According to economic theory:
...The way in which the relative decline of investment in
respect to savings results in economic crisis is not difficult to
see.
In the modern economic community, the sum total of goods and services
appearing in the market is at one and the same time the income of
the community and the aggregate cost of producing the goods and
services in question.
The sums expended by
the entrepreneur on wages, rents, salaries, raw materials,
interest, lawyers' fees, and so on, represent costs to him and
income to those who receive them.
His own profits also enter the picture, since they are his
income and the cost of persuading him to produce the wealth in
question. The goods are offered for sale at a price which is equal
to the sum of all costs (including profits). In the community as a
whole, aggregate costs, aggregate incomes, and aggregate prices are
the same, since they are merely opposite sides of the identical
expenditures.
The
purchasing power available in the community is equal to income
minus savings. If there are any savings, the available purchasing power will
be less than the aggregate prices being asked for the
products for sale and by the amount of the savings.
Thus, all the goods
and services produced cannot be sold as long as savings are held
back. In order for all the goods to be sold, it is necessary for the savings to
reappear in the market as purchasing power.
The usual way in which
this is done is by investment. When savings are invested,
they are expended into the community and appear as purchasing
power. Since the capital good made by the process of investment is
not offered for sale to the community, the expenditures made by its
creation appear completely as purchasing power.
Thus, the disequilibrium between purchasing power and prices in
which was created by the act of saving is restored completely by
the act of investment, and all the goods can be sold at the prices
asked.
But whenever investment is less than savings, the available
supply of purchasing power is inadequate by the same amount to buy
the goods being offered.
This margin by which purchasing power is inadequate because of
an excess of savings over investment may be called the
"deflationary gap." This '"deflationary gap" is the key to
the twentieth century economic crisis and one of the three central
cores of the whole tragedy of the century.
The deflationary gap arising from a failure of investment
to reach the level of savings can he closed either by lowering the
supply of goods to the level of the available purchasing power or
by raising the supply of purchasing power to a level able to absorb
the existing supply of goods, or by a combination of both.
The first solution will give a stabilized economy on a low level
of economic activity; the second will give a stabilized economy on
a high level of economic activity. Left to itself, the economic
system under modern conditions would adopt the former
procedure.
This would work roughly as follows: The existence of the
deflationary gap (that is, available purchasing power less than
aggregate prices of available goods and services) will result in
falling prices, declining economic activity, and rising
unemployment.
All this will result in a fall in national income, and this in
turn will result in an even more rapid decline in the volume of
savings. This decline continues until the volume of savings reaches
the level of investment, at which point the fall is arrested and
the economy becomes stabilized at a low level...
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