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What is Forced Savings

Forced Savings

In economics, forced savings occur when the spending of a person is less than their earnings due to the consumer goods shortages. It can also happen when the available goods are too expensive so that a person who has no access to credit has to accumulate the money for the purchase for a long time.

Forced saving plays an important role in explaining how expansionary monetary policy generates artificial booms.

Forced Savings refer to

(a) Taxes on individual income and wealth
(b) Compulsory deposits imposed on income tax payers
(c) Provident fund contribution of private sector employees
(d) Reduction of consumption consequent to a rise in prices

Answer: (c) Provident fund contribution of private sector employees

Comments

  1. Forced saving is unlike when someone decides to put some of their income into a savings account or other form of investment. There are two things to note. Firstly, the reduction in their present consumption is voluntary – they are happy to exchange present consumption for increased future consumption. Secondly, this will constitute an increase in the supply of loanable funds, and thereby push interest rates down.
    By contrast a credit expansion by the central bank will also lower interest rates, but this has not stemmed from more real resources available for investment, and will also reduce the purchasing power of those who hold money. These are “savings” in the sense that people's ability to consume is reduced, and “forced” in the sense that it is involuntary.
    Forced savings therefore creates two major problems. Firstly, it has distributional effects in terms of who receives the new money (and enjoys an increase in purchasing power) and who doesn’t. Secondly, the tension between the signal being sent to entrepreneurs and the real resources that are available to fund investment is the essence of the boom bust cycle. At some point the investments that are funded through “forced” savings will be revealed as errors, and the liquidation process is what constitutes a recession.

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