Friday, January 14, 2011

Why the Government must run the right size deficit

A commenter brought up this quote, which I think illustrates the mechanics of how vertical money works rather nicely:
No, money is neither of neither of these.... In an economy without capital (a technology that transfers forgone consumption today into increased POTENTIAL output tomorrow) there simply is no saving.

Take... an economy that produces only back scratching services where nobody can scratch their own back. Suppose there are 100 people in the economy and suppose that everyone only has the strength to provide one back scratch per day. Thus, daily potential output is 100 backscratches, the money supply is $100 distributed uniformly in the population so each backscratch costs a dollar.

Now, suppose one person (only one) decides he'd like to save. He wants to forgoe todays scratch but get two tomorrow. Thus, he provides a backscratch and gets paid a dollar for it which is added to the dollar he already had. However, someone else was unable to sell a backscratch but still consumed his and now has no money. Today output fell to 99 backscratches.

Now, tomorrow the guy with the extra money gets 2 backscratches and still provides one, the guy with no money gets none but still provides a backscratch. Output is back to 100 and the money is back to its uniform distribution. Furthermore, because potential output is capped at 100 total backscratches printing an extra dollar and giving it to the guy who was unemployed on day 1 just causes inflation, no increase in aggregate output. (Although it does have a welfare effect by allowing the unlucky guy to get a fraction of a backscratch.)

So, no net savings, just forgone ouput. Without capital, a way that forgone consumption today is transformed into increased potential outupt tomorrow there will always be zero net savings and any attempt on the part of agents to save in real terms will only result in an output loss. Money in no sense represents past savings here, only productive capital can do that.
I think the comment was meant to refute MMT, but instead it just illustrates the critical role the Government uniquely plays, as currency issuer, to create net financial assets (equity) for the private sector to store.

In the toy economy setup in the quote, there is no source of net financial assets. The economy is endowed with $100 net financial assets at the start. Somewhere, therefore, there must be an entity that has -$100 net financial assets, but stands outside the economy. In our world, the currency issuer (ie. US Fed for the US $) carries a negative net equity balance, and currency users (ie. everyone else) carry, overall, a positive financial asset (equity) balance.

In the example, when one backscratcher wants to save, he just reduces the real output (backscratches) and deprives someone else of income. This is exactly what can happen in the real world in paradox of thrift conditions. There is no way for the economy to increase its net financial assets (equity), all it can do is shuffle around the allocation. This shuffling may or may not result in full output.

In the example, the next period, the backscratcher who had hoarded the extra dollar got an extra backscratch, and everyone was fully employed again. Great! But suppose that the other backscratchers saw that one of their own was idle, and decided they might need some extra money stashed away as well to carry them through lean periods. Well, some of them might try to hoard a dollar too, and now real output is depressed further.

The simple solution to this is for the endogenous currency issuer to simply issue more currency that the backscratchers can happily hoard. This way, you maintain full employment, everyone has their nest egg, and all is well. If the currency issuer over does it, then it can simply tax away some of that extra money so the price of back-scratches remains $1.

46 Comments:

Blogger Neil Wilson said...

The currency issuer could probably also increase interest rates so that hoarding dollars was more attractive than backscratches.

And out of that you see one of the other systemic revelations of MMT - that hoarding money has the same impact on output as taxation. And that's because taxation can be seen as the government hoarding money.

12:12 AM  
Blogger Neil Wilson said...

"In the example, when one backscratcher wants to save, he just reduces the real output (backscratches) and deprives someone else of income. "

Doesn't he actually reduce the real demand for backscratches. The real output was ready, but was wasted.

If that signal continues then some actors are going to simply stop providing backscratches - or forget how to provide them.

What causes the problem here is that the suppliers have no idea that the saver actually wants two backscratches tomorrow. From the suppliers' point of view people suddenly don't want backscratches any more and worse than that their lack of income means they can't inform other suppliers of their demand for a backscratch.

12:27 AM  
Blogger Neil Wilson said...

There is of course one other lesson from the classical model described. The design assumption is that you don't get any income unless you sell something.

And what happened is that one individual did everything the economy asked of him. He stood ready to provide backscratches. Set out his stall as the designers of the economy required. And yet nobody turned up. He had no income. He wasn't able to get his backscratch. He was unemployed.

And all because some other actor in the economy made the rational decision to defer gratification. Again not unexpected behaviour.

In this model nominal saving causes unemployment and suffering for real people. And for that reason alone it is an unacceptable system - however algebraically pure it might be.

1:23 AM  
OpenID vimothy said...

But there is no real saving on aggregate, even with the NFA injection which prevents the fall in output, because on aggregate the economy cannot "carry consumption forward" unless it increases future production of consumption goods, and it cannot do that unless it adds to the capital stock.

4:09 AM  
Blogger Neil Wilson said...

Yes vimothy - totally agree. There can be no nominal savings either at this level of activity as you would have to run a balanced government budget to prevent inflation.

