I know it sounds like I’m being sarcastic or trollish, but I mean this sincerely. Over the years I have seen other economists use national income accounting identities to make points about saving and investment, and I am not deft in such things. I think it’s because in my undergrad days I was at an anti-Keynesian / anti-macro school, and then by the time I went to NYU they were teaching formal New Keynesian models with microfoundations and rational expectations, so we didn’t do I+G = S+T kind of stuff.
In that light, then, please read Scott’s recent response to a commenter at EconLog who thought the Fed was distorting the capital markets and causing saving to go into existing assets, rather than new ones. Because the wording might be important, here’s exactly what the guy said: “In a less risk-averse and more economically free environment, savings would be flowing into new investments. But right now all that’s happening is that this savings is being used to bid up prices on existing assets, mainly housing. So this asset bubble is reducing investment in other areas of the economy.”
Now, here’s how Scott apparently blew the guy up:
Saving does not and indeed cannot flow into existing assets, at least in net terms. You might use $X of your income to buy a certain asset, like an existing house. But that’s offset by the fact that the person you buy the house from receives $X for selling the asset. In net terms, no saving has been absorbed in this transaction. In contrast, savings get absorbed when new capital goods are constructed, as when a new home is built. Because saving equals investment, we need never worry about saving being directed into non-investment uses, at least in aggregate terms.
I think I understand (partially) the kind of argument Scott is making, but I don’t think his conclusion follows. Specifically, I think Scott interpreted the commenter to be saying, “Because of the Fed, S > I.” Then Scott was showing that no, that’s impossible, S necessarily equals I.
However, that wasn’t what the guy was actually claiming (go re-read if you need to). In the comments, the guy backed down, no doubt intimidated by Scott’s superior command of economics and his (Scott’s) confidence. But I think the guy should’ve stuck to his guns. Here’s what I would have said:
1) “Scott, you think you’ve proven that savings can flow into a new capital good, but you left out one important thing: When I spend $100,000 on a newly constructed house, that money goes to the seller of the house. So no net saving could’ve been absorbed by this transaction after all–right? I mean, that’s the same argument you used against me.”
2) “Scott, I’m having a hard time reconciling your position with the subjective theory of value. Suppose Smith starts with a $100,000 house. Then he builds another, small house right next to it, and sells that second (new) house for $25,000. We all agree this represents net $25,000 of investment in the economy, right? OK, now suppose instead Smith builds a deck on his original house, and sells the whole thing for $125,000. We all agree that this represents a net $25,000 of new saving and investment in the economy, right? Finally, because all of a sudden Smith is famous, people want to live in his house more than before. His house appreciates in value to $125,000, and Smith sells it to a fanboy. Are you saying this does *not* represent $25,000 in net investment in the economy? Why not? Is it because physical nails and hammers weren’t involved?”
So I am being dead serious, I would appreciate it if someone (preferably a trained economist) could explain to me what Scott meant, and how he would answer the above, hypothetical pushback. (If Scott himself chimes in, even better.)