Knut Wicksell Savings and Investment

Knut Wicksell, Savings and Investment

So we come to the difference between saving money and investing it, considered as a disturb­ing factor. Under the influence of the Walrasian timeless system, Wicksell thought it strange that when prices fall, the fall does not merely release purchasing power and thus bring a counteracting increase in effective demand. He assumes that the spending of one individual is the income of another, so that the aggregate purchasing power remains the same. In this con­nection, no allowance is made for time lags.

With this approach, he assumes that "normal" means a con­dition in which (1) Income = Spending, and in which (2) all income not spent for consumption is spent for capital (invested). Such a condition, he thinks, would mean a constant price level, so that, in the last analysis, this is his criterion of normality.

Then he goes on to suggest that departures from normal arise from inequality between voluntary saving and investment. Consumption depends upon the part of their incomes which people want to consume; but investment does not depend on mere voluntary saving. The decisions to save and invest are made by different people. So saving may increase beyond investment, and then income is reduced, consumption declines, and prices fall.
But Wicksell suggests that this process can be controlled by means of the bank discount rate. The market rate can be maintained below the natural rate. This would stimulate investment. Prices would then rise, till finally the market rate rises. Such is the celebrated "cumulative process."