But by putting in the policy you would prevent unemployment and somebody suffering from an itchy back. And in this system that would probably mean taxing the saver, which would probably prevent them saving in the first place.

And you could take that taxation action after you'd provided 'unemployment benefit' to the individual who lost out.

4:50 AM  
Blogger JKH said...

Winterspeak,

Very good.

I think your analysis probably implies that in a service economy with no real investment, the assumed money “endowment” by default must be NFA originally provided by the government, assuming a fiat currency system. There’s no obvious assumption as to exactly what the government might have originally purchased from non government in order to generate that NFA, so the easiest default assumption is to assume that it was effectively a gift from the government (e.g. a tax credit), generating the positive NFA endowment for the non-government back scratchers.

The final paragraph of the quote correctly identifies the fact that there is no net saving from a national accounts perspective (assuming a closed economy for simplicity), and no real investment. Investment = saving from a NA perspective.

But several more things need to be considered to understand how this economy operates:

a) The macro fact (implied) of non government positive NFA as the endowed money position

b) For a GIVEN NFA setting, the potential for micro positive and negative saving (flows), summing to zero for the accounting period, both on an NA basis and an NFA basis

c) The potential for additional NFA flow perturbations generated by the government, such as new policy responses to overly thrifty back scratch behaviour

BTW, at the end of the day, it ALWAYS comes down to consistent definitions and consistent accounting as the sine qua non of real understanding and communication in economics. The thorn that plagues most of the internet debate around economic issues is the failure to use standard accounting terms correctly, or at least the failure to recognize that lack of precision or care or agreement in using them really messes up a conversation from square one. And then you have those economists who actually believe that accounting is irrelevant. It is absolutely essential in the case of a monetary economy, as well as the case of comparing a monetary economy with a barter economy. Which means it’s always essential.

P.S.

“In our world, the currency issuer (i.e. US Fed for the US $) carries a negative net equity balance”

Bravo on the use of the term “negative equity”.

True MMT’ers would not be so bold, which is a problem, IMO

P.P.S.

My favourite part of the original conversation:

“You're "F****N" right it's an accounting question!!! I just did the entries for you @ 5:30!!!!”

:)

5:30 AM  
OpenID vimothy said...

Neil, ws, anyone,

So how does the economy add to the capital stock and produce real savings?

5:37 AM  
Blogger Current said...

I don't really like this example. If it shows anything it shows that in an economy without durable assets, without real assets it may be useful for someone to create money. That may be true, but it doesn't have anything to do with our real world where there are loads of durable assets.

I think I'll explain my view on recessions, I agree with George Selgin and Steve Horwitz's "monetary disequilibrium" view. Let's say there is a recession for some reason, it could be a political crisis or an episode of ABCT. Now, that recession has led to the destruction of productive capital, that will lead to future real income being lower than it would have been. There is nothing that can be done about that.

That crisis may also lead to greater uncertainty about the future. That can cause households and businesses to demand more money to hold. There can be an overall economy-wide rise in the demand for money. That demand could be matched by a rise in the supply of money. If that happened then there would be little change in prices (though inevitably some). But, what happens if there isn't an increase in supply of money? In that case people will hold onto money that they are receiving as income, or sell assets, they will "hoard". If you like the equation of exchange you can look at this with it. Velocity is decreasing, the velocity V in MV=PT is inversely proportional to accepted demand for money. In order for the excess demand for money to be accepted prices must fall. But, prices are not perfectly flexible. So, if a rise in demand for money beyond supply occurs quickly then they may not adjust quickly enough. If that happens then quantity adjustments will happen as well as price adjustments - output will fall. Hayek called this the "secondary recession" secondary because it happens after some crisis or other. If the quantity of money stays fixed then prices will eventually fall to a level where the excess demand for money is eliminated. That process would be more damaging than meeting the demand in the first place, but it could occur.

Notice that what I'm saying applies to the short-run where money prices are very important. It's the delays in prices changing or "price stickiness" that cause the problem. So, price stickiness, production of money and generation of uncertainty are the important problems for macro policy.

8:50 AM  
Blogger winterspeak said...

vimothy: In the toy example, there is no durable output, and therefore there is no real (atom & sweat) saving or capital stock.

Suppose we changed the example so backscratches were somehow durable, and could be consumed in the period they were produced, or any future period.

In this new state of the world, when someone decided to save (nominal) it meant that a produced backscratch would no longer be consumed. Since backscratches are now durable, this backscratch would be available in future periods. Therefore, it would be booked in the current period as capital stock of some sort.

Labor produces real (sweat & atoms) output and is paid in nominal units (number in a spreadsheet). If they choose not to consume all of their real output, some of that output is available next period. In the current period, it is booked as real investment (inventory or real atom & sweat capital). By choosing not to consume all of their real output, they are also choosing not to spend all of their nominal income (number in a spreadsheet). This nominal income is booked as "savings".

Thus, S=I. Savings "creates space" for, but does not direct, real investment.

10:15 AM  
Blogger Current said...

Winterspeak,

What would be a good paper to read about the MMT/Neo-Chartalism approach to savings and deficits?

