I have a had this silly doubt regarding savings all the time.neel wrote: A glut of personal savings would result in a fall in interest rates as the supply of loans would have increased. But low interest rates represent a lowered cost of money. Lower cost means higher larger quantity demanded, which manifests as stimulated borrowing, either by people making big ticket purchases, businesses making fixed capital investments, or governments spending borrowed money to buy votes or (less likely) make infrastructure investments (i.e., 100 people saving what they would have otherwise spent on Rs. 5000 bottles of champaign in the bank means that the bank now has Rs. 5 lakh available to loan to either a family buying a new car, a business buying a new delivery van, or a babu providing a man-day of "work" to 5000 people in a moderately large village). Every time someone puts a rupee in the bank, the interest rates fall; every time that bank proceeds lend (i.e., every time that a borrower purchases the lending services from the bank for a loan of) that rupee, the interest rate rises. In a credit market without structural impediments to liquidity, this results in every rupee saved in the bank being lent out by the bank (> 5% of loans are never withdrawn from the banking system as cash, so the CRR constraint has no affect on the liquidity situation). Even if the time scale works out so that the real interest rate is negative for a time (i.e., the banks are so flush with cash that they are paying you to borrow from them), that just induces people to borrow money even faster, so in a monthly average, the money is all lent out (into a more efficient allocation, since businesses got some to fund capital expenditures).
Shouldn't all the money in the system be actually saved in Banks?
even if we spend, that money actually goes into company savings or to pay to employees or to pay for raw materials which inturn goes into bank accounts.
Then how can one distinguish between money saved, lent, spent or invested when its known the same money simply changes hands from consumer to producer to bank?
] I find this line of reasoning strange - this seems to put no onus on the banks to do a due diligence before lending. How does this sit with the 'market knows best' sentiment? (I know RBI governor Y V Reddy was of the view that Banks will cheat if they can). Second, it is also true that the Glass Stegal Acts etc were diluted because of extensive lobbying by the banks them selves who wanted to provide 'comprehensive' services - insurance, investment and core banking. They steamrolled the obvious conflicts of interets. Now shree Greenspan was an avowed 'free market' believer and boy was he proved wrong.
. Now back to my self imposed exile from Econ.