Monetary Realism

Understanding The Modern Monetary System…

Krugman on Say’s Law


Still Say’s Law After All These Years

“When John Maynard Keynes wrote The General Theory, three generations ago, he structured his argument as a refutation of what he called “classical economics”, and in particular of Say’s Law, the proposition that income must be spent and hence that there can never be an overall deficiency of demand. Ever since, historians of thought have argued about whether this was a fair characterization of what the classical economists, or at any rate his own intellectual opponents, really believed.

Not being an intellectual historian myself, I won’t venture an opinion on that subject. What I will say, however, is that Say’s Law (Say’s false law? Say’s fallacy?) is something that opponents of Keynesian economics consistently invoke to this day, falling into exactly the same fallacies Keynes identified back in 1936.

In the past I’ve caught Brian Riedl and John Cochrane doing it; now Peter Dorman finds Tyler Cowen in their company.

Cowen can’t see why corporate hoarding is a problem. Like Riedl and Cochrane, he concedes that there might be some problem if corporations literally piled up stacks of green paper; but he argues that it’s completely different if they put the money in a bank, which will lend it out, or use it to buy securities, which can be used to finance someone else’s spending.

But of course there isn’t any difference. If you put money in a bank, the bank might just accumulate excess reserves. If you buy securities from someone else, the seller might put the cash in his mattress, or put it in a bank that just adds it to its reserves, etc., etc. The point is that buying goods and services is one thing, adding directly to aggregate demand; buying assets isn’t at all the same thing, especially when we’re at the zero lower bound.

What’s depressing about all this is that Say’s Law is a primitive fallacy – so primitive that Keynes has been accused of attacking a straw man. Yet this primitive fallacy, decisively refuted three quarters of a century ago, continues to play a central role in distorting economic discussion and crippling our policy response to depression.”


The underlying issue here at the present time seems to be the lack of investment mobilization of corporate cash hoards that presumably have resulted from corporate profits. To the degree this is correct, it concerns a certain tranche of macroeconomic saving – undistributed corporate profits or retained earnings.

Aggregate macroeconomic saving at any point in time is a recorded event that cannot have taken place unless there has been corresponding macroeconomic investment.

In addition to this macro level saving, well defined sector measures of saving can reflect dissaving in other sectors. This type of saving is not matched by investment. Sector dissaving cancels out sector saving at the macro level.

Both of these kinds of saving involve matching up of expenditure to income (or borrowed income), ex post.

Such measures are income statement measures, from a financial accounting perspective.

At any point in time, it is simply not possible for already measured macroeconomic saving to finance new investment. Such saving corresponds to macroeconomic investment that has already been made.

The saving that will correspond to investment that has yet to be made can only materialize in future accounting statements. All saving that has been made to date is already used.

And this is the case regardless of whatever pattern of corporate profits and cash hoarding that is already in place.

And that is really goes to what is wrong with Say’s Law at the most fundamental level.

Say’s Law denies that a propensity to save from income can cause underemployment of resources. In other words, it claims that a propensity to save will be matched by employment of resources. This is what Keynes attacked. Aggregate demand can fail as a process.

But saving from income doesn’t finance investment in ANY meaningful ex ante aggregate demand sense – let alone the way in which Say’s Law or Tyler Cowen seem to think it does. Macroeconomic saving cannot be deployed, ex ante, into new investment. That relationship has already happened. And so Say’s Law cannot hold simply due to the error in macroeconomic causality of saving and investment and the impossibility of attempting to force saving to “do something” in terms of an ex ante effect on the employment of resources.

Banking is part of the mix. This muddies the waters even further, and in complicated ways.

The income statement measures of consumption spending, investment, and saving are not directly related to the way in which the medium of exchange is sourced to spend on new investment – or the way in which it is used to provide inter-sector finance (e.g. bank consumer lending) that causes spending and related sector specific dissaving to generate sector specific saving in the future.

