It is often asserted that there is a national income identity, so that in a closed economy without a government sector there is an identity between saving and investment. Explore the implications of this statement by doing the following:
Given a closed economy without a government sector, modify the IS-LM model by the assumption that saving and investment are identical (i.e. equal under all circumstances and not merely in equilibrium) and answer the following: What is the level of aggregate demand? Is the LM relationship required for its determination? Is any interest rate consistent with equilibrium in the commodity market?
Now discuss the following statements: "For purposes of a satisfactory theory of money supply and prices, the IS relationship must never be treated as an identity, so that there is only a national income equilibrium condition." "A satisfactory macroeconomic model must incorporate the potential for disequilibrium between saving and investment, even in a closed economy without a government sector."