Saving is a key economic variable because it is closely related to the rate of wealth accumulation. In the rest of this section we discuss the relationship of saving and wealth. To do so, however, we must first introduce the concept of stocks versus flows.
Stocks and Flows. The economic variables we have discussed so far in this
chapter—such as GDP and the various types of expenditure, income, and saving— are measured per unit of time (for example, per quarter or per year). For instance, annual GDP figures measure the economy’s production per year. Variables that are measured per unit of time are called flow variables.
In contrast, some economic variables, called stock variables, are defined at a point in time. Examples of stock variables include the amount of money in your bank account on September 15 of this year and the total value of all houses in the United States on January 1, 2013.
In many applications, a flow variable is the rate of change in a stock variable. A classic example is a bathtub with water flowing in from a faucet. The amount of water in the tub at any moment is a stock variable. The units of a stock variable (gallons, in this case) don’t have a time dimension. The rate at which water enters the tub is a flow variable; its units (gallons per minute) have a time dimension. In this case the flow equals the rate of change of the stock.
15The current account and its relationship to international borrowing and lending are discussed in
ChAPTEr 2 | The Measurement and Structure of the National Economy 41
Wealth and Saving as Stock and Flow. Saving and wealth are related to each other
in much the same way that the flow and stock of water in a bathtub are related. The wealth of any economic unit (a household, firm, or government), also called net worth, is its assets (the things that it owns, including IOUs from other economic units) minus its liabilities (what it owes to other units). Wealth is measured in dol- lars at a point in time and is a stock variable. Saving is measured in dollars per unit time and is a flow variable. Because saving takes the form of an accumulation of assets or a reduction in liabilities (for example, if saving is used to pay off debts), it adds to wealth just as water flowing into a bathtub adds to the stock of water.
National Wealth. National wealth is the total wealth of the residents of a coun-
try. National wealth consists of two parts: (1) the country’s domestic physical as-
sets, such as its stock of capital goods and land;16 and (2) its net foreign assets. The
net foreign assets of a country equal the country’s foreign assets (foreign stocks, bonds, and factories owned by domestic residents) minus its foreign liabilities (domestic physical and financial assets owned by foreigners). Net foreign assets are part of national wealth because they represent claims on foreigners that are not offset by foreigners’ claims on the domestic economy.
Domestic financial assets held by domestic residents are not part of national wealth because the value of any domestic financial asset is offset by a domestic financial liability. For example, a checking account of a U.S. resident in a U.S. bank is an asset for the depositor but a liability for the bank; it thus does not represent wealth for the economy as a whole. In contrast, a U.S. resident’s checking account in a foreign bank has no corresponding domestic liability (it is a liability of a for- eigner) and so is part of U.S. national wealth.
National wealth can change in two ways over time. First, the value of the existing assets or liabilities that make up national wealth may change. For example, the dramatic increase in the stock market during the 1990s increased U.S. national wealth.
The wearing out or depreciation of physical assets, which corresponds to a drop in the value of those assets, reduces national wealth.
The second way that national wealth can change is through national saving. Over any particular period of time, with the value of existing assets and liabilities held constant, each extra dollar of national saving adds a dollar to national wealth. That is,
S = I + CA,
which you will recognize as Eq. (2.10). This equation shows that national saving has two uses: (1) to increase the stock of domestic physical capital through invest- ment, I, and (2) to increase the nation’s stock of net foreign assets by lending to foreigners or acquiring foreign assets in an amount equal to the current account balance, CA. But each dollar by which domestic physical assets or net foreign as- sets increase is a dollar by which national wealth increases. Thus, as we claimed, increases in national saving increase national wealth dollar for dollar. As in the example of water flowing into a bathtub, the more rapid the flow of national sav- ing, the more quickly the stock of national wealth will rise.
16In principle, national wealth should also include the value of the skills and training of the country’s
residents—what economists call human capital. In practice, because of measurement problems, human capital is not usually included in measures of national wealth.
42 PArT 1 | Introduction
2.4 real GDP, Price Indexes, and Inflation
How do national saving and investment in the United States compare to that in other countries? The United States is a relatively low-saving country, com- pared with other industrialized nations. Investment is also relatively low in the
United States, according to the official statistics.17 However, investment rates in
the United States are generally higher than saving rates. Using the relationship S = I + CA, we see that, if investment, I, is greater than national saving, S, then the current account balance, CA, must be negative. As we mentioned earlier, the U.S. current account has indeed been in deficit nearly every year since 1980. In contrast, high-saving countries such as China have typically had investment rates lower than their saving rates, resulting in consistently positive current account balances for those countries.
17Some economists have suggested that the low U.S. saving and investment rates reflect various
measurement problems as much as fundamental differences in behavior. See, for example, William Dewald and Michael Ulan, “Appreciating U.S. Saving and Investment,” Business Economics, January 1992, pp. 42–46.
All of the key macroeconomic variables that we have discussed so far in this chapter—GDP, the components of expenditure and income, national wealth, and saving—are measured in terms of current market values. Such variables are called
nominal variables. The advantage of using market values to measure economic activity is that it allows summing of different types of goods and services.
However, a problem with measuring economic activity in nominal terms arises if you want to compare the values of an economic variable—GDP, for example—at two different points in time. If the current market value of the goods and services included in GDP changes over time, you can’t tell whether this change reflects changes in the quantities of goods and services produced, changes in the prices of goods and services, or a combination of these factors. For example, a large increase in the current market value of GDP might mean that a country has greatly expanded its production of goods and services, or it might mean that the country has experienced inflation, which raised the prices of goods and services.