I know there are lots of blog posts about it, but is there a paper that brings it all together.

I know about Wray's book, but I don't really want to buy that right now.

11:07 AM  
Blogger JKH said...

Winterspeak,

Don’t understand what you’re getting at with “saving creates space for investment”.

Saving is the forced (macro) accounting result of income paid to the factors of production of investment goods. Investment forces the accounting space for saving, if anything, the way I see it.

Wouldn't you agree?

11:53 AM  
Blogger Rogue Economist said...

"suppose one person (only one) decides he'd like to save. He wants to forgoe todays scratch but get two tomorrow. Thus, he provides a backscratch and gets paid a dollar for it which is added to the dollar he already had. However, someone else was unable to sell a backscratch but still consumed his and now has no money. Today output fell to 99 backscratches"

But what if the amount involved constitutes the whole income stream of these persons? How does that change the dynamics of the economy? The last person not getting his $1 doesn't buy his backscratch either (he doesn't have the money), so neither does the next person who would have given him the scratch. So it's pretty quick process going from 100 scratches to zero. And with everyone now having zero income, how do you get everyone back to getting scratches?

12:29 PM  
Blogger winterspeak said...

Rogue: Yeah, it can get ugly quickly. You need the endogenous money issuer to step in and supply the demanded net financial assets, either by draining less (through taxes) and/or supplying more (by spending).

Current: I don't have a paper recommendation -- I would try all the "required readings" at Mosler Economics though.

JKH: I don't think we're too far off. I use the term "makes space" to emphasize how the savings does not fund or direct the investment. Orthodox macroeconomist interpret S=I as somehow the savings is funding the investment, and therefore savers have responsibility if the investment goes bad. This isn't true for a whole host of reasons, but the way I try to explain it is as I did in the post.

"Investment creates savings" is the Harless interpretation, and I'm OK with that too, but if I choose to forgo some consumption in this period, it leaves some real output somewhere for next period -- which is investment. I think there's more to it than a Tesla factory worker getting his monthly paycheck and deciding not to spend it all at once.

2:02 PM  
Blogger Greg said...

Winterspeak

Your last three posts, plus the comment section exchanges, are some really good stuff. You are on a roll.

I think its the care which MMT takes with the terms savings, investment, financial assets etc that make it so easy to follow and give it strength.

Without proper accounting there is no way to know how much of what is where and who has it.

2:32 PM  
Blogger Current said...

Personally, I'm struggling to see the genius here.

"You need the endogenous money issuer to step in and supply the demanded net financial assets, either by draining less (through taxes) and/or supplying more (by spending)."

By "endogenous money issuer" do you mean government? Or do you mean banks?

If he has to step in then isn't he exogeneous? I'm OK with economic theories where government action is endogenous, but in those you have to be rigourous about using the term.

2:38 PM  
Blogger winterspeak said...

LOL! I'm being perfectly rigorous, Current.

By "endogenous" I mean able to create net financial assets for the sector demanding them. There are no banks in our model, but even if there were, they cannot create net financial assets, only gross.

4:25 PM  
Blogger RSJ_2011 said...

"on aggregate the economy cannot "carry consumption forward" unless it increases future production of consumption goods, and it cannot do that unless it adds to the capital stock."

Yes, but this comment is a bit like responding to "Look, I ate a great dinner!" with "Well, yes, but Obama is president." You are talking about two different things.

The purpose of saving is to time shift consumption.

Therefore, in aggregate, there will be some people who are pulling consumption forward because they have saved in the past (or expect to save in the future), while there are others who are saving now in order to repay past consumption or fund future consumption.

None of that requires an increase in the capital stock -- in fact, it's completely orthogonal to the size of the capital stock. In general, savings doesn't have anything to do with the capital stock at all.

Economy-wide, these two should cancel out unless you provide some good reason for them not to. Why should, in the aggregate economy, more people be saving than dissaving? Perhaps a growing population, or changing preferences, or new techniques, etc.

Therefore what you are measuring by looking at aggregate savings is not the individual's optimization program, but rather you are measuring population growth -- or changing preferences, etc.

Aggregate savings has nothing to do with the individual's time-shifting problem.

And of course, the "aggregate economy" is not time shifting anything, it is producing consumption and capital goods in response to changing prices and outlook.

4:46 PM  
Blogger Tom Hickey said...

Current, for starters, try Scott Fullwiler, Modern Monetary Theory - A Primer on the Operational Realities of the Monetary System

Fullwiler, Modern Central Bank Operations— The General Principles

re Winterspeak @ 2:32:

As Neil points out above, it is consumption that sends the signal for investment, rather than saving. In fact, saving as non-consumption sends the opposite signal. This is basic to understanding demand-side v. supply-side.

S=I is an identity that has nothing to do with transmission. Saving does not cause investing and the amount of saving doesn't cause investment, just as the amount of reserves doesn't cause lending. Again, it seems to be confusing ex post with ex ante. As Winterspeak mentioned previously, loans create deposits, deposits don't create loans.

