Wednesday, 16 May 2012

Why I called this blog Saving and Investment

I called this blog Savings and Investment because the basic national income accounting entity that equates savings with investment symbolizes, in my mind, the difficulty connecting finance with economics. With the national income account and some basic algebra, the savings equals investment equality can be easily derived:

Y = C + G + I + NX  (output = consumption + government + investment + net exports)
Savings =  Y - C - G (savings = output - consumption - government
Savings = I + NX  (savings = investment + net exports)
Savings = Investment (for a closed economy or the world as a whole)

Does the savings equals investment equality imply that when an individual saves part of their income, in the form of a bank deposit, investment increases by the same amount?  The answer is no.  Does the answer change if your saving is used to purchase equity in a company? Not necessarily. Do banks refuse to lend money to consumers because of a lack of savings?  Again, no. These answers are not intuitive given that savings equals investment.

With my graduate degree in economics and the CFA designation, I have not, to my satisfaction, been able to bring the pieces of my knowledge together to form a coherent understanding of how finance and economics interacts.  For example, some economists maintain monetary policy in the United States in the early to mid 2000s was too loose, causing asset price bubbles, ultimately leading to the financial crisis.  Other economist claim monetary policy was appropriate.  Who's right?  I want to know!

Macro economists have traditionally, following the lead of Paul Samuelson, concluded that finance is merely a "veil" between savers and borrowers, having no real impact on the economy.  The recent financial crisis clearly demonstrates finance is more than a veil, and matters to the real economy.

I intend to explore these and related issues in this blog.

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