The rise in returns to education and the decline in household savings

Over the past 25 years, returns to higher education have increased while the household savings rate has fallen to almost zero. In this paper, we present a representative agent model where a decline in savings emerges as an outcome of an exogenously driven increase in the return to education. In particular, we find that a rise in the return to education raises the education spending ratio by less than what it reduces the aggregate savings rate, and for some parameter values, it actually reduces both ratios. The paper highlights the fact that a part of the decline in savings may reflect a relative reallocation towards human capital investments away from physical capital.