5:06 PM  
Blogger JKH said...

Winterspeak,

You and I are typically closer to agreement with each other than with others. Nevertheless, we usually end up with some differences. As you say, we are close, but here are some nuances:

“Orthodox macroeconomist interpret S=I as somehow the savings is funding the investment, and therefore savers have responsibility if the investment goes bad.”

I hear you, but the dimension of responsibility (a la Waldman, presumably) has nothing in fact to do with proper accounting and causality - notwithstanding that Waldman himself tends to drive the issue of responsibility on the premise of what you and I would consider to be a false assumption about causality.

“If I choose to forgo some consumption in this period, it leaves some real output somewhere for next period”

Forgoing consumption in the current period (presumably micro, and at the margin) leaves consumption for somebody else in the current period. It has no necessary effect on anything in the next period, unless there is an actual contract to reverse the current period transfer, which may be your assumption here. In any event, it need not have any link to real investment in the current or next period, due to the potential and frequent existence of negative saving dynamics, in lieu of a real investment offset to micro saving.

“I think there's more to it than a Tesla factory worker getting his monthly pay check and deciding not to spend it all at once.”

I don’t think a reasonable person (e.g. me hopefully) would interpret “investment funds saving” that way. Investment forces macro saving in an amount equal to investment goods production factor payments. That’s an accounting and causality identity. But obviously that doesn’t mean the factor payments constitute the saving. The factors consume like anybody else. But by the mathematical implications of the identity, and using as a starting point the temporary/starting assumption that factor income would otherwise constitute macro saving, any actual consumption by the factors then forces others to save an equivalent amount. I.e. to the degree that the factor recipients spend on consumption rather than save, others must save. In addition to that, and quite separately in terms of the macro/micro logic of the investment/saving identity, those who borrow to consume essentially dissave at the margin, which forces others to save. All of this adds up to the identity that investment equals and drives macro saving.

5:26 PM  
Blogger Current said...

> By "endogenous" I mean able to create net financial
> assets for the sector demanding them.

What "endogenous" means coming from within. In economics if you have a model then a variable is endogenous if it is determined by that model. It is exogenous if it isn't determined by the model, if it's imposed from outside.

Within a model you can't say that something endogenous "has to" do this or that, endogenous means that they *will* do it by assumption.

Are the government endogenous or exogenous in your model? Sounds like they're exogenous to me.

> There are no banks in our model, but even if there
> were, they cannot create net financial assets,
> only gross.

Well, there are banks in the real world. But, you're right, they can't create a net of financial assets over liabilities in the private sector. For every pound of asset they create they create another pound of liability.

7:23 PM  
Blogger winterspeak said...

Current: Oops! I meant "exogenous" not "endogenous". Hopefully it all makes more sense now.

RSJ: Orthodox macro models savings as an intertemporal consumption decision, but I think this model is a poor treatment of the behavior. I've gone into why in some depth in prior posts, and you can read where orthodox macroeconomists (Harless, Rowe) go with the model. I think it's ridiculous on its face, but please make up your own mind. It's just really hard to move consumption forward.

btw -- are you the same RSJ as the RSJ who appears sometimes on Mosler? Why the timely extension to your nom de guerre?

7:59 PM  
Blogger winterspeak said...

JKH posted this, not sure why the web page did not update. Anyway, from JKH:

Winterspeak,

You and I are typically closer to agreement with each other than with others. Nevertheless, we usually end up with some differences. As you say, we are close, but here are some nuances:

“Orthodox macroeconomist interpret S=I as somehow the savings is funding the investment, and therefore savers have responsibility if the investment goes bad.”

I hear you, but the dimension of responsibility (a la Waldman, presumably) has nothing in fact to do with proper accounting and causality - notwithstanding that Waldman himself tends to drive the issue of responsibility on the premise of what you and I would consider to be a false assumption about causality.

“If I choose to forgo some consumption in this period, it leaves some real output somewhere for next period”

Forgoing consumption in the current period (presumably micro, and at the margin) leaves consumption for somebody else in the current period. It has no necessary effect on anything in the next period, unless there is an actual contract to reverse the current period transfer, which may be your assumption here. In any event, it need not have any link to real investment in the current or next period, due to the potential and frequent existence of negative saving dynamics, in lieu of a real investment offset to micro saving.

“I think there's more to it than a Tesla factory worker getting his monthly pay check and deciding not to spend it all at once.”

I don’t think a reasonable person (e.g. me hopefully) would interpret “investment funds saving” that way. Investment forces macro saving in an amount equal to investment goods production factor payments. That’s an accounting and causality identity. But obviously that doesn’t mean the factor payments constitute the saving. The factors consume like anybody else. But by the mathematical implications of the identity, and using as a starting point the temporary/starting assumption that factor income would otherwise constitute macro saving, any actual consumption by the factors then forces others to save an equivalent amount. I.e. to the degree that the factor recipients spend on consumption rather than save, others must save. In addition to that, and quite separately in terms of the macro/micro logic of the investment/saving identity, those who borrow to consume essentially dissave at the margin, which forces others to save. All of this adds up to the identity that investment equals and drives macro saving.

