Investment and Savings
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Investment - Spending on capital and buildings by businesses and new homes by consumers.
- Notice that the way economists use the word investment is not the same as you may be used to. You may think of someone asking you where you are going to invest your money, or if you put your money into the stock market you might be asked if you felt it was a good investment.
- You putting your money in the stock market, an IRA account, a CD, or a savings account is called savings.
- Investment is what is done with your savings.
- When you buy a stock (savings) you give money to a business (expecting a return) so that they can build a machine or build a new building (investment).
- When you put your money in a savings account (savings), the bank doesn’t just leave the money there; it loans your money to a business to build a factory or buy a machine or to a consumer to buy a house (investment)
- Thus in the end investment = savings.
- Investment is an important piece of GDP and aggregate demand.
- Investment is sensitive to the interest rate. In order for a business to purchase capital or build a building or for a homeowner to get a mortgage, they must borrow the money (from you the saver).
- If the interest rate is high, it is more expensive to pay back a loan. As a result, businesses may wait to build a new building and investment falls.
- If the interest rate is low, it is easier to pay back a loan. As a result a potential homeowner may decide by build a house now rather than later and investment rises.
- This sensitivity to the interest rate, which a monetary authority can control in the short run, makes investment the path through which monetary policy can influence the economy.