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By Heather Luea, Academic Department Chair Published November 2014
Black Friday sales are just around the corner. What will we do—save or spend?
In September, we examined whether savings or spending drive the economy and determined that both, in fact, did drive it. We concluded that too much savings can depress economic activity in the short-run but drive economic growth in the long-run. Too much spending accelerates the economy in the short-run but can lead to inflation and slower economic growth in the long-run. Our next step is to examine the factors that drive savings and spending behavior. Two of those factors are interest rates and consumer confidence.
Interest RatesThe most obvious answer might be interest rates. Savers want to earn higher rates of return on their funds, so they prefer to save more when interest rates are high. On the other hand, savers are less motivated to save when rates are low. Borrowers want to borrow more at low interest rates and borrow less at high interest rates.
Interest represents more than just dollars paid or received in interest. Interest rates represent an opportunity cost for both borrowers and savers. When savers deposit funds into a savings instrument, they forego the convenience and liquidity that cash provides. When savers hold funds in cash, they forego any interest that would have been earned had the funds been deposited. Therefore, when rates are high, the opportunity cost of holding cash is high because the foregone interest is high. When rates are low, the opportunity cost of holding cash is low because the foregone interest is low.
Borrowers also face an opportunity cost. If they forego an opportunity because they choose not to borrow funds at a high interest rate, they miss out on a potential profit or the satisfaction of using the financed good or service.
Consumer ConfidenceConsumer confidence also impacts borrowing and saving behavior. A convenient way to measure consumer confidence is through the Consumer Confidence Index (The Conference Board, 2014). The index is a composite measurement of consumers’ outlook on areas of the economy such as business conditions, household income, and the labor market.
Generally, if consumer confidence is higher, households and businesses are more likely to borrow funds; conversely, if consumer confidence is low, they are less likely to borrow funds. From a savings perspective, households might decide to save more if they feel the economy is headed for a slowdown. They may decide to put more funds into emergency savings and postpone large purchases.
As you can see, interest rates and consumer confidence have a major impact on savings and borrowing behavior. However, we probably won’t be thinking about these two factors as we page through the sales flyers this shopping season.
“Consumer Confidence Survey” The Conference Board. https://www.conference-board.org/data/consumerconfidence.cfm Accessed: October 22, 2014.
Heather Luea is an academic
department chair at Kaplan University. The views expressed in this article are
solely those of the author and do not represent the view of Kaplan University.
The contents of this article are
presented for informational purposes only. Always check with a
professional regarding any questions you may have regarding financial services.
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