8:18 PM  
OpenID vimothy said...

Don't follow the reversal of causality here...

Flows of output available for investment are equal to whatever is unconsumed or used for public purpose (in a closed economy).

8:51 PM  
Blogger winterspeak said...

JKH: OK, let's go deeper.

It is true that if I forgo consumption of real output in a period, then someone else may consume that output. But they still need to pay for it, and them buying my output means they cannot by someone elses. At an aggregate level, a savings decision by me means there is some real output left unconsumed somewhere, even if the specific piece of output I chose to leave unconsumed is consumed by someone else instead.

Therefore, whatever piece of real output that ends up not being consumed, directly or indirectly by my decision to (nominally) save, is still available in the next period. This is booked as real investment.

I am assuming that my decision to save is not negated by someone else's decision to dissave. My savings decision ends up constituting the aggregate savings for the period. I am also not assuming that the real output I choose to not consume is the real output available next period, someone else may choose to consume that but then they would leave some other item of real output unconsumed, and therefore available in the future etc.

9:24 PM  
Blogger Neil Wilson said...

Doesn't it also depend whether the real output that gets left is ephemeral or not. Service effort cannot be saved. A Pret A Manger sandwich is not saved.

There is another consumer - waste.

10:37 PM  
Blogger RSJ_2011 said...

Winterspeak,

Yes, it's me -- but your blog requires registration, so I made a gmail account, and three letters wasn't enough.

"RSJ: Orthodox macro models savings as an intertemporal consumption decision, "

I am arguing that orthodox macro does not properly model savings as an intertemporal consumption decision because they effectively use national savings divided by the number of households as the input into the amount saved.

That means any actual savings as traditionally practiced by households is zero in those models.

All that you have is the residual, which doesn't have anything to do with a household's intertemporal problem, but is a measure of things like population growth or technological growth.

Savings in orthodox macro has nothing to do with the household consumption problem -- it has no micro roots -- it's based on growth theory.

They get around that internal inconsistency by assuming dynasties, etc., but that's not a plausible model of behavior. Very few households leave any nest eggs behind, and yet in the course of their lives they engage in large amounts of borrowing as well as saving. That means that they are consumption smoothing for their own lives, not for the life of the "economy".

With overlapping lives, you would not expect there to be a big relationship between the savings problem of the individual and economy-wide savings.

Here is a specific example:

Imagine an economy with no investment, but pet rocks -- e.g. land. Households buy the pet rocks when young and sell them when old, thus shifting consumption across time.

Each has household has savings, and yet no savings occur in the economy.

Now suppose the pet rocks are purchased with credit. It just gets a little bit more complicated, as households borrow to buy the pet rocks when young, and can get what is effectively a reverse mortgage when old.

The point is, in this model, you clearly have interest rates.

And yet you have no "real" savings and no "real investment".

So what determines interest rates in this model, in which there is no such thing as a loanable funds market?

The answer is the same thing that determines interest rates in the real world -- the financial market, or the market for borrowers and lenders in general. Even if there are no savers or investors in the "real" sense.

Moving onto the world in which we have both pet rocks as well as productive investment options, again what determines interest rates? It cannot be the desire for "real" savings agains the desire for "real" investment. It still must be the desire to borrow and lend only, for any purpose. That may or may not correspond to a certain amount of investment and saving in the national income sense.

So the conflation of household savings with national savings is a big problem, IMO. Models of the economy in which national investment clears national savings as a result of interest rate considerations can only apply to models in which there are no pet-rocks and it is impossible to roll-over debt from one period to the next.

In terms of whether you should view savings as deferred consumption at all, you have to. As long as you define savings as income - consumption, then by definition savings is deferred consumption. That some people prefer to hoard is another question, relating to the utility derived from savings, rather than the definition of savings itself.

11:03 PM  
Blogger RSJ_2011 said...

Winterspeak,

Yes, it's me -- but your blog requires registration, so I made a gmail account, and three letters wasn't enough.

"RSJ: Orthodox macro models savings as an intertemporal consumption decision, "

I am arguing that orthodox macro does not properly model savings as an intertemporal consumption decision because they effectively use national savings divided by the number of households as the input into the amount saved.

That means any actual savings as traditionally practiced by households is zero in those models.

All that you have is the residual, which doesn't have anything to do with a household's intertemporal problem, but is a measure of things like population growth or technological growth.

Savings in orthodox macro has nothing to do with the household consumption problem -- it has no micro roots -- it's based on growth theory.

They get around that internal inconsistency by assuming dynasties, etc., but that's not a plausible model of behavior. Very few households leave any nest eggs behind, and yet in the course of their lives they engage in large amounts of borrowing as well as saving. That means that they are consumption smoothing for their own lives, not for the life of the "economy".

With overlapping lives, you would not expect there to be a big relationship between the savings problem of the individual and economy-wide savings.

