For any given level of current income, households tend to save less when
their expected future income is higher. If people anticipate that their
income will be higher in the near future, their desire to smooth their
spending (between now and the future) means that they will want to
spend some of that higher future income now, thus reducing their current
saving.
The best example of this behaviour is shown by many of you who are
reading this book. Students are busy acquiring human capital and are
usually earning little or no income. As we discussed in Chapter 14 ,
people with university degrees earn more on average than people with
only a high school diploma. Thus, students are examples of people whose
expected future income is considerably higher than their current income.
The result is that many students are spending at levels that would be
unaffordable (and quite imprudent!) if they were to earn their current
incomes permanently. These students are spending at relatively high
levels precisely because they expect to have much higher incomes in the
near future. They are borrowing now (from parents or through student
loans) because their future income will be high enough to pay back these
debts.
An increase in expected future income leads to a decline in current saving, and thus to a
reduction in the supply of financial capital.Saving and the Interest Rate