No: Saving Does Not Increase Savings
The misconceptions embodied in this post’s headline sow more confusion in economic discussions than any others.
“Saving” and “Savings” seem like simple concepts, but they’re not. They have many different meanings, and their different usages (often implicit or unconscious) make coherent understanding and discussion impossible — even, often, in writings by those who have otherwise clear understandings of the workings of financial systems.
In short: if you disagree with this post’s headline, you are thinking (perhaps unconsciously) in the “Loanable Funds” model. And the loanable funds model is complete, incoherent bunk. (I’m not even going to bother citing the hundreds of supporting links here, including unequivocal papers from central bank research departments worldwide; Google them.)
Think this through with me:
Your employer transfers $100K from their bank account to yours to pay you for your work. You’ve saved.
But is there more savings in the banks? More money to lend? Obviously not.
You buy $50K in goods from your employer, transferring the money from your account to theirs. They’ve saved. You’ve dissaved (spent).
But is there more or less savings in the banks? More or less money to lend? Obviously not.
You transfer $50K from your bank to your employer’s, in exchange for $50K in Apple stock or government bonds.
Did you just “save” again? Is there more savings? More money to lend? Obviously not.
When people save up money by spending less than their incomes, they do not add to the stock of monetary savings — the mythical stock of “loanable funds.” Monetary saving does not increase monetary savings.
And since saving up money doesn’t increase the stock (supply) of money, it doesn’t lower the cost (interest rate) of money. On the aggregate level, saving doesn’t “fund” lending. (Banks lend by creating new money ex nihilo if they think they’ll make a profit; that’s what they’re licensed/chartered to do.)
This error and misunderstanding exists partially because there are two ways to “save,” which are widely confuted, conflated, and confused:
Pay people to create real assets — drill presses, houses, ideas, skills, etc. — that you own or have a claim on. Paradoxically, in this case you save by spending.
Increase holdings of financial assets (net of debt) — from dollars to debt securities to Dell stock to CDOs. (It’s much easier to think about this coherently if both dollar bills and deeds are viewed as financial assets: legal constructs designating particular rights or claims on real assets.)
The confution of these two, of course, was all hashed out many decades ago in the Cambridge Capital Controversy — when the MIT/classical Cambridgeans admitted defeat at the hands of the Cambridge Cambridgeans, including acknowledging their central point. (The classicals have proceeded to ignore the whole thing ever since, acting and thinking just as they did before, as if it never happened.)
…the measurement of the “amount of capital” involves adding up quite incomparable physical objects – adding the number of trucks to the number of lasers, for example. That is, just as one cannot add heterogeneous “apples and oranges,” we cannot simply add up simple units of “capital.” As Robinson argued, there is no such thing as “leets,” an inherent element of each capital good that can be added up independent of the prices of those goods.
(This also explains why the the Q in PV=MQ is utterly incoherent: the only unit that can be used to measure Q — dollars — varies with P. It’s like measuring a rubber band using a ruler whose inches vary in length with the changing length of the rubber band.)
People get confused about this partially because “saving” in the national accounts encompasses both real capital created (measured by dollars spent to create it), and net acquisition of financial assets. It’s not what people think it is: a simple sum of everybody’s money saving (income minus expenditures) — not even close.
Here’s how monetary saving happens — aggregate increases in people’s net holdings of financial assets:
People spend money (some of it borrowed from the financial sector), paying people to create real assets. (Purchases of existing real assets can spur creation of new ones — a second-order effect — but the creation’s the thing.)
The market decides that the financial assets that are claims on those assets are worth more than was paid to create the real assets. (Sometimes the market overestimates; this is a problem.)
The people’s debt is unchanged, but their financial assets are worth more. Their net worth has increased. They’ve saved up money. (When the market optimistically bids up financial assets, there’s suddenly, magically, more money.)
Saving (not-spending) money doesn’t increase monetary savings. We saw that obvious reality at the top of this post. Spending (partially enabled by new money creation via bank lending and government deficit spending), coupled with market re-pricing of financial assets, increases monetary savings. This is how the financial system monetizes the accumulated surplus from production.