For example, there is no way that macroeconomic saving can be “put in the bank” that subsequently lends it out to new investment projects that “use” that same saving at the macro level. This is a sequence of conflated real and monetary causality and timing that is logically impossible.

First, as noted, macro saving can’t create investment, ex ante. Second, the bank deposit that both Krugman and Cowen refer to in their examples already exists in the banking system. That money corresponds (by popular presumption) to the (presumed) cash result of retained earnings, which in turn have been generated by prior sales of goods and services. The monetary execution of those sales includes transfers of money from buyers’ banks to sellers’ banks.

That money cannot fund a new loan in the macro sense. Loans create deposits at the macro level – not vice versa. Existing loans already account for deposits originally created from them. In addition, the liability composition of banking is constantly swirling in mix such that deposits may be converted into other liability forms and vice versa. But all of that occurs within the accounting constraint of double entry bookkeeping, such that deposits that exist at a point in time cannot logically be linked to subsequent incremental lending at the macro level.

More generally, banking stocks and flows are quite separate and distinct from the macroeconomic measure of saving and investment. By even referencing corporate cash hoards in the same context as presumed corporate saving, the issue of Say’s Law has become commingled with the issue of accounting coherence.

The “primitive fallacy” of Say’s Law in conjunction with the existence of a monetary system mangles the required logical linkages of accounting across time and across the real and monetary subsets of accounting at a point in time. This mangling appears to be deeply embedded in mainstream economics. Banking transactions such as those referred to are generally captured in flow of funds accounting, while any expenditure and income effects that may be subsequently associated with that flow of funds are measured in income statement accounting. NIPA is an example of macro income accounting. The Fed Flow of Funds report is an example of macro flow of funds accounting. In this sense, roughly speaking, income statement accounting is aligned more closely to the mathematical measure of real economy output – while flow of funds accounting is aligned more closely to the mathematical measure of monetary economy activities that enable the liquidity to support that income generation. That bifurcation is not pure, but it is notable. These two types of accounting, while separate, are inextricably interconnected by pristine logic – which is what comprehensive financial accounting is about.

Krugman is obviously right on Say’s Law, and in his basic message about the macro dynamics of aggregate demand. But his writing seems to complicate the explanation of aggregate monetary dynamics by citing micro level examples that obscure substantive macro accounting issues. For example, there’s no need to introduce bank reserves into such a discussion. There is no need to talk about “putting money in the bank”, when the money is already in the bank at the macro level. This micro fall back tendency is in evidence in other discussions involving banking – such as the recent monetary base debate with Steve Waldman, or the big banking debate with Steve Keen a year ago. On banking, perhaps Krugman tends to go a little too micro, when he might stay macro. Perhaps there is a way of explaining banking system T accounts at the macro level that would be translatable to his NY Times readers, although this would be difficult. Apart from that, he seems to know and explain everything as well as anybody.

The thing about corporate cash hoarding is that there is not even a precise linkage between that and corporate saving. It is quite possible and even likely that a strong correlation does exist and perhaps has been excavated from the flow of funds reports – but it is also the case that corporate balance sheets reflect complex patterns in the flow of funds that overtake the assumption of a simple connection from retained earnings to cash in the bank. In any case, it is the future flow of funds that will end up determining the future deployment of those cash balances. And when that happens, the associated future investment and saving will be separate from the macro level saving that has already occurred.


View all posts by

174 Responses

  1. JKH says
  2. JKH says

    I have something nearly ready on this, but I’m wavering between answering you here, versus making a post out of it. So I think I’ll refine it a bit more, and on Monday I’ll either make it a new post – or a reasonably thorough comment back here. Sorry for the delay again, but my time has been partly consumed with comments at the more recent post.

