Savings Shock

At the beginning, the economy is in the long-term equilibrium. Under these circumstances, the savings ratio increases on its own. In the phase diagram, both demarcation lines move to the right such that capital per head goes up and money wages come down. For the streamline see figure 1. In the short term, this impulse reduces consumption, aggregate demand and output, in per capita terms, respectively. On that grounds, unemployment comes into existence. The decline in income calls forth a decline in money demand, which lowers the interest rate and raises desired capital per head. As a consequence, investment per head mounts.