This paper explores the effects of saving at both a personal and aggregate level. I begin by considering questions about the personal and aggregate concepts of wealth. What constitutes wealth? Why do people strive to accumulate it? Why is higher investment (broadly defined) necessary to raise national wealth? I then examine the theory that explains how saving at the personal level is typically assumed to translate into higher investment that adds to aggregate wealth. Simply put, higher saving raises the supply of “loanable funds” in the capital markets, which reduces the rate of interest, lowers the cost of capital, and encourages firms to invest more in durable assets. According to this theory, a penny saved must necessarily be a penny earned in the form of tangible assets.
As I discuss next, however, the conventional loanable funds theory assumes away a fundamental problem. Additional saving, by definition, must result in lower spending by the saver. All savers recognize this point explicitly. But it is not so obvious that an increase in someone’s saving lowers others’ incomes (because one person’s spending is another’s income). Those whose incomes fall cannot accumulate personal wealth in the way that they planned; they become, in a sense, the victims of other peoples’ saving: their saving falls as the result of increase in saving by others. From this perspective it becomes clear that the supposed increased supply of loanable funds that is typically assumed to lower the cost of capital and stimulate investment in the conventional theory does not exist in any direct sense.
For a higher desire to save in the aggregate to translate into higher investment requires the operation of a subtle and potentially fragile string of economic phenomena relying on adjustments to wages and prices and the effects of these adjustments on aggregate spending. Unemployed resources arising from lower spending must cause wages and prices to fall (or at least to inflate more slowly), and the resulting disinflation must raise aggregate spending through indirect channels. I summarize theoretical and empirical evidence that raise serious doubts about whether these complex phenomena operate effectively, thereby questioning the assumption that policies that encourage saving actually lead to higher investment and higher wealth. I conclude, in sharp contrast to conventional wisdom, that it is more likely for an increased desire to save, other things equal, to reduce investment, and thereby reduce social wealth.