Is there a best level of savings?
July 2nd, 2009 | Published in Economics idea | 2 Comments
People’s ability to wait for gratification deminishes over time.
Behavioral economists have found that while people are willing to accept a smaller payment now rather than a larger payment a year from now, they prefer to wait for the larger payment if the year’s wait is far off in the future. To be specific, People who would prefer to get $100 today than $110 a year from now would usually choose to get $110 eleven years from now than $100 ten years from now. This is despite the fact that ten years from now they will regret their decision when they can’t have $100 and have to wait.
Another way to see this is that we want to be able to resist temptation in the future, but often fail when the temptation nears. Think of the runner who sets his alarm for 5:00 in the morning because he wants to get a run in before work. He knows he will be tired but the run will have long term benefits. When the alarm goes off at 5:00, he shuts it off and gets an extra hour’s sleep.
This type of switching between choices makes me believe that we don’t have a particularly stable mechanism for making trade-offs over time. It seems that we want our rationality to overrule our emotional urges but often fail. This leads to crazy things like setting an alarm clock across the room to force yourself out of bed in the morning. While there may be tricks to force ourselves to be more rational some of the time, it makes me wonder how good we really are at making trade-offs over time.
If we aren’t good at making trade-offs over time, then there isn’t much to be lost if we are somehow forced to save a little more or less than we would have on our own. Indeed, people like having pension plans because it forces them to save for their retirement when they might be tempted to spend too much.
The conclusion I am reaching is that the savings rate in a society is somewhat arbitrary. If mechanisms like pensions are in place, people save more. If they aren’t, they save less. There’s no way to tell what the right level of savings is.
July 2nd, 2009 at 4:17 pm (#)
Stephen,
What are you measuring “best” by? For some measure of the overall society benefit, or from the individual’s point of view?
Your examples seem to be about maximizing individual “happiness”. Whether you enjoy a medium coffee today more than a large coffee tomorrow seems to be a fairly fine decision point. In judging savings, I’d say that a more important measurement would be whether people can support themselves through retirement, ideally at their target standard of living. But if someone chooses to live it up when they’re young at the expense of a modest retirement, or vice-versa, I don’t see how it really matters.
Eric
July 3rd, 2009 at 9:30 am (#)
Eric.
As you know from reading the economics section of my website, I envision the government building up its wealth until interest rates are zero. The strongest argument against doing this is that it would make people worse off because they would prefer to consume more now than to save (indirectly through the government saving).
What I am exploring here is the possibility that people aren’t very good at making decisions over time. If they aren’t, the forced savings through government taxation might not make people worse off. In fact, it could make them better off.