Since saving money is not-spending, more saving results in there being less savings (relative to the counterfactual of more spending). Or if you must call them this, less loanable funds.
Spending increases savings.
There’s more I’d like to say, but I’ll leave this with a question for my gentle readers:
The IS/LM model seems to be inescapably based on the misconception detailed above — that more saving results in more savings hence, because of supply and demand for loanable funds, lower interest rates.
But: if Krugman’s constantly repeated assertions are correct, that model seems to perform very well.
Why is this true? What am I not understanding?
Cross-posted at Asymptosis.
The more liquid the good the more it looks financial. However, if we posit that counting real goods is a fallacy of composition, then matching liquidity to goods is impossible.
Liquidity take about three months to compute, real goods about a month. So, the summation of liquidity is a slower moving variable, mainly because of the problems you outlined.
@Matt: “The more liquid the good the more it looks financial.”
That’s one way to think about it, and I get it. But I don’t think it’s a really coherent or conceptually useful way to think about it.
It’s closely related to what I think is a misconception re: “money” — that money-like things are specific types of financial assets that can be easily exchanged for real goods. Dollar bills, bank deposits, and such.
But I find it more useful to think about money as the exchange value that is embodied in financial assets (in which class I include both dollar bills and deeds — both claims on real goods/assets). In this construct dollar bills are not money any more than are untradeable auction-rate securities, or deeds. They’re all financial assets — embodiments of money. (That require [almost] no inputs to production and cannot be consumed, human utility cannot be derived from them.)
This does raise a question for me: is your untapped credit limit a financial asset? Is it money? You can trade it for financial assets and for real goods. Pondering this…
This: “People spend money (some of it borrowed from the financial sector), paying people to create real assets”
Caught my eye.
Adding all goods works over time. Look at the arrival rate of the good that is sustainable. Select a probability of an inventory shortage to, say 15%, for all goods. Call it the error rate. If all goods arrive within a 30 year period, then the probability of arrival of any good, k, is the number of times that the good will arrive within the thirty year period, k is less than zero when divided by all possible arrivals in the thirty year period. In this condition, the price is. -log(k), I think. This is the queuing model in a system with 15% congestion (I am sort of hand waving). The bankers curve should follow the same model. The Solow model assumes no congestion.
The difference of no congestion implies separability. The assumption that longer term interest rates can be composed from the short term rate does not work in congestion.
@Matt: Have you or another written this up at more length? Interesting stuff.
“The IS/LM model seems to be inescapably based on the misconception detailed above — that more saving results in more savings hence, because of supply and demand for loanable funds, lower interest rates.”
Well for a start the causation here is wrong. Interest rates are not determined in the IS/LM – equilibrium interest rates are. Higher interest rates results in both lower borrowing for investment and less spending by households. (Really you need to see the IS curve as an equilibrium path not a behavioural relation).
MV=PQ (Which I think you actually mean) being incoherent doesn’t really matter since
MV = T is completely adequate (T = P*Q) since T is well defined. The split of changes in T into changes in P and changes in Q is indeterminate n the short term, but if we accept that Q is upper bounded in the longer term then the relationship between MV and P stands. What determines V is another matter though.
Your are simply re-discovering what J M Keynes had well explained in his General Theory: saving is only a residual variable, and there cannot be any (ex-ante or ex-post) difference between investment and saving within a multiplier theory of income generation. Any additional savings from one agent or sector of the economy always generates an equal amount of dissaving from other agents or sectors. And this holds both in a closed or in an open economy, as for instance, additional net domestic saving corresponds necesarily to an equal net dissaving from the foreign sector.
As regards the IS part of the IS-LM model, you may well have I= I(i), with negative derivative, where i is interest rate, and S=sY, where s is the marginal propensity to save. The equlibrium relationship between i and Y (, that is, the IS curve) will be negatively sloped, and this would be perfectly consistent with your (Keynes’s) view of saving.
One does not need to include any positive functional relationship between S and i (as in lonable fund theory) to get an IS curve.