Lecture 9
Saving and Investment

1. How is investment related to saving?

• I = S + (T - G) + (IM - X)

• Alternatively,
  I = S + (T - G) + (KA + ORT)     (why?)

• Private investment will be higher if:
  • Private saving goes up
  • Government saving increases
  • Foreign capital inflow increases

2. Foreign capital

• Consider an economy with:
  • Flexible exchange rate system, and
  • No government

• Any excess of private investment over private saving must be made up through foreign capital inflow:
  • I - S = KA

• Graphs of S and I
  • Negative slope for I(r)
  • Positive slope for S(r)
  • Closed vs open economy

3. Application of the Solow model

• Consider 2 countries, A and B, in steady state
• Country A has a higher saving ratio than B

• Country A will have a higher k*     (draw graphs)
• Country A's interest rate is lower     (why?)
• Direction of capital flow?     (S, I graphs)