  3. stone says

    Morgan Warstler, I can definitely see the sense of some of what you seem to be getting at. I agree that it is damaging to the economy to have the government provide a massive supply of risk free financial assets such that wealth can be stored in a non-productive way. To me though it makes no difference whether those risk free financial assets are bank reserves or treasury bonds- having a few extra trillion of either is equally damaging IMO. Also I don’t get your meaning about bank reserves somehow “disappearing” in response to your proposed negative interest rates. As far as I can see an asset tax is the only hope for reducing (or keeping a lid on) that stock of risk free financial assets. Government securities (whether bank reserves or treasury bonds) are out there in the system until they are retired and the only entity that can retire them is the government and retiring them is what we call taxation.

  4. stone says

    Morgan Warstler, do you agree that “loans create deposits”?
    Do you agree that bank lending decouples credit provision from the prior stock of money?
    It almost seems as though you somehow have a distinct vision of bank lending where loans don’t create deposits. If you see things in a way different from “loans create deposits” then PLEASE explain your view of bank lending.

  5. Tom Brown says

    OK, great.

  6. Greg says

    Here’s my point. If a good is produced and not meant to be consumed then dont sell it! If a good is consumed someone intended for it to be consumed and was paid for it. Its not a crowd out its a choice.

    Consumption and investment can both be growing simultaneously. Its NOT an either or. You are correct that the same good cannot simultaneously be consumed and saved but in aggregate they can both be rising.

  7. JKH says

    Working on a few other things in parallel, Tom.

    I’ll have something for you here by next Friday, Feb 22.


  8. Ramanan says

    “Well, consumption goods do crowd out investment goods in a very direct sense: output cannot be consumed _and_ invested, it’s got to be one or the other. So the output mix represents a genuine trade-off between consumption today and consumption in the future.”

    Your assumption is GDP = C+I+G

    GDP is given by the supply side so an increase in C leads to a decrease in I.

    But GDP is not determined by the supply side – which is what makes John Maynard Keynes great. Both C, I and GDP can increase together. I don’t know how C will crowd out I. We live in a world where consumption has been increasing over the years and so has I. When has C crowded out I?

  9. vimothy says

    Well, consumption goods do crowd out investment goods in a very direct sense: output cannot be consumed _and_ invested, it’s got to be one or the other. So the output mix represents a genuine trade-off between consumption today and consumption in the future.

    With that said, various outcomes are possible when the public’s MPC increases. I wasn’t intending to give an exhaustive list. My point was only that, whatever happens, the adjustment is not going to be born primarily by inventories, because that is not a process that is sustainable indefinitely. At some point, the inventories will run out, be replaced, or whatever.

    Instead the natural candidates would seem to be the real interest rate and income.

  10. Greg says

    Ahhh better. Funny thing, I still pretty much knew what you meant.

    It does sound like a crowding out argument. “Hey your consumption is eating into my production…. stop it!!”

    Seems kinda silly

  11. Ramanan says

    Sorry ate some words!

    “That is what is you is as if producers cannot expand production capacity and somehow consumption crowds out production of capital goods.”

    should be:

    “That is what you are saying is – it is as if producers cannot expand production capacity and somehow consumption crowds out production of capital goods”.

  12. Greg says

    “That is what is you is as if producers cannot expand production capacity and somehow consumption crowds out production of capital goods.”


  13. Greg says

    You are winning? Charlie Sheen? Is that you?

    No Morgan is just like those DBs who get torched for 6 TD passes and then dance and taunt when they make a meaningless 4thqtr INT.

  14. Greg says

    Money is not the veil for true barter.

    A true barter system could never end up with the distribution we have. In barter you trade things of equal value. Its a zero sum game. The barter system that must be played to end up like this is more like;

    ” Hey I want that”
    “Nope, dont want anything you are offering”
    “Okay,….well how about I kill you if you dont give me that

    Its a pure bully system
    Somewhere someone didnt trade anything other than a promise NOT to kill someone to get what they wanted.

    And as you pointed out (rightly I believe) that the state did not start out as anything other than property rights protection, that which was stolen by bullying got codified by law and then protected by enforcement of law.
    There is no modern capitalism without a strong state. It is necessary to the function of capitalism.

    A pure barter system is socialism.

  15. OhMy says

    You are winning? Charlie Sheen? Is that you?

