Consumption and Saving - Spend Now or Save to Spend Later

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like an Economist. The German Historical Museum is one of
the most popular museums in Berlin. It has a huge
range of items about the country's history, from rare books
and maps and newspapers to toys and clothes, to medical
instruments and everyday household items.
The museums also exhibit a piggybank and money boxes. The
sorts of items which people used to save their money
in were the oldest ones, being four hundred years old.
Some have inscriptions on them about the importance of saving money.
Others have engravings of bee hives, which traditionally symbolize prudence.
Germans have one of the highest savings rates in the world,
with households typically saving at least around ten percent of
their income and often much more, and.
During the current COVID pandemic, Germans saved even more than usual.
At the end of twenty nineteen, German households were saving
over eighteen percent of their income. This jumped to a
whapping twenty eight percent in March twenty twenty.
In fact, it's pretty common for people to save more
when there's a lot of uncertainty about the future. And
when you save more, well, you'll be spending or consuming
less today. Pandemic or not. We all make decisions all
the time about if we should spend our money today
or save it to spend in the future. This week,
we're going to be looking at consumption and saving on
think like an economist. With me, Betsy Stevenson, and with.
Me just a Morphers, we're teaching you the super tools
of economics so that you can transform your life. Nestra
and Tebercoli far joins us.
We just heard about savings. Consumption is also a huge
part of our day to day lives.
It is, and it's a massive part of the economy.
In the US, consumption makes up over two thirds of
the economy.
And let's recap. Consumption is what households or everyday people
spend on final goods and services. That means everything from
rent to food, medical bills, and pretty much most things
we buy.
Consumption is the biggest component of GDP, and in general,
people consume more when they earn more. We'll dive into
just how much more a little later.
So we're looking at consumption and savings in this episode.
I guess if we don't spend our money, we're saving.
It, yes, and so in this episode we're going to
look at that relationship between consumption and saving and think
big picture, how much do we consume over the span
of our lifetime.
You can think of saving as being your future consumption.
After all, the main point of saving is to have
money to spend in the future.
Now.
This is important as a lot of us are making
decisions all the time about how much of our income
to spend now versus how much to save, or rather
how much to spend at some point in the future.
We're using your interdependence principle here. We're saying your choice
is for future spending depend on your choices about how
much you'll spend today.
We can break this down more. You know, whenever you
get your monthly paycheck nows you know, you have to
decide how much you're going to consume and how much
you're going to save.
And questions about how much or how many are about
the marginal principle.
Yes, you can break it up into that question should
I consume one more dollar this month? And at each
point you'll be using the cost benefit principle.
So should I spend this extra dollar if the benefit
exceeds the cost?
Right?
So, now let's factor in the opportunity cost principle.
Which asks or what as in what could I be
spending this dollar on instead? What's the next best alternative
to spending this dollar?
Yeah, and one of those or whats is that you
could save that dollar or an interest on it, and
then spend the money in the future. Don't forget that
you are an interest on the money you save.
Ultimately, what you'll hopefully be doing is applying what we
economists call the rational rule for consumers. You should spend
that next dollar today if the marginal benefit of spending
that dollar today is more than the marginal benefit of
spending that dollar plus the interest to learn in the future.
So interested in this concept that we're constantly deciding whether
to spend today or spend in the future. I know
a lot of us do this on a monthly basis
when we get paid.
It goes beyond that. A lot of us make decisions
about whether we should spend now or in the future,
when we're looking at spending today versus spending in a year,
five years, ten years, or twenty years down the track.
Now you've been to university and I know you studied economics.
How did you pay for it.
It was a mix of savings and scholarships and loans,
which I think is pretty typical for a lot of people.
And so you were spending more money than you actually
had at the time. That is pretty typical. You had
to borrow to be able to spend money for university.
Well, the thinking was that my education would help me
earn more in the future, so it would make sense
to borrow money and to pay it off later.
I totally agree. In fact, I often tell my students
to borrow money for that backpacking trip that they keep
dreaming about in university, because in the future, when they're
busy with their careers, they'll be money rich but time poor.
They can afford to take a loan out and pay
the trip off later.
And I assume there are times in our lives when
we need to do the opposite, where we should probably
save more today so we can spend more in the future.
That's right, and a lot of us do this when
it comes to save for retirement. It makes sense to
borrow money to go backpacking when you're nineteen, is you're
going to earn a lot of money later on when
you start working and you can pay that trip off.
But when you're in your late thirties or forties and
you're probably around the peak of your career in earnings,
you should be living well within your means and putting
money away for your retirement.
So we're adjusting how much we spend at different points
in our lifetimes. When we're students are not earning, we
should borrow, and when we are earning, we should first
pay back what we borrowed and then save so we
can spend when we retire. So it sounds like we
sort of even out how much we spend at different
points in our lifetime.
