Savings and Investment
Savings and investment determine an economy's long-run level of wealth. Mankiw devotes an entire chapter to the market for loanable funds in each of his editions, showing that national savings finance productive investment and that the real interest rate is the equilibrium price between the supply of funds (savings) and the demand for funds (investment).
Last updated: 8 July 2026
Definition
DefinitionThe fundamental national accounting identity establishes that, in a closed economy, national savings (S) necessarily equals investment (I): S = I. National savings is composed of private savings (income of households and firms not consumed) and public savings (the State's budget surplus, or dissaving in the case of a deficit). This identity is derived from the equation Y = C + I + G.
The market for loanable funds is the meeting point between the supply of funds (savings) and the demand for funds (investment). The real interest rate is the equilibrium price of this market: it determines how much savers receive for their savings and how much borrowers pay to finance their investments. Formally: S(r) = I(r), where S is increasing in r and I is decreasing in r.
Why it matters
Savings determine the long-run level of wealth; only technological progress sustains durable growth. A country that saves more can invest more, which raises its capital stock, productivity, and potential GDP. The Solow model, however, clarifies the scope of this mechanism: because of diminishing returns to capital, a rise in the savings rate raises the level of GDP per capita at the steady state, but not the long-run growth rate — the growth effect is only transitory.
The real interest rate plays a central signaling role in the allocation of resources between present and future consumption. A high real rate, in theory, prompts agents to save (postpone their consumption) and discourages investments with low expected returns. A low or negative real rate encourages borrowing and investment, but can lead to inefficient capital allocation if unprofitable projects are financed.
Key points
The identity S = I means that in a closed economy, everything that is saved is automatically invested. In an open economy, a country can invest more than it saves by borrowing abroad (current account deficit)
Policies that encourage saving (tax incentives for saving, budget surpluses) shift the loanable funds supply curve to the right, lowering the real interest rate and raising equilibrium investment
Budget deficits reduce public savings and therefore national savings. They absorb part of the loanable funds, raise the real interest rate, and crowd out private investment. Mankiw presents this mechanism as one of the most important costs of public debt
The optimal savings rate according to the "golden rule" is the one that maximizes consumption per capita in the steady state: it corresponds to the condition MPK = δ + n (the marginal product of capital must equal the sum of depreciation and population growth), which becomes MPK = δ + n + g once technological progress at rate g is introduced. Saving more than this rate paradoxically reduces welfare because too many resources are devoted to investment at the expense of consumption
Concrete example
ExamplesJapan historically displayed a very high household savings rate (15-25% in the 1970s-80s), but this has fallen to around 2-4% in recent years due to demographic aging. Despite a still-strong national savings rate (driven by firms), growth has remained sluggish for three decades, illustrating that savings alone are insufficient if profitable investment opportunities are lacking or if demographics are declining. Conversely, China maintained an investment rate exceeding 40% of GDP for two decades, financing spectacular growth but raising questions of overcapacity in certain sectors. In France, the household savings rate reached about 18% of gross disposable income in 2024 (versus ~14% on average before 2020), one of the highest in Europe.
Mankiw anecdote
MankiwMankiw presents the market for loanable funds as a simple but powerful model: supply (savings) and demand (investment) determine the equilibrium real interest rate according to S(r) = I(r). He uses it to analyze the impact of three policies: saving incentives (which increase private savings and shift the supply of funds to the right), a budget surplus (which increases public savings), and an investment tax credit (which increases the demand for funds). Each modifies the market equilibrium in a predictable and coherent way.
📊 Marché des fonds prêtables
Market impact
MarketsThe real interest rate influences all asset classes. A negative real rate (nominal rate below inflation) pushes investors toward risky assets (equities, real estate, crypto-assets) because safe placements offer zero or negative real returns. A high positive real rate makes bonds and money-market investments attractive relative to equities and favors portfolio arbitrage toward safety. The level of the long-term real rate determines the fundamental valuation of all financial assets.