, prepared by the President’s Council of Economic Advisers, involves a benchmark unemployment rate of 5.1 per cent that is consistent with a zero level of the output gap in 1978. This rate is well below the natural unemployment rate deduced by most economists (see U.S. President (1979), pp. 72–76).
In the absence of J-curve effects, a depreciation of country B’s currency would presumably be required to shield its net exports from the effects of cyclical declines abroad. However, it is unlikely that country B can obtain such a depreciation in real terms when private capital movements are free, even if commodities are differentiated to some extent by country of origin. Hence, this polar case is again implausible.
Cause and effect are often confused by those who argue that an endogenous decline in the rate of investment lowers the rate of growth of potential output. As explained in footnote 2, the natural growth rate of an economy is not normally a function of k or kd. Outside the steady state, the stock of capital may enter into empirical estimates of potential output growth if k is changing, for instance, because capital deepening is induced by a permanent decline in r. Recurring cyclical disturbances, however, lead to investment being higher than normal during one part of the cycle and below normal in the other part. Hence, there is no reason for the growth rate of potential output to change or for future levels of potential output to be systematically different from what they would have been if the past cyclical disturbances around the normal level of the gap had not occurred.
The comparative insulation of the United States has been documented in a number of studies. Dornbusch and Krugman (1976, p. 568) point out, for instance, that export prices in the seven major industrial countries show considerable responsiveness to competitors’ prices except in the United States.
By contrast, whether or not there is a close correlation between national saving and domestic investment across countries rather than over time within countries depends very much on the international mobility of certain types of financial capital, as Feldstein and Horioka (1980) have pointed out.
In these accounts, net foreign investment is defined as net exports of goods and services plus net capital grants received by the United States minus net transfer payments from persons and government to foreigners and minus interest paid by government to foreigners. Since capital grants are rarely received or bestowed by the United States, the main difference between the balance on current account on the balance of payments accounts basis and net foreign investment on the national income and product accounts basis lies in the treatment of the net reinvested earnings of incorporated affiliates of U. S. direct investors. Not being part of the U. S. gross national product, such earnings are not treated as an export of services in the national income and product accounts but netted directly against the corresponding capital export. As a result, net foreign investment was $9.7 billion lower than the balance on current account in 1978.
By definition, E(∊i,∊j) = Ω, where the elements of the error variance-covariance matrix Ω are symmetric. Now let ξi,ξj be independently distributed normal random variates, N(0,1) with E(ζζ’) = I, that serve to generate disturbances in the corresponding errors ∊i,∊j and thence in all correlated errors. To determine how changes in the vector of ∊s are related to the random variations in ξ, one would have to find a matrix, L, such that ∊ = Lξ. L would have to satisfy the condition Ω = LL’, so that E(∊∊’) = LIL’ for ∊∊’ = Lξξ, L’. The L that satisfies this condition is not unique, although a unique L can be found if restrictions on the form of L are accepted. One such restriction is that L is lower triangular. One implication of this restriction would be that changes in the e referring to the first equation would affect all ∊s, while changes in the ξ referring to the last equation would affect only the corresponding ∊ and no other. If L were upper triangular, the reverse would hold. Thus, unless there are economic reasons for imposing a particular form on L, L and the relation between ∊ and ξ are arbitrary and underdetermined.
Although the rate of growth of potential output declined in a number of industrial countries during the 1970s, and not just in the United States, the same is not necessarily true for developing countries (including oil exporting countries) and compatible estimates are difficult to obtain. The failure of terms-of-trade effects (the net absorption deflator relative to the NNP deflator) to yield significant results in the PS equation and of foreign cyclical effects to help explain the net retained earnings originating in the rest of the world is detailed in von Furstenberg (1980 a). Furthermore, a variable representing the relative price of energy (the ratio of the wholesale price index for fuels and related products and power to the general wholesale price index) failed to be significant in either the CS or the FI equation reported in this paper, although jumps in this ratio are positively associated with inventory profits (negatively with the inventory valuation adjustment) and negatively with the rate of growth of potential output.
See the F-tests for three subperiods reported in von Furstenberg (1980 a). It has been pointed out to the author that the adjustment for first-order serial correlation may contribute to this result, although p ranged from 0.86 to 0.58 in the subperiods, compared with 0.81 in the combined run. As explained in Section IV of this paper, the rule by which fiscal policy is made is stable only with respect to the official estimate of GAP and not with respect to deviations from the equilibrium level of income as later derived.
