The savings investment identity is an important concept in macroeconomics that shows the relationship between national savings, national investment, and GDP. It states that national savings is equal to national investment. This reveals key insights into how savings and investment drive economic growth.
The savings investment identity provides a framework for understanding the drivers of GDP growth in an economy. It shows that higher savings leads to more funds available for investment, which boosts productivity and economic expansion. Therefore, policies aimed at increasing savings rates can have a stimulative effect on growth. The identity also underscores how maintaining adequate investment levels is critical for GDP growth over the long run.
The savings investment identity equation links savings, investment and GDP
The savings investment identity can be summarized in the following equation:
Savings = Investment
Where:
Savings = national savings
Investment = national investment
This shows that total savings in an economy must equal total investment in the economy. Savings represents income that is not consumed, while investment represents the portion of national output that is not consumed.
The identity also reveals that:
Savings = Investment = GDP – Consumption
That is, national savings equals national investment, which also equals GDP minus total consumption spending.
This identity must hold true by definition because the amount not consumed (savings) must equal the amount not consumed (investment). The two uses of GDP – consumption and investment – must sum to total GDP.
Higher savings allows more investment, boosting economic growth
The savings investment identity highlights the importance of savings for enabling investment and economic growth. When people and businesses save more of their income, those savings are made available for investment into productive capacity like factories, equipment, technology, and education.
Higher investment levels then increase productivity and expand the economy’s capacity to produce, which translates into higher future GDP growth.
Therefore, the identity shows how increasing the savings rate can stimulate growth over the long run. If consumers save more and consume less, this frees up resources for investment that grows the economic pie.
Many fast-growing economies like China have high savings rates that have enabled high investment levels and rapid GDP growth. Meanwhile, low savings rates can constrain investment and limit growth potential.
Policies like forced savings schemes and higher interest rates to encourage savings are justified by the savings investment identity. Governments aim to raise national savings in order to fund greater productive investment and national development.
Maintaining adequate investment is essential for economic growth
The savings investment identity also highlights the critical importance of investment levels for GDP growth. Over the long run, economic expansion is driven by investment into productive capacity and innovation.
If savings rise, but the funds are not invested productively, no long-run growth will result. Policies must ensure savings are channeled into productive uses.
During recessions, the identity shows that insufficient investment demand from businesses can cause sharp declines in GDP. Firms cut back on investing in response to weak expected growth.
Government policies to maintain investment levels during downturns are therefore vital. Initiatives like investment tax credits, infrastructure spending, and interest rate cuts aim to sustain investment demand when private investment falls.
The savings investment identity demonstrates that investment – fueled by savings – is the engine of long-term economic growth. Savings represent foregone consumption today in return for higher production and consumption tomorrow. Therefore, the identity can guide policies aimed at national development.
The savings investment identity reveals the critical linkage between savings, investment and economic growth. It shows how higher savings enables greater investment, boosting productivity and GDP. The identity also underscores the vital role of maintaining adequate investment levels through business cycles. Therefore, the savings investment identity provides key insights to guide policies aimed at financial stability and promoting national economic development.