Investment Precedes Saving

One argument sometimes leveled at Modern Monetary Theory that is misplaced is that it puts too much emphasis on the monetary and too little on the real. The charge is misplaced for at least two reasons. On the one hand, it is imperative to integrate money into the analysis of what is a monetary economy. It is the tax basis of the demand for money, for instance, that creates real unemployment. It is the hope of turning a sum of money into a larger sum of money – not real output – that motivates capitalist real investment. Attempts to separate completely the monetary from the real in such an economy fail at the most basic level. But, on the other hand, it is modern monetary theorists, and heterodox economists before them working in Marxian or Keynesian traditions, who attempt to make clear what is going on in terms of the real, while it is the orthodoxy that constructs a mystified view of the world in which the real is allowed to be bound by the monetary, for example by pretending a currency-issuing government is financially constrained in its capacity to boost demand and hence real output.

These differences between the various schools of thought are exemplified in debates over investment and saving. The debates concern causation. In this context, it is the behavior of planned or desired (or ex ante) saving and investment that is at issue, not the identity between actual saving and investment. Accordingly, in what follows saving and investment should always be taken to refer to their planned or ex ante levels.

In a simple two-sector model (see here and here), macroeconomic equilibrium requires saving to equal investment. Whereas the orthodoxy conceives real interest rates as long-run equilibrators of saving and investment and as intertemporal allocators of consumption, Marx and Keynes influenced economists stress the primacy of investment in determining income and saving.

Modern monetary theorists, of course, share the view of the Marx and Keynes influenced economists. The conclusion follows clearly from an understanding of endogenous money. In a credit economy, an increase in investment does not require a prior increase in the desire to save. Indeed, an attempt, starting from equilibrium, to increase the proportion of income saved will simply lead to an unanticipated buildup in firms’ inventories, a cutting back of production and lower income. The income adjustments will continue until saving settles back at the level of investment, a higher proportion of a lower level of income. This is the ‘paradox of thrift’. Any attempt to alter the level of saving independently of decisions to invest will cause income adjustments that defeat the attempt.

Investment is the independent variable. If, starting from equilibrium, investment is stepped up, there will be a multiplied increase in income, the process continuing until desired saving reaches the higher level of investment. If investment is reduced, income will continue to adjust downwards until desired saving equals the new, lower level of investment. In either case, saving passively adjusts to investment via income adjustments until macroeconomic equilibrium is restored.

Neoclassical economists prior to the Keynesian revolution had instead supposed that interest rates play the role of equilibrating saving and investment. The logic relied on the notion of a loanable funds market in which an excess of saving would lower the rate of interest and encourage investment, and vice versa. The loanable funds doctrine is clearly invalid. In a credit economy, there is not a finite amount of saving available for investment. Banks will extend loans to firms for the purposes of productive investment if it is perceived to be profitable.

In the aftermath of the Keynesian revolution, neoclassical economists accepted Keynesian causation in the short run, but attempted to retain neoclassical causation, resting ultimately on the inapplicable loanable funds doctrine, in the long run. The orthodox approach was further undermined in the capital debates (see here, here and here).

There is no basis for supposing the price mechanism via interest-rate adjustments can bring about macroeconomic equilibrium, even in the long run. In a simple two-sector model, it is income that adjusts saving to investment. In more elaborate models, the same logic applies except that income adjusts planned leakages (the sum of saving, tax revenue and imports) to injections (the sum of investment, government spending and exports).

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42 thoughts on “Investment Precedes Saving

  1. “It also creates the capacity to produce still higher levels of saving in future periods if society opts to devote an increasing proportion of available labor time to investment activity.”

    I think the words ‘investment’ and ‘savings’ are loaded with too much semantic baggage here.

    This is entirely an algebraic construction. Some spending is on stuff that transcends the accounting period you are looking at. If you pull that out as ‘durable spending’, you need a ‘anti-durable spending’ just to make it balance.

    Whether spending is on something durable or fleeting depends on the size of the accounting period, the size of the transaction and, frankly, arbitrary judgement.

    For example the national accounts definition of ‘intermediate consumption’ includes ‘Expenditures on research and development, staff training, market research and similar activities’.

    Most people would probably consider that investment.

