How do adjustments in the savings rate relate to adjustments in investment and the propensity for economic recovery? Please include references or source

 

The global financial crisis and the euro area sovereign debt crisis then led to major and abrupt adjustments as the risks posed by the large imbalances materialised. Although the institutional shortcomings in the EU that permitted the emergence of imbalances have been largely addressed since 2008, the adjustment process is not yet complete. From a macroeconomic perspective, the imbalances in the external accounts have led to the accumulation of high levels of external liabilities that need to be reduced, which, in turn, is weakening investment and therefore weighing on growth prospects and growth potential. From a macroprudential perspective, the lingering imbalances have added to systemic risk and rendered the euro area more vulnerable to risks.

the fall in private saving relative to investment "explains" how the trade deficit could continue to worsen in the late 1990s in spite of the big improvement in the fiscal balance. Also, the budget deficit was decreasing in the years 2003-7 while the trade deficit was widening rapidly; it was again the fall in the saving-investment balance that was correlated with the worsening of the current account at that time.

The saving-investment balance behaved counter cyclically, that is, it rose in recessions and fell in recoveries, because investment is more cyclically sensitive than saving. However, the private saving-investment balance exhibited an unprecedented drop into negative territory during the 1996-2000 periods, and, after rising in the recession of 2000-1, fell back to negative levels in the subsequent recovery (especially 2004-7).

During the times when the saving-investment gap was negative, the U.S. private sector was unable to finance domestic investment spending. The negative saving-investment gap had to be filled by some combination of either an increased budget surplus (which means more government net lending to the private sector) or a reduced current account balance (which implies increased borrowing from abroad). As median wages and household incomes stagnated in spite of rising productivity, households increasingly relied on debt to finance consumption expenditures, and this was aided by the boom in housing prices as well as innovative (and irresponsible) lending practices in deregulated financial markets. 

When the private saving-investment balance turned negative in the late 1990s and again in the early 2000s, the openness of the U.S. economy to international financial flows meant that the extra saving needed to finance domestic investment (which includes housing construction) could be borrowed from other countries. This international borrowing was a necessary enabling factor for the decline in the private saving-investment balance to occur. Without the increase in the current account deficit and the corresponding net inflow of foreign funds, it would have been impossible for the saving-investment balance to fall.