  16. Oilfield Trash says


    Wow thanks for the input, much to digest.

  17. Ramanan says

    “Producers can run down their stocks for a time, but that can’t be true indefinitely–at some point, these stocks will have to be replaced and production of consumption goods will have to rise, meaning that production of capital goods will have to fall, or people will have to consume less, etc.”

    I don’t know why such a thing is said Vimothy.

    That is what is you is as if producers cannot expand production capacity and somehow consumption crowds out production of capital goods.

  18. JKH says

    Thanks BF – appreciate those words and your recommendation.

    Regarding your recommendation – that’s an interesting idea, and I’ll discuss it with Cullen, Mike, and Beowulf at some point, offline.

    Regarding this particular post, I am the moderator for it, so I am responsible for any accumulation of the type of drag that you note. But I hear you loud and clear.

    Regarding my own participation in comments and how that relates directly to the issue in the case of this post, I think it’s clear from some of my responses that I’m evolving the criteria that will apply in this particular case, with more force if necessary. And I’m evolving them because I don’t yet have what should be a more permanent framework for those kinds of criteria firmly set in my own mind. So it becomes a matter of evolving judgement on how this sort of thing should be handled. But feedback like yours helps develop that sort of judgement.

    Unfortunately I’m out for a good part of the day today, so any further irritation that might occur along these lines may have to wait until later today for any necessary response. But I’ve been pretty clear on my guidelines for this case, as they have evolved.

    Meanwhile, my approach to this so far is to view the comments in question as some rather curious graffiti across what is a much longer wall of economic understanding. And that on its own is actually not a point of disrespect – this sort of thing has not caused me not to think about economics. That’s can be a constructive thing – up to the point where it inflects into something that is actually unnecessary and even disruptive.

    But the real issue here at the end of the day is one of behavior and the effects of that behavior on others. That requires a sober evaluation of that behavior and the consideration of consequences that flow from the evaluation. In this case, it will end up being an authoritarian evaluation – should it become necessary to act on the warnings I’ve expressed so far. And the justice in this case has the potential to be rather severe for somebody who currently enjoys (presumably) commenting on blogs.

    Your idea for a democratic process is interesting. My first reaction is that it would have to strike the right balance in terms of being a respectful process in its own right – but that is only my first reaction. So I will discuss it with Cullen, Mike, and Beowulf a bit later.

    Thanks for taking the time to opine on this.

  19. vimothy says

    I think the point is that we want to consider more than just the realised, equal by identity, quantity S=I. We also want to consider what the quantity S=I is, and if it changes, why it changes. And what other things it influences, and so on.

    To talk sensibly about what actually happens, we need a way to discuss what does not happen because it cannot, because, for example, it violates consistency. This means we need a way to talk about saving and investment over a range of potential outcomes, many of which will never occur.

    If you consider saving and investment as functions, as behavioural equations that describe actions over potential outcomes, then S=I only in places where they meet. It’s not something that is true everywhere the functions are defined.

    So S=I is true by identity, but it’s not just an identity, it’s also a (or part of a) model. In equilibrium, supply of saving and demand for investment is consistent. Something that to make those two things consistent, and that something might be the interest rate, but it might be something else.

    Could that something else be inventories? Well, I’m not sure if I understand you. It seems to me that inventories might bear some of the short-term adjustment process, but in the long-run, something else has to happen. Producers can run down their stocks for a time, but that can’t be true indefinitely–at some point, these stocks will have to be replaced and production of consumption goods will have to rise, meaning that production of capital goods will have to fall, or people will have to consume less, etc.

  20. BF says

    Goofy is fine.

    IMHO JKH sets a high standard in three respects. Firstly, judging by written words he has an extraordinary technical understanding over a range of different subject matters; and his intuition on any grey areas is characteristically sound. Secondly, on those grey areas which we all have to some extent, he certainly seems driven more than most to seek out the truth of the matter and deliver thereon.

    Thirdly, JKH’s characteristic humble demeanour is refreshing; and alas in limited supply in the blogosphere and among those who inhabit the field of economics. I’ve never see him take a cheap shot at an opponent; indeed, the words honest, measured and fair come to mind in respect to his debating style.

    My suggestion for a “pathetic drivel” or “troll-like behaviour” meter was to express my own opinion about the worthlessness of those who try and sometimes succeed to hijack a thread through the use of an abrasive shock-jock style of debating. Such web etiquette should not be tolerated especially if it just wastes the time of one of the most respectful commentators in the blogosphere.

  21. stone says

    BF, if that is about me -sorry for lowering the tone. I’m stupid but I hoped goofy comments were OK since they can elicit responses that clarify things. Let’s face it, even you clued up people presumably benefit by being caused to think of ways of explaining things so that they can be grasped by the most stupid of us.

    Morgan, my issue with your land titling idea is that homesteaders in the USA, for instance, had land and yet got into debt buying equipment, dealing with droughts etc and lost their land in foreclosures. If you read the histories of which homesteaders actually prevailed and kept their land, it was typically those that had other non-land forms of wealth from the outset. Cheers for your response though.

  22. BF says

    I have a recommendation to make the comments section a more constructive and respectful forum.

    Is there a way to introduce a pathetic drivel meter? And by that I mean a way for readers to flag their opinion that the style of argument by any given commentator is dismal and inappropriate.

    The idea is X number of flags = look at by moderators = a decision to either keep or remove content. And if that commentator were to register on the pathetic drivel meter on different posts above say X times = suspension of freedom to post a comment for X period (may be up to infinity).

    By “style” I obviously do not mean the analytical content of the comment. If someone is relatively new to economics or old to economics but still new to understanding it, then, there is no problem IMHO in that person expressing an opinion even when fully suspecting that the technical matters might be a bit more complicated.

    The problem is commentary that is thought clever but just a waste of space and waste of time such that the very posting of it lowers the collective intelligence of humanity; and, leaving it up is a crime against reason. That includes the thought clever waffle that adds nothing to the subject intermixed with ego claims about rightness of oneself and wrongness of others; baseless inferred positions; and feeble-minded victory dances on self-defined parameters incomprehensible to anyone who is in not fluent in mumbo jumbo (or the less known dialect gobbledygook).

    A little bit of randomness and cluttered thoughts is fine, still, when accusative incoherent ramblings are the game it is a game not worth watching or playing. I mean everyone can feel sad for someone who needs to sate a insatiable ego at a primary school styled level of debate; nonetheless, I’d like to be able to flag churlish idiocracy because pathetic drivellers just distract to whatever insights might otherwise occur.

  23. Morgan Warstler says

    Ok I read it.

    I’d move the adam smith ground rents argument to the very top of the article. Re-read after this.

    I say the very first form of taxation should and ought to be highly levered towards the thing it is for: titled property ownership.

    Look, property titling is the FIRST function of the state. The state is formed by land owners who want to create and protect the guys who already own the land.

    The state doesn’t begin to affirm ownership, it confirms it. The first is about what’s true, so it says nothing. The second if about agreeing with someone else’s truth, that’s what states do.

    But we don’t want guys forming a state for property titling, getting it engraved as law, and then putting the costs of government as taxes first on other activities.

    Titling starts govt. let it pay the biggest share for government. They get the most, charge them the most.

    Notice what I did there?

    I made a populist appeal that distinguishes between types of wealth and types of investing.

    Anytime someone is so crude and elementary to think rich and poor, chastise them for not thinking land vs. not land. Land owners are consuming more value from government than anyone.

    This isn’t about a bigger state, this is about a smarter approach to properly assessing the folks with platinum protection insurance against risk of their holdings.

    If you want a big plot of choice land to call your own, you are going to feel rax increases before anyone else, and the size of payments will almost ensure nobody can expects to hold it long term.

    Once you have dialed in that tax, then you think about others.

  24. Tom Brown says

    OK, I’m eagerly awaiting your response ;)