Saving Paradox, Monetary & Fiscal Policy, Steady State

The Paradox of Saving

As Blanchard states, when autonomous consumption falls (c₀▼), meaning consumers reduce their level of autonomous consumption, equilibrium income decreases. Consumption also decreases, so the level of saving remains unchanged. Mathematically, we can see this in the following formula: S = Y - T - C

We can also see that what really produces variations in saving are variations in investment, public spending, or taxes, and not the fall of autonomous consumption. Mathematically, we can see this in the following formula, where investment equals saving: I = Private Saving + Public Saving; I = S + (T - G), so S = I - T + G

In economics, this theory is known as the paradox of saving, which is closely related to Keynesian economic theory.

Balanced Budget Change (ΔT = ΔG)

If the government simultaneously increases public spending and taxes by the same amount, the budget deficit will not change (Budget = T - G); ΔT = ΔG = Budget Δ = 0

Income will change by the same amount as public spending and taxes:

ΔT = ΔG = ΔY

Monetary Policy

Monetary policy is an economic policy that uses the amount of money as a control variable to maintain economic stability. Monetary policies are based on setting a target interest rate (i) or making decisions that affect the money supply and demand (M_s, M_d) (e.g., purchasing or selling bonds). The central bank is responsible for monetary policy.

• Expansive monetary policy involves lowering the interest rate (▼i) or increasing the money supply (M↑), for example, by purchasing bonds in the open market. In our model, the LM curve will shift downwards (LM ▼).
• Restrictive monetary policy involves increasing the interest rate (i↑) or decreasing the money supply (▼M), for example, by selling bonds in the open market. In our model, the LM curve will shift upwards (LM↑).

Fiscal Policy

Fiscal policy is an economic policy that uses the government budget (T - G) as a control variable to maintain economic stability. We consider that fiscal policy is used by the government.

• In an expansive fiscal policy, the government will increase public spending (↑G), reduce taxes (▼T), or both (T - G ▼). In our model, the IS curve will shift rightwards (IS →).
• In a restrictive fiscal policy, the government will decrease public spending (▼G), increase taxes (↑T), or both (T - G↑). In our model, the IS curve will shift leftwards (IS ←).

Steady State

An economy is in a long-run equilibrium, or in a Steady State, when its capital stock cannot grow anymore because the entire amount of investment that the economy can generate is required to make up for depreciation. In this case, net investment becomes zero, and the capital stock cannot grow anymore.