Understanding the response of personal savings and expenditure to changes in the interest rates is a central to many issues in the economic policy. If personal savings decline as a result, the overall increase in the national savings would be less than the reduction in the budget deficit. Alternatively, contractionary monetary policy generally causes interest rates to rise. It personal saving increase as a result, the corresponding fall in consumer expenditure helps to slow the economy. Household behaviour is the lifecycle model, which assumes that people determine their consumption and savings at each point in their lives by looking forward to their future income and desires, rather than considering only their current income and desired expenditure. Households have planning horizons that extends beyond their own lives and choose their consumption and savings to allow for bequest for their children. The effect of interest rate changes on households
Considering the effect of an unanticipated increase in the interest rate, the first effect of increase in interest rates is that household increase their savings. They increase the amount of future expenditure by forgoing a certain amount of money today in expectation of higher revenues in the future. By making today’s consumption more costly relative to tomorrow’s consumption, the interest rate increase encourages people to consume less today and save more. The second effect of an increase in interest rates is that credit consumption will have to pay more in the future than they would today. This leads to households being insolvent and therefore ends up becoming credit unworthy. When a household is with the credit bureau, enforcements are made to ensure the credit agreement and outstanding balance is paid off. It becomes very difficult for a household to be cleared out in the credit bureau system and be given a clearance certificate. This will need debt counsellors. An individual’s financial wealth...
References: * Attanasio, O. P. and Weber, G. 1993. Consumption growth, the interest rate, and aggregation. Review of Economic Studies, (60)(3).
* Avery, R. B. and Kennickell, A. B. 1991. Household Saving. Review of Income and Wealth, 37(4).
* Barro, R. J. 1974. Are Government Bonds Net Wealth. Journal of Political Economy, 82(6)
* Goodman, Jr., J. L. Luckett, C. A. and Wilcox, D. W. 1988. Interest Rates and Household Cash Flow. Federal Reserve Board.
* Department: National Treasury, RSA Government Fixed Rate Retail Savings Bond. www.rsaretailbonds.gov.za
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