  2. Peter,

    I don’t think thaet the proposition “investment precedes saving” makes any sense. I guess that you mean that saving is impossible without income, and income is impossible without prior investment (in some sense), but this is pretty trivial.

    This statement,

    “Investment produces saving in the current period”

    Is certainly false.

    Prior investment produces income in the current period, by definition. Whether that income is saved, and how much of it is saved, is entirely separate.

    Lets say in t1 that C = Y. How much investment takes place in this period? None! Say in t2 that C = Y. How much investment takes place in tyhis period? None! Say in t3 that C = Y. How much investment takes place in this period? None! And so on… In fact, we can make this very general: if in ti C = Y then I = 0 for all i.

    Investment requires saving in the sense that Y = C + I and S = Y – C.

  3. vimothy: Thanks for your comment.

    I began to compose a response but decided to turn it into a more general post that attempts to clarify the point I am trying to make in recent posts regarding interest rates, investment and saving.

    Since the post is broader in scope, I did not respond specifically to your examples. I will just note here that in the examples you give, there is no investment, and so no saving. That is exactly what I would expect, and no doubt also what you would expect. So I think there is a miscommunication regarding the point I am trying to make.

    As I see it, the debate concerns causation, and the implications are broad and important.

  4. I agree that there is much confusion. One of the problems it seems to me is that MMTers think that investment requires a sum of money, when in fact the supply of money is infinitely elastic, and so consequently, they conclude, investment does not require savings as a source of funding. This is partially correct and partially fallacious. As we can demonstrate pretty easily with simple maipulation of basic GDP identities, investment requires that some quantity of the output flow is unconsumed, which is what saving is. Therefore, investment really does require saving (conditional on a proper understanding of what we actually mean by “saving”).

  5. “investment requires that some quantity of the output flow is unconsumed,”

    Investment merely requires that something is classified as durable (what you call unconsumed), which will then bring about the equivalent amount of the element you are calling ‘saving’ by simple identity to make things add up.

    It’s a simple trick used every day by accountants to turn cash accounts into accrual accounts.

    And the classification is in the eye of the beholder.

  6. I should point out that it flows the other way as well. If you classify something as saving, then the equal and opposite investment pops up instantly.

  7. Peter,

    “I will just note here that in the examples you give, there is no investment, and so no saving”

    Output cannot be consumed and invested. It is impossible to invest if saving is zero, regardless of the level of prior investment (prior saving and investment is irrelevant).

    Some quantity of output is produced in current period. Call it X. Proportion of X is consumed to meet current living standards: C = αX. Remainder of output is not consumed; instead it is used to augment future flow of output, i.e. it is invested: I = (1 – α)X. Investment requires saving, i.e. deferment of consumption. Otherwise, no investment can take place (C = X is necessary and sufficient for I = 0).

    There is a more subtle point about why it is that we need the investment, given some saving. Say that in one period households save some of their income. Say that in the next period households save none of their income and spend their previous savings. Obviously, this is only possible if 1, production in period two is higher than in period one, or if 2, production was no greater, and the price level adjusts. In 1, there must have been investment in the initial period that increased output and so satisfied the intertemporal substitution choices of the saving households. In 2, it was impossible for all consumption choices to be satisfied on aggregate, because production was no greater in the later period. Hence, saving requires investment. Otherwise, future consumption cannot increase.

    “Investment causes saving”, “saving causes investment”— I’m not sure that it’s really necessary to choose between the two. As such, positioning the debate as though it falls between them is a little misleading.

  8. vimothy: The way I see it, if there is excess capacity, an increase in investment does not require a reduction in consumption (the normal situation, in my opinion), and investment does not require prior saving. With excess capacity, there is still room for more consumption. Idle capacity indicates that some consumption is being foregone for no purpose.

    I agree that if there is full employment, an increase in investment requires a reduction in consumption. This is why I think the debate comes down to whether there is an automatic tendency to full employment. And this, in turn, comes down to a debate over interest. I think this is why these controversies are central.

  9. “Obviously, this is only possible if 1, production in period two is higher than in period one”

    That isn’t the case.

    Period One

    Household: +$100 savings
    Business: +$100 Stocks (unplanned inventory – classified as investment).

    Period Two

    Household: -$100 savings
    Business: -$100 Stocks (unplanned inventory).

    No increase in production required to satisfy excess demand from stocks.

