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Savings and Risk-Free Rates

Hi Cullen,

I was wondering if you could answer a question I had about savings held in the bank. I've read about S = I + (S-I). If I understand correctly, if you invest for productive purposes (you buy a restaurant, for example) you save via "I". If you put your money in an insured savings account at your bank, you're saving via "S-I", which is for non-productive purposes.

But what confuses me is that if savings are sitting in a bank account not being productive, why are you paid interest on it? How are you earning a risk-free rate in this example? Given that the loanable funds model isn't correct, its not like your savings are being lent out right? So what gives? How am I earning any return at all?

Thanks for reading.

Hi BC,

I think you have this a bit off. (S-I) refers to the govt's deficit. That is non-govt saving. I refers to private sector saving, which is equal to I. When I buy a restaurant that increases in value my total savings increase. When the govt spends to create a restaurant that also increases non-govt S via S-I, deficit spending.

Hope that clarifies.

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche

Hi Cullen,

Thanks for the reply. From reading your other material, that's more or less the way I understood it. The government deficits allows the private sector their S-I, but to my understanding this is the portion of saving that's not being invested to increase productivity (since obviously it's not I). This is non-productive saving that gets put in, say, your high interest savings account. It's the stuff that commentators always complain that people are "hoarding".

So assuming that's true, if a person's savings account isn't for productive investment, and since a savings account is essentially a risk-free return, why does someone with a savings account get paid interest at all?