EUR 125.00 For Business Accounts Only

MOSL: FUEL OR ENGINES (ECONOMY)-Loans create deposits, not savings-Investments are necessarily constrained by savings

FUEL OR ENGINES (ECONOMY): Loans create deposits, not savings; Investments are necessarily constrained by savings

 

• According to our , India’s investments, and thus, sustainable higher growth, is constrained by the sharp decline in the gross domestic savings (GDS) led by the household sector. While related arguments are gaining traction in the mainstream, several pseudo theories have come forward, two of which are gaining momentum. However, with some basic analysis, these two related pseudo theories can be proved invalid.

Pseudo theory#1 – Loans create deposits, and thus boost savings: According to this theory, low deposit growth, and thus, lower savings can be addressed if lenders are able to lend freely. Since all loans automatically lead to deposits, more credit will address the issue of low savings.

Pseudo theory#2 – Low savings can be addressed by pushing investments higher: It is also argued that the key to revive savings in the economy is by pushing investments higher. Since savings and investments move in line with each other, higher investments will boost savings, and thus, the policymakers should focus on the former than the latter.

• Both these theories start with undeniable facts – a tautology, in fact – but end up with grossly incorrect conclusions. In this note, we prove that while loans create deposits, they don’t impact savings at all. Money creation (via credit/deposits) must not be confused with loanable funds (savings/investments) theory.
• Further, historical evidences prove that while investments and savings move together, as our suggests, a pick-up in investments has always outpaced the pick-up in savings. This leads to higher current account deficit (CAD), and thus, makes the revival in investments unsustainable. Investments, therefore, are necessarily constrained by savings. And it is always desirable if the revival in savings precedes the investments recovery.