  10. ” This is why I think the debate comes down to whether there is an automatic tendency to full employment.”

    30 years of evidence in the real world suggests that there isn’t.

    When you have to resort to the trick of reclassifying full employment as several cities worth of people left on the scrap heap, then you’ve already lost that argument.

    The only ‘full employment’ definition that is acceptable is that everybody who wants work can get it.

    Nobody involuntarily without work for longer than a month, and a minimum income that will allow them to live free from poverty – which is the minimum acceptable level of income that the society is prepared to tolerate.

    For me that is an essential and non-negotiable part of the specification for an economic model. Anybody coming up with a model that can’t meet that requirement should be sent away to come up with a different design.

  11. Neil: I also take the view that there is no tendency to full employment. But I am trying to identify the source of the difference between vimothy’s perspective and Keynes influenced perspectives. As I understand it at the moment, vimothy’s view of investment and saving can make sense if there is both equilibrium and equilibrium entails full employment. For example, your scenario with unplanned investment applies in disequilibrium, whereas the neoclassical approach is usually confined to equilibrium analysis. Similarly, my scenario involves unemployment and excess capacity, whereas neoclassical analysis tends to involve an assumption of full employment (since that is the state neoclassical theory supposes in the long run). For instance, vimothy referred to Solow’s model, which implies supply-determined full-employment equilibrium outcomes.

    I’m trying to decipher whether vimothy is taking his position on saving and investment because of the usual neoclassical implicit assumption of full-employment equilibrium, or whether he is in fact making a different argument. If it is a different argument, I am trying to understand where he is coming from. At this stage, I don’t follow if he has in mind an unemployment (and/or disequilibrium) situation. The way I think of it is the Keynesian way that an increase in investment will bring with it an increase in consumption (due to induced consumption) provided there is unemployment and excess capacity.

  12. Neil,

    “That isn’t the case.”

    In your example production in period 2 is higher than production in period 1 as a result of (unplanned inventory) investment in period 1.

  13. “In your example production in period 2 is higher than production in period 1 as a result of (unplanned inventory) investment in period 1.”

    Ah so that’s the trick. Production is simply defined as consumption + investment in the current period.

    Only in economics could you call depreciation and destocking production.

  14. Peterc,

    “If there is excess capacity, an increase in investment does not require a reduction in consumption (the normal situation, in my opinion), and investment does not require prior saving.”

    Excess capacity means that there are some inputs to the production process not being used. In that case, we could potentially have higher output without any (flow of new) investment.

    The flow of investment in the current period corresponds to the portion of the output flow that we do not consume but instead use to augment future output. We take some output and we use it to create machines (for example) that increase the amount we can produce in the future. As such an increase in investment really does require a reduction in consumption, because we cannot consume the output that we are using to increase future productive capacity.

    Current investment does not require prior saving—it requires current saving.

  15. Excess capacity means that there are some inputs to the production process not being used. In that case, we could potentially have higher output without any (flow of new) investment.

    Agreed. But unemployment means that we could also have higher investment at the same time.

    As such an increase in investment really does require a reduction in consumption, because we cannot consume the output that we are using to increase future productive capacity.

    This is like saying the production of shoes reduces the amount of socks we can consume even though there are still idle resources that could be used to produce socks at the same time as the shoes. The production of shoes reduces the potential amount of socks that could be consumed but does not require us to reduce the actual amount of socks we consume whenever there remain idle resources.

  16. At the margin, the production of anything specific reduces the amount of everything else that we can consume. If you want to produce iPods instead of doughnuts, then there will be more iPods and less doughnuts available for consumption than there otherwise would be. If you want to increase the amount of I in GDP, then you have to decrease the amount of C.

  17. You can’t change I without it also changing GDP and C (induced C) whenever there is unemployment.

    At the margin, the production of anything specific reduces the amount of everything else that we can consume.

    How can that possibly matter if, due to unemployment, it is possible to undertake two “specific” things at once. 🙂

    On the upside, at least I think I’ve comprehended what you are saying now. Thanks for clarifying.

  18. “Ah so that’s the trick.”

    It’s not a really trick–it’s just the logical result: income is the sum of consumption and investment, or Y = C + I.

  19. “You can’t change I without it also changing GDP and C whenever there is unemployment.”

