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> Excessive wealth is usually hoarded (in bank accounts), not used: But if you want the economy to work the most (creating jobs, etc.), you need to make money c

• nhaehnle 13y ago
  The savings identity is usually misinterpreted by laypeople, though. Here's a small story to illustrate why S=I can be very misleading: Company C has always produced some type gadgets, for many years. Demand for the gadget has been stable, they just keep producing to what the demand is, end of story. Sounds boring, but this is what 99% of the economy is. Now, for whatever reason (a recession, a policy change, it doesn't really matter), consumers want to save more. In doing so, they decide to reduce their purchase of C's gadget. What happens now? Well, saving S goes up. At the same time, company C involuntarily builds up an inventory of gadgets that they had already started producing but which they can no longer sell. This build-up of inventory is counted as investment in the national accounts! So I goes up, and the identity S=I is maintained. But S=I is maintained in a way that is in total conflict to the typical layperson's interpretation of the equation. So, yes, an exogenous increase in saving will tend to push up "investment" (in quotation marks because it is involuntary investment). When all is said and done, we may all well be poorer for it in real terms, because the level of economic activity may have been reduced. On the other hand, when there is an increase in voluntary investment, then I goes up. Then people's income increases, and that tends to lead to an increase in savings. So S=I is also maintained, but we tend to be richer for it in real terms due to a higher level of economic activity.