How Money Smoothens Transformation of Savings into Investments?

In a modern economy, savings and investments are affected by two distinct sets of people: Households and Firms. Households save. Firms invest. In real terms, there is no direct link between the savers and the investors.

Economy, thus, needs transformation of savings into investments. In real terms, investments means using of the surplus of real income (in excess of consumption) as resources saved from consumption in producing goods meant for further production.

When savings are aptly invested, there is equality between investment and savings which is an essential condition of equilibrium level of income, output and employment.

Money transmutes real resources into liquid form. Savings in terms of money can be easily mobilised. Households can lend their savings (money saved from income) to firms.

The mobilisation of savings can be effectuated through the working of various financial institutions: banks and non-banking financial intermediaries. Money capital so borrowed by the investors when used for buying raw materials, labour, factory plant etc. becomes investment.

Investment, in real terms, thus, leads to the generation of employment, income and output. Money being the best liquid asset, savings in terms of money or money capital can be channelised into any direction of productive investment.

In this way, money smoothness the transformation of savings into investment in a modern economy.

Use of money as a means of deferred payment has given birth to credit transactions lending and borrowing as a consequence of which the money market and capital market have developed in a modern economy.

The main function of money and capital market is to mobilise savings for investment Thus, money is the basis of transforming savings into investment.

Indeed, money and the consequent development of monetary and financial institutions is an important factor in the process of economic development of a country.

Furthermore, as Paul Einzig points out, with the aid of the modern monetary system, a government is in a position to spend much in excess of the amounts it can rise by taxation, because it can borrow any amount from the public and from the banking system.

The money economy, thus, enables the government to embark upon costly economic, social and political policies which would be out of its reach financially were it not for the dynamic functions of money.

Moreover, money may also play an important part in the social sense by redistributing income and wealth by means of taxation and expenditure.

The institution of money is an extremely valuable social instrument, which makes a large contribution to economic welfare. In the absence of money, many of the transactions of a modern economy and in particular, credit transactions, would not be worth making and as a consequence, division of labour would be hampered and lesser amount of goods and services would be produced.

Real income would, therefore, not only be allocated less satisfactorily from the standpoint of economic welfare, but it would also contain a smaller amount of money, if not all sorts of goods. Obviously, then, money is not merely a veil or a garment.

It is a key by means of which the productive energies which would otherwise be latent can be released. Though money by itself creates nothing, it vehemently influences the creation of utilities.

Chandler aptly writes: “Money is sterile in that by itself it can produce nothing useful, but it has a very high indirect productivity owing to its ability to facilitate exchange and specialisation.”

Money does not merely remain a technical device of exchange. It affects the operative forces of the economy also. All such effects are not always helpful. Modern economists rightly contend that money often gets out of order, sometimes in one way or another, which considerably changes the mode of a capitalist economy.

In fact, the starting point of modern monetary theory is that money is inherently unstable and that it will not manage itself in the best interest of the economy.

Here intelligent and progressive application of the monetary system tends to result in a fuller utilisation of natural resources and in a higher standard of living.

On the other hand, a too narrow and rigid application of the monetary system is ill-managed money supply, which can lead to grave setbacks and let loose destructive forces in the economy.