<p>The investment (<span class="math-container">$I$</span>) equals savings (<span class="math-container">$S$</span>) result is derived by Keynes just from national identity, as a result it just hold by definition. Keynes in the passage starts with the simplified version of national identity that omits government. That is:</p>
<p><span class="math-container">$$Y=C+I \implies I=Y-C$$</span></p>
<p>And simply solves it for investment. The solution of investment tells us that private investment is equal to difference between income and consumption. But a difference between income and consumption is also by definition savings <span class="math-container">$(S)$</span>. Hence keynes derives this result just using accounting. In the end accounting always has to hold because its just an identity based on definitions - in itself it has no economic meaning (In a proper version of identity that would include government this would still hold true but then investment would be equal to private and public saving <span class="math-container">$I =Y-C-G$</span>).</p>
<p>Furthermore, later when it comes to the paradox of thrift Keynes does not abandon the above interpretation. Rather Keynes would say that during recession <span class="math-container">$I$</span> is fixed at some level <span class="math-container">$\bar{I}$</span> so any increase in savings <span class="math-container">$S=Y-C$</span>, which can happen only by lowering consumption <span class="math-container">$C$</span> will be just corresponded equal fall in income <span class="math-container">$Y$</span>. The argument is that your spending is an income for someone else - you cut your spending you will also cut their income - however by cutting their income you also force them to spend less and their spending is your income (this holds in liquidity trap where <span class="math-container">$I$</span> is fixed).  At least this is the contemporary interpretation of what Keynes meant as a standards of rigor in economics were not as high in the  past as they are nowadays always leaving some room for interpretation  (see for example Blanchard et al. Macroeconomics an European Perspective - the box about paradox of thrift).</p>
<p>Even when we go beyond mere accounting identity to the IS-LM AS-AD model which is currently the dominant model used to explain the macroeconomy the level of investment and effective demand will be determined first by peoples exogenously given expectations and preferences and the level of savings will be afterwards determined to match this (see Romer's Advanced Macroeconomics for more complex treatment of IS-LM models).</p>
<hr />
<p>A  side note: you should also note that precautionary savings (i.e. money households set aside to have some reserve just in case) will still normally be transformed into investment provided it is held in some account even if it is at normal deposit account even though you as an account holder might never know about it. The above still applies though - I am just mentioning this because from reading your Q I thought you might be having this misconception.</p>

CC BY-SA 4.0
2020-08-26T18:25:14.380Z
I do understand that banks do invest your savings. I think I may be misunderstanding liquidity preference then; I interpreted it to refer to a desire to keep cash outside of the financial system, since I figured whether cash is kept as liquid cash in checking accounts or as illiquid CDs/bonds was irrelevant to interest rate. Is that assumption wrong?
H Huang
CC BY-SA 4.0
2020-08-26T18:30:28.977Z
@HHuang yes that’s not correct- what the desired cash holding is depends on interest rate. In fact the whole idea of liquidity trap depends on what the interest rate is. Under the New Keynesian models liquidity trap would occur when the nominal interest rate zero or negative because then preference for holding cash becomes virtually infinite (abstracting from real life problems such as storage issue) as cash is in its essence an instrument with 0 nominal interest rate implicitly attached to it
1muflon1
CC BY-SA 4.0
2020-08-26T18:33:51.913Z
Ah, ok, it all makes a lot more sense now. Thanks!
H Huang
CC BY-SA 4.0
2020-08-26T09:28:39.330Z
2020-08-26T09:46:46.753Z
2020-08-26T09:46:46.753Z
1muflon1
<p>This paper argues that saving is the accounting record of investment:</p>
<p><a href="https://www.boeckler.de/pdf/v_2008_10_31_moore_2.pdf" rel="nofollow noreferrer">https://www.boeckler.de/pdf/v_2008_10_31_moore_2.pdf</a></p>
<p>which I think maps to the Post-Keynesian school where investment decisions by firms are validated by banks and other financial intermediaries who generate new credit to finance those investments. In this model savings does not come before investment. Instead investment is financed by deals which generate net new credit instruments and this causes an increase of financial savings equal to the spending for investment over an accounting period.</p>
<p>When one abstracts away from monetary economies, for example in the Robinson Crusoe economy, there are still two types of activity given as consumption and investment. In this theory Crusoe could spend all his labor efforts making consumption goods and there would be no saving or investment. If he spends some labor effort making goods that last more than one year then he has engaged in saving and investment. But there is no financial saving in the one person Robinson Crusoe economy. There is only Crusoe deciding to either make investment goods or consumption goods using his labor effort. When a society organizes production to pay wages and costs for production of investment goods and consumption goods, and when credit is offered to boost consumption above the level of wages earned in one's youth, then there is a challenge convincing oneself that investment spending over a period must equal the increase of financial saving during the same period, which is the identity asserted by the economic theory of income equals expenditure models.</p>

