When Investment Is Not Investment


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In macroeconomics, our terminology sometimes conflict with other disciplines.  That is definitely the case when economists distinguish between saving and investment when looking at the financial market, which is also known as the loanable funds market.  Banks and other financial institutions act as intermediaries where they take deposits from savers and loan them to borrowers.   In order to understand the difference between saving and investment, know that saving is defined as the amount of income left over after consumption spending, while investment is the purchase of new capital.

Given the definitions of both, there is typically confusion over why purchasing stock is not considered investment, but rather saving.  That is because purchasing stock is always called investment in the world of finance.  However when thinking about purchasing stock from a macroeconomist perspective, think in terms of individuals seeking higher yields where people will buy more stocks and boost their saving.  Let’s look at the supply curve within the loanable funds market where there are two interest rates (4% and 6%).  When the interest rate is 4%, the quantity of loanable funds supplied was 40.   However when the interest rate rises, savers are more interested in saving with the quantity of loanable funds supplied increased to 60.  That makes sense.  When individuals can earn higher yields, then it will be more attractive to buy stocks.

Loanable Funds - Supply

Now let’s look at investment where firms and individuals are interested in acquiring productive assets.  That means these new assets will enable them to make or hold more products and services.  For instance, if Proctor and Gamble wants to increase the production of paper towels, then they might want to purchase more machinery, which can speed up the production of paper towels.  However when they purchase machinery, they typically finance it by borrowing money from a bank.  Since acquiring capital usually involves borrowing, firms will seek lower interest rates, rather than higher interest rates.   Assume that the interest rate still rises from 4% to 6%.  In this case, Proctor and Gamble is less likely to purchase more machinery because a higher interest rate makes it more costly to acquire machinery.  That should also be intuitive when we think about ourselves.  If Visa provides you an offer raising your interest rate, then you are less likely to use it.  Let us look at the demand curve for the loanable funds market where we again see the interest rate rising from 4% to 6%.

Loanable Funds - Demand

Notice at 4%, the quantity of loanable funds demanded is at 60.  Then when the interest rate rises to 6%, notice how firms are less interested in borrowing and the quantity of loanable funds demanded is at 40.

In summary, recognize that the supply of loanable funds refer to saving, while the demand for loanable funds refer to investment.  Each will want interest rates to move in opposite directions and that is why the supply curve is up-sloping and the demand curve is down-sloping.

Here are common examples of saving and investment below:

SAVING

INVESTMENT

Saving accounts Large machinery
Certificate of deposits Commercial equipment
Money market accounts Factories
Stocks and bonds New real estate
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5 thoughts on “When Investment Is Not Investment

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