THE KEYNESIAN ANALYSIS OF SAVING AND CONSUMPTION
With his monetary theory of interest Keynes unhinged saving and investment from their neo-classical moorings. He was therefore obliged to supply some new connexions to explain the determination of these two variables.
Only after this manoeuvre had been satisfactorily executed was he equipped to present an alternative theory of the determination of national income.In neo-classical thought, the rate of interest had been regarded as the primary regulator of the volume of saving. This is not to say that neo-classical writers entirely neglected changes in national income as an influence on saving. But this relationship was given little attention and, within the framework of their thought, for ample reason. National income, after all, was regarded as a rather stable variable, fluctuating only slightly and temporarily from the normal equilibrium of full employment. Fortified by this presupposition, it appeared to be more pertinent to concentrate attention on the rate of interest. Once Keynes had demonstrated that equilibrium at full employment was far from assured - indeed it was
perhaps the least likely of a range of possibilities - the emphasis assigned to income and to the rate of interest in the interpretation of savings decisions was reversed. The level of income became the crucial determinant, while the rate of interest was cast in a secondary role.
Keynes's decision to tie the theory of savings more closely to the level of income had more than this analytical reason to recommend it. He also argued that this interpretation offered a more realistic account of the behaviour of savers than did the neo-classical explanation. Few people, he maintained, were highly sensitive to interest rate changes in their decisions to save. 'Interest to-day', he argued, 'rewards no genuine sacrifice, any more than does the rent of land.’8 In his view, people sought first an acceptable level of consumption and undertook to save only when their income was more than sufficient to cover consumption requirements. Saving was thus a residual, varying in amount with changes in the level of income.
Few people were likely to be influenced by changes in the rate of interest when allocating their income between consumption and saving.An important corollary was attached to this part of Keynes's argument. Not only was the level of income the most forceful influence on the volume of saving but - as income rose - saving was likely to rise both absolutely and as a proportion of income. Expenditures on consumption, though still rising in absolute terms, would claim a diminishing share of total income. This point had sweeping implications for a rich society's efforts to achieve and maintain full employment. It indicated that a high and rising volume of investment expenditure would be required to bring saving and investment into equilibrium with one another at a full employment level of activity. As Keynes saw the problem:
... the richer the community, the wider will tend to be the gap between its actual and its potential production; and therefore the more obvious and outrageous the defects of the economic system. For a poor community will be prone to consume by far the greater part of its output, so that a very modest measure of investment will be sufficient to provide full employment; whereas a wealthy community will have to discover much ampler opportunities for investment if the saving propensities of its wealthier members are to be compatible with the employment of its poorer members.9
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