Here is a specific example:

Imagine an economy with no investment, but pet rocks -- e.g. land. Households buy the pet rocks when young and sell them when old, thus shifting consumption across time.

Each has household has savings, and yet no savings occur in the economy.

Now suppose the pet rocks are purchased with credit. It just gets a little bit more complicated, as households borrow to buy the pet rocks when young, and can get what is effectively a reverse mortgage when old.

The point is, in this model, you clearly have interest rates.

And yet you have no "real" savings and no "real investment".

So what determines interest rates in this model, in which there is no such thing as a loanable funds market?

The answer is the same thing that determines interest rates in the real world -- the financial market, or the market for borrowers and lenders in general. Even if there are no savers or investors in the "real" sense.

Moving onto the world in which we have both pet rocks as well as productive investment options, again what determines interest rates? It cannot be the desire for "real" savings agains the desire for "real" investment. It still must be the desire to borrow and lend only, for any purpose. That may or may not correspond to a certain amount of investment and saving in the national income sense.

So the conflation of household savings with national savings is a big problem, IMO. Models of the economy in which national investment clears national savings as a result of interest rate considerations can only apply to models in which there are no pet-rocks and it is impossible to roll-over debt from one period to the next.

In terms of whether you should view savings as deferred consumption at all, you have to. As long as you define savings as income - consumption, then by definition savings is deferred consumption. That some people prefer to hoard is another question, relating to the utility derived from savings, rather than the definition of savings itself.

11:04 PM  
Blogger Neil Wilson said...

@Current

Does it help if you consider the government sector has just being the central bank?

The difference between the central bank and a regulated normal bank is that the central bank is not capital constrained - therefore it has infinite capacity to expand its balance sheet. Its deposits are in demand by all since they are the only way to extinguish tax liabilities.

From the government's point of view the central bank is just a big credit card account.

MMT has a horizontal model for the non-government sector. Government deposits (High Powered Money in MMT terms) are exogenous to this horizontal model.

The horizontal model usually has a 'deficit' or a 'surplus' of government deposits.

Generalised the model is that there is a hierarchy of money and the currency issuer sits above the currency users in that hierarchy. Currency issuer to Currency user is a vertical transaction. Currency user to Currency user is a horizontal transaction. Currency issuer + Currency users = currency zone.

So 'currency' is endogenous to the currency zone but exogenous to the currency users.

All AIUI

11:18 PM  
Blogger Neil Wilson said...

"This is booked as real investment."

It might be called that economically. I think that's an unfortunate term. In accounting its very likely to be called 'inventory' which is negative for production in the next period.

Accountants don't like inventory.

12:07 AM  
Blogger Neil Wilson said...

@Current

This paper by Scott Fullwiler might help. It's an overview with links in it.

2:29 AM  
Blogger JKH said...

Winterspeak,

I’m not quite sure of the point of your last comment at 9:24 p.m., unless it’s for illustration/ confirmation of a specific case. You’re running a specific scenario – one of several possibilities – that is constrained at the macro level according to your ultimate specifications (which BTW contradict your initial general statement in the same comment). But it’s only one scenario.

But let me restate/rerun your scenario in my own terms, for confirmation hopefully:

Suppose in case 1 there is no change in inventories over the accounting period. That means aggregate consumption is EQUAL TO the LEVEL of all goods produced for consumption in that period.

Now define case 2 as case 1 plus additional saving by Winterspeak of 1 unit over the same period, and nothing else.

Then inventories increase by 1 unit. There is real period output of 1 unit left unconsumed in that case. That results in an increase in inventory. That increase in inventory now becomes additional investment for the period. I believe that’s your example fully stated.

Now define case 3 as case 2, but where I also consume an additional unit during the same period. I dissave at the margin (micro) and inventories are back to case 1 level. There is no real output for the period left unconsumed in that case, and no increase in investment.

(Remember that the starting inventory level is not included in the measure of goods produced for consumption during the period.)

So it is clear that case 3 does not satisfy your general claim that:

“At an aggregate level, a savings decision by me means there is some real output left unconsumed somewhere, even if the specific piece of output I chose to leave unconsumed is consumed by someone else instead.”

In fact, in case 3, the output you didn’t consume is “consumed by someone else instead”, and yet there is no “real output left unconsumed somewhere”.

But then you subsequently contradict your initial general claim by specifying the macro constraint that defines the feasibility of your case 2 (in distinction to my equally feasible case 3):

“I am assuming that my decision to save is not negated by someone else's decision to dissave.”

That’s a particular constraint with a different outcome. But that qualification contradicts your first statement of generality. It’s the qualification that I deliberately overrode in structuring case 3, changing your case 2, and meaning that your first statement above isn’t true as a generality.

There are different cases with different outcomes, so I’m not sure what point you’re making, unless again it’s just for clarification/illustration. You’re describing micro behaviour with a result that in order to be true is constrained by a very specific macro result – a macro result that you were ultimately forced to specify in full. Other outcomes are possible, according to different macro specifications.

