Explain why savings must equal investment spending. What government policy could be used to increase the natio

Question

Explain why savings must equal investment spending. What government policy could be used to increase the national savings rate and how this would impact investment spending?

Answer 1

it is not necessarily savings must equal investment. if you are talking about 3 sector economies,

savings (S) + tax (T) = investment (I) + government spending (G)

4 sectors

S+T+imports (M) = I+G+exports (x)

basically injections in the economy (I, G, X) must equal with withdrawal (S,T,M) for economy to be in equilibrium

to increase national savings rate, increase interest rates

the higher interest rates would induce consumer to save to get a higher return

due to the inverse relationship between interest rate and asset prices, the higher interest rates will lower price of assets. consumers will more likely to hold cash and save (a higher return compared to investing in assets).

and consumer spending will also decrease as consumer durables (such as cars) are interest rates sensitive

the lack of profits will lower the firms and investors confidence on future profits

due to a higher cost of borrowing, firms are less likely to borrow money and invest

hence, consumption will fall, investment spending will fall. aggregate demand will fall, national income will fall, gdp will fall.

Answer 2

Okay, imagine you could consume something or not consume it.  If you have not consumed it then you have saved it.  Being purely technical the food you have in your refrigerator is part of your investment for the future and is also savings.  However, getting away from nit-picking, for someone to invest money in new capital goods, someone must have kept money aside for them to invest with.  There should be some statistical noise between the two accounts, frictions happen, but in a frictionless environment for money to be invested, it must first be saved.  Likewise, if you save money but earn no income from it, then you have wasted that savings.  People do not like to waste savings, so it is at least deposited in a bank.  Banks, ignoring friction, will alter interest rates to accommodate the extra money and the need to lend additional funds.

The only policies that could work are those that prohibit consumption and forbid capital export.  However, it would act as a subsidy to industry and result in a less competitive environment for industry an would be welfare reducing across the board.