    I find that statement hard to parse. Given a particular value for GDP, an increase in I must decrease C (and increase saving). Whether there is unemployment is irrelevant.

    If there is spare capacity today, it is possible to increase GDP today, for instance, using monetary policy–but this has nothing to do with investment per se.

    In order to invest, we still need to save–regardless of the level of unemployment.

    “On the upside, at least I think I’ve comprehended what you are saying now.”

    Cop that, Feynman! 😉 Can you clarify your “prior saving” comment? I’m still a bit confused by that.

  20. “If there is spare capacity today, it is possible to increase GDP today, for instance, using monetary policy–but this has nothing to do with investment per se.

    “In order to invest, we still need to save–regardless of the level of unemployment.”

    Yes, but we could have a situation where there is low investment and saving, low consumption and low income (high unemployment) or we could have a situation with high investment and saving, high consumption and high income (let’s say, full employment).

    In the low-income situation, it is possible for both investment and consumption to increase. In the full-employment situation it is only possible for investment to increase if consumption is decreased.

    So the way I see it, extra investment only requires reduced consumption if full employment is the norm (or at least there is a tendency to full employment). If there is no tendency to full employment and there is currently unemployment, it is not necessary for consumption to be reduced to make way for investment. Yes, any investment means less potential consumption (less consumption associated with full-employment output), but if the economy was not going to be at full employment in any case (if there is no automatic tendency to full employment), then extra investment won’t require a reduction in actual consumption (a reduction below what would have been the case without the investment). Higher income enables higher consumption and saving.

    (My last comment under the most recent post attempts to discuss this point. But I posted that before reading your most recent comments in this thread.)

    Addendum:

    There is a point I should have picked up on earlier, which I think you correctly identify as another source of difference in our perspectives. You wrote in an earlier comment in this thread:

    One of the problems it seems to me is that MMTers think that investment requires a sum of money, when in fact the supply of money is infinitely elastic, and so consequently, they conclude, investment does not require savings as a source of funding.

    In my view, yes, investment does require a sum of money in a capitalist (monetary production) economy. In a different kind of society, investment would not necessarily require money. But under capitalism, there is no purchasing power (no access to goods) unless demand is backed by money. Although the government as issuer of the currency can easily increase the supply of its money if it so desires, money for users of the currency (e.g. firms and households) is not easy to obtain.

    In the case of investment, an item will only be purchased if a firm wishes to, and can, obtain money with which to purchase it, and this may depend on credit-worthiness that, in turn, depends on demand conditions (demand backed by money) in the economy. If goods produced with the intention of being used for investment are not purchased, the intended investment does not take place (only an unplanned investment). Or, alternatively, if a prospective investor is unable to place an order for an investment good, production of it will not take place, and investment will not occur at all.

    If production of the investment item does go ahead, but then fails to find a buyer, the unsold item will temporarily represent unplanned investment and saving, but the weak demand conditions will tend to result in contraction of output and income and an elimination of the (unplanned) investment and saving. It is the decision not to invest (by the firm who chose, or was unable, to purchase the item) that caused income and saving to fall. If, instead, the firm had chosen, or was able, to purchase the item (i.e. make an intended investment), the extra investment would sustain the extra saving. In monetary terms, and through historical time, the investment results in payment of money that goes to the seller of the item, a portion of which can be used for consumption and a portion for saving. Whatever the portion saved, the multiplied increase in income generated by the purchase of the investment good will be just sufficient to sustain saving equal to the extra investment.

    The decision to invest, in this view, is paramount. Intended investment involves a payment of money that provides the seller with corresponding purchasing power that sustains further income generation, consumption and saving, since money backs demand. Without that transference of money, there is no additional demand or income generation. Moreover, the (unplanned) investment and saving that does occur will be eliminated through negative income adjustments.

    In a barter economy, it could be different. But the capitalist economy is a monetary one, and commodities exchange for money, not for commodities. If there was no uncertainty and perfect credit markets, profitable investment could always find funding even in a monetary economy, but there is uncertainty (and hence a demand to hold money for its own sake). Even without uncertainty, in a capitalist monetary economy, if the government keeps NFAs too scarce, there will be insufficient profitable outlets for productive investment to sustain full-employment output. Again, it could be different in a barter economy.