CC BY-SA 4.0
2020-08-26T15:35:53.883Z
2020-08-26T17:19:12.950Z
2020-08-26T17:19:12.950Z
SystemTheory
<p>Keynes defines saving as equal to investment, saying:</p>
<p>&quot;Having now defined both income and consumption, the definition of saving, which is the excess of income over consumption, naturally follows ... Our definition of income also leads at once to the definition of current investment. For we must mean by this the current addition to the value of the capital equipment which has resulted from the productive activity of the period. This is, clearly, equal to what we have just defined as saving. For it is that part of the income of the period which has not passed into consumption.&quot;</p>
<p>To me, Keynes' assumption that all income that is not consumed is invested in augmenting capital seems problematic. It's pretty obvious that people do keep money on hand without either consuming it or investing it. Keynes himself doesn't seem to rely on this definition in the rest of <em>The General Theory.</em> In fact, his own concept of liquidity preference seems to contradict this definition. My understanding of liquidity preference is that it is the desire of people to hold their money in liquid form, as opposed to <em>investing</em> it to earn interest. Keynes himself says:  &quot;For if a man hoards his savings in cash, he earns no interest, though he saves just as much as before,&quot; acknowledging that people can and do hold parts of their income without investing or consuming it.</p>
<p>Am I misunderstanding Keynes? Does Keynes address this definition further in any of his works?</p>

<investment><keynesian-economics><saving><keynes>
Keynes' conception of investment
H Huang
# Keynes' conception of investment

(Asked by: username_0 on 2020-08-26)

Keynes defines saving as equal to investment, saying:

"Having now defined both income and consumption, the definition of saving, which is the excess of income over consumption, naturally follows ... Our definition of income also leads at once to the definition of current investment. For we must mean by this the current addition to the value of the capital equipment which has resulted from the productive activity of the period. This is, clearly, equal to what we have just defined as saving. For it is that part of the income of the period which has not passed into consumption."

To me, Keynes' assumption that all income that is not consumed is invested in augmenting capital seems problematic. It's pretty obvious that people do keep money on hand without either consuming it or investing it. Keynes himself doesn't seem to rely on this definition in the rest of *The General Theory.* In fact, his own concept of liquidity preference seems to contradict this definition. My understanding of liquidity preference is that it is the desire of people to hold their money in liquid form, as opposed to *investing* it to earn interest. Keynes himself says: "For if a man hoards his savings in cash, he earns no interest, though he saves just as much as before," acknowledging that people can and do hold parts of their income without investing or consuming it.

Am I misunderstanding Keynes? Does Keynes address this definition further in any of his works?

