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.