A popular national income accounting framework for discussing the economy is the GDP expenditure equation:
Y = C + I + G + (X - M), where C refers to consumption spending, I references investment spending, G is government spending, and X - M is net imports (X, exports; M, imports). Savings is defined as income that is not consumed. C, is consumption. Investment, I, is made into capital (plant and machinery, also 'human capital' - training and education), with intent to increase productivity, efficiency and output of goods and services. I can be generally defined as purchases of good that will be used to produce more goods and services in the future. In national accounting terms, stocks, bonds, mutual funds, and other cash equivalents, are not classified as investments but rather are classified as savings. Savings from this perspective facilitates capital purchase which are included in investments
Saving is what households (participants in the consumption account) do. The level of saving in the economy depends on a number of factors:
- A higher real interest rates increases returns to saving.
- Poor expectations for future economic growth, increase households' savings as a precaution.
- More disposable income after fixed expenditures (such as mortgage, heating bill, basic goods purchases) have been made increases saving.
- Perceived likelihood of reduced return through regulation or taxation on savings will make saving less attractive.
Marginal propensity to save
The factors as stated affect the marginal propensity to save (MPS), the percentage of after-tax income that an economic agent will choose to save. The greater the MPS, the more saving households will do as a proportion of each additional increment of income. Stocks and bonds are considered to be important intermediary forms of savings as these get transformed into a capital investment that produces value .
Bonds are a type of savings
Savings are used to fund investments, where investments are defined as expenditures on factory plants, equipment and homes.
Savings and Investment
Assuming a closed economy, one where there is no export or impart activity to interfere with the domestic savings level, on an aggregate basis individual savings creates the supply of loanable funds available for investment purposes. The amount of savings available in the economy is equal to the amount of funding available for investment activity. The higher the level of savings, typically the lower the relative interest rate, ceteris paribus. On a macroeconomic theory basis, a higher the savings rate promotes business activity my lessening the cost of money and increasing risk taking activities to facilitate growth or production of goods and services.
Financial intermediaries can assist with increasing the incentive to save through developing financial products that offer ease of liquidation but provide a higher return than a savings account. In this manner, financial intermediaries are a significant component to the transformation of savings into investment. Mutual funds, pension obligations, insurance annuities, and other forms of savings marketed by financial intermediaries all consist of stocks, bonds, and cash balances, which in turn pay for the investment capital that increases productivity, efficiency and output of goods and services.