That's exactly it. This is an idea where your economists
call consumption smoothing. This is about having a steady amount
of spending or consumption over time. Instead of being poor
as a student and as a retired person and living
it up when we're working, we should aim to smooth
our consumption over time through borrowing and saving. If your
smooth your consumption, you'll be roughly spending a similar amount
through your life.
You can think about it another way, and there are
times in your life when you're rich you're earning a
lot of money, and times well when you're poor because
you're not earning as much. Consumption smoothing is about taking
money from your rich self, who probably doesn't need it
as much, and giving it to your poorer self, who
probably needs it more. It's about shifting your money around
to when you need it most.
So, Betsy, you were saying about encouraging your students to
borrow money for a trip, and I said, how I
borrow to cover some of my university feeds or with
the knowledge that we'd be earning enough in the future
to pay this all off. I guess this makes sense
for economics graduates who tend to earn more once they're
own jobs. Would you encourage others to take out big
loans as students?
That's an important consideration. You can afford to borrow more
if you're studying economics or medicine or computer science, and
you can be confident that you'll be earning good money
when you graduate. But the truth is if you're going
into social work or something like that, where it pays
more modest, you probably have to be more careful about
how much you borrow as a student because you know,
I'm going to earn so much later on, so it'll
be harder to repay.
Your expectations about how much you're going to earn when
you graduate will affect how much you should borrow and
how much you should spend as a student. The higher
you expect your future income to be, the more you
can afford to borrow and spend today.
We call this the permanent income hypothesis. Your permanent income
is the best estimate of your long term average income.
The higher your permanent income, the more you can afford
to spend both today and tomorrow.
Consumption smoothing is really interesting. It sounds pretty organized, though
we know that the real world is sometimes a bit
messier than these theories.
Yeah, that's true. What we observe in the world is
that most people, through most parts of their life operate
a bit like this, and that's because people don't like
to have their consumption jump up and down. But not
everybody is what we call a consumption smooth That is,
someone who will borrow and save so that they have
fairly consistent level of spending throughout their lifetime.
There are a lot of people who live paycheck to paycheck.
We call these people hand to mouth consumers. It may
be that they have difficulties planning ahead, or for some
other reason, they tend to spend whatever income they have
straight away.
It sounds like these hand to mouth consumers are a
bit disorganized, But is that the whole picture.
No. One of the main reasons someone may be a
hand to mouth consumers they can't get access to credit.
A bank is more likely to lend you money if
you already earn good money, or you have a house
or something that they can take away if you don't
repay your loans. If you're unemployed, well, a bank is
less likely to want to lend you money just so
that you can pay your rent. It's going to be
harder for these folks to spend some of their future income,
So consumption smoothing is going to be more difficult.
I think a really great example of how people get
constrained like that is taking a look at what happens
when people become unemployed. Without unemployment checks, people's consumption falls
a lot. Those unemployment checks get spent in their entirety,
because without them, people don't have access to the other
kinds of credit they would need to be able to
maintain their consumption.
Will unemployment checks tend to get spent right away. Not
everyone tends to spend money as soon as they get it,
And during the current COVID pandemic, the US government gave
everyone twelve hundred dollars, most Americans actually saved a lot
of this money. Our figures show the typical person spent
around three hundred and fifty dollars and put the rest
away to spend in the future.
That last point is really interesting about how most Americans
saved a large portion of the twelve hundred dollars checks
they got from the government. A lot of people have
been hit really hard by the pandemic. I'd have thought
most people would have spent this money.
The key here is that expectations play a huge role
in whether we spend money today or save money to
spend it in the future.
I assume that when we're doing really badly, we may
perhaps want to be more cautious.
That's right. When people feel pessimistic, they save more is
the future looks bleak, so they want to be prepared
for any upcoming hard times.
The thing is this can be a bit of a
self fulfilling prophecy. I used to joke with reporters in
twenty nineteen that they kept asking economists so much about
if there would be a recession, that this would scare people,
making people feel pessimistic about the future, and so we
would end up causing a recession.
Expectations are just so powerful when it comes to how
much we spend and save. Remember we started this episode
by talking about how Germans save a lot. Harold James
is an economic historian at Princeton University. He's written researched
a lot about Germany's finances. He says that historically Germans
have been more concerned about the future and Americans and
so more likely to prepare themselves in case there are
hard times.
And so, coming back to the pandemic, how has consumption
and saving played out? And I'm interested in decisions you've
both made over this time.
Well, we were planning on buying a new car back
at the start of twenty twenty, but then we had
no idea how the pandemic would impact our income, so
we held off.
However, you know, on the flip side, it turned out
we were spending less on a line lot of other
things due to lockdown and not being able to be
out and about the obvious one is eating out.