Feldstein and Horioka (1980) would expect most or all of the stimulus to go to net domestic investment in the long run; Artus (1980) expects to see it in net foreign investment; and Lederer (1980) expects both investment components to be affected in the full employment context, since savers increase their demand for foreign and domestic assets when the supply of national saving shifts outward. In earlier work, Feldstein (1975) and Boskin (1978), like many others, assumed a one-to-one correspondence between those reductions in the national saving rate that they attributed to the wealth effects of government social security programs or to the taxation of interest income received by U.S. taxpayers and reductions in the net stock of capital (as well as potential output and welfare) in the United States as if the openness of the U.S. economy could be ignored in the evaluation of the economic effects of government programs.
See von Furstenberg (1980 a) for the derivation of AN. AN was not found to be statistically significant in the CDUR equation, and any fiscal surprise that may affect CS is captured directly in the CS equation via changes in the corporation income tax rate.
Let the levels of government transfer payments, X, and NNP, Y, both be functions of time, t, and GAP, k, so that X = f(t,k), Y = g(t,k). Then the change in the transfer rate, d(X/Y) = ∂(X/Y)∂t + (X/Y)((∂Y/∂k)/x — ((∂Y/∂k)/Y). Assuming that ∂(X/Y)/∂T and (∂∂K)/X are constant, and given that (∂Y/∂k)/Y is constant by definition, d(X/Y) = a0 + a1 (X/Y). Hence, the coefficient on GAP would be the variable a, (Pr. Thus, GAP must be multiplied by (X/Y) or a cyclically neutral proxy variable that rises at the same average rate as X/Y before an unbiased coefficient can be expected.
W rises by a factor of 2.2 from first quarter 1955 to fourth quarter 1978, the same as the rise in TRANS, and deviations in the rates of growth are small in the interim because of the steady growth in both series.
Adding the difference between wage accruals and disbursements, which is charged against corporate and government saving in the national income and product accounts, to PS amounts to converting wages and salaries in disposable income from a cash basis to an accrual basis for consistency. Adding the statistical discrepancy to personal saving is more problematic although commonly done. See, for instance, Boskin (1978). The author has been advised that the excess of flow-of-funds saving of households and unincorporated businesses over personal saving and consideration of net incomes earned in illegal activities suggest that disposable personal income and personal saving are both underestimated in the national income and product accounts, so that adding the (generally positive) statistical discrepancy to personal saving appears warranted. If one further nets interest paid by consumers to business against interest received by consumers from business so as to exclude this item from both disposable income and personal outlays, the remaining differences between unity and the share of redefined disposable income in NNP is CS + TAX — TRANS, where CS is the corporate saving rate.
This view is implied in Tanner’s (1979, p. 319) statement that “households perceive an extra dollar of government saving and of corporate saving in exactly the same way—both contribute equal amounts to the household’s perception of its life-cycle resource availability,” provided GS is varied by changing TAX or TRANS in such a way that the net tax rate, TAX—TRANS, is affected.
If a small, worldwide reduction in the rate of return on saving reduces saving in other countries and stimulates capital deepening everywhere, an increase in net foreign investment by the country experiencing a decline in its rate of potential output growth is feasible. It is also feasible if growth opportunities rise in other countries without a corresponding rise in their national desire to save. However, if growth opportunities decline elsewhere as well, not every country is likely to be able to maintain the net national saving rate at its former level. If the international mobility of capital is imperfect, some countries will experience steeper declines than others in rates of return on saving, so that the old rates of national saving may become allocatively excessive over time in some countries, depending on their natural rate of growth. For a discussion of some related aspects see Artus (1980).
Dividing the result by NNP yields the net foreign investment rate, NF, used in this paper, which treats capital grants received by the United States (net) the same as in the current account (balance of payments accounts basis). See footnote 11.
The equation lacks a net user cost of capital variable, although certain measures that have been used in lieu of such a variable, such as Tobin’s “q,” are correlated with included variables. The variable q appears to respond positively to the potential output growth rate and negatively to GAP and perhaps to credit crunches reflected in SL, apart from displaying high serial correlation. Lagged values of q were not found to be statistically significant when added in the equation for FI.
I/S was held at its 1959 average value of 0.278 prior to the fourth quarter of 1958. This value is close to the average of 0.279 for the entire sample period. Only the year-end ratios are reported in the, national income and product accounts prior to 1959; these ratios range from 0.279 to 0.289 from 1954 to 1958, with unknown variations in between.