  21. “For instance, vimothy referred to Solow’s model, which implies supply-determined full-employment equilibrium outcomes.”

    I’m not sure that it does actually. The key assumptions in the Solow growth model are that the production function, Y(t) = F(K(t), A(t)L(t)), has constant returns to scale in its two arguments (K and AL) and that inputs other than labour, capital and “knowledge” are unimportant, and a set of assumptions related to the evolution of the stocks of labour, capital and knowledge over time.

    The evolution of unemployment is completely ignored. As you can see, it’s simply not in the model—along with a host of other factors. Consequently, the Solow growth model doesn’t have a lot to say about whether we are at full employment. Instead, it tells us about the growth rate of output (i.e. its proportional rate of change) over time given a set of growth rates of inputs.

    Its main finding is that differences in the accumulation of (physical) capital cannot account for differences in the growth of real income (PC output) over time and geography.

  22. “(My last comment under the most recent post attempts to discuss this point. But I posted that before reading your most recent comments in this thread.)”

    Heh—our comments in the various threads seem to be converging on some kind of ur-topic. I was going to post this in the other thread, but now it seems more relevant here, so…

    “…or even whether full employment is the norm, since it is the only circumstance in which there is a macro tradeoff between investment and consumption”

    Irrespective of the level of GDP, and given any particular level of GDP, there is a direct trade-off between consumption and investment. Further, any changes in the level of GDP correspond directly to changes in the levels of consumption and investment. So if GDP increases then we know that at least one of its components must have also changed. For instance say that Y = C + I and that Y increases from 100 units to 110—it must be the case that the sum of the changes in I and C is equal to 10 units. As such, we would expect that higher levels of GDP will correspond to higher absolute levels of both consumption and investment. But that’s not really a result, more a feature of the way we’ve specified GDP.

    In your comment on this thread you write, “Higher income enables higher consumption and saving”, which is, of course, true. Since the income is the sum of its constituent parts, and increase in the level of income must correspond to an increase in the level of consumption and/or investment (decomposing total spending into either consumption or investment). It is therefore the higher income that implies the increase in the levels of saving and consumption, not employment per se.

  23. I am reading a new working paper by Randall Wray called Money in Finance. Peter, vimothy, would you mind commenting on it? Specifically, this seems relevant to discussion (page 7):

    It is commonly believed that “savings finance investment.” Indeed, we discussed above the possibility that an individual finances spending (which could be investment spending) by running down financial wealth that was accumulated whilst saving. True enough. But the saving of the individual is in the form of claims on others—debt issued by others to allow spending to take place. At the aggregate level, saving is not really a source of finance—a point made by J.M. Keynes (1964), simplified as the “paradox of thrift” taught through the textbooks: reducing consumption in order to increase saving only reduces aggregate income and results in no additional saving. Instead, saving is increased by spending more on investment. The textbooks, however, generally do not explain how the extra investment is financed. The answer is that if we want a higher national income and gross domestic product through higher investment, it must be financed through additional debt. This additional investment will then create higher income and, through the marginal propensity to save, additional aggregate saving—accumulated as credits against debtors.
    Above we looked at a simple circuit of money and admitted that circuits might not close so that monetary debts are not cancelled. Saving can be thought of as resulting when a circuit does not close, so that debt was left outstanding. If that finances individual spending (including investment) it merely allows the circuit to close. Saving can never be a net source of finance at the aggregate level—when accumulated saving is spent, that
    merely returns debt to its issuer. New finance requires new debt

  24. Thanks for the link. I enjoyed the paper. Not surprisingly, I agree with Wray’s argument concerning saving and investment.

  25. I think my earlier criticisms of the Chartalist approach to investment and saving apply. Wray seems focused solely on the monetary circuit here, and doesn’t consider the problem from the perspective of intertemporal choice.

    An example may help. Think of a two period economy that produces 10 units of output per period for $10. Output can either be consumed or invested. 1 unit invested in the current period raises output by 1 unit in the next. Say that saving in the first period is $5. Since there are only two periods, output in the second period must be higher by 5 units in order for the saving to be realised in real terms. So, on a macroeconomic level, (aggregate) saving requires investment (higher future output) just as investment requires saving (in the current period).

