01
May
2020
My Full Response to Neil Irwin / Skanda Amarnath
In BMS ep 177 I talked through this, but at mises.org I have a full response to their claims that the paradox of thrift shows it is literally impossible for everyone to save more. I simply offer some counterexamples.
When Keynsians make the sort of statements that Amarnath makes they are normally referring to government issued financial assets (that is: fiat money and government bonds). It is undoubtedly true that the only way that the public can net save these assets is if the governments creates more of them by running a deficit.
As Bob points out its quite possible to save in things other than government issued financial assets and the vast majority of people’s savings will generally not be in cash or governments bonds but in private financial assets or in physical things like houses. I doubt that most Keynesian would deny this. I think their point is rather that as cash (a government asset) is used in almost every transactions then if people in aggregate try to net save it then this will lead to a decline in NGDP which many economists consider a problem (the paradox of thrift). I’m sure Bob would have a strong argument against this theory too but I don’t think just pointing out that non-government assets can always be net saved will dent the Keynsian argument much.
Without having (yet) followed your link, and without having read the piece you’re responding to, isn’t it obvious that Robinson Crusoe can plant a tree? And is that not all the counterexample we need?
Steve, that’s what I said in response to Krugman in 2011. I tried a different tack this time, using state governments and Covid-19 response.
Are you suggesting that Keynesian economists don’t think that aggregate savings is possible ?
I’m pretty sure that in their standard model I=S and both I and S represent ‘tree planting’ type activity (things produced that are not consumed in the current period).
But (to state the obvious) that is not what the ‘paradox of thrift’ is about. The paradox is simply that in expenditure and income stream terms if everyone tries at once to ‘save’ by reducing their expenditure then aggregate income will also fall. And this fall in aggregate income and expenditure (in a world without flexible prices) could be a bad thing.
The ‘paradox of thrift’ may be a valid or an invalid way of trying to understand the business cycle – but to argue against it on the basis that ‘Keynesian are so stupid they think that net savings are impossible’ seems a bit off base to me.
(I agree that the way that Amarnath states his case makes him a soft target – but shouldn’t we strive to ‘straw man’ our opponents arguments ?)
There’s a difference between tangible physical assets (like a palm tree) and paper assets where one human writes a contract with another human.
Both are assets, but they do not follow the same rules. In accounting terms, if I write any agreement with another human, this agreement must necessarily be a nett zero between the two of us. If that agreement is an IOU note, then one side has an asset, and the other side has a liability exactly and precisely equal to the asset. More complex variations are possible, but we can’t both end up with an asset from each other. Presence or absence of government makes no difference to the nett zero of these type of contracts.
MMTers usually fail because they presume that accounting identities also apply to trees. We went through this a few years back and had a guy deciding he would get into the business of printing coconuts … but that venture didn’t work out too well. Mind you, there’s companies 3D printing burgers these days, so perhaps MMT will eventually come into its own.
Small world, I’m actually a childhood friend of Skanda Amarnath.
Hi Bob. Thanks much for your thoughts on this important issue. There is much confusion on this topic. More broadly there is great confusion on the saving/investment issue throughout the economics profession. I believe this confusion can be largely eliminated by simply clarifying what people are talking about. The Paradox of Thrift can be stated more clearly by explaining that it asserts that net FINANCIAL saving can not occur at the overall level. It says nothing about non-financial (real) saving – which clearly is always positive when it occurs and which a lot of counter-arguments wander into – which miss the point and muddy the discussion. .
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As you note, all spending = all income. Financial saving = income minus spending = zero. Thus the Paradox of Thrift – properly defined – must be true.
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In your first example (I’ll call Alice1), Alice reduced her consumption by $10000 and instead invested the $10000 in an additional entrance to her house. As you explain, she did not reduce her spending but she did increase her non-financial saving. Hence, financial saving was unchanged overall but a new non-financial asset (saving) exists – the entrance.