Yeah, I noticed that when I was doing my taxes recently.
I was going through my accounts and it was actually
really shocking seeing just how much money I'd saved by
not eating out since March.
It makes sense, and as eating out during a pandemic's
less desirable if it's even possible, so it's better to
save that money to eat out in the future instead,
once the world's more open and back to normal and
eating out is a more enjoyable experience. Don't forget the
opportunity cost of spending on money on something today is
not being able to spend in the future instead.
We're recording this in February twenty twenty one, and vaccination
programs are now underway, so the future is looking promising.
A lot more promising. There's optimism, and economists are hoping
that once we've all been vaccinated, people are going to
spend all that money that we've been saving while we've
been cooped up indoors.
We're more likely to save when we're feeling bleak about
the future, or if we know we aren't going to
be earning, such as when we say for retirement now,
what else will make us more likely to save or
rather more likely to spend in the future instead of today.
People will save if they've an expensive life change coming up.
Say you're getting married, you're thinking about buying a house,
you're planning to start a family. Certainly justin and I
can tell you that families are expensive, so it's worth
building up some savings in the run up to all
of that.
Another reason why people save money is that you may
want to pass wealth on when you die. For some people,
their motivation is for their descendants to live well. Others
may care about a cause and want to leave some
of their wealth to help the world when they pass.
We call these bequests, and these explain why a lot
of elderly people don't spend all their money is they'd
like to leave something behind for others.
And macroeconomic factors have a big influence on consumption and
saving decisions as well. For example, if the real interest
rate goes up, it's going to be much more attractive
to save.
The real interest rate meaning the interest rate adjusted for
inflation exactly.
A higher real interest rate means you'll earn money by
not spending it and putting it into a savings account,
so you can spend more in the future than you
could today, and one of the main ways to encourage
people to save is to increase that real interest rate.
And vice versa. I was recently looking at some Bank
of England figures and notice they hugely dropped the interest
rate in March twenty twenty, which is when the pandemic
really started spreading around the world and there was a
lot of uncertainty.
That would makes sense. They probably wanted to encourage people
to spend instead of squirreling their money away.
We're ending this episode by looking at savings. I reckon
a lot of people listening to thing like an economist
probably want to live well today, but are also looking
to the future as well. I know I want to
save more money and to be smarter about it too.
What lips do you have about saving.
One of the things that can really help is to plan, literally,
write down a plan so you're not tempted to spend
at the last minute. The best way to avoid temptations
is to set a budget and stick to it. People
tend to make better decisions when they're making them in
advance rather than the heat of the moment. And if
your plan isn't working well, then sit down, reassess it,
try a new plan, see how that works. At least
make sure that you're thinking things through in advance.
We've already talked about saving for a rainy day. Another
important thing is to take advantage of any kind of
retirement plans you're offered. You know, if your employer has
a retirement plan you can sign up for sign up
for it, and even better, if your employer offers some
kind of retirement match. Never miss an opportunity to get
more money from your boss, even if you'll be spending
it when you retire.
And there are some simple tricks that could make saving
feel a whole lot easier. For instance, once you paid
off your student loans, then put the same amount of
money away each month in a savings account instead do
you mean.
To say that, once I've paid my loans off, I
should just put two hundred and fifty dollars into a
savings account each month.
That's right. Continue to budget as though you won't ever
be able to spend the two hundred and fifty dollars
that goes into paying off your loans. It's an easy
way to build up your savings without even noticing.
And finally, try to keep as much money as you can.
This sounds obvious, but retirement and investment accounts will charge
you fees, and sometimes these fees can be a lot
of money. Shop around for accounts with the smallest fees.
Governments also have programs which encourage savings, and they tend
to give you a bit of a break on your taxes.
That's another way you can build more for your future.
Bessie justin, I'm going to start planning for my future savings.
Hey, Nas, thanks for coming on this podcast, and I
think you really saved it.
You know, when I was in college, I had to
do a critical writing workshop and the thing I wrote
about was consumption smoothing. I was totally fascinated by it
because I was dead broke in college, so broke, and
I'm always sensitive about these hand and mouth consumers because
you know, there were like weeks when I was living
off of a box of crackers.
Pitsy. Coming back to the big question, if your future
rich yourself could have sent money back to your poorer students.
I couldn't borrow, but if you could, I would have
and I did. I did travel around Europe. I was
so broke and I maxed out every way I could borrow.
And I had no shame in asking to borrow money.
I took every loan opportunity I could. And then here's
the key, though, you got to pay it all back.
You can't just like think I got a job, wooo spend.
I was in my thirties before I bought my first
full price pair of shoes. I was like, oh, shoes
that are not from a markdown bin. I'm gonna do it.
I am now thirty two, I'm going to do it.
Thanks for listening.
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