Dark age of macroeconomics

13 September, 2016 at 15:41 | Posted in Economics | 3 Comments

In his 1936 “The General Theory of Employment, Interest and Money”, John Maynard Keynes already recognized that the idea that savings finance investments is wrong. Savings equal investment indeed, which is written as S=I. However, the way that this identity (roughly: definition in the form of an equation) holds is exactly the opposite …

461226-1Income is created by the value in excess of user cost which the producer obtains for the output he has sold; but the whole of this output must obviously have been sold either to a consumer or dark age of macroeconomicso another entrepreneur; and each entrepreneur’s current investment is equal to the excess of the equipment which he has purchased from other entrepreneurs over his own user cost. Hence, in the aggregate the excess of income over consumption, which we call saving, cannot differ from the addition to capital equipment which we call investment. And similarly with net saving and net investment. Saving, in fact, is a mere residual. The decisions to consume and the decisions to invest between them determine incomes. Assuming that the decisions to invest become effective, they must in doing so either curtail consumption or expand income. Thus the act of investment in itself cannot help causing the residual or margin, which we call saving, to increase by a corresponding amount …

Clearness of mind on this matter is best reached, perhaps, by thinking in terms of decisions to consume (or to refrain from consuming) rather than of decisions to save. A decision to consume or not to consume truly lies within the power of the individual; so does a decision to invest or not to invest. The amounts of aggregate income and of aggregate saving are the results of the free choices of individuals whether or not to consume and whether or not to invest; but they are neither of them capable of assuming an independent value resulting from a separate set of decisions taken irrespective of the decisions concerning consumption and investment. In accordance with this principle, the conception of the propensity to consume will, in what follows, take the place of the propensity or disposition to save.

This means that investment is financed by credit. When banks create new loans, new deposits are credited to the borrower’s account. These deposits are additional deposits that did not exist before. When spending, the investment takes place (and rises by some amount) and the seller of the goods are services that constitute the investment will received bank deposits. This is income not spend, which means that savings go up (by the same amount). Hence savings equal investment, but not because savings finance investment! Before Keynes, Wicksell and Schumpeter wrote about this as well, so it was common knowledge that loans finance investment and not savings. Today, we live in a dark age of macroeconomics and monetary theory since this insight has been forgotten by most of the discipline.

Dirk Ehnts

3 Comments »

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  1. In the Keynesian circular flow, there’s only spending. Spending on consumption goods is consumption; spending on investment goods is investment. Spending on the accumulation of a hoard of currency or financial claims untethered to ownership of the income of any factor of production ought to have a name, but no one should imagine that the accumulation of such financial claims (aka debts) constitutes the creation of productive factors, aka new capital.
    .
    Recognizing the role of credit in spending, whether for investment goods or consumption goods, is a small advance, but to squander that small advance on the conceit that savings equals investment as a consequence is a terrible waste of realism.
    .
    Money is real. The stupid idea here is that money is an illusion from which we can usefully abstract. Money and the allied ideas of credit, debt and ownership may be fictions used to paper over uncertainty and make deals with the future, but being fiction does not make it merely an illusion.
    .
    The notion that we can strip the shiny baubles and colored fabric of money from the body of the economic system and find the naked real economy beneath is the illusion. It is not a matter of whether investment follows savings or savings follows investment. In a money economy, money savings is not going to equal “real” investment (aka spending on investment goods). Not in a putative “equilibrium” even if such can be imagined. If we are going to be realistic, we had better get real about the reality of money.

    • “The notion that we can strip the shiny baubles and colored fabric of money from the body of the economic system and find the naked real economy beneath is the illusion.”

      Oddly enough, almost all societies, prior to the development of large, professional armies, organized their economic systems without money.

      That and many more amazing facts can be found in _Debt: the First 5000 Years_.

      • Mostly, we don’t really know enough to be confident that we understand how economic systems were organized. We know almost nothing about the financial systems of the ancient Mediterranean, except that they had them — an urbanized trading civilization that lasted 1200 years without leaving archeology much more clue than a lot of coins.
        .
        One problem with the historical appreciation of money is that the well-documented experience of the last three centuries suggests no particular system of money lasts very long without extensive and fundamental changes of architecture — a bit more than a century at the absolute most. The American institutions of money have been altered radically roughly every other generation since colonial days. We’ve been thru three central banks, not counting the Bank of England. We’ve used absurd mixtures of Spanish and other foreign coins, scrip, fur skins, local and overseas merchant credit, and didn’t authorize a national banking system until the 1860s, when a paper currency was issued under wartime pressures. We’ve tried bimetallism and several gold standards; minted silver trade dollars for China; prohibited citizens from even owning gold for a while, stored vast quantities of bullion at Ft Knox and in the basement of the New York Federal Reserve, fixed exchange rates and floated them and now flirt with a digital currency that exists only in the bits of the ether. And, we keep reforming bankruptcy and bank regulations; we have usury laws and then we don’t. And on it goes.
        .
        If the ancient world found monetary and financial systems even half that unstable, they went thru a lot of them over the centuries and we don’t know much more than that they did bookkeeping centuries before they wrote poetry down. Who knows? Maybe the Bronze Age collapse was a particularly nasty bank crisis and not climate change or the invasion of the Dorians and the Sea Peoples after all.😉


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