Macroeconomics/Savings and Investment

Role of Savings and Investment

There are two views of the topic titled Savings and Investment. One is considered to apply to real physical macroeconomic activity, the "Keynesian", or National Accounts view. The other is considered to apply to money and banking, the "Monetarist" view. They primarily differ slightly in definitions of terms, which consequently lead to different discussions about very different subject matter. The two views actually are different subject areas, making it the historical debate difficult to collate, let alone reconcile.

Keynesians start with accounting definitions, where Savings is equal to Investment, by construction, and tend to emphasize the nonproductive (zero sum) nature of all vehicles by which savings eventually ends up as capital. Monetarists tend to focus on technical distinctions of how savings is transformed from money balances, eventually into capital, and emphasize the value of those vehicles in selecting which capital to invest in.

In a Keynesian sense, savings is whatever is left over after income is spent on consumption of goods and services, investment is what is spent on goods and services that are not 'consumed', but are durable. Since Income = Output, Savings = Investment for the total world's economy (or for a hypothetical 'closed' economy with zero foreign trade).

In a Monetarist sense, savings is the total rate at which units of account exceed expenditures, and are accumulated as unit of account (e.g. dollar) balances with financial intermediaries. Or sometimes hoarded as currency. Investment is the rate at which financial intermediaries and others expend on items intended to end up as capital that directly creates value, i.e. physical capital, durable goods, human capital, etc. In general, savings does not equal investment, but differs slightly at all times, the differences constituting a behavioral relationship, rather than an accounting one, as in the Keynesian view.

The two views are just looking at very different things. The most commonly referred meaning of the phrase "Savings and Investment" is in first year college economics, where Keynesian and neoclassical macroeconomics are taught, and national accounts, (i.e. the identity Y = C + I + G) is explained.

Savings

Saving is what households (i.e. participants in the consumption account) do. The level of saving in the economy depends on a number of factors (incomplete list):

• A higher real interest rate will give a greater return on saving as banks offer more favourable rates.
• Poor returns on risky forms of saving, e.g. stocks and bonds, make it more advantageous to hold money savings (in contention between Keynesian and Monetarist views here, mostly because of differences in definitions).
• Poor expectation for future economic growth, increase households' savings as a precaution for a grim future.
• More disposable income after fixed expenditures (such as mortgage, heating bill, basic goods purchases) have been made (in contention between Keynesian and Monetarist views here, mostly because of differences in definitions).
• Perceived likelihood of plunder of the future value of savings, via legal or extralegal means, will make saving less attractive (in contention between Keynesian and Monetarist views here, mostly because of differences in definitions).

These factors affect the marginal propensity to save (MPS) - the greater this MPS, the more saving households will do as a proportion of each additional increment of income.

Investment

• Investment is made into capital (ie. plant and machinery, also 'human capital' - training and education), with intent to increase productivity, efficiency and output of goods and services
• In national accounting terms, stocks, bonds, mutual funds, and other items whose value is risky, are NOT investments. They fall into the savings account, not the investment account.
• In monetary terms, the relationship between savings and investment is modeled, rather than being an accounting identity. Stocks and bonds are considered to be important intermediary forms of savings as it gets transformed into a capital investment that produces value. Mutual funds, CDs, BICs, GICs, pension obligations, insurance annuities, and other forms of savings marketed by financial intermediaries, all consist of stocks, bonds, and cash balances, which in turn pay for the capital that increases productivity, efficiency and output of goods and services.

The 2 Forms of Investment

a) voluntary

• normal investment → plant equipment etc.
• planned increases in inventory.

b) involuntary

• unplanned increases in inventories, output not consumed.

Note on so-called "fiscal" policy, i.e. marginal discretionary government spending:

a) Planned Injections (J) and Planned Withdrawals(W)

saif buneri J > W = ↑economy expansion J < W = ↓economy contraction J = W = -economy at equilibrium

b) Savings and investment flows most likely to change economic activity

Y = Consumption(C) + Savings(S) → Output(O) = C + I → Y = O → C = C → S = I → Therefore:

• Consumers Y = C + S

plan → 100 = 85 + (15) OR 100 = 90 + (10)

• Producers O = C + I

plan → 100 = 90 + 10 OR 100 = 85 + 15

actual result → 100 = 85 + (15) => meaning a downswing in the economy OR actual result → 100 = 90 + (10) => meaning an economy upswing