Monday, June 08, 2009

How Investment Creates Savings

In the standard identity, Savings (S) = Investment (I). The typical causality associated with this: people save, and those savings are parceled out as investment, comes from the gold standard world and, as such, is non-operative in today's fiat world.

It took me a long time to think through why this was the case, but you can see me work through it in this old Interfluidity comments thread.


1. In a given period, an economy produces a certain amount of stuff. This quantity of stuff is that economy's real income.

2. Some of that production (real income) is consumed in the same period. The rest of it is not consumed, and is, instead saved/invested.

3. If you look at it in nominal terms, then income not spent is saved. If you look at it in real terms, production rolled over to be available for consumption in the next period (either in capital stock, or inventory) is investment. Thus savings and investment and flip sides of the same coin. If you don't consume all of your real output in a given period, then someone, somewhere, must have consumed less than they produced (saved). Real investment is recorded as nominal savings. Savings is how we account for real production that's been made available (via investment) for a subsequent period.


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