A past surge of inventory profits due to materials cost inflation tends to erode corporate profit margins and to reduce business and consumer purchasing power in subsequent quarters. These effects would, of course, not all go away if all corporations switched from a first in, first out to a last in, first out basis so that IVAC would become negligible. IVAC is, therefore, used as a convenient proxy for materials cost inflation over the sample period.
Some of the effects estimated were, however, extremely small. Thus, a maximum difference of 5 percentage points between the actual and the officially expected inflation rate that yielded a (PI — EPI) of around 0.05 in several quarters of 1973 and 1974 would raise GS by a mere 0.0007, or by less than one thousandth of NNP. With an NNP of around $2,000 billion at the end of the sample period, such a shock would lower the government deficit by $1 billion to $2 billion at an annual rate. A rise in SLLAG by one percentage point from its mean of —1.0, which would indicate a transition from normal backwardation of the term structure of interest rates to the threshold of a credit crunch, also has only rather slight effects. Both Fl and CDUR would be reduced by about 0.003, while PS would be raised by an equal amount because of the decline in CDUR. The effect of changes in the cyclically adjusted version of Marshall’s “k,” DM, are negligible as well, because changes above ±0.004 are rare. A positive change of this size would reduce PS and GAP by about 0.0008 directly, or by less than one thousandth of NNP.
See David and Scadding (1974). Another inference drawn from rationality is that households offset government saving whether or not changes in government saving are due to cyclical variations in net taxes (TAX – TRANS), as they usually are, or to changes in government purchases. For a statement of this position and its critique, see Barro (1978), including the comments by Feldstein on pp. 42–45.
While the coefficient on TAX is not statistically significant, the coefficient on AN is. This is pertinent to appraising the possible effects of fiscal actions, since David and Scadding (1974) made no distinction between changes in net taxes that are part of the rule and those that deviate from it in arguing that the private saving rate and the government saving rate are independent.
Given that there is also some cyclical simultaneity, although CS is leading and FI is lagging behind the cycle, the close correlation between CS and the corporate component of FI found by Feldstein and Horioka (1980) across countries for 15-year averages of these rates is likely to hold also within any country over time. Their challenge to identify common causes of the variation in both national saving and domestic investment that could explain their covariation even in a world of perfect capital mobility can be met by pointing to persistent international differences in the rates of growth of potential output. The lower the rate of output growth, and hence the rate of net domestic investment relative to NNP, the less internal financing is required in relation to NNP if the financial structure of corporations is to remain unchanged.
This applies, for instance, to changes in the average corporate profits tax rate, which are found to have a strong effect on CS in the first year, although the effect declines rapidly thereafter. Raising the corporate tax rate by 10 percentage points (TC04 = 0.10) amounts to raising the ratio of such taxes to NNP by about 1 per cent, or 0.01 of NNP. Since the effect of such an action is a reduction of CS by 0.0076 of NNP in the first year, about three fourths of the added taxes are initially paid out of corporate saving.
This was confirmed experimentally by generating recurring 15-quarter cycles through an error pattern of ε = 0.005, 0.01, 0.015, 0.01, 0.005 in the first 5 quarters of each cycle. After 19 simulation cycles, GAP began to repeat itself to six places of decimals every 15 quarters, although the amplitude of the resonant cycle so generated was quite small (0.028 from the peak in the fifteenth quarter to the trough in the fifth). NF was highest in the first quarter (-0.00142) at the beginning of the recession and lowest in the fourth (-0.00650) toward its end, compared with —0.00436 in the noncyclical solution (Table 2). Thus, NF is fairly synchronized with the cycle and moves procyclically in this experiment.
This is less likely to happen in countries such as the Federal Republic of Germany and Japan, where positive values of NF have frequently been equal to a substantial fraction of the national saving rate or in some developing countries where large negative values of NF have been encountered in relation to the size of their economies or saving rates. For comparisons of the Federal Republic of Germany and Japan with the United States in this regard, see Kindleberger (1976) and McKinnon (1978).
A less attractive feature of equation (27) is that there remains evidence of significant serial correlation, as the Durbin-Watson statistic is only 1.24. Such correlation should have been eliminated, but apparently was not removed completely by the adjustment for autocorrelation in all the equations on the other side of the saving-investment identity, if the autoregressive process in each was of the first order assumed. Estimating all the equations in Table 1 by ordinary least squares showed that the equation for inventory change, IC, had the worst fit