More on Savings and Investment

Here is a mashup of comments from Steve Waldman, from the comments section over at Steve Roth’s excellent Asymptosis.

“It is perfectly possible to hold the international balance constant, have the government reduce debt, and have “people” save more.

“People’s” financial savings consists of claims on firms and claims on government. If I perform some work for a firm that (however infinitessimally) increases the firm’s real economic value, and I accept as payment a share of that firm’s stock, I have performed the economic act of saving, and increased the net saving of “people” — of the household sector. Net private sector financial assets have not increased: my “savings” is the firms’ obligation, the household sector’s surplus is offset by the business sector’s deficit.

But much of what we call saving is exchanging real resources for claims on the private business sector. And as long as the private business sector doesn’t entirely squander those real resources, that act contributes to macroeconomic S. If the private business sector does squander the resources, then while I still perceive my contribution as “saving”, the value of macroeconomic S = I does not increase, and my claim amounts to a transfer from other shareholders of the firm.

But even in today’s terrifyingly %$&*-ed up world, people make a lot of productive contributions to private business in exchange for financial claims. The act of doing so increases S = I, but has no effect on “net private-sector financial assets” and requires no government accommodation.

Suppose out of honesty or competition for my labor, the owners of the firm want to pay me the full value of my work, less some small epsilon of profit we’ll ignore. They have a choice: They can all give me ~9% of their existing shares (0.1/1.1), or they can have the firm issue 10% more shares and give me those.

In real terms, the effect is the same. I end up owning ~9% of the firm (the fruit of my labor), and they end up epsilon better off for my efforts. But the dollar value of the shares will be different by virtue of the two choices.

If they give me 9% of preexisting shares, there will be “deflation”. The value of each share will have increased by 10%. They will have 91% of their original number of shares, each worth 10% more, so they’ll retain 100% of the original value. There will be “deflation”, if we consider company stock as a kind of currency.

Alternatively, if they issue new shares to cover the increase in value, the old owners will hold the same number of shares that they held before, and they will each have the same value that they had before. The extra value that I created would be diluted away from them by the issue of new shares.

In a world of stock, “deflation” or “price stability by dilution” is a choice of the firm. In either case, I have genuinely saved in a real economic (terms).

It’s just a question of how we account for the savings, by holding the unit of account stable and making direct transfers to me, or by “inflating” the unit of account and accounting for the real value inflated away from the old owners by giving claims made from thin air to me.

There’s no such thing as a fixed supply of nominal assets in a world where banks can issue nominal claims. If we are in a regime where the central bank targets consumer price stability, my creation of firm value will not necessarily cause any policy response.

But suppose that the value that I produce means that the firm can sell consumer goods more cheaply, and this puts downward pressure on the consumer price level. The status quo response to this (before the Great Recession & ZIRP) would be for the central bank to lower interest rates to prevent the deflation. The lowering of interest rates corresponds to a reduction in the rate with which net financial assets are issued to the private sector, as the transfers of interest from the government are diminished.

Another policy response, much discredited during the “Great Moderation” but nevertheless potentially effective, would be for the government to spend money into the economy to counter the recession while the central bank held interest rates constant.

So, while it is true that one potential reaction to economic value production is issue of NFA by the state to hold the price level constant, that is a consequence of one uncertain conjecture and two discretionary policy choices:

  1.  the economic value production must impact consumer prices of existing goods;
  2. The state must hew to an anti-deflationary price stability commitment; and
  3. The state must implement that commitment via fiscal rather than conventional monetary policy. (Conventional monetary policy involves no issue of net financial assets.)

There is no “to the penny” sort of accounting relationship between household-sector financial saving and government issue of NFA. You can tell stories of how there might be a positive relationship between the two, but those are a function of policy choices and behavioral models, not logically necessary as a matter of accounting.

