savings strategies in low-income countries (see for example Kulikov _et al_ ., 2007, or Abdelkhalek _et al_ ., 2009.). Horioka and Wan (2007) suggest that educational levels along with fertility patterns, particularly number of children per working adult, are important predictors of households’ saving. These findings are in line with those of Edwards (1996) who, using a panel of 36 countries, finds the level of determinants is the main explanation of lower savings rates in some Latin American countries.

II.1 The Macroeconomic Determinants of Armenia’s Savings Rate Most of the theoretical findings about the macroeconomic determinants of domestic savings have been drawn from the standard framework of consumption/savings developed by Modigliani. From the review of the literature, we can list the following determinants:

**GDP per capita** : As consumption tends to decrease with the level of income, i.e. the richer we are the lower is the share of consumption in the budget and the higher is the level of savings, the savings rate tends to be higher in countries with higher GDP per capita. Thus an increase in the GDP per capita is supposed to have a positive impact on the savings rate (Jongwanich, 2009).

**Interest rate** : According to the economic theory, the interest rate on deposit has an ambiguous effect on savings rate due to adverse effects of substitution (positive effect) and income effects (negative effect).<sup>3</sup> These effects are usually modeled in a two period consumption model (Obstfeld and Rogoff, 1996; Romer, 1996).

**Inflation** : Since inflation creates uncertainty in future income, this creates an incentive to raise savings to cope with that uncertainty. Jongwanich (2009) found a positive impact of inflation on private savings in Thailand in 2009, and Horiako and Wan (2007) found similar results in China in some cases.<sup>4</sup>

**Real exchange rate** : The impact of this determinant has been less explored in the economic literature. The Real Effective Exchange Rate (REER) measures how expensive domestic products are compared to foreign products, with a rise in the REER corresponding to an appreciation of the real exchange rate.<sup>5</sup> As the Armenian Central Bank does not target the real exchange, we cannot hypothesize regarding the sign of the effect of the REER on savings.<sup>6</sup>

**Fiscal deficit** : Theoretically an increase in the fiscal deficit is supposed to lead to an increase in saving, by virtue of the Ricardian Equivalence. However, given

> 3 Let’s consider an increase in the interest rate. If the initial level of assets is high, that increase in the interest rate will lead to a higher net return which could be used to consume more, hence an income effect. In this case a negative effect on savings rate will be seen. On the other hand, an increase in the interest rate raises the price of current consumption compared to future consumption, that is, an incentive to save more today in order to consume more later given the higher interest rate. This is the substitution effect which has a positive impact on savings. The final effect will depend on the relative strength of substitution and income effects. 4 The positive correlation between inflation and savings rate is true for their specifications using pooled sample of urban and rural area households.

> 5 In a simple model considering two goods (tradable and non-tradable) the REER also measures the resource allocation between the two sectors producing the two goods.

> 6 Montiel and Servèn (2007) showed in there cross country analysis that there is a positive correlation between the real exchange rate and saving rate. However, this correlation cannot be interpreted as causality since there is an obvious endogeneity problem.

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