Question

Explain why saving rises as the interest rate rises.

Short answer

Saving tends to rise as the interest rates rise because high interest rates provide a greater return or reward on saved money. This incentivizes individuals to save more of their income rather than spending it, leading to increased overall saving.

Step-by-step solution

Understanding Personal Savings

Personal savings are the portion of income that is not spent on consumption. People can either spend their income or save it for future use. The decision between saving and spending is influenced by a variety of factors, one of them being the interest rate.

Understanding Interest Rates

Interest rates are essentially the cost of borrowing money or, conversely, the reward for saving money. In the context of a savings account, the interest rate is the amount the bank pays savers for keeping their money in the bank.

Correlation between Interest Rates and Savings

When interest rates are high, the reward for saving money is also high. As interest rates increase, the incentive to save rather than spend also increases. Therefore, as interest rate rises, people tend to save more as they receive more return on their saved money, leading to an increase in overall savings.