Saving Behavior in Low- and Middle -Income Developing Countries: A Comparison


WP/95/3-EA
Saving Behavior in Low- and Middle-Income Developing Countries: A
Comparison by Masao Ogaki, Jonathan D. Ostry, and Carmen M. Reinhart

The responsiveness of saving to changes in real interest rates is a key
parameter in the evaluation of the effects of a number of exogenous and
policy-induced shocks in developing countries. Financial sector reforms
have typically resulted in increases in real interest rates in developing
countries, but the response of saving--and the effects on investment and
growth--have been much less clear-cut. In addition, the effects on the
external current account balance of fiscal policy changes that alter
domestic interest rates depend on the responsiveness of private saving to
movements in real rates of return. Finally, temporary terms of trade shocks
or trade liberalizations that are not credible contribute to movements in
consumption rates of interest (which measure the true cost of consuming
today relative to consuming tomorrow) in developing countries, the effects
of which on the current account depend critically on the elasticity of
saving with respect to the real interest rate.

Empirical evidence suggests that the intertemporal elasticity of
substitution in consumption (on which the interest rate elasticity of saving
depends) varies considerably across developing countries. This paper argues
that a main reason for this variation may be a country's level of
development. Specifically, because of the role of subsistence consumption
in household expenditure, low-income developing countries will typically
exhibit a negligible response of saving to movements in real interest rates.
As the per capita income level rises, the fraction of the budget left after
subsistence needs have been met increases. As only this fraction of the
budget is sensitive to movements in real interest rates, the model implies a
nonlinear relationship between the intertemporal elasticity of substitution
and the level of development. The interest rate elasticity of saving should
therefore be much higher in middle-income than in low-income countries
(where it will be close to zero), but it will be only slightly higher in
high-income than in middle-income countries, where subsistence plays little
role in the expenditure patterns of most households.

These notions find support in the data. Using macroeconomic data from
a sample of countries with diverse income levels, the paper concludes that a
model in which the intertemporal elasticity of substitution is an increasing
function of the gap between permanent income and the subsistence consumption
level cannot be rejected. The model implies very different responses of
private saving to (exogenous and policy-induced) real interest rate shocks,
depending on the level of development.