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Let me also address your example where Alice lends the $10000 to Bob – which you explain in your footnote (I’ll call Alice2). To me, this example is slightly more straightforward than the example where Alice buys newly issued stock from Bob – though, as you note, the overall economic result will not differ.
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Bob has taken this money and invested the $10000 in new equipment.
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Initially, after saving $10000, Alice’s financial assets were higher by $10000. After lending this money to Bob, her financial assets are unchanged in value – as they are now represented by the IOU from Bob.
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Let’s assume Bob’s company is a sole proprietorship. Bob’s company now has (a) $10000 in new equipment and (b) $10000 in new debt to Alice. Bob’s overall wealth is unchanged. In your footnote, you note that “Bob’s financial wealth is unchanged”. This is incorrect. Bob’s OVERALL wealth is unchanged. His non-financial wealth (saving) is higher (the new equipment) while his financial wealth (saving) is lower (his new debt). His reduction in financial saving offsets Alice’s increase in financial saving such that, as always, net financial saving is zero.
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Since we assumed that Bob’s company is a sole proprietorship, this result is easy to see. In your footnote narrative, you are assuming that Bob has equity shares in the business. You explain that the increase in the value of Bob’s stock holdings is an increase in financial wealth – offsetting his decrease in financial wealth from his debt. What I am explaining is that the increase in the value of Bob’s stock reflects an increase in the NON-FINANCIAL value of the company’s assets. Hence, this increase in value does not reflect an increase in financial wealth. Yes, Bob could sell his shares to another entity and increase his financial assets. However, the buyer of the shares would be decreasing his financial assets and would now own the increase in the non-financial value of the company. Perhaps a poor analogy – but you could sell your car and receive money but that does not mean a car is a financial asset.
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Thus your story (Alice2) of Alice lending $10000 to Bob is, I believe, just another version of Alice1 – only the money has moved from Alice to Bob. The principle change is that Bob has new equipment instead of Alice having a new entrance. The point is that, in either case, financial saving overall is unchanged and, as always, nets to zero. In each case, non-financial saving has also increased and society is richer
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Since this is too long – I won’t cover Alice putting her $10000 into stock issued by Bob. As you note in your footnote, the overall results will be the same (though who gets what changes somewhat).
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To reinforce and summarize:
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Alice1: Alice saves $10000 and spends (invests) the money in a housing entrance.
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Alice: Financial saving – unchanged
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Alice: Non-financial saving (housing entrance) – $10000 increase
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Bob: Not in picture
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Alice2: (Alice saves $10000 and lends it to Bob – who purchases equipment with the money)
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Alice: Financial saving – $10000 increase (now in form of an IOU)
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Bob: Financial saving – $10000 decrease (the IOU to Alice)
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Bob: Non-financial saving (equipment) – $10000 increase
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Thus net financial saving in either scenario is zero, as always. Non-financial saving is positive. Separately, the recipients of the investment spending have changed, of course, but their incomes are the same in either scenario.
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If the net financial saving = zero result were otherwise it would violate the all spending = all income identity – which you acknowledge is valid.
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As you know, the wealth of a nation is a function of its investment in non-financial assets – tangible and intangible – and the resulting innovation and productivity improvements they produce. The Alice1 and Alice2 scenarios are straightforward examples of this beneficial type of saving – that is, non-financial saving.
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Thus, a higher standard of living is not about money. I’m sure you agree. If it were, we could print our way to prosperity. However, on the narrower subject of financial saving, it seems it must always net to zero. Thus Amarnath is correct. He just needs to explain that he is talking about financial saving only.
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Does this make sense to you? Thanks for any comments and, especially, criticisms.
Reading the Deficit Owls Twitter response to your article and man, it’s not a discussions about MMT until proponents say “[X] here is defined as …”, is it?
All spending= all income. So financial saving = income minus spending = zero. That’s all you really need to know. Agreed? Thx.