Saving and Investment

This article explains the relation between saving and investment, and the important difference between individual saving and aggregate saving.

Individual Saving

Individual saving means spending less on consumption than available from one's disposable income.  What an individual saves can be held in many ways.  It can be deposited in a bank, put into a pension fund, used to buy a business, pay down debt, or kept under the mattress, for example.  The common element is the claim on assets that can be used to pay for future consumption.  If there is a return on the saving in the form of interest, dividend, rent, or capital gain, there can be a net gain in individual saving, and thus in individual wealth.

Effect of Increased Individual Saving

Suppose an individual decides to increase saving by consuming less.  His cutback in spending necessarily means a reduction in income to others.  They in turn might cut their consumption to match the loss of income, but then others would lose income.  Most people do not reduce consumption equal to the loss of income, so there will usually be a net reduction in saving.  Thus the net saving of everybody else may decrease more than the original increase, which would result in a decrease in aggregate saving.

Aggregate Saving

Aggregate saving does not increase as a result of individuals acquiring pieces of paper like dollar bills or stock and bond certificates.  That merely swaps one type of financial asset for another without affecting the total.  Aggregate saving occurs when the nation acquires real domestic assets, such as new housing, new machinery, new factories and offices, additions to a firm’s inventory of goods, or new claims on assets overseas.  And that is precisely what is meant by investment. 

Aggregate Saving Equals Investment

Investment is what provides for growth in aggregate wealth.  However we cannot increase investment without increasing aggregate saving.  Measures taken to increase individual saving will not increase aggregate saving unless they increase investment.  Instead they may bring down the income of others, and thereby reduce both aggregate saving and investment. 

Investment equals aggregate saving, but it is more revealing to say aggregate saving equals investment.  For example if investment increases by 10 billion dollars, aggregate saving must have increased by 10 billion dollars.  That means the aggregate income must have increased by 10 billion dollars more than the increase in aggregate consumption.