Macroeconomics
The Savings and Investment Identity
Before we delve into the factors that influence the demand and supplycurvesofloanablefunds,itis essential to understand the relationship between savings and investment spending. The savings-investment identity asserts that all investment spending (I) is funded by savings (S), denoting that S = I . Let's dissect this identity tocomprehend the conclusion it leads to. Recallthatinaclosedeconomywherethereisnointernationaltrade,exportsandimportsareexcluded, and we have the following equation for national income (Y) or aggregate expenditures:
Y = C + I + G
Now isolate “I”, which represents the investment spending based on the S = I identity:
Y − C − G = I
Considering that the government fnances its spending through taxes, and taxes are deducted from income, we arrive at the following equation:
Y − T − C+ T − G = I
This equation breaks down into two components:
● Y − T − C: This represents private savings whichistheincomeleftafterdeductingtaxesand consumption. ● T − G: This represents public savings which is the income left after subtracting government spending from taxes. The government is said to run a budget defcit when public saving is negative, meaning that T < G. This means that the government does not have suffcient tax revenuestocoveritsspending.Alternatively,thegovernmentrunsa budgetsurplus whenithas apositivepublicspendingwherebyT>G.Thismeansthatthetaxrevenuesexceedgovernment spending and are enough to cover expenditures. The combination of private and public savings forms national savings (S) which is the source of loanablefunds. Byreplacingprivateandpublicsavingswithnationalsavings(S),weobtaintheidentity S = I. Now,let'sconsideranopeneconomy.Inthisscenario,wemustaccountforthefactthatsomesavings will flow overseas, while others will come from abroad into the country. This is reflected in the net capital inflow (NCI) , which represents the difference between fnancial capital entering the country (capital inflows) and fnancial capital leaving thecountry (capital outflows) .
Therefore, the equation becomes:
Y − T − C+ T − G+ NCI= I
→ In an open economy, S + NCI = I
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