**Tags:** investment, keynesian-economics, saving, keynes

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## 2 answers

### Answer by username_1 on 2020-08-26. Score: 5

The investment ($I$) equals savings ($S$) result is derived by Keynes just from national identity, as a result it just hold by definition. Keynes in the passage starts with the simplified version of national identity that omits government. That is:

$$Y=C+I \implies I=Y-C$$

And simply solves it for investment. The solution of investment tells us that private investment is equal to difference between income and consumption. But a difference between income and consumption is also by definition savings $(S)$. Hence keynes derives this result just using accounting. In the end accounting always has to hold because its just an identity based on definitions - in itself it has no economic meaning (In a proper version of identity that would include government this would still hold true but then investment would be equal to private and public saving $I =Y-C-G$).

Furthermore, later when it comes to the paradox of thrift Keynes does not abandon the above interpretation. Rather Keynes would say that during recession $I$ is fixed at some level $\bar{I}$ so any increase in savings $S=Y-C$, which can happen only by lowering consumption $C$ will be just corresponded equal fall in income $Y$. The argument is that your spending is an income for someone else - you cut your spending you will also cut their income - however by cutting their income you also force them to spend less and their spending is your income (this holds in liquidity trap where $I$ is fixed). At least this is the contemporary interpretation of what Keynes meant as a standards of rigor in economics were not as high in the past as they are nowadays always leaving some room for interpretation (see for example Blanchard et al. Macroeconomics an European Perspective - the box about paradox of thrift).

Even when we go beyond mere accounting identity to the IS-LM AS-AD model which is currently the dominant model used to explain the macroeconomy the level of investment and effective demand will be determined first by peoples exogenously given expectations and preferences and the level of savings will be afterwards determined to match this (see Romer's Advanced Macroeconomics for more complex treatment of IS-LM models).

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A side note: you should also note that precautionary savings (i.e. money households set aside to have some reserve just in case) will still normally be transformed into investment provided it is held in some account even if it is at normal deposit account even though you as an account holder might never know about it. The above still applies though - I am just mentioning this because from reading your Q I thought you might be having this misconception.

> **Comments:**
> **username_0**: I do understand that banks do invest your savings. I think I may be misunderstanding liquidity preference then; I interpreted it to refer to a desire to keep cash outside of the financial system, since I figured whether cash is kept as liquid cash in checking accounts or as illiquid CDs/bonds was irrelevant to interest rate. Is that assumption wrong?  
> **username_1**: @HHuang yes that’s not correct- what the desired cash holding is depends on interest rate. In fact the whole idea of liquidity trap depends on what the interest rate is. Under the New Keynesian models liquidity trap would occur when the nominal interest rate zero or negative because then preference for holding cash becomes virtually infinite (abstracting from real life problems such as storage issue) as cash is in its essence an instrument with 0 nominal interest rate implicitly attached to it  
> **username_0**: Ah, ok, it all makes a lot more sense now. Thanks!  

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### Answer by username_2 on 2020-08-26. Score: 0

This paper argues that saving is the accounting record of investment:

<https://www.boeckler.de/pdf/v_2008_10_31_moore_2.pdf>

which I think maps to the Post-Keynesian school where investment decisions by firms are validated by banks and other financial intermediaries who generate new credit to finance those investments. In this model savings does not come before investment. Instead investment is financed by deals which generate net new credit instruments and this causes an increase of financial savings equal to the spending for investment over an accounting period.

When one abstracts away from monetary economies, for example in the Robinson Crusoe economy, there are still two types of activity given as consumption and investment. In this theory Crusoe could spend all his labor efforts making consumption goods and there would be no saving or investment. If he spends some labor effort making goods that last more than one year then he has engaged in saving and investment. But there is no financial saving in the one person Robinson Crusoe economy. There is only Crusoe deciding to either make investment goods or consumption goods using his labor effort. When a society organizes production to pay wages and costs for production of investment goods and consumption goods, and when credit is offered to boost consumption above the level of wages earned in one's youth, then there is a challenge convincing oneself that investment spending over a period must equal the increase of financial saving during the same period, which is the identity asserted by the economic theory of income equals expenditure models.


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