The Savings equals Investment condition: What can this tell us about organic growth?

It is known by macroeconomists through the circular flow of income that, given a balanced budget and current account of goods and services, aggregate savings by households is equivalent to aggregate investment by businesses.

It took me a while to understand how this works, but having done some reading and thinking, I have been interested in looking at this in more detail.

Definitions and Assumptions of S=I

By investment here we mean the purchasing of plant, property and equipment or the development of intangible assets. We can see investment resembling the addition to fixed assets of firms over a period of time.

By savings we mean any income that is not personal consumption. To build up wealth not including one’s own house, car and such.

Given the assumption that savings has tended to equal investment over a stretch of time it must be true that aggregate savings of households equals total fixed assets or capital of firms. For if the current account is balanced so is the capital account, thus any savings directed for investment overseas is offset by FDI.

Given this, we are in the same position if we assume, for simplicity that there is no flow of capital across borders.

Balanced budgets over time mean, on the whole, no outstanding government bonds which could be a haven for savings.

What Can This Tell Us?

Through S=I, we may be able to learn a few things….

Firstly we must know that Investment by businesses is done by 2 methods.

  1. Businesses money: Retained earnings
  2. Other people’s money: Stock or debt issues

Household savings only fills in #2, through the banking system, funds of various sorts and personal interests in ventures in the macro economy. When stock and debt is owned by another business, it can be seen as ownership by owners of the holding company. Household savings do not go to organic investment.

So this leads us to the idea that #1, the buying of capital by retained earnings is equal, given our assumptions, to household savings not held in stock or business debt over any period of time.

This would be investments in household and mortgage debt. Consumer, not producer debt.

Government securities are another use of savings but are excluded with the assumption of a balanced fiscal policy over time….

Conclusion

Without going into great detail, but using the savings=investment condition and the assumptions and defintions given. We can come to the idea that:

Investment through retained earnings is roughly equal to total outstanding household and mortgage debt (consumer debt), and this influences organic growth…..

Sure, there are a few things that haven’t been considered, such as depreciation and why stock and debt issues are reasonably assumed to be for the purpose of investment etc but on the surface what I have come up with appears to be true. It is a bare bones and there may be something I have missed out!

Thoughts please.

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: