Some Clarifications on Cash Balances and Saving
Surprise surprise, my last post didn’t end the controversy. But in the comments, I realized there were some understandable misconceptions. Let me clarify what I am saying, and then answer one of Major Freedom’s better objections.
The Clarifications: Part of the problem here is the difference between saving as a flow variable, that happens during a period, and savings as a stock concept. When we define Saving = Income – Consumption, it is clearly a flow variable (since Income is clearly a flow). However, if we say that our cash balances are part of savings, then “savings” is obviously a stock concept.
In reading some of the comments, I realized this was confusing people. So let me clarify with the same example I used in the last post:
Our period of analysis will be one month. Andrew starts out the month with $20,000 in cash balances. During the course of the month, his income is $10,000 and his consumption is $9,000. He ends the month with $21,000 in cash balances.
So for the above scenario, I would say: Andrew saved 10% of his income, or $1,000, over the course of the month. Because of that, his savings increased from $20,000 to $21,000.
Notice, I am NOT saying, “Andrew saved $21,000 during the month,” or “Andrew saved $20,000 during the month.” If you simply hold on to your cash balances, without adding to them, that act is not saving during the period. You are simply refraining from dissaving, i.e. you aren’t drawing down your capital from prior acts of saving. But of course, in order for you to accumulate the $20,000 balance in the first place, in the past Andrew must have been consuming less than his income.
To summarize, if you save during a period, then your savings will increase by the difference. (Perhaps it would be good to avoid this confusion altogether and drop “savings” as a stock concept, and refer instead to “capital.”)
Handling the Objection: People who got hip-deep in the comments at the last post, will know that I have become exasperated at times with Major Freedom (MF). However, I really liked the following argument he gave, because it took me a minute to realize what my answer would be. I think most readers will agree that my solution is independent confirmation that I am approaching this the right way, and MF (and Salerno) are not.
To set the scene, remember that I had come up with a real zinger of an argument. Salerno (and MF) want to argue that when someone holds cash balances “earmarked” for consumption, that this can’t possibly be a contribution to their stockpile of savings. So I said, what happens if Johnny earns an income of $20 on Monday, holds it as cash intending to spend it (six days later) on consumption at the movies, but then in the meantime changes his mind and invests it? Since he invested the income, he clearly had to save it. So it seems Salerno and MF are forced into saying that Johnny first consumed his income, then six days later changed his mind and un-consumed it, in order to save and invest it. To me, it was clearly more sensible to say that Johnny was saving his income all along. He held it in the form of cash balances, initially intending to consume it, but then before he actually consumed it, he changed his mind and invested it. So clearly–I thought–Johnny didn’t actually consume it ever, and clearly therefore he must have been saving it all along.
In light of this challenge, MF responded:
[L]et’s switch it around. Suppose that Johnny had the $20 earmarked for investment, but then on his way to the seller of CDs, he decides to buy $20 in movie tickets instead. Should we say “Clearly Johnny saved, because you can’t consume what you haven’t first saved.”? If so, then you are saying that consumption, in addition to investment, requires savings, which is, you must admit, not a conventional way of understanding the implications and requirements of consumption at all. I don’t think I have ever heard of any economist saying that consumption requires a prior act of saving. I have only ever heard the statement “Investment requires a prior act of saving.”
As I said earlier, I really like this one, because it stumped me for a second. But now that I have what I consider to be the correct answer, it highlights the superiority of my approach and the untenability of MF’s.
As always with these things, we have to first specify the interval of time for the analysis. If it’s wide enough to include the expenditure on consumption, then there is no problem. For example, let’s take it as a week. Then for the week (assuming he only works on Monday), Johnny’s income is $20. If he spends $20 at the movies, his consumption for the week is $20. Therefore there is no saving; Johnny’s cash balances at the end of the week are what they were at the beginning. So does my position force me to say, “Saving is always required prior to consumption?” No, not at all. In this example, Johnny consumed $20 during the week, and didn’t save at all.
Ah but wait! MF thinks my treatment relies on my arbitrary choice of one week as the time unit. What if instead we reckon in terms of 24-hour days? Now I am forced to say that on Monday, Johnny’s income was $20, his consumption was $0, and so his saving is $20. And yes indeed, his cash balances (compared to the day before) have risen by $20. So far, so good. (Not that it matters, but suppose Johnny intends to spend the $20 a few days later buying a CD that yields 100% per month.)
But then a few days later on Sunday, Johnny is seduced by the movie poster for Transformers 3. Instead of walking down to the bank (which amazingly is open on Sunday) and buying the CD, Johnny goes into the theater and buys a ticket and popcorn for $20. On that day, I would say Johnny’s income was $0, his consumption was $20, and so he dissaved by $20–as evidenced by the fact that his cash balances drop by $20 over the course of the 24-hour period.
Holy smokes! MF has caught me in his trap, right? I am forced to admit that there was a prior act of saving, in order to finance the consumption of the movie and popcorn.
Yes, I am forced to admit that, and it’s a good thing. Because if we decide to slice up time in 24-hour increments (as opposed to one-week intervals), then Johnny earned his income before he consumed. That is, Johnny earned his income on Day 1 of the week (Monday), didn’t consume it that day, didn’t consume it the next day, and so on, until six days later, when he finally consumed it. So yes, if we are going to analyze time in such discrete units that now Johnny earns his income at one point, and doesn’t consume it until a later time–i.e. in the future–then he must have saved the income.
I submit that far from being a problem, this confirms that my framework is the proper one. If we choose the unit of time such that Johnny uses his income to buy a future good, then he necessarily must have saved the income in the intervening time periods. In contrast, MF is forced to say that Johnny somehow managed to earn an income at T1, “not-consume” it for periods T2 through T6, and yet he never saved during T2 through T6. In other words, MF’s position forces him to say that “not-consuming” is a different thing from “saving.” Do people really want to keep walking down this path with Major Freedom?
Last point: We see now how the unit of time can affect the reckoning of income, saving, and consumption. So what is the proper unit? As good subjectivists in the Austrian tradition, we should defer to the actor’s time horizon and assessment of the situation. So if I pay Johnny $20 on Monday at 3pm, and in his mind he thinks, “Oh man, I’m so thirsty, I’m gonna spend this right now by going down to the store and paying $2 for a Slurpie!”, then the proper time horizon for “the current period” has to include that purchase. After all, Johnny himself thinks the Slurpie is a present good.
Salerno thought this type of example tripped me up, but no it doesn’t: It proves the validity of my approach. For if we define the time interval to be wide enough to include not only Johnny’s earning of the income, but also his purchase of the Slurpie, then over that interval of time, Johnny didn’t save the $2 he spent on the drink.
My response to that challenge (borrowing from my earlier approach) would be to say that Johnny consumed 6 days’ worth of option value from that $20, and then invested the remaining value. More generally, the length of time that you hold cash is equal to the option value of it that you consume. You could then say that at the moment of earning anything, you are saving $X times infinite-days option value, like an American option with no expiry (though it has finite value!).
Silas, you’re right, but I thought that would just introduce another layer of complexity. But perhaps it’s best to go whole-hog right away, rather than look like I’m a moving target.
Understood. I’m surprised our thinking on this issue is so similar, though!
My response to that challenge (borrowing from my earlier approach) would be to say that Johnny consumed 6 days’ worth of option value from that $20, and then invested the remaining value
What exactly is going on as Johnny is holding $20 for 6 days? He is consuming option value and then investing the remaining value? What does that mean other than “6 days of time has passed”? Are we in a monetary economy or are we in an economy where value is not measured by prices? I am honestly trying to get what you are saying, I’m not trying to be pretentious or anything.
More generally, the length of time that you hold cash is equal to the option value of it that you consume.
So if I hold $20 cash for 6 days, the 6 days is equal to…what exactly? What’s “the option value of it that you consume”? It seems as though you are defining consumption to be something other than spending money not for the purposes of making subsequent sales. Are you just saying that by “consuming” you mean “time is passing”?
You could then say that at the moment of earning anything, you are saving $X times infinite-days option value, like an American option with no expiry (though it has finite value!).
So you too are defining cash holding as “saving.”
So you too are defining cash holding as “saving.”
No, my whole approach is to disentangle the confusions that lead us to ask such questions — the same as I would do for “If a tree falls in a forest …” or “Is alcoholism a disease?”.
That is, I’m identifying what factors we *associate* with “saving” or “consumption”, and identifying which of those factors are true for holding cash. Like I argue in the linked post (or the post it links), there are senses in which holding cash matches the characteristics of consumption, and senses in which it’s like investment or saving.
Once you have recognized and resolved these questions, there is no additional “fact of the matter” as to whether cash holding “is” “saving”. Whatever label you want to use for it, it still remains true that when you hold cash you:
– keep your options open,
– lose some of that option value as time progresses
– avoid using that cash to consume real resources
– and so on.
No, my whole approach is to disentangle the confusions that lead us to ask such questions
No? You said “You could then say that at the moment of earning anything, you are saving $X times infinite-days option value…” That is a declaration of defining cash holding as saving.
Look Silas, you’ve already said that you won’t connect what your approach is to determinants of interest, which in my view is the crux of this whole debate, so if you want to talk about what “factors” affect one’s saving and one’s consumption, and which of those factors are also true for holding cash, and then hey, all the power to you, but I really can’t understand how to connect what you are saying to interest rates. I’m still trying, so bear with me.
Murphy says he knows exactly what you are talking about, and he agrees with what you’re saying, but he too has not defended the challenges against the liquidity preference theory of interest. He’s still in defending his definition of saving mode, as pretty much the rest of us are who agree and disagree.
Like I argue in the linked post (or the post it links), there are senses in which holding cash matches the characteristics of consumption, and senses in which it’s like investment or saving.
Sure, and at atomic scales everything is similar. But so what? Understanding comes through not only finding similarities, but finding differences and distinctions as well. An individual’s value scale is a single concept, and as such, there is always one demand for money. Saving and investment in relation to other forms of spending determine, in my view, interest rates.
Saying that holding money is “like” consumption in some respects and “like” investment in other respects, I can’t see how that gets us any closer to truths, but maybe that’s just because I’m too dense to get the level of sophistication that it appears you have command over.
Whatever label you want to use for it, it still remains true that when you hold cash you:
– keep your options open,
– lose some of that option value as time progresses
– avoid using that cash to consume real resources
Sure, but how does this relate to interest rates?
Saying that holding money is “like” consumption in some respects and “like” investment in other respects, I can’t see how that gets us any closer to truths, but maybe that’s just because I’m too dense to get the level of sophistication that it appears you have command over.
I’d say that’s a fair characterization, and I appreciate your honesty.
I’m glad that you find appreciation in moving forward on that particular issue.
I’ll be waiting eagerly for when you find appreciation in moving forward regarding the economic topic(s) at hand.
Somehow, I think this is not over.
Only because Mr. Murphy refuses to admit that there is a clear difference between abstaining from consumption and delaying consumption. He believes the two to be the same thing which they are not. I can increase my cash balance for consumption, or for uncertainty or for investment. Only one of these is an absolute act of saving. Savings is the result of the absolute act of not consuming. Period. The confusion comes because all of the above mentioned acts involve an increase in cash balance. But, it should be clear that they are not the same thing. We live in a money economy so the unit by which multiple needs and wants are met will be money. Therefore all acts will involve money. This does not mean that all acts to increase cash balance are for an absolute abstention from consumption.
Edward King wrote: “Only because Mr. Murphy refuses to admit that there is a clear difference between abstaining from consumption and delaying consumption. He believes the two to be the same thing which they are not.”
What is the difference between “saving” and “delaying consumption” then? That’s one of the pillars of the free-market way of looking at this stuff. Everything we do economically is ultimately directed toward consumption. If we abstain from consumption in the present, it’s only to consume more down the road.
@ Bob
I think there are just two different qualities/levels of saving. I don’t need money to explain that. If I am collecting fruits, I can save them the simple way, in just stockpiling them -> Increasing my fruit balance. Or I can use them to plant a field with them, which is tantamount to investing.
In the first case it will not increase my marginal efficiency of labor, but it might save me on a rainy day, it helps me to avoid risk. In the latter case it may yield a higher output in the future, but it will in fact increase risk and uncertainty. (Therefore it would be nice if I knew that there are other people who value my investment, to whom I could sell my planted field, if I suffer a rainy day).
Both are delaying consumption or saving. They are just serving two entirely different purposes. Is this correct?
Isn’t that all trivial?
What I fail to see is why this refutes time preference or proves liquidity preference. Or why it legitimates it to force people to be liable for everyone else (especially for too big to fail) to artificially switch off risk, and restore confidence. This must necessarily end in a casino mentality society,
But I have yet to finish Bobs dissertation and lots of Keynesian writings. So I have not done my homework yet, but it would be nice if on the first part you could comment. Then I’d know if I am on the right way. Thanks.
Although I do realize that there is also a difference in holding a cash balance and holding a fruit balance. Fruits are the real stuff that is saved. Money in a cash balance is only a claim on real stuff, which is not realized equally in real stuff. Only spent money determines what happens with the fruits.
What is the difference between “saving” and “delaying consumption” then?
What is the difference between “cash holding” and “delaying consumption” then?
ABSTAINING from consumption is a whole other beast.
Everything we do economically is ultimately directed toward consumption. If we abstain from consumption in the present, it’s only to consume more down the road.
Which is not a delaying of consumption, since everyone who earns money at all delays consuming out of their cash balances. An actual abstaining from consumption, which not everyone does (invest), is not delaying consuming out of one’s cash balance. It is impossible NOT to abstain in this way, in your view, so it’s incoherent to say that one is “doing” anything other than continuing to exist.
It is impossible for one to NOT “abstain from consumption in the present, in order to consume more down the road” in your treatment. It is inevitable. Any time anyone earns any cash at all, BOOM, they are “abstaining from consuming in order to consume more later on down the road.”
Since it is impossible for someone to NOT “abstain from consumption in order to consume more later on down the road” in your treatment, then it’s not even an economically viable concept on its own, that has a coherent purposeful action component to it. It can’t be chosen upon, because it’s inevitable due to the very fact of earning money. It’s logically intertwined with the very nature of earning money, which is a choice on its own.
In short, you want to create a whole new economic reality that supposedly exists on its own, totally apart from earning of money which carries a necessarily positive amount of time elapsing before money is re-spent. You want to say aha, they are “abstaining from consuming in order to consume more later on down the road” during that time, when others like me would say no, you’d only be abstaining from consuming if you observed someone invest their money, and no, not “invest” in a cash balance, but an actual investment where you see the individual make a choice between consuming or investing.
” I can increase my cash balance for consumption, or for uncertainty or for investment.”. Let’s say I do for uncertainty. Now let’s say that I can go to a bank and deposit the money in a deposit account. The bank, by offering liquidity insurance, makes it possible for me to access the capital market. As a result the money is invested. At 0% interest, I have to hold the same amount, at >0% I need to hold less than 100% of the previous balance. How do you classify that balance at 0%? How do you classify that balance at >0% and how do you classify that balance outside the bank? The funds are still held for exactly the same purpose.
Argosy, Freddie and Jason would stand in awe of Major Freedom’s immortal position on this issue. I have thought I killed it about 6 different ways.
It’s truly amazing to see how many times you can declare victory without achieving an actual victory.
I thought I was refuting your position umpteen different ways.
Hmmm…
But you were wrong every time you thought you refuted me. I was switching examples to “weight loss” and “Earth’s position among other heavenly bodies” which showed your critiques were invalid.
But you were wrong every time you thought you refuted me.
Am I living in the twilight zone?
Your stuff on weight loss was the result of redefining away very clear concepts such as income, which is money earned for a definite time period, and not just any old time period that you ad hoc select, but a set time period. You ad hoc defined it away when you said that Andrew’s income was $10,000 a month, and then $10,000 a day. That is a contradiction and I don’t care how you try to hand wave your way out of it.
Prior to that, you were challenged point blank on three criticisms of the liquidity preference theory of interest, something like 4 or 5 times, by me, and by others, and not one word has been said in response to them, when it is theories of interest that started this whole thing.
You seem to have decided that “winning” a debate on which interest theory is correct centers around whether or not it is proper to define cash holding as saving. As others have pointed out, those are not the same things.
The only thing I can see that you proved me wrong about was a typo I made when I said investment instead of production being stock. Well, you made a goof too when you said “Oops” after you thought I was responding to a different post. But did I declare “checkmate” on that? Of course not, because I am not in desperation mode. I am very comfortable with my position, and I have shown on many occasions that your position contains flaws.
I mean, you even declared “checkmate” on the typo I made, as if your entire view on interest is correct because you noticed that. To me that smacks of “Please let this stop ASAP because I can’t defend my central arguments.”
I mean wow is all I have to say.
But don’t worry, you’re claim that you have shown yourself to be right all these posts is not at all convincing, and I know you are wrong in every response you made on this issue, and I know you are wrong to believe that liquidity preference is what determines interest.
I sense an extreme desperation from your many declarations of victory. But go ahead, keep declaring victory all you want if it makes you feel better.
This debate is like that old Timex commercial. Takes a licking but keeps on ticking.
One of these days (weeks, months?) this is going to be settled, but until then, I can say that after reading this latest blog post, serious issues remain, and now some new ones have appeared.
First up, your statement:
So it seems Salerno and MF are forced into saying that Johnny first consumed his income, then six days later changed his mind and un-consumed it, in order to save and invest it. To me, it was clearly more sensible to say that Johnny was saving his income all along. He held it in the form of cash balances, initially intending to consume it, but then before he actually consumed it, he changed his mind and invested it. So clearly–I thought–Johnny didn’t actually consume it ever, and clearly therefore he must have been saving it all along.
My position definitely does not force me into saying that Johnny first consumed his income, then six days later he changed his mind and unconsumed it, in order to save and invest it.
My position is that Johnny simply held cash the entire week, did not consume (nor invest) with it, and his expectations were to consume on Sunday, but then he changed his mind and invested instead. THAT ACT of investment I will say requires savings, if we define savings as abstaining from consumption. In other words, in order for Johnny to invest $20, he has to abstain from consuming $20. Yes, it has to come from his cash balance, which you define as savings, but all transactions have to come from cash balances, so it’s a rather moot point, and it’s violating Occam’s Razor to have to include “savings” must precede every single monetary transaction. Just say cash holdings and it’s much simpler.
Your position would force you to say that savings is also “abstaining from investment.” Again, which economist ever says that? Who says that they intend to save, so they will abstain from investment to do it?
Going back to the “saving = income minus consumption” formula, I must ask you: where is the investment variable? Shouldn’t you be out there proposing that all mainstream textbooks be changed so that they contain the formula “savings = income minus investment”? But weren’t you so adamant about it and thought I was absolutely crazy for even questioning the “saving = income minus consumption” formula?
Combining the formulae, we get:
saving = income minus consumption = income minus investment
Doing some re-arranging, we get:
saving + consumption + investment = income
Shouldn’t THIS formula be in all the mainstream textbooks? The formula “saving = income minus consumption” is not correct even in your own worldview, and yet you are treating the formula as if anyone who dares question it is an idiot!
Suppose though that you DO accept this new formula of saving. Here’s the new question: Isn’t this new formula just what Wenzel emphasized when he said that you can only do three things with your money, hold as cash, consume, or invest?
All you are doing is defining cash holding as saving, which leads to confusion, because you yourself accepted the “saving = income minus consumption” formula, which I hope you will admit is not even consistent with your own worldview!
The other reason why I reject that formula, in addition to my view that it’s comparing apples and oranges, which I know you don’t agree with, is because it necessarily equivocates investment with cash hoarding. Mises, Rothbard, and every other Austrian that I know of treats cash holding and investment as SEPARATE concepts. But Keynes, and you, are treating them as the same thing. I mean you even said on more than one occasion “saving and then investing in cash,” (which I challenged you on, because it makes it seem like you are doing two separate things, when in your worldview it is a single action of taking ownership of earned money, period).
As always with these things, we have to first specify the interval of time for the analysis. If it’s wide enough to include the expenditure on consumption, then there is no problem. For example, let’s take it as a week. Then for the week (assuming he only works on Monday), Johnny’s income is $20. If he spends $20 at the movies, his consumption for the week is $20. Therefore there is no saving; Johnny’s cash balances at the end of the week are what they were at the beginning. So does my position force me to say, “Saving is always required prior to consumption?” No, not at all. In this example, Johnny consumed $20 during the week, and didn’t save at all.
Ah but wait! MF thinks my treatment relies on my arbitrary choice of one week as the time unit. What if instead we reckon in terms of 24-hour days? Now I am forced to say that on Monday, Johnny’s income was $20, his consumption was $0, and so his saving is $20. And yes indeed, his cash balances (compared to the day before) have risen by $20. So far, so good. (Not that it matters, but suppose Johnny intends to spend the $20 a few days later buying a CD that yields 100% per month.)
But then a few days later on Sunday, Johnny is seduced by the movie poster for Transformers 3. Instead of walking down to the bank (which amazingly is open on Sunday) and buying the CD, Johnny goes into the theater and buys a ticket and popcorn for $20. On that day, I would say Johnny’s income was $0, his consumption was $20, and so he dissaved by $20–as evidenced by the fact that his cash balances drop by $20 over the course of the 24-hour period.
Holy smokes! MF has caught me in his trap, right? I am forced to admit that there was a prior act of saving, in order to finance the consumption of the movie and popcorn.
Yes, I am forced to admit that, and it’s a good thing. Because if we decide to slice up time in 24-hour increments (as opposed to one-week intervals), then Johnny earned his income before he consumed. That is, Johnny earned his income on Day 1 of the week (Monday), didn’t consume it that day, didn’t consume it the next day, and so on, until six days later, when he finally consumed it. So yes, if we are going to analyze time in such discrete units that now Johnny earns his income at one point, and doesn’t consume it until a later time–i.e. in the future–then he must have saved the income.
I submit that far from being a problem, this confirms that my framework is the proper one. If we choose the unit of time such that Johnny uses his income to buy a future good, then he necessarily must have saved the income in the intervening time periods. In contrast, MF is forced to say that Johnny somehow managed to earn an income at T1, “not-consume” it for periods T2 through T6, and yet he never saved during T2 through T6. In other words, MF’s position forces him to say that “not-consuming” is a different thing from “saving.” Do people really want to keep walking down this path with Major Freedom?
Only if they insist like you that we DEFINE cash holding as “saving”. Are people really wanting to go down the path of defining holding cash as “saving”, even though it leads to having to say that consumption requires a prior act of saving?
When I say saving, I mean abstaining from consuming, which means investment, which is SEPARATE from cash holding. I am not forced to admit that not consuming is different from saving. It only appears that way because you yourself want to define cash holding as saving, such that the mere holding of cash, even if someone intends to consume with it, is still savings solely because he owns the cash.
But then what if I liquidate an investment for cash (assume at par)? My cash holding went up, my capital investment went down, and the formula “saving = income minus consumption” would tell me that “saving” has increased. This is because my income increased, but my consumption remained the same. So in your world, you would be forced to say that people would be adding to their savings if they liquidated their capital investments for cash!
Which economist would say that? None that I have ever heard. Most economists would say that if you sold a stock for cash, then even though your income went up, even though your consumption remained the same, your savings, despite the formula, did not go up. Why? Because you haven’t made an additional choice to abstain from consumption and add to your investment, that’s why.
Just more evidence that your treatment of savings is the wrong one.
Last point: We see now how the unit of time can affect the reckoning of income, saving, and consumption. So what is the proper unit? As good subjectivists in the Austrian tradition, we should defer to the actor’s time horizon and assessment of the situation. So if I pay Johnny $20 on Monday at 3pm, and in his mind he thinks, “Oh man, I’m so thirsty, I’m gonna spend this right now by going down to the store and paying $2 for a Slurpie!”, then the proper time horizon for “the current period” has to include that purchase. After all, Johnny himself thinks the Slurpie is a present good.
Salerno thought this type of example tripped me up, but no it doesn’t: It proves the validity of my approach. For if we define the time interval to be wide enough to include not only Johnny’s earning of the income, but also his purchase of the Slurpie, then over that interval of time, Johnny didn’t save the $2 he spent on the drink.
But Bob, you just said this kind of thinking is wrong, on the basis that it is possible that Johnny could change his mind. Now we’re supposed to consider your example of intentions like they are set in stone?
If we are now supposed to take expectations only as determining “the” correct time period, and say that because Johnny is intending to go to the store to spend $2 on consumption as soon as he can, that this is the current time period, then you’re only re-iterating Salerno’s argument that any time period you pick to understand the situation is necessarily arbitrary. Sure, you can say that Johnny intends to spend the $2 on consumption as soon as possible, say 5 minutes it takes for him to run to the store, but it is still true that he could change his mind in the meantime, and even if he didn’t, then we can just arbitrarily focus another time period that way you arbitrarily chose that 5 minute period, in order to say that according to you, his “savings” is at least $2, because he is holding onto at least $2 cash. But then all we’re doing is the same thing as before, which is defining cash holding as saving.
You can’t refute Salerno’s argument by simply ignoring it and then changing the time horizon yourself to salvage your argument, that is, saying “For if we define the time interval to be wide enough to include not only Johnny’s earning of the income, but also his purchase of the Slurpie.” If you “define” the time scale ad hoc they way you do, then you can make savings anything you want. Thinking that you’re not defining the time period ad hoc because now you’re taking into account subjective expectations, actually undercuts your own criticism of Salerno’s argument where you said people’s minds can change and so Salerno’s worldview is wrong!
Mises, Rothbard, and every other Austrian that I know of treats cash holding and investment as SEPARATE concepts. But Keynes, and you, are treating them as the same thing.
Not to nitpick, but this is wrong.
Hazlitt and Hutt are two Austrian economists I know that consider holding cash balances as a type of savings AND a type of investment. In fact, Hazlitt uses that to argue contra Keynes on liquidity preference.
Not to mention, the quotes from Mises I provided about cash balances.
In MF’s defense, I’m not sure that Mises would say holding the cash balances it investment, but he would definitely say it’s saving. (If you think I’m contradicting myself, the idea is that the individual refrains from consumption and saves by accumulating larger cash balances. But in “real terms” Mises might focus on the freed-up physical resources that now can be devoted to something besides consumer goods. So S=I still, but maybe someone else in the economy is doing the investing, rather than the guy who accumulated larger cash balances.)
Exactly!!! And Mises would be right.
The interest rate would fall because the prices of consumers goods would fall more then the prices of future goods. Visualize the Hayekian triangle; It becomes longer. This is so because in all your examples, the people always raise their cash holdings by deferring consumption, but never investments. At the end, the slope of the triangle is still just about the proportional allocation between future and present goods. So what if some stock of money is permanently hoarded. It’s still time preference that dictates the interest rate. In all your examples, the end result is that people are demonstrating their preferences for two separate things: Cash and future goods. The demand for money is still time neutral.
MF, Mises and Rothbard would both say that Saving = Income minus Consumption. I grant you that Rothbard might not endorse my overall discussion; I’m not sure. (I think Mises would.) But I just want to be clear, the controversy here isn’t over the formula Saving = Income minus Consumption. Every professional economist, including Mises, Rothbard, Garrison, and Keynes, endorses that.
When it comes to the cash balance stuff, I think in Salerno’s mind, the reason Johnny’s $15 in his cash balance isn’t “saving” is that he’s earmarked it for consumption. But even there, Salerno would agree that Saving = Income minus Consumption. He would just say (I believe) that Johnny’s saving is $0, because his Income = Consumption = $20 for the week.
But I just want to be clear, the controversy here isn’t over the formula Saving = Income minus Consumption. Every professional economist, including Mises, Rothbard, Garrison, and Keynes, endorses that.
Yes, they endorse it, provided we know what they meant by all the terms, and provided savings = investment.
If
savings = cash hoarding
then wouldn’t
saving = income minus investment
be legitimate in your worldview?
I think Bob has defined savings as cash balance and investment. Therefore the formula would be:
savings = cash balance + investment
or
savings = income – consumption
or
cash balance + investment = income – consumption
or
cash balance = income – consumption – investment
your formula doesn’t follow from that:
savings = income – investment
If Bob holds that
savings = cash balance + investment
Then he will be forced to admit that the Federal Reserve generates new savings simply by printing new money and buying t-bills.
In my view, savings is the use of revenue or income for purposes other than consumption. That means counterfeiting cannot generate new savings.
And one more thing:
Murphy once said that cash holding is an investment on its own, so the formula you think he is adhering to, namely:
savings = cash balance + investment
wouldn’t make any sense.
This is because if one were to “save” $20 as cash, then Murphy wouldn’t have an answer on which “bin” to put it in, i.e. cash balance or investment.
Therefore the formula would be:
savings = cash balance + investment
This is pure nonsense. Murphy himself defined cash balance as a form of investment (in money), so you have:
cash balance=investment
so all you’re saying now is:
savings=investment + investment =2*investment (assuming the + is an arithmetic operator)
This is all very silly! Which only proves the point that mere cash balances reveal nothing about time preference and the interest rate. All of you people are going to go in circles if you think you can incorporate cash balances in a theory of interest rate. This is quite amusing.:)
Thats a definition game. If cash balance is a form of investment, then this would only mean that:
cash balance investment + other investment = gross investment
gross investment = savings
and you still could not follow
savings = income – gross investment
The point is that MF used investment with two different meanings, because he thought Bob would use investment with two different meanings. But I don’t think that is true. I think the definitions are quite consistent of Bob as he uses them.
And I am not arguing that the definitions would change interest theory. Altered definitions can by definition not affect the truth of a theory.
I can do that…
Maybe my algebra was/is way off, but I also see this in the formulae analysis:
If
saving = income minus consumption
and
saving = income minus investment
then
income minus consumption = income minus investment
Which breaks down to
consumption = investment
That makes my brain hurt.
Murphy: ” So for the above scenario, I would say: Andrew saved 10% of his income, or $1,000, over the course of the month. Because of that, his savings increased from $20,000 to $21,000.”
But what is the big revelation about this? This is not at odds with anything that has to do with the pure time preference theory of the interest rate. Mises talks about this in HA. de Soto talks about this in His Money, banking, etc…. book, and so on….
You are avoiding the main objection to your thesis, which is basically not over the proper definition of “savings” but what determines the natural rate of interest. In your example, If we assume that this $1000 of deferred consumption is regarded as permanent, then this action of deferred consumption can free up capital, which will lower the interest rate(assuming that someone else in the economy doesn’t just raise his consumption by $1000 to offset Andrew’s action). But it is the available freed capital on account of a societal lower time preference, evident by the fact that $1000 is saved (assumed to be saved permanently by entrepreneurs) that lowers the interest rate. Nothing in your “revelation” has any bearings on the pure time preference theory.
Well Dan, I’m fending off 19 different attacks. You are saying there’s no big revelation in my description, and yet MF and now even Salerno are saying it’s wrong.
I think Salerno is attacking your definition of savings in the context of what you “conspire” to do with it. Namely, to claim that there is something not right with the pure time preference theory. I believe he made that clear when he (Salerno) says:
“Although debates about the meaning of words are always treacherous and seldom fruitful, in this case, I believe we can add some clarity to the conceptual issues at stake by analyzing Murphy’s simple example more closely.”
I think Salerno is basically saying in his piece that your use of the term “savings” conceals the fundamental difference between demand for money and time preference, which is why in a monetary economy, Salerno, Rothbard, Ebeling, etc… prefer to reserve the term “savings” when it is clear that time preference is lowered and not merely when reservation demand for cash is on the rise, although I don’t think any of them would deny that the two can and often do in reality (as I’ve been pointing out here) can occur together, which in my opinion is what causes you to blunder and reach the faulty conclusion that the natural rate of interest rate is not all about time preference.
And also, just to give an example of what I mean above. People can increase their cash holdings by not deferring consumption, but on the contrary, by deferring only direct investments on future goods, in which case we have not only NOT have deferred consumption, but we now have capital consumption!
So now you have a definition of savings which results to capital consumption. Can you please solve this problem??
I’m trying to convince myself which side is right. Can anyone critique this formula?
Pure Austrian time preference:
Savings = ∑(t=0..death) PV[U(consumption(t))] and thus the market interest rate has to exceed the indvidual’s discount rate to be invested instead of held as cash balance.
Or the Keynesian
Savings = ∑(t=0..death) PV[Ut(consumption(t))] + ∑{U(E[σ(income(t)]} and thus the interest rate is a function of both the time preference and the perceived volatility of future income. Thus there can be a psychological phenomenon of “inadequate” investment after a market panic.
Nevermind, that’s all screwed up.
Dr. Murphy I think you may have inadvertently showed your dissertation was not well read with this whole debate breaking out years later. On the other hand, you’ve shown the meteoric rise of your influence in the Austrian camp as they scramble to refute now that your big time.
Dan, I would put it more like this: Capital and interest theory is really difficult stuff. So before someone was going to waste perhaps a week of his life trying to understand the arguments I was making in my dissertation, he wanted to see some evidence that I wasn’t a punk kid.
Just like, I didn’t bother looking into Bohm-Bawerk’s theory of interest, until I had read some of his other stuff and thought it was awesome. Prior to then, I was content in thinking Mises had torn him a new one.
Hey everybody, remember that there is a difference between “saving” (as a flow variable that is the difference between income and consumption) and “savings” (as a stock concept referring to a collection of assets). So yes, I think your cash balances are always a part of your savings, but that doesn’t mean your decision to hold them is saving each period.
If you think that sounds wacky, switch to the term “investment.” If I buy a $1000 stock this month, we all agree I invested $1000. Now if I hold that stock, we should all agree that it is part of my collection of “investments.” But my decision to hang on to that stock, doesn’t constitute fresh rounds of investment every month from now until I sell it.
Hey everybody, remember that there is a difference between “saving” (as a flow variable that is the difference between income and consumption) and “savings” (as a stock concept referring to a collection of assets). So yes, I think your cash balances are always a part of your savings, but that doesn’t mean your decision to hold them is saving each period.
If you defined savings as the use of revenue or income by a business
or individual for purposes other than expenditure on
consumers’ goods, and did not define cash hoarding as savings, then you wouldn’t need to go out of your way to set up two meanings of the same word “saving”, such that you say “folks, there is saving as in flow concept, and saving as in stock concept.”
You could just say “investment is flow” and “cash holding is stock” and wipe your hands.
Presuming you are talking about a stock that sees regular turnover, then it is effectively a new investment decision every month (or even every day) the point being that the choice is available to you to sell that stock quickly and easily at any time.
If we are talking about a stock that does not trade high volume, or even shares in a private company, not publicly listed… then that’s a different matter, but also the nature of the investment is also very different… and that’s kind of the whole point.
This might help: I say that your saving (as a flow variable) each period equals the change in your cash balances (if we hold everything else constant). Notice that the dimensions work out fine: a flow variable equals the change per unit time in a stock variable.
So e.g. when Andrew has income of $10,000, consumption of $9000, he saves $1000. His cash balances go from $20,000 to $21,000, so yep, that checks out–the delta in his “savings” is his saving that period.
To repeat, it’s unfortunate that we have such similar terms (saving vs. savings); it might be less confusing to drop “savings” and call it “capital.”
To repeat, it’s unfortunate that we have such similar terms (saving vs. savings); it might be less confusing to drop “savings” and call it “capital.”
Or you could just call it “cash holding”.
If you define a cash balance as “capital”, then does the Federal Reserve create “capital” by inflating the money supply and buying t-bills? Mises never tired in pointing out that credit expansion doesn’t generate new capital.
Bob,
What if Andrew’s income is $10,000, consumption is $1000, but he decides NOT to reinvest $1000 out of his investment portfolio ( out of whatever its total sum happens to be)? His cash balance is now also $21,000 and this is compatible with your savings(as a flow variable) equal to the same change in cash balance of $1000. Now obviously, you can still say that the $1000 is deferred consumption since he could have increased his consumption to $11,000. But the point is, that your “flow variable” or change in cash balances is actually a result of dissaving (capital consumption) and not savings.
This is the problem with simply equating cash balances with savings, for it is obvious that the changes in cash balances themselves reveal nothing about “savings” or “dissavings”
MF, let’s say Exxon earns a net income of $1 billion in 3rd quarter of 2010. But it earns $0 in income in 1st, 2nd, and 4th quarters of 2010.
I claim that an accountant would say, “Exxon’s income in 3rd quarter 2010 was $1 billion,” and that the accountant would say, “Exxon’s income in 2010 was $1 billion.”
Are you saying the accountant would be contradicting himself? That’s exactly analogous to my treatment of Andrew’s $10,000 income which occurs within a single day of a month. Whether you look at it from the 24-hour period, or the one-month period, the measured income is the same, because (by stipulation) he doesn’t earn income on any other day that month.
I realize you think I am screwed up on this, but I really don’t know how we can proceed when you don’t get something this basic. Maybe I’m wrong about the grand things of interest theory; I’m open to that possibility. But we can’t even get to that if you keep accusing me of contradictions with stuff like the above, when it is straightforward accounting with different units of time.
Also, after you answer the Exxon question MF, answer this one:
Suppose Michael Jordan scores 40 points in the first half of the game, but then he comes down on his ankle wrong and sits out the second half. I would say:
(A) Jordan scored 40 points in the first half of the game, and
(B) Jordan scored 40 point during the whole game.
Are you starting to get it? If someone accused me of contradicting myself in (A) and (B) above, can you see why I would be reluctant to get hip-deep in an argument about liquidity preference?
Also, for those of you who think MF is generally right on this argument: That’s fine, but to make sure I’m not going crazy, do you all see this really basic point I’m making about time periods of analysis? We all agree that Jordan scored 40 points in both the first half and the total game, right? And so MF is just being silly by accusing me of contradiction regarding Andrew’s $10,000 income?
You have the patience of a saint sir (you’re not going crazy).
I would say he scored 40 points in the half that he played, for a point per game average (income) of 80 ppg.
He didn’t score 0 points in the second half because he wasn’t even playing.
Heck, you will even see in his stats that the 40 point total (income) will be associated with 24 minutes only, and not 48 minutes.
If someone accused me of contradicting myself in (A) and (B) above, can you see why I would be reluctant to get hip-deep in an argument about liquidity preference?
Your reluctance preceded this issue coming up, BTW.
Oh my gosh… OK MF, suppose he plays the whole game, but scores 0 points in the second half.
Can’t you please look one move ahead to economize on time here?
Now, in the amended example, you agree he scored 40 points in the first half and 40 points in the whole game? That it’s not a contradiction for me to say that? I’m not asking how you would describe the situation, I’m asking you if I just contradicted myself.
Here’s my thinking:
Suppose I performed labor for 5 days, 8 hours a day, and at the end of the week, I receive a check for $500.
I would say that my income is $500 per (work) week.
Now, if you came along and said, “MF, you got a check for $500 on that single day, so your income for the day was $500,” then I would say you’re crazy, because the $500 was payment for my labor for the 40 hours during the week. My $500 income was for the week, not just for the day that I physically received the check.
It is in this sense that your Andrew example sent off alarm bells to me. If you say his income is $10,000 per month, then that means he is performing some kind of service or offering a supply of goods over the period of the month.
So for you to then say “Andrew took his daily income of $10,000 to…” I thought WOAH!! that makes no sense, because you already said his income was $10,000 per month.
Can’t you please look one move ahead to economize on time here?
Forgive me, I guess I am just not as quick on the draw as you. I think much slower.
Now, in the amended example, you agree he scored 40 points in the first half and 40 points in the whole
If Jordan was PLAYING for 48 minutes, and his point total was 40 points, but he scored the individual points all in the first half, then I would say his points per game is 40. He “earned” the 40 points over 48 minutes. His “income” is 40 points per 48 minutes.
MF, as a bystander in this argument I feel you are do a disservice to yourself. The Michael Jordan example should have resulted in a yes or no answer. Either he contradicted himself or he didn’t. When you start going on aboutnhis avg per 48 minutes you’re going to lose credibility. Answer the question he asked and don’t change his question around so you don’t have to give the response he is looking for. Unless your position is patently absurd you should have to bend over backwards to not agree that Dr. Murphy didn’t contradict himself with A and B in the Jordan example.
Also if I was commenting on the hypothetical game above and said Jordan scored 40 pts in the first half and 40 pts for the entire game and then you told me that was a contradiction for any reason I would immediately walk away from the conversation to find someone who was being rational.
MF, as a bystander in this argument I feel you are do a disservice to yourself. The Michael Jordan example should have resulted in a yes or no answer. Either he contradicted himself or he didn’t. When you start going on aboutnhis avg per 48 minutes you’re going to lose credibility. Answer the question he asked and don’t change his question around so you don’t have to give the response he is looking for. Unless your position is patently absurd you should have to bend over backwards to not agree that Dr. Murphy didn’t contradict himself with A and B in the Jordan example.
Sorry, I won’t pander just to make someone receive a yes or no that you feel they deserve. That would do a disservice to MYSELF. If that means you take me less seriously, then so be it. I’m not worried.
Also if I was commenting on the hypothetical game above and said Jordan scored 40 pts in the first half and 40 pts for the entire game and then you told me that was a contradiction for any reason I would immediately walk away from the conversation to find someone who was being rational.
If I earned $500 in a week for performing labor for 5 days and 8 hours a day, then I would walk away from anyone who said that my income is also $500 a day just because I received physical payment on the one day at the end of the week.
It would do a disservice to you to answer the question he posed? I guess I have to take that to mean it would weaken your argument to give an honest answer.
“If I earned $500 in a week for performing labor for 5 days and 8 hours a day, then I would walk away from anyone who said that my income is also $500 a day just because I received physical payment on the one day at the end of the week.”
If run in place for 5 hours, how far did I run? See, I can answer your questions with a question that has nothing to do with the original question posed as well. This is a great way to debate.
It would do a disservice to you to answer the question he posed? I guess I have to take that to mean it would weaken your argument to give an honest answer.
I did answer the question posed. If you don’t like it, then what else do you want me to do?
“If I earned $500 in a week for performing labor for 5 days and 8 hours a day, then I would walk away from anyone who said that my income is also $500 a day just because I received physical payment on the one day at the end of the week.”
If run in place for 5 hours, how far did I run? See, I can answer your questions with a question that has nothing to do with the original question posed as well. This is a great way to debate.
You ran for zero distance. Now answer my question.
BTW Dan, I did not answer a question with a question. When I posed that question to you, it was in response to a statement you made, not a question you made. I don’t see a question mark at the end of the part I was responding to.
You didn’t answer the question. He asked you if he contradicted himself and said he wasn’t asking you to describe the situation. So you went ahead and described the situation in your words and ignored the actual question of whether he contradicted himself.
You didn’t ask a question. You made the statement:
“Also if I was commenting on the hypothetical game above and said Jordan scored 40 pts in the first half and 40 pts for the entire game and then you told me that was a contradiction for any reason I would immediately walk away from the conversation to find someone who was being rational.”
I responded to that with the question about the $500 per week.
That is what you were referring to when you said I answered your question with a question, is it not?
No, I have only commented on the fact you wouldn’t answer Dr. Murphy’s question. Notice the fact that I use he instead of I in my last comment.
“You didn’t answer the question. He asked you if he contradicted himself and said he wasn’t asking you to describe the situation. So you went ahead and described the situation in your words and ignored the actual question of whether he contradicted himself.”
This is the question I am saying you didn’t answer. If you felt I was referring to anything else I apologize for not being more clear but I thought it was perfectly clear. So would you care to answer the question of whether Dr. Murphy contradicted himself in the Jordan example I will be satisfied.
No, you commented that my question to you was allegedly in response to a question you asked, but there was no question you asked when I asked that question.
If you don’t want to answer the question I asked, then how can you be so sensitive about other people supposedly not answering questions?
OMG we both agree I didn’t ask you a question. If you would rather desperately try to change the point of my comment that’s fine but Dr. Murphy answered your example. You never answered his on whether he contradicted himself. So I agree with Dr. Murphy’s answer to your example. Now will you answer his question on whether he contradicted himself?
Will you answer my question regarding the $500?
I feel like we are speaking two different languages. I specifically said that I agree with the response that Dr. Murphy gave to your $500 example. Ok, your turn. Did Dr. Murphy contradict himself with the Jordan example? I promise I will drop this when you answer that.
MF wrote:
Suppose I performed labor for 5 days, 8 hours a day, and at the end of the week, I receive a check for $500.
I would say that my income is $500 per (work) week.
Now, if you came along and said, “MF, you got a check for $500 on that single day, so your income for the day was $500,” then I would say you’re crazy,
Right I AGREE with you here, and that’s why I specifically constructed my example of Andrew to AVOID this. Remember the part where I said something like, “I have him giving a one-off speech, because otherwise if he had a normal job, he’d be earning income each day he worked, and then would just convert that accrued asset to cash on payday.” ?
So now we can all kiss and make up. I haven’t been contradicting myself at all, you just didn’t realize what I was saying.
Right I AGREE with you here, and that’s why I specifically constructed my example of Andrew to AVOID this. Remember the part where I said something like, “I have him giving a one-off speech, because otherwise if he had a normal job, he’d be earning income each day he worked, and then would just convert that accrued asset to cash on payday.” ?
Then his income is $10,000 per 2 hours, or however long his service was provided for.
So now we can all kiss and make up. I haven’t been contradicting myself at all, you just didn’t realize what I was saying.
Yes, let’s. This point is so tengential that it is distracting from the major issue.
OK Major_Freedom, where do we meet for that kiss?
When you get into the top 10 for libertarian oriented websites.
Now that is some motivation. I’m going to start putting in pictures of supermodel investment banker interns like Wenzel does.
Yeah I saw that. The man has no shame. But he’s probably got website hits because of it.
But you don’t need to use such tricks.
So when Jordan actually scores 40 points in the game, you believe it is correct to say he’s scored an average of 80 points per game? You must be a fan of fractional reserve banking. 🙂
The unit in this measurement is “game”. So by scoring 40 points, his average is 40ppg. If you take the unit to be halves, then his average is 20pph ((40 + 0) / 2)
I don’t see where 80ppg comes from in this example.
I don’t see where 80ppg comes from in this example.
I just meant the 80 ppg average to be the extrapolated “rate” of points per 48 minutes, a full game, to make the analogy to economic income more consistent.
In the NBA, this is not actually the way they calculate ppg. If a player scores 40 points in 10 minutes, 24 minutes, or 48 minutes, it doesn’t matter. Their ppg would still be 40.
This is why some folks look at “points per 48 minutes” instead.
I don’t know how you don’t see that you are answering your own confusion here…
No, it’s really not, because in the economic world, income is per a set unit of time, which would mean we’d have to select 48 minutes, 24 minutes, and nothing else.
MF wrote: No, it’s really not, because in the economic world, income is per a set unit of time, which would mean we’d have to select 48 minutes, 24 minutes, and nothing else.
No MF you are just making stuff up here. This is simply not true.
The next time someone tells you his annual salary–e.g. “I make $100,000 per year”–I expect you to correct the guy. “Whoa sir, you work 52 weeks per year?”
“Well no,” the guy will respond. “I get two weeks of vacation every year.”
“Ohhh,” you will say, with a condescending smirk. “So your annual income is actually $104,000 per year. Since you earned $100,000 for 50 weeks of work, and a year has 52 weeks, you can see that your actual rate of pay is $104,000 per year. Stop low-balling yourself with this ‘I make $100k a year’ stuff.”
When that happens, everyone in earshot is going to say, “Good job Major Freedom! I can’t believe that guy doesn’t know how to report an annual income.” Right? I’m the one being weird here with funky definitions?
no you can select whtaever unit of time you want you just have to the be consistent about it. Saying “his income was 1000/day for one day and then 0/day for the next 29 and his income was 1000/month are both equally accurate. The same as
“In the NBA, this is not actually the way they calculate ppg. If a player scores 40 points in 10 minutes, 24 minutes, or 48 minutes, it doesn’t matter. Their ppg would still be 40.”
Yes it’s true that if you only looked at one day and it happened to be the day that he earned 1000 and you extrapolated from that to estimate his monthly income, having no other information, you may estimate that it is 30000 per week. But if you did this you would be wrong. As soon as you observed other days you would realize this. Once you had observed a whole month you would see that it was really 1000/month. There’s nothing contradictory about this.
No Murphy you’re still not getting it. And please stop telling me that I’m making stuff up. I’m not making anything up. That would imply that I am lying, and I am not lying. I am being honest.
If the DEFINITION of 1 year in the context of working is “52 weeks”, then when someone tells you they make $100,000 per year, then that means they earn $100,000 for working for 52 weeks, and not for 50 weeks.
If they have 2 weeks vacation, then that means 1 year is DEFINED as 50 weeks in the context of working, and so when they say they make $100,000 a year, it means they make $100,000 income for working for 50 weeks.
At the end of the day, the WORD is unimportant. As long as the time period is a given set of seconds, minutes, hours, whatever, then when people say what their income in dollars is, then it is for a set period of time and no other.
That means you cannot then use the same dollar amount and say it applies to just any period of time, just because you can merely imagine more days and weeks surrounding a cash payment.
The income is not the cash payment, the income is the money earned per particular period of time. The physical payments may come on certain days and moments, but INCOME is money PER UNIT OF TIME.
Are we really going to start quibbling on what a year is defined as? When people say they earn $100,00 per year, then obviously they don’t meant they work 24 hours per day for 365 days (actually 365.25 days is a year). The implicit context is the definition they use for the year, which is 50 work weeks or whatever.
The point is that a DEFINITE time period is connected a given dollar amount of money if that money is called an income. That means you cannot just use any old time period just because you move from the concept of income to a the concept of cash payment in physical form, which is related to, but not equal to, income.
Income is money per unit of time. It’s not physical cash payment on friday such that you can ignore the definite time period the money relates to.
You keep confusing single cash payments to be income. But income is not just physical cash payments. Income is cash earned per a set time period.
OK you’re right MF, I shouldn’t say you are making stuff up. I believe that you think you are being perfectly reasonable in this. I still think you are wrong though, and that you keep generating irrelevant differences to protect your treatment of Andrew’s income from all the analogies I’m throwing at you.
MF wrote:
If the DEFINITION of 1 year in the context of working is “52 weeks”, then when someone tells you they make $100,000 per year, then that means they earn $100,000 for working for 52 weeks, and not for 50 weeks.
MF, if someone asks me, “Bob, what was your income in the year 2010?” that means, how much was my income for the calendar year 2010. It would be wrong of me to exclude the days I didn’t work and then proportionally bump up the number.
By the same token, then, when someone asks Andrew, “Hey, how much did you make last month?” his correct answer is, “$10,000.” You want him to say, “I earned income at a rate of $300,000 per month, during last month” (if there were 30 days). If Andrew said that, he would be lying.
Yes, if you want, Andrew wouldn’t be lying (just highly misleading) if he said, “On the 15th day of the month, I earned income at the rate of $300,000 per month.” That’s true. It is not true for him to say, “During that month, I earned $300,000 in income.” No, during that month, he earned $10,000 in income. The way to reconcile this apparent contradiction is that on the other 29 days, he earned income at the rate of $0 / month. So when you average out the daily rates, the monthly rate of income earning–over the course of the month–is $10,000.
MF, if someone asks me, “Bob, what was your income in the year 2010?” that means, how much was my income for the calendar year 2010. It would be wrong of me to exclude the days I didn’t work and then proportionally bump up the number.
If someone asked you what was your income in the year 2010, then that is a point blank question that most likely implies the relevant time period is 365 days, and only 365 days.
If you say your income was $100,000 for the year, then you cannot then say that your income was $100,000 for the day, on the day you received a check (assuming you had a weird job where get a lump sum payment for the entire year’s income all on one day). You can say you got a cash payment on that day, but you cannot then say your income was $100,000 on that day. Your $100,000 income was for the year, regardless of the cash payments.
