Money and Markets: Essays in Honor of Leland B. Yeager

178 Steven HorwitzUnrealizedcapitalaccumulationForced investmentshown by bulge inaccumulationApparent“underconsumption”CooC 1 ,I 1C 2 ,I 2ooSTA G ES O F PRODUCTIONiC 1I 1Excessdemandfor moneySIS’market rate= natural rate i 0oonew naturalrateoDI 2 ,S 2I 1 S 1Figure 12.2 Intertemporal discoordination due to excess demand for money.funds demanded by borrowers is less than that supplied by savers. The hollow pointof disequilibrium on the supply curve in the lower right quadrant represents theactual level of savings at i 0, while the hollow point on the demand curve representsthe actual level of investment at i 0. The difference between those two quantitiescorresponds to the excess demand for money. The long side of the market ruleshere, as in Garrison’s case, because there actually is the level of savings at i 0takingplace. 12 The excess quantity of savings can also be decomposed into two effects.The first is the shift in the supply curve that sets the whole process into motion,while the second is the implicit movement along that new curve that results fromthe market rate of interest remaining stuck at i 0.This excess supply of loanable funds/excess demand for money implies a declinein consumption expenditures. The amount of this decline can be determined byfinding the level of consumption that corresponds to the level of actual saving S 1taking place. The right hollow point in the lower right quadrant corresponds toconsumption level C 1on the production possibilities frontier. However, the actualpoint the economy moves to during the excess demand for money is at the level ofconsumption C 1and the level of investment I 1. Recall that the actual amount offunds available to entrepreneurs is I 1not S 1because the banking system is nottranslating savings into investment appropriately. The hollow point thatcorresponds to (C 1, I 1) is inside the production possibilities frontier, reflecting theWicksellian cumulative rot. It is also of note that I 1corresponds to the originalamount of investment that was taking place before the change in savings behaviorby the public. The net result of the banking system failure is a decline in consumptionand no change in investment. Had the banking system operated properly, we