Final answer:
Increasing the saving rate in the Solow growth model leads to a temporary increase in the capital-labor ratio, eventually reaching a new steady-state. While moderate increases in the saving rate can be beneficial for long-term growth, excessive saving might not be practical. The elasticity of savings influences the impact of policy changes on saving behavior.
Step-by-step explanation:
According to the Solow growth model, an increase in the saving rate would have specific effects on the capital-labor ratio in the United States. In the immediate effect, a higher saving rate would lead to more accumulation of capital since more of the economy’s output is saved and invested rather than consumed. This increase in saving results in more capital available per worker, temporarily boosting the capital-labor ratio.
In the long-run, however, the model predicts that the economy will move towards a new steady-state where the capital-labor ratio stabilizes at a higher level than before. This is due to diminishing returns to capital; as more capital is accumulated, the extra output produced from an additional unit of capital decreases, eventually balancing out the savings rate and depreciation, leading to a stable capital-labor ratio.
Regarding whether it is beneficial to increase the saving rate, it depends on various factors, including the current state of the economy, the existing saving rate, and the future needs for investment. In general, a moderate increase could be beneficial for long-term economic growth, as it leads to more capital accumulation. However, saving excessively, such as 95% of income, might not be practical or beneficial as it might reduce current consumption too drastically and lead to underutilization of resources in the present.
The concept of elasticity of savings is relevant here. If the supply curve for financial capital is elastic, then incentives such as tax breaks to save can significantly increase the quantity of savings. If it is inelastic, the effects will be smaller. The evidence suggests that, at least in the short run, the elasticity of savings with respect to the interest rate is fairly inelastic, meaning that increases in the return to saving do not lead to large increases in savings.