By the same token, then, when someone asks Andrew, “Hey, how much did you make last month?” his correct answer is, “$10,000.”
If you say someone’s income was $10,000 for the month, then the month is the relevant time connected to the $10,000 income. You cannot then say that he earned an income of $10,000 for the day on the day he got the $10,000 payment.
You want him to say, “I earned income at a rate of $300,000 per month, during last month” (if there were 30 days). If Andrew said that, he would be lying.
I don’t want him to say anything in particular. Only that if he says one thing, he should not also say something else.
Yes, if you want, Andrew wouldn’t be lying (just highly misleading) if he said, “On the 15th day of the month, I earned income at the rate of $300,000 per month.” That’s true. It is not true for him to say, “During that month, I earned $300,000 in income.” No, during that month, he earned $10,000 in income. The way to reconcile this apparent contradiction is that on the other 29 days, he earned income at the rate of $0 / month. So when you average out the daily rates, the monthly rate of income earning–over the course of the month–is $10,000.
He can’t earn both $10,000 per month and $0 per month. The sneaky thing you did was change the context of income into a calculated “rate” of income, which then enables you to extrapolate a given income for a set period of time into any time period you want. If you do that, then sure, the annualized, or daily…ized, or monthly….ized “rate” of income can be anything, such that $10,000 for the two hours he worked (which I will say his income is $10,000 per 2 hours, or $5,000 per hour) can be $10,000 x 24 / 2 “rate” of income per day, $10,000 x (24 / 2) x 30 “rate” of income per month, or $10,000 x (24 / 2) x 30 x 12 “rate” of income per year, and so forth.
Whatever these dollar amounts happen to be, each and all of them are unique to a single time period that is considered.
MF, do you understand why I have Andrew giving a speech on one day? I’m saying, he does NOT work any other day of the month. He sits in a hammock in his back yard.
There are plenty of well-known speakers who make more than $10k for showing up and giving an after-dinner talk. (I know because I’ve looked into booking them for events I’m hosting.) Maybe that’s what’s throwing you here; even though I have said a few times now, that Andrew in our story earns the entire income on a single day, you keep not believing me because that is such a lot of money.
OK? Andrew earns it in a single day. Just like, if I worked only one year in my life, you and I agree my salary for that year would be (say) $100,000. But then the salary for my life would also be $100,000, if I never worked except during that one year. This is not a contradiction, anymore than saying my house is in Nashville and in Tennessee.
ZOMG!!!!
I totally thought you had him pinned down, Bob.
I’m with you Dr. Murphy. I’m not even saying MF is wrong on the overall argument but it is pain stakingly obvious he is wrong on this point.
My only complaint would be that if Jordan had rolled his ankle he would’ve only scored 20 pts in the 2nd half, no way he sits out. I mean the guy scored over 30 pts and hit the game winner in game 5 of the finals in 95′ with the flu.
Dan,
Suppose I performed labor for 5 days, 8 hours a day, and at the end of the week, I receive a check for $500.
Would you say my income is $500 for the day I received the check, the minute I received the check, or the week that I worked in order to earn that check?
See this is where you are losing me. Dr. Murphy asked you a simple question. He either contradicted himself in the Jordan example or he didn’t. Don’t change the example to something completely different. Answer his example and then you can propose your own example to be answered. Just don’t be surprised that people won’t carry on a debate with you further when you refuse to answer their questions. I can only assume at this point that you are so afraid that each question Dr. Murphy asks you is a potential land mine and so you feel it is best to avoid them altogether.
And just to be clear I don’t know if you or he is right on the overall theory. I’m just trying to help you see how this debate looks from an outsider right now. If their are people on the fence you are pushing them over to Dr. Murphys side when you can’t answer simple questions like these. I mean is there anyone else here who would say Dr. Murphy contradicted himself with the Jordan scenario?
My point is that when Murphy said Andrew earned $10,000 in income for the month, then just as it would be silly for me to say that I earned $500 for the day, on the basis that I received the check for the day, after I already said I earned $500 for the week’s worth of labor I performed, so too would it be silly to then say that Andrew earned $10,000 in income for the day, on the basis that he received the check on that day.
If I say that I earned $500 in income for the week, then the time period is one week, period. I can’t then say that I earned $500 in income for the day, or hour, or minute that I physically received the check.
Are you endorsing Warren Mosler’s description of the monetary system as score keeping?
Are you saying the accountant would be contradicting himself?
Would the accountant be contradicting himself if he wrote down that Exxon’s income was $1 million per second, in 1,000 different seconds spread apart by various time periods of weeks and days and hours, whereby they received checks from companies in the next stage of the production structure?
You said that Andrew earned $10,000 for the month, which presumably is his monthly income, and then you said he earned $10,000 income for the day, which is something else entirely.
Suppose that instead of one lump sum of $10,000 on the 15th, he instead got 10 $1,000 payments for the first 10 days of the month. His monthly income is the same, that is, $10,000. But now his income(s) per day are quite different. In no single day does he receive a $10,000 payment.
So what does this mean? It means that income has to have a definite time period associated with it. If all you have is one payment, then you can make it seem like the individual is earning $10,000 per year, month, week, day, hour, minute, even down to the second. But income NEEDS a definite time period and only one time period. If you say $10,000 per month, then THAT’S the income. If you want to change the time period, then you’re changing the income. You couldn’t see that with a single payment, but you can clearly see it when there are multiple payments over time.
So if Andrew got daily payments totalling $10,000 per month, then you can see that you can’t just change the time period and then claim you are saying the same thing. It’s difficult to discern when there are only single payments.
Open question: If you were writing a dictionary of economic terms, what would you put in the entry for ‘saving’?
Are you talking to me? If so, I would define saving as the difference between income and consumption, as living below one’s means. (That’s basically the wording I used in Lessons for the Young Economist.)
I can’t think of any sane Austrian who would disagree with such a definition. However, do you agree or not that changes in cash balances do not by themselves reveal whether “savings” according to the above definition has increased or decreased?
Dan (DD5) wrote:
I can’t think of any sane Austrian who would disagree with such a definition [that Saving = Income – Consumption]. However, do you agree or not that changes in cash balances do not by themselves reveal whether “savings” according to the above definition has increased or decreased?
Ah, good point Dan, maybe this is what is tripping people up. I’m not saying an increase in cash balances is the same thing as saving, I’m just saying that’s a form that saving might take. (For example, it definitely was in some of the examples that I was working with.)
But remember I also said that if Andrew sells stock worth $25,000, so that his cash balances go from $20,000 to $45,000, that’s not saving (for that period). He has just transformed one asset into another. (He must have saved in the past, out of previous periods’ incomes, in order to accumulate the stock, but during the present period, if he just turns the stock into cash, that’s not a new act of saving.)
Does that make sense? Am I answering your concern?
To drive home the point: Somebody could have zero income in a certain month, sell off his house, cars, etc. for $500,000 in cash, then blow $300,000 at the casino. Even though he ends the month with a lot more in cash than he started, he greatly DISsaved during the month.
Yes, that makes a little more sense and it follows from your own elaboration here on your position, that an increase in reservation demand for money is in no way the same thing as an increase in savings (and vice versa) . Savings may or may not accompany a rise in cash balance. Or to summarize what you should also agree with, there can be 3 different results on total savings when people increase their reservation demand for money:
1. Increase in savings
2. Decrease in savings (you just gave an example)
3. No change at all in savings
But now here’s the thing. You can define your cash balance as “savings” or “investment in money”, so long as you agree that it is distinct from the the form of savings that is directly channeled to capital investments. In other words, when you save by investing in cash, you cannot do a sort of “double dip” like the “free bankers” would like to have it and simply channel those funds to capital investment.
Also, this is why many Austrians will not consider mere cash balances as just savings, since changes in them do not by themselves reveal anything about the changed state in the available capital or changes in deferred consumption, which is after all what actually constitutes the real savings in the economy. And this is also why it holds true that demand for money is time neutral and should not affect the interest rate.
Well OK what you are saying here I think I agree with, but there’s nothing special about cash balances in this respect. For example, I could say, “Hey, my neighbor last month just added five drill presses to his business operation. So I guess he saved and invested, huh?”
Not necessarily. Maybe he sold off 18 factories down the road, and spent the proceeds on heroin. So during the month as a whole, he dissaved greatly. But would you therefore conclude, “Ah, so investments in capital goods don’t necessarily go along with saving”?
I.e. there’s nothing special about cash balances (in the way I’m handling your earlier question) that wouldn’t work for any type of investment. Yes, in order to build up your cash balances (or any other type of investment), you must have saved more than in a baseline where you don’t accumulate cash balances or build up the investment (and instead consumed). But that doesn’t mean looking at your whole activity that you on net saved during the period in question.
