Session 2 Week 12: Saving, Investment & the

Financial System (Ch. 13)

Theories of the Relationship between National

Saving and Investment
 Saving & Investment
& the Macroeconomic Identities
• Y = C + I + G + NX, by the definition of GDP
• Y = C + S + T, based on the circular flow
• So: C+I+G+(EXP-IMP)= C+S+T
• So: I+G+EXP= S+T+IMP, or “Injections = Leakages”
• Solving for I: I = S + (T-G) – NX
• Investment = Private Saving + Government Surplus – Net Exports
• Mankiw defines “National Saving” as S+(T-G), and assumes a
closed economy, so: I = SN = SP+(T-G)
 A (first) Mainstream Theory of
Supply and Demand for Loanable Funds
• Supply of Loanable Funds comes from SN = SP+(T-G), while
Demand for Loanable Funds is demand for funds for Investment
• (note thati the Demand for loanable funds WILL be expanded later)
i (interest rate) SF

i0

DF

I0 Loanable Funds
 Savings Incentive

i (interest rate) SF SF1

i

i0
i1

DF

I0 I1 Loanable Funds
 Investment Incentive

i (interest rate) SF
i

i1
i0

DF DF1

I0 I1 Loanable Funds
 Government Deficits

i (interest rate) SF1 SF

i

i1
i0

DF

I1 I0 Loanable Funds
 Class Exercise One

• Form into groups of three to four students, and do the following

analyses:
• (A) Draw a model of the Loanable Funds market. Show the result if
there is an improvement in technical knowledge that creates new
opportunities to invest in new profitable industries
• (B) Draw a model of the Loanable Funds market. Show the result if
there is an increase in the government surplus (or, equally, a reduction
in a government deficit).
• Report your results to the class.
 MMT, Investment and Savings

• Under MMT, the Leakages = Injections identity is seen in a

different light
• It is not assumed that a Long Run Equilibrium or “natural”
rate of output exists, so under normal economic conditions,
there is not a $1:$1 tradeoff between government purchases,
consumption, and investment
• It is argued that depressed economic conditions can persist
for long periods, and under these conditions there is little or
not tradeoff at all.
• Only at or close to full employment do MMT economists
agree that something close to a $1 to $1 trade-off exists.
 MMT and the “Three Balances”
• GDP = Earned Income:
• Y=C+I+G+NX=C+I+G+(EXP-IMP)
• Imports leaking out mean that the income from producing the
product was earned somewhere else. And Earned Income from
the domestic part of production may leak out as taxes, or leak out
as savings, or be spent on consumption:
• Y=C+S+T
• And the Macroeconomy is not stable until the “C” that goes into
generating Y is the same as the “C” that is generated by Y:
• So: Y-Y=0 → C+I+G+(EXP-IMP) – (C+S+T) = 0
• Since “C=C” → (G-T)+(I-S)+(EXP-IMP) = 0
 MMT and the “Three Balances”
• We can put the fiscal policy position on one side, and that leaves the
“private economy” on the other side:
(G-T) = (S-I) - NX
• Now, in THIS chapter, we are assuming a “closed economy” (which
can equally well be a “balance trade” economy), which in algebraic
terms translates into NX=0, so our “simplified” Two Balances is:
• (G-T)+(I-S) = 0
• So (G-T) = (S-I)
• So the MMT view of things is that a Government Deficit is required if
we are to have a Private Surplus.
• In other words, “financial wealth” is a promise from someone to give
you money. “Investment” that is financed by borrowing created
corporate bonds that act as financial wealth. But government bonds
issued because of a government deficit also provides a new financial
asset that people can hold as financial wealth.
 MMT & Three Balances Analysis

• Suppose the economy is in recessionary conditions

• The opportunities to benefit from investment are weak, and the
incentives to save are strong. So there will be pressure on (I-S) to go
negative. If NX is balanced, the two possible results are
• The government accomodates the desire to save by running a
deficit, creating the new debt instruments for people to “save in”
• or else GDP must drop until the desire to save is frustrated by the
lack of income.
• With banks available as a source of new loanable funds, and a Federal
Reserve Bank maintaining a stated Federal Funds Rate, an MMT
Supply of Loanable Funds relation would be flat in the simplest
version of an MMT loanable funds model.
 MMT & Savings Incentives

i (interest rate)
i

SF
i 1 = i0

DF
DF1
Loanable Funds
I1 I0
 MMT & Investment Incentives

i (interest rate)
i
DF DF1

SF
i 1 = i0

Loanable Funds
I0 I1
 MMT & Government Deficits

i (interest rate)
i
DF1
DF
SF

i 1 = i0

Loanable Funds
I0 I1
 Class Discussion One

• Form your permanent semester working groups of three to four

students, and discuss the following question.
• (A) What is the key mainstream assumption that implies that the
Savings Incentives and Government Deficits have their main impact
on the Supply of Loanable Funds, instead on the Demand for
Loanable Funds?
• (B) Why is the assumption in (A) more important in the Long Run
than in the Short Run?
• Report your conclusions to class.