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.
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.