In term of specifying any FEASIBLE future scenario, the specification of macro always constrains the end result of micro. Many economists don’t consider this fully in their discussion of possible outcomes – especially those who bluntly and foolishly shun the value of accounting as an embedded and required discipline within economics. The fallacy of composition is the general case of such accounting neglect. (A lot of what Keynes did was simple accounting logic and constraint recognition.) In your comment example, you have fully specified the macro constraint (ultimately, in your final paragraph) that produces your desired outcome, which is fine, and what people should do when constructing scenarios.

I’ve said nothing that denies the possibility of your specific scenario, so I’m assuming your deeper point is one of constructing an example of one possible outcome. But your initial statement in the same comment regarding the assumed generality of its accompanying macro context does not hold. Macro must always be specified in constructing coherent, fully formed and feasible micro outcomes as potential future scenarios.

2:47 AM  
Blogger winterspeak said...

JKH: Sorry, I was really unclear. I'm just trying to illustrate my position.

In case 1, as you say, there is no change in inventories over the accounting period. Aggregate consumption is equal to the level of all goods produced in the period.

Note that this does not mean no individual saved (or dissaved). It just means that the quantity of micro savings must be equal to the quantity of micro dissavings, so net, there is no change in the macro level of savings (nominal) over the accounting period either.

In order for there to be an increase in inventory in a period, aggregate consumption must be smaller than the level of all goods produced in the period.

This means that there must be macro (nominal) savings in that period. Assume there is no dissavings (for simplicity). An individual micro savings decision does not determine what real good actually ends up being available next period. I decide not to eat a banana and save the money instead. But someone else eats the banana instead of buying a lightbulb. The lightbulb is now available in period 2.

If i had not saved and ate the banana, the lightbulb would get consumed too and there would be no real goods left over for the subsequent period.

thanks for the old link btw. what a blast from the past. I think when we first met, I was an austrian!

10:02 AM  
Blogger JKH said...

Very good.

BTW, an amusing reference to Waldman toward the end of this post:

http://www.themoneyillusion.com/?p=8324

1:25 PM  
Blogger JKH said...

P.S.

Krugman rocks:

http://krugman.blogs.nytimes.com/2011/01/16/when-logic-and-proportion-have-fallen/

:)

1:30 PM  
Blogger Current said...

When you folks are worried about saving are you concerned about a rise in the demand for money?

Or, are you concerned about all types of saving including bonds?

1:50 PM  
Blogger winterspeak said...

JKH: Glad I was able to clarify myself. I'm not sure whether we're on the same page though, as I don't think I'm saying the same thing as you are saying.

And poor old robot-like Sumner. So desperate to get Krugman to notice him again that he sidles next to a toad like DeLong. I see Waldman continues to rub shoulders with Power. Good for him! Even though his knowledge of this stuff is pretty limited, amongst the blind at the AEA he must be like a King. Pity he desires to enslave us all (for our own good of course!) but in that too he's hardly unique.

Current: I'm glad you're on this board. You remind me of me about 2-3 years ago. Mosler should be your next stop.

3:14 PM  
Blogger JKH said...

I think I'm OK with your 10:02

but ... bananas, light bulbs, back scratches ...

what has Nick Rowe done to you?

3:25 PM  
Blogger winterspeak said...

I'm taking meds.

Anyway, that's what I mean when I say savings "makes room" for investment.

4:33 PM  
Blogger RSJ_2011 said...

Winterspeak,

When you refrain from buying $1 of goods, then

1) The price of goods can fall, so that the same number of goods are still produced and sold, and real national income, savings and investment is unchanged.

2) The good is not produced (e.g. haircuts, services), so that real national income declines and national savings and investment does not increase.

3) The good is produced, but not sold and carried over into inventory.

You seem to be assuming that only #3 is possible.

You cannot assume anything about national savings or investment as a result of the actions of a single person.

National Savings and Investments are aggregate phenomena that can only be determined after you take into account the reactions of everyone else to the decision of the individual.

They are ex-post side effects of the interplay between the savings/consumption trade off of the individual with the production/investment trade-offs of producers.

All the producers can take actions to invest more, and all the consumers can take actions to save more, and yet national investment can decrease.

National investment, national consumption, and national income are not the objectives that actors optimize, and there is no direct relationship between the actor's own value functions and aggregate quantities such as national income or national savings.

P.S.

Yes -- it's me, but Google doesn't allow for 3 letter acronyms :)

6:36 PM  
Blogger Current said...

What on earth is a "causality identity"?

2:32 AM  
Blogger JKH said...

Winterspeak,

I didn’t intend to return to this, but:

I agreed your “saving makes room for investment” applies in the context of your 10:02 comment above.

That’s because excess saving leads to unintended inventory accumulation, which is classified (correctly in my view) as investment.

But this idea of “saving makes room for investment” does not apply to the firm’s intended permanent investment, ex inventory and inventory volatility.

