Question

how would savings and investment work in our economy? what form of economic growth will take place as a result of savings?

Answer 1

Apparently, Saving and Investment looks same but that is not the case.

In the first step savings will be differentiated from Investment.

Saving

Saving is the entire process of keeping a portion of current income for future use, or in other words, the flow of resources gathered/accumulated in this way over a given period of time.

Saving may take the various forms: Increases in bank deposits or purchases of securitie, or keeping the cash under bed (increased cash holdings). The extent of saving is affected by people's preferences for future over present consumption, the rate of interest and their expectations about future income.

Saving bears no risk or a slight of risk at all. It can be deposited in a bank or pension fund, buy a business, pay down debt etc.

Levels/extent of savings are influenced by

• Interest rates – higher interest rates result in more saving and vice-versa.
• Confidence – low confidence in the investment climate can encourage households to save more

Investment
On the other hand, Investment encompasses the process of exchanging income for a stock or asset that is expected to produce earnings in future periods. Thus, in the process of investment, consumption in the current period is sacrificed in order to obtain a greater return in the future.
For an economy to fulfill the condition of investment, total production must exceed total consumption.

Mainly there are two types of investment - purely financial investment and investment in the means of production . From the perspective of an individual, both types will provide monetary return to the investor. However, from the perspective of economy purely financial investments indicates only as title transfers and do not add to productive capacity of an economy.

Investment possesses risk.

Extent Levels of investment is affected by

• Interest rates – higher interest rates results in more expensive investment ( reason being cost of borrowing goes up)
• Confidence – If there is a positive market sentiment, people will be more willing to invest.
• Economic growth – Rise in the rate of economic growth will push firms to invest to meet future demand.

Saving and Economic Growth

Saving is closely associated/related to investment. By deciding not to use income to buy consumer goods & services, there is more possibility for resources to be invested for producing fixed capital, such as factory & machinery. Consequently, Saving can, therefore, be /essential vital to increase the amount of fixed capital available which ultimately contributes to economic growth.

Yet increased saving doesn’t always refers to increased investment. If saving is put under bed and not deposited in a financial intermediary like bank, savings would not be recycled as an investment by business.

Thus we can conclude that saving may or may not increase without increasing investment. If it doesn't increase investment, it causes a shortfall of demand rather than to pursue economic growth. It it increases investment it results in economic growth.

Thus, In the short term, if saving falls below investment, it leads to a growth of aggregate demand and consequently, economic boom is experience.
However, In the long term, if saving reduces below investment then it eventually reduces investment and detraction from future growth is possible as present consumption is foregone to increase investment.