  26. But if you define saving as non-consumption then it is trivial that investment requires saving just because in the millisecond before one takes income and invests it, this person has to not consume/save. This seems totally unilluminating. As Nick Rowe says in comments under his post you mentioned on Winterspeak:

    When I teach Y=C+I+G+X-M I always explain it this way to my students: “try and find a fault in it. You can’t. Because whenever you find something wrong with it, I will just re-define my terms to that it stays true. The inventory investment is one fudge. Excluding used goods is another. Excluding spending on intermediaries is another. Saying that capital gains aren’t included in income is another, etc.

  27. It’s not my definition and in a sense, it is trivial. (I think I disagree with Nick about the GDP identity, but that’s beside the point). If I tell you that a + b = c, where a = 5 and c = 10, then it’s not really necessary to tell you what b equals. Since saving is not consuming income, it’s obvious that investment requires saving. And from the point of view of the individual’s balance sheet, investment is saving—just an asset swap. There’s no huge difference between owning a corporate bond or the title deed on some real asset.

    But in economics, “saving” normally refers to non-consumption of income and “investment” normally refers to production of new fixed assets. In order to invest, there needs to be some flow of output that is not consumed, so that cet par higher consumption in the future requires increased investment, and therefore decreased consumption, in the present. And saving in the present implies that consumption demand will be higher in the future, which requires investment in the present if that saving is to be realised in terms of higher real consumption.

  28. “And saving in the present implies that consumption demand will be higher in the future, which requires investment in the present”

    But it will be in real terms, because real savings is real investment. They are just the opposite side of the same journal. They occur at exactly the same time.

    In nominal terms though aggregate saving does not imply that consumption will be higher in the future. Nominal speculation can turn out to be the wrong move.

  29. When you as an individual “save” some fraction of your monthly money income—does the capital stock magically increase by the some equivalent amount? Obviously not. Nevertheless, we can talk about the real value of your saving, which is its value in exchange for quantities of output. But for the whole economy, the stock of real savings is the capital stock.

  30. “When you as an individual “save” some fraction of your monthly money income”

    Never said anything about individual savings or anything about monthly nominal income.

  31. I said something about it @ 23 March 2011 at 7:22 PM, and you responded with a comment 24 March 2011 at 8:05 AM. If you don’t think it’s relevant, why did you raise the issue?

  32. But is the level of saving not affected by the cost of capital? If a firm want to increase investment, then some income other actors is “forced” into saving. But if others actors had planned to consume that income, they will demand an sufficient return on their capital. So while investment may precede saving, propensity to save still must have an effect on either the level of investment, or the success of investment (i.e. investment which earns a return above the cost of capital). So is it not true that policies that punish saving (future consumption) relative to consumption increase the cost of capital, and decrease investment, whether it be in the current period or future periods?

  33. Hi Erik. If there is unemployment and idle resources, the propensity to save will affect how much income ultimately rises as a result of the investment. In the simple two-sector model, if there is a low propensity to save, investment will cause a larger multiplied increase in income that is just sufficient to adjust saving to investment. The adjustment in saving will represent a smaller proportion of a larger change in income. If, instead, there is a high propensity to save, investment will generate a smaller change in income. Saving will adjust as a high proportion of a small change in income.

    If a firm want to increase investment, then some income other actors is “forced” into saving.

    We can think of this in monetary or real terms.

    In monetary terms, investment is not funded out of current income. It is independent of current income and will be funded either out of prior income (retained earnings) or through borrowing. If funding is through borrowing, banks create the loans ex nihilo. Banks are not reserve constrained in their lending. They will take into account the rate of interest they can charge on the loan in comparison to the expected profitability of the investment. However, there is no need for prior saving or for a high propensity to save to make room for the investment if there is unemployment. (At full employment, it is true that investment could only be increased if consumption were decreased. Below full employment, investment and consumption can both increase together. The investment will increase income which will induce further consumption.)

    In real terms, investment is the production of goods not for current consumption. To the extent production is undertaken for this purpose, the resulting output cannot be consumed in the current period, and so is forced to be saved in real terms. Nevertheless, if there is unemployment and idle resources, the decision to invest in real terms (produce some goods not for current consumption) does not prevent others from making a decision to produce for current consumption. Both types of production can be increased together provided there are idle resources and unemployment.