Inventory can be viewed as an investment where the firm is essentially short a call option, such that the potential purchaser/consumer has the right to convert the firm’s investment to the purchaser’s consumption (strike price = sales price).

Inventory fluctuates to the degree that the firm accumulates inventory investment, issues those options, and whether or not they are exercised.

Thus, “saving makes room for investment” is the case in this particular context, in that the potential consumer can choose not to exercise the option to purchase, and to save instead. His/her choice “makes room” in that sense.

However, this optionality characteristic does not apply to the firm’s intended permanent investment infrastructure (“non-circulating” is a term I seem to recall from somewhere long ago.). I.e. it does not apply to investment ex inventory.

The consumer has no right or capability to convert the firm’s permanent investment to his/her own consumption. That investment remains permanently with the firm, with no conversion option, by construction and by definition.

All my previous comments then apply to this permanent investment piece, in the sense that “investment creates saving”.

It is inventory and inventory volatility where your observation applies, and it is an important observation IMO, since it drives saving at the margin. It can make room (inventory accumulation) or take away room (inventory drawdown) in the sense of marginal saving or dissaving.

2:33 AM  
Blogger winterspeak said...

Hi JKH:

I'm actually glad that you brought this up, because I knew there was something we had not settled on.

Let me argue that "savings makes room for investment" in the case of inventory (as we agree) AND in the case of a firm's intended permanent investment (ex inventory and inventory volatility).

Suppose a firm decides to invest in a plant. They hire people to build it and buy material to construct it out of. When the firm pays those factors of production, it books it as "investment" and the factors book it as "saving" (within the period, directly or indirectly). This is the coarsest interpretation of Harless's "investment creates savings" essay.

Nominally, you can see how the numbers change.

Switch to real (sweat & atoms). In order for the plant to be available next period (ie for it to be really investment) it must not be consumed in the current period. This means that, somewhere, factors of production who have the savings to consume the real components of the plant, or substitutes, have decided not to excercise that option (or were unable to because time ran out in the period).

Whether it is for inventory or durable capital, in order for real investment to occur, sweat & atoms output cannot be consumed in the period. And if all aggregate sweat & atoms output is not being consumed in the period, some (nominal) renumeration of that output must be not spent. There must be aggregate savings somewhere.

10:26 AM  
Blogger JKH said...

Winterspeak,

Sorry, I found your last comment to be somewhat confused in my viewing of it:

a) The factors that produce investment goods don’t book (all) their income as saving. I went through this above – they WOULD book it as saving IF they didn’t consume anything else, BUT they DO consume other things, which forces those others (i.e. those other factors) who earned income from producing those consumption goods to save. The latter have to save because the consumption goods they produced are no longer all available for them to consume. It’s a process of logical iteration/regression.

b) You seem to have adopted my option terminology. I explained that this doesn’t apply to core investment goods ex inventory; there is no option to consume core investment goods ex inventory – it doesn’t exist by construction and definition of what (core) investment goods are. They are not inventories of consumer goods. They can’t be consumed by consumers under any circumstances. There is no option. That’s precisely why I introduced the option model – to illustrate the point that applies in the case of inventories of consumer goods but not in the case of core investment goods. That’s the illustration of why core investment creates saving and saving does not make room for core investment. There is no making room when there is no option not to make room (i.e. no option to consume core investment goods) in the first place.

c) Yes, there is aggregate saving offsetting the real investment. We agree on that. But that doesn’t involve saving making room for investment, as it does for inventory increases. Core investment (i.e. ex inventory) forces saving as I’ve described all along, and as I described again in a) above. BTW, this has nothing to do with Harless; I’ve viewed it this way for ages. He just wrote something reasonably good that’s roughly consistent with the way I view it.

11:08 AM  
Blogger Ohm (Ώ) said...

Very Good article. And the Govt has both issued a lot of fresh currency over the last many years AND created additional money supply via the Feb and banking system leverage. The finetuning act has to be now delivered by: "If the currency issuer over does it, then it can simply tax away some of that extra money so the price of back-scratches remains $1"

12:25 AM  
Blogger Greg said...

Actually I'm not sure why the price of backscratches should remain $1, it is better maybe to insure that incomes can support whatever price back scratches are. As long as people arent going into serious debt to pay for back scratches the game will go on just fine.

6:01 AM  
Blogger Ohm (Ώ) said...

"Actually I'm not sure why the price of backscratches should remain $1, it is better maybe to insure that incomes can support whatever price back scratches are. As long as people arent going into serious debt to pay for back scratches the game will go on just fine."

@ Greg ~ Agree. The problem is not literally with the price of backscratches as long as your condition is met. The issue is that a lot of, over a period of time, wear and tear, has occurred in the physical, educational, and social infrastructure. Money needs to be spent/invested in upgrading and renewing the same. The arguments going around are that doing this spending will hyperinflate the price of backscratches, while incomes are not likely to rise. That's what brings tax rework on the table. But I agree that it's ultimately about having a good socioeconomic infrastructure while {price levels, repeatable incomes, household debt} outcomes are within a healthy band.

3:47 PM  

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