India’s savings rate surged from 13% in 1970 to 38% in 2008, declining steadily thereafter to 30% in 2019. Unlike other developing or developed nations, the savings rate in India, and some other countries, shows a hump-shaped trajectory with its peak coinciding with the Great Recession of 2007-2009. We build a neoclassical monetary-growth model with perfect foresight to explain the long-run savings pattern in India. We find that the post-2009 decline in inflation is a key factor in explaining the decline in the savings rate. Since the fall in inflation increases future wealth, perfect foresight induces households to increase consumption and lower savings in the future. Consumption smoothing and risk aversion induce households to increase consumption in the initial periods as well. While this smoothes consumption along the transition path, it reduces savings in the initial periods. Thus, household savings are low but rising in the 1990s, peaking along with inflation in 2008 and then declining post-2008. The fit of the model improves considerably when we extend the model to allow for two types of agents: Ricardian and Rule of Thumb. Our model predicts a dynamic association between inflation and household savings that mimics the hump-shaped pattern in savings that India and some other countries have experienced.
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Institute of Economic Growth, University Enclave, University of Delhi (North Campus),
Delhi 110 007, India