Dan (DD5), I just want to expand a little bit on the above because it may not be clear. Let’s forget cash balances for a minute because that’s controversial, and instead focus on the drill press case:
So a business owner sells off 18 of his factories and their contents, raising $1 million. He spends $900,000 on heroin. He spends the remaining $100,000 on new drill presses for his sole remaining factory.
Now, is it correct to say that he invested in the drill presses, and that this investment required a prior act of saving?
Well, there’s a sense in which the answer is yes. After all, the guy could’ve spent the $100,000 at the casino, but instead of consuming it, he acquired the drill presses with it. So he invested instead of consuming, right?
But on the other hand, he isn’t really doing so out of his income, he rather transformed his original capital assets from one form into the drill presses.
So if you want to say there was saving-and-investment with respect to the drill presses, but these actions were more than counterbalanced by the dissaving-and-consumption of the 18 factories and the heroin, I’m OK with that. Or you could just say, “On net for the period, neither saved nor invested.”
Right, so with respect to your example (but I’ll make it more clear) of reducing18 factories but then adding only a mere 5 drill presses to the economy, while no reduction in previous consumption (or even an increase in your example) you are basically conceptualizing a decrease in total available capital, or an act of dissavings. I think you would then have to agree that the interest rate would be determined by this new allocation between consumption and capital.
But here’s the thing. if, as according to even you, the above example can be illustrated by simply increasing your cash holdings after selling off those factories, so you don’t have to buy those drill presses or get high on heroin (or perhaps come up with a different combination of spendings but still increase your cash relative to before) and you still end up with an act of dissavings, why does the interest rate now all of a sudden not determined solely by the new allocation between consumers and capital goods? All the increase in cash did was allow me to satisfy another of my demands unique to a monetary economy, while the market rate of interest remained solely a function of the ratio between actual available capital, and consumption, which you by the way, explicitly agree can be altered in all directions(or not altered at all) not only by straight forward changes in spending between the two, but also by changing your reservation demand for money. In other words, all changes in cash balances can do is provide another mechanism by which we can alter that ratio between future and present goods, but it remains true that it is only this ration that determines the interest rate.
This also by the way has to mean that, ceteris paribus, demand for money satisfies all those things Mises talks about and by itself, has nothing to do with time preference. I just want to make it clear that my problem with your argument is not over mere definitions of “savings”, but what you think that conceding to “holding money is a form of savings” leads to. Really not anything that posses any risks to the pure theory of time preference. Actually, I think it strengthens it.
Dan: “All of you people are going to go in circles if you think you can incorporate cash balances in a theory of interest rate. This is quite amusing.:)”
Here I did it (=
http://realfreeradical.wordpress.com/2011/07/22/savings/
I’ve commented on your blog.
Free radical, it seems that you are hinging your theory of interest rates on the existence of changes in the purchasing power of money.
Would you agree that if the purchasing power of money rose over time, for example 3% per year, or fell over time, for example 3% per year, then would the existence of positive interest rates in both “worlds” constitute a refutation of your theory?
Yes my theory hinges on changes in the purchasing power of money. I’m not sure what you mean by both “worlds” though.
OK, let me rephrase:
Could a specific change in purchasing power, up or down, large or small, ever lead to an economy where loans do not pay interest?
It’s already happened in Australia: standard bank savings accounts pay essentially zero interest, and when you consider the various fees involved you are actually loaning your money to the bank and paying for the privilege.
However, lots of people seem OK with the idea, otherwise the banks would have closed down by now.
Standard bank accounts like checking and other demand deposit accounts are not loans. I was referring specifically to loans.
“Time is of the essence” – that is what this discussion of “saving” has been about. As a student of accounting, I should point out that there are a few different “basis’ of accounting.” The bases relevant to this discussion I think, are: 1) Cash basis and 2) Accrual Basis. Cash basis, recognizes revenues and expenses at the time physical cash is actually received or paid out. Accrual basis recognizes income in a company’s books at the time the revenue is earned (but not necessarily received) and records expenses when liabilities are incurred (but not necessarily paid for). Got that?
Per MF’s point(s), with cash basis accounting, you only “recognize” income when you “receive” cash, (i.e. your paycheck). So technically speaking, yes, it is truthful to say you “earned” $500 in one day, even though you worked one week for that $500 – this is the nature of cash basis accounting. Obviously cash basis accounting has some problems in representing reality, which is why many choose to use accrual basis accounting – its nature is closer to reality.
Reporting for accrual basis accounting, requires an income statement (your revenue and expenses measured over a PERIOD OF TIME), a balance sheet (your assets and liabilities measured at a POINT IN TIME) and statement of cash flows (your inflows and outflows of cash and cash equivalents measured over a PERIOD OF TIME).
As an Austrian, subjective value theory still applies to whatever methodology of accounting an individual chooses to use (despite what the government may force them to use). So in a sense, “saving” is in the eye of the beholder. However, assuming we use the accrual basis of accounting, I would argue “net income” (that is, after dividends and expenses), that which is referred to as “retained earnings” which gets added to ones equity/capital. In this sense, “equity/capital” = ones “savings” (net assets). “To save” means to withhold a portion of a “set expense” e.g. a budgeted expense came in under what was budgeted for.
I hope this provides some clarity to all.
If cash based accounting is used, then we would have to drop the “flow” attribute of income, wouldn’t we? If income under cash accounting is measured at the time of receipt, then there wouldn’t be a time period associated with it that connects it to goods and services offered over time to earn that cash payment.
But then, it would even be wrong to say:
So technically speaking, yes, it is truthful to say you “earned” $500 in one day, even though you worked one week for that $500
You couldn’t even say “one day”, because that implies a whole 24 hour period of time. Surely payment of cash occurs quicker than 24 hours? You could at best only say something like “you earned $500 in one split moment, at 4:05:23 pm”, and even that wouldn’t be completely accurate, because this measure of moment in time is only accurate to seconds, and ownership of $500 could potentially change even faster than that.
Hence my lead-in of: “Time is of the essence.”
MF: “You couldn’t even say ‘one day,’ because that implies a whole 24 hour period of time.”
MF you are correct, thanks for catching that. Instead, I should have wrote:
“So technically speaking, in cash basis accounting, it is truthful to say you ‘earned’ $500 at a POINT IN TIME, even though you worked a PERIOD OF TIME for that $500.”
You can see then, the perverse nature of cash basis accounting.
Revenue, expenses and equity/capital position in cash basis accounting is measured by POINTS IN TIME (stock concept) – when cash comes in and cash goes out. Accrual basis accounting measures revenue and expenses over a PERIOD OF TIME (flow concept), and equity/capital position at POINTS IN TIME (stock concept). Measuring over a PERIOD OF TIME = FLOW CONCEPT. Measuring at a POINT IN TIME = STOCK CONCEPT.
I think the lesson to take from this is that if ‘we’ are going to have a discussion about what ‘savings’ (equity/capital) then it is necessary to specify what accounting methodology is being used to measure one’s revenue, expenses and equity/capital position. If we are trying to figure out, what it means “to save,” well, I think it is clearly understood to be: spending less than what was budgeted for. I don’t think we need to know what accounting methodology is being used when we are discussing what somebody “saved” as long as we know what their budgeted and actual amounts of spending were.
I must also say, that I am having trouble with the way the word “spending” is often used. Are we really “spending” (using up resources), when we “exchange” cash for machinery – or – are we merely “exchanging” value for value? Is “money” a resource that can be “spent” (used up)? …Is “money” a tangible resource? Or, is “money” an intangible aberration of the human mind, created when something has been conferred such status by man? Where am I taking this, I do not know, but it is interesting to think about.
I agree with Murphy that cash balance is saving, but this is only true when the cash is earned or produced, not fiduciary media created by FRB. Why cash balance is saving is clearly illustrated in the chapter 7 and 8 in Murphy’s “Lessons for young economist”. In indirect exchange, holding cash means the deferral between supplying a good now and actually redeem for good/services in the future. There is no doubt that cash balance yield zero monetary return, however, holding cash balance had tremendous benefit compared to a barter economy. There is no difference between holding and hoarding.
When Bernanke print money and lend out to government to spend, then holding these money should not be considered as savings, as there is nothing saved behind the these cash. They rather stand for legal robbery tickets towards existing property owners.
When talking about cash holdings, there is no value free analysis. You have to ask what income is, should money printing be considered legitimate income?
Somewhat related. I’m reminded of this great post by Andy Harless on the definition of savings. Cleared up many things for me.
http://blog.andyharless.com/2009/11/investment-makes-saving-possible.html
On page 252 of “The Theory of Money and Credit” Mises explicitly includes bank deposits in the stock of money-loans (i.e. savings): “”the development of capitalism has made money-loans (bank and savings-bank deposits and bonds, especially bearer bonds and mortgage bonds)”
Can someone summarize this argument so slow people (me) can understand?