  34. Thank you for your response.

    There still must be factors that affect the cost of capital. You cited retained earnings and bank loans as 2 sources of funds. New share issuance and bond issuance are 2 others. Banks are not reserve constrained, but they are capital constrained, so their cost of capital must be passed on in some way through their lending, yes?

    Let’s assume the economy is at or near full employment. The shares and bonds will be priced by the market. Is it not true that their pricing will be affected by propensity to save vs. propensity to consume, and taxes on the returns of such assets vs. taxes on consumption?

  35. I agree that we can’t rule out effects on interest rates or the cost of other forms of funding from many factors. However, whether investment goes ahead will depend on a comparison of expected profitability and cost of funding. The point of this post, though, is not whether the investment will go ahead, but that if the investment goes ahead it will generate the necessary saving, irrespective of interest rates or the cost of funding. If the economy is near full employment, there may not be room for the investment in real terms. Saving will still be generated, but it will primarily represent only a nominal increase in income (and investment and saving), not a real increase.

    Even at full employment, we need to be careful in supposing any particular systematic effects of changes in interest rates on investment. It is clear from the capital debates, for instance, that in comparing two full-employment outcomes, it cannot be supposed, in general, that the one with the higher real rate of interest will be the one with lower investment.

  36. I agree there are many factors at play here. My main concern is that some MMT sites (not necessarily this one) basically make the case that a conscious decision to save necessarily leads to “demand leakages” and therefore slower growth. They go on to say that any preferences for savings in the tax code should be eliminated (even though our tax system is very biased against saving already). While I agree that consumption should be boosted when there is a large amount of slack in the economy, I think in the long-run full employment economy, removing penalties on saving results in a lower cost of capital and therefore more investment.

    I understand the point of the post; this seemed like a good place to get answers to relevant questions, as most MMT blog authors are less responsive. My main area of interest is how this applies to optimal tax policy.

  37. “removing penalties on saving results in a lower cost of capital and therefore more investment.”

    It’s not really necessary. Reserve funding at 0% from the central bank can do that if you want a lower cost of capital.

    Or even the state doing direct equity investment to break the equity funding logjam. That has a lot of appeal because it allows you to sell the successful firms to the private sector for a large capital profit – which helps attack the concentration of nominal assets issue you get with a ‘net savings’ accommodation strategy.

    There is literally no need to save if you have security of income and borrowing is cheap.

  38. Neil, if the state became the main source of funding for both debt equity investments, that would lead to gross malinvestment and inflation. It would be similar to what we are seeing in China. There would be massive credit expansion as well. And there is a need to save for retirement if you want to live beyond the meager means of Social Security in retirement.

  39. “And there is a need to save for retirement if you want to live beyond the meager means of Social Security in retirement.”

    Then stop that being meager – particularly as the so called private pensions are funded by government bonds anyway. Just cut out the middleman and the inefficiency they represent. Pay the bond interest directly to the pensioners as a proper pension.

    “Neil, if the state became the main source of funding for both debt equity investments, that would lead to gross malinvestment and inflation”

    No it wouldn’t – any more than private spending causes gross malinvestment and inflation. Because the spending is the same thing.

  40. The state is already the main source of equity financing for everything we do after we finish schools and in many countries universities. Moreover, the whole technological boom that we have today is based on public investments that were made in the 50s and 60s and even 70s. Those investments are now successfully milked out by the private sector. But I agree with you that all Apple products are seriously over-priced.

  41. Today’s average SS payment per year I believe is around 12K. Even a tripling or quadrupling of that would be still be just a middle class lifestyle at best if people had no other savings. Some of us aspire to be rich.

    “No it wouldn’t – any more than private spending causes gross malinvestment and inflation. Because the spending is the same thing.”

    You’re assuming that the amount of spending would remain unchanged. I argue it would increase dramatically for myriad reasons. 1) Without a profit motive, the state would fund numerous firms/projects doomed to failure (see Solyndra). 2) Interest rates would be as low as possible and credit spreads would collapse, increasing the ability of junk-quality firms to lever up and fund things they would have never been able to fund before. 3) The state would inevitably fund projects for purely political reasons that fail on economic grounds, then continue to fund them to save face. 4) Our economically illiterate politicians would see the revenue from any successful investment as a reason to spend more. 5) Without the market allocating funds to their most productive use, productivity growth would slow, and therefore become less of an offset to the increased spending.

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