And it is household-sector saving that conventional morality so strongly proclaims as a virtue. No bourgeois moralist ever complains when the value of a firm’s assets rise, implying an increase in business-sector “indebtedness” to shareholders. (Firms owe their full value to financial claimants, as their value rises, so does what they owe.)

It is a bad rhetorical trick that MMTers sometimes pull, to confuse an increase in “private sector net financial assets” with an increase in household-sector savings in order to recruit bourgeois support for the latter in the cause of promoting net issuance of government securities.

There are a lot of perfectly good reasons to support net-issuance of government securities during times like now, and I’m certainly allied with MMTers in their promotion of wise fiscal policy. But claiming “saving” is impossible as a matter of accounting without a government deficit is a bait and switch, a game played with definitions by rhetorical confusing household sector financial surplus with an aggregate private sector surplus.”

Steve is pretty sharp. Godley’s theorem tells us we need some sector to run a deficit, but it doesn’t really have to be the government sector. It can easily be a private company or bank which runs this deficit, as long as it’s willing and able to do so, and as long as the rest of the world accepts the “NFA” created.

(RE: Equity in a firm. The nominal value is the number of shares which can be expanded or destroyed at will.  The real value is the economic value of the firm. It’s like a mini-government, able to create script, which is only dependent on the willingness of others to accept that script.)

It’s extremely misleading to claim the government is the only possible source of savings. It’s not true. And admittedly, it’s really hard to talk about Savings in a non-confusing way, so I cut those others a bit of slack.

But these points about savings are really important for people to understand, and it’s crucial to be able to discern when fiscal or monetary or trade policy or private money creation “should” be used, and also how these things impact our economy. Yes, we’ve been relying exclusively on monetary policy for a long, long time, so it seems reasonable to blame monetary policy for everything that’s gone wrong.

But banks are an important part of what humans do. Credit has been part of human society since we started recording documents. Some of the first written documents we have are tallies of credits and debits. We humans like banks and credit, even if banks are not net profitable over their entire history.

It seems dangerous to me to ignore the ability of the private sector to create savings out of nothing.

(P.S. I frequently have a “problem” with Steve W’s posts and comments. Every line seems to demand a book length exploration! )

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Dan Kervick
4 years 5 months ago

Yes, households are not the whole private sector. They are only part of the private sector. The private sector can be in surplus even if the non-household part of the private sector is in deficit.

In the system as currently constituted the endogenous bank-driven processes of money creation involve private banks creating liabilities for government money, in a way that is not constrained by their prior reserves. Ultimately, if the liabilities are validated and not cancelled, the government has to supply the money whose creation was initiated by the private sector lender.

We can create mathematical models of free-banking systems that are purely endogenous, with one or more private banks creating their own money, and other banks creating additional liabilities for those private monies. But that is not the system we actually live under.

A lot of this discussion is moot, however, because the issue is not what sort of operations and causal effects are possible in principle, but what kinds of effects we can expect from policy decisions taken in the economic environment we are actually experiencing. The fact that banks can in one way our another – whether as chartered subsidiaries of the government’s monetary systems or through free concoctions of purely private money – supply the financial resources needed for a booming economy means nothing if the reason the economy is not booming is due to an inadequate demand for credit, consumption and productive investment. The problem with our economy does not lie on the financial supply side.

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geerussell
4 years 5 months ago

“It can easily be a private company or bank which runs this deficit, as long as it’s willing and able to do so, and as long as the rest of the world accepts the “NFA” created.”

If it’s not at the top of the liability pyramid, doesn’t it still face the same solvency and convertibility constraints as any other currency user? That is, if it runs deficits it will go broke.

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Max
4 years 5 months ago

On a somewhat related point, creating money and government bonds doesn’t require the government to run a (net) deficit, since the private sector can be “in debt” to the government in the same way that the business sector is “in debt” to the household sector.

That is, the government can “save” money into the economy (i.e. acquire private financial assets) as well as “spend” money into the economy (i.e. acquire goods and services).

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