Savings and investments—an old debate in times of trouble

Abstract

Central banks are widely regarded as being capable of controlling the interest rate. From this perspective, the classical viewpoint on savings and investments is criticized for assuming that the interest rate equilibrates the two but credited for observing that investments are not indeterminate. Keynes correctly stated that any level of investment generates the necessary savings. This is what I label the "IS-logic," which is shown to hold under more general assumptions. But the IS-logic does not recognize the limitations imposed by a considerate central bank. These insights are applied to the 2007-8 financial crisis to generate insights for reform.

Keywords:

• financial crisis
• interest rate
• liquidity trap
• loanable funds
• monetary policy rule