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The Saving-Investment Link: Short-Run Recession vs. Long-Run Economic Growth

This analysis explores the intricacies of the saving-investment relationship in economics. While increased savings may lead to short-run declines in consumption (C) and aggregate demand (AD), resulting in a potential recession, the long-run effects can enhance economic growth. Lower interest rates can stimulate investment (I) spending on machinery and factories, leading to higher real GDP per capita. This interplay of aggregate supply and demand (AS-AD) models reveals how temporary setbacks in economic activity can pave the way for robust growth in the future.

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The Saving-Investment Link: Short-Run Recession vs. Long-Run Economic Growth

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  1. The Saving – Investment Link What May Cause a Recession in the Short Run will Definitely Enhance Economic Growth in the Long Run

  2. AS-AD LRAS We begin with an economy at full employment. SRAS PL AD Loanable Funds Market RGDP Sfunds Reali.r. Dfunds Qfunds

  3. AS-AD If people decide to save more,we see a short-run effect on both AD and interest rates. S up  C down  AD down S up  Sfunds up  real i.r. down LRAS SRAS PL AD AD1 Loanable Funds Market RGDP Sfunds Sfunds1 Reali.r. Dfunds Qfunds

  4. AS-AD While I spending should rise, it probably won’t rise enough to make up for the decline in C, hence a recession in the short run. BUT . . . LRAS SRAS PL AD AD1 Loanable Funds Market RGDP Sfunds Sfunds1 Reali.r. Dfunds Qfunds

  5. AS-AD 4. Lower interest rates WILL increase I spending some and, to that extent, the economy will experience faster economic growth in the Long Run. Remember: I spending is spending on machines and factories. The result? More RGDP per capita (bigger slices of pie)!! LRAS SRAS faster PL AD AD1 Loanable Funds Market RGDP Sfunds Sfunds1 Reali.r. Dfunds Qfunds

  6. Here’s the whole walkthrough: S up  C down AD down  Y down, PL down, unempl. Up S up  Sfunds up  real i.r. down  I up . . . LRAS up faster (PPF out faster) in Long Run

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