Source: Mises Institute Facebook page
I see variations on this theme in a lot of Austrian and right-wing circles – I add right-wing because it conveys a sense of valorizing austerity, similar to what Lars Christensen called Calvinist Economics.
As sympathetic as I am personally to normalizing non-consumption, the thinking here – while intuitively plausible – depends on a 19th century Ricardian understanding of the economy. In the end, while there are a few ways to “save” the concept of savings, none of them really comport with the claim in the image. Given its Ricardian baggage and the fact that there are more apt terms for everything it might be defined to cover, it seems better to drop the term entirely from macroeconomics.
The intuitive appeal of the idea that savings lead to growth comes from what I’ll call a “realist” vision of the economy. In the realist vision, money is a veil, so to speak. The relationships in a money economy are isomorphic to some pattern of barter relationships. This pattern is easier to do economics on: if you imagine the economy this way, certain things are supposed to stand out much more clearly than if you get mucked up in money relationships.
The idea of savings-led growth is one thing that follows from this conception. In a frictionless barter economy, an investor can only amass a stock of wealth for investment if he either abstains himself from consumption for a while, or solicits a loan from someone else who has abstained from consumption. There is, accordingly, a determinate amount of “saving” in the economy that can be intermediated by banks toward investment projects. Superimpose money back onto the economy, and we can define it in terms of a single dollar-valued scalar.
By contrast there is also a “nominalist” view of the economy, in which money is irreducible to a pattern of barter relationships. Money constitutes the exchange relationships in a way that alters them from any conceivable barter economy.1
By contrast to the realist model, in a proper money economy investment does not depend on anyone’s conscious decision to save. All it requires is the purchasing power to bid away resources into investment use. This purchasing power can be amassed by abstaining from consumption, as in the realist scenario. However, the more practical scenario is to solicit a loan from the bank. In a money economy, the bank creates the money ex nihilo, marking up its assets and its liabilities in a stroke. This is a fundamentally different operation than the intermediation of accumulated savings in a Ricardian-realist economy. The investor is able to bid away resources from other uses without any deliberate abstention on the part of would-be consumers. There is no “stuff” saved up for him to borrow, and the money he borrows does not in any sense represent saved up stuff.
In sum: a nominalist vision of the economy destroys the idea of savings as a stock of stuff measured in physical terms.
There have been more than a few attempts to rehabilitate the idea of savings into something operational in a money economy. Much of this, I think, is motivated by the intuition that the realist vision is basically right, even if we have to nuance it a bit. Unfortunately the realist vision turns out to be a rather poor guide for economic intuition, at least in this case.
One way to make “saving” a necessary precondition of investment, while recognizing the importance of monetary credit, is to broaden the concept to include “forced saving”, a term used for the aforementioned bidding of resources away from consumers and toward investors via credit issue.
Forced saving comes across as a morally loaded term in its own right, no doubt because it seems like something foreign to “normal” Ricardian saving.2 But if all investment is made on the basis of gratuitous credit, then “forced saving” is very much the norm. This wipes out any moral significance to saving as a deliberate act implied by the original image. If it counts as “saving” whether or not anyone has deliberately abstained from consumption, it’s hard to see how the statement carries any normative weight.
If we are willing to abandon the moralizing, however, the idea of forced saving holds forth the prospect of still being able to define a stock of saving by partitioning the transactions destined for consumption from those destined for investment. This is the approach taken by some Keynesians, who try to sidestep the problem by redefining S=I as an accounting identity rather than an equilibrium condition, so that investment spending ipso facto represents saving.3 Savings are defined as aggregate assets, and investment as aggregate liabilities – equal by definition and quite consonant with the actual process of credit creation.
This move has the virtue of being an intelligible concept of saving. It is also very far from the Ricardian notion of saving as abstention,4 and gives up entirely on the proposition that saving is a precondition for investment (which, to be fair, many Keynesians want to do anyway).
There are a few hitches, however. First, it’s not clear that “aggregate liabilities” and “aggregate assets” are economically meaningful categories if they are defined so as to be equal. Every liability is an asset to someone, but as Mehrling (2012) points out, not every asset is a liability to someone. Most importantly, saving can be held in the form of base money, but it can also be held in any number of liquid goods. If a substantial portion of savings are held in this form, assets do not equal liabilities, at least for ‘saving’ in the usual sense of accumulated surplus value. And if we exclude those sorts of assets, why not refer simply to the quantity of x liabilities or class of liabilities, rather than shoehorning it into the old concept of saving?
(In fact, the definition of savings as aggregate liabilities makes the paradox of thrift totally non-operational. For an increase in saving to impair the volume of spending would require saving to be defined as, or at least include a large degree of, holdings of non-liability assets. Gratuitous bank credit turns out to be the very thing that breaks the link between the demand for liabilities and the volume of spending.)
On the other hand, if we are not willing to make saving and investment equal by definition, we have to identify a non-arbitrary criterion for what transactions count as investment and which as consumption. As Barnett (1980) complained about simple-sum monetary aggregates, without a clear theoretical and functional definition, “any aggregate is inherently arbitrary and spurious and does not define an economic variable.”5 The fact that he could justifiably say this about aggregates like M2 goes to show that just because an aggregate exists and is kept track of, doesn’t necessarily make it economically meaningful.
I can think of no non-arbitrary criterion for cleanly (or even roughly) partitioning spending into consumption and saving/investment in a way that corresponds to the ostensible economic meaning of those terms. All transactions probably have elements of both, especially if Stigler and Becker are to be believed. When we have to draw arbitrary lines and place transactions into rigid buckets, it suggests our theory is problematic. People do borrow for consumption too after all, and while this may be in principle distinguishable from investment borrowing in a Ricardian economy, it makes no sense to do so in a money economy.
There are also attempts to define an inherently monetary stock of savings. Selgin (1988, ch. 4), for example, attempts to translate the process of gratuitous bank credit back into Ricardian language by interpreting the stock of “savings” as the public’s willingness to hold circulating bank liabilities.
This conception is similar to the Keynesian approach in that it matters whether the public holds its savings in liabilities or base money – though it’s better equipped to account for the latter as “dead” savings rather than “not savings”. And because S=I is no longer true by definition, it supposedly rehabilitates the ability to interpret the supply of loanable funds as a “savings” curve.
This makes some sense in light of his argument that the public’s demand for a bank’s liabilities limits the quantity of those liabilities it can maintain in circulation (ch. 3). In short, the bank maintains some level of “precautionary reserves” given a gross volume of clearings in order to keep the risk of failing to meet its regular redemption obligations at some acceptably low level. Unwanted liabilities are returned for redemption via the clearing mechanism and impinge on the bank’s reserves. In order to maintain its precautionary reserves, therefore, the bank’s quantity of issues is determinate. If we suppose that the public’s holdings of base money are negligible, this strict relationship between demand for liabilities and the bank’s capacity to issue credit supposedly renders intelligible the idea of a determinate “quantity of savings”.
This argument, however, assumes a constant risk preference for the bank. Facing particularly enticing investment prospects, a bank may on the margin decide that the risk of lowering its precautionary reserves is worth the expected return. So unless we are willing to stipulate some objectively “correct” level of acceptable risk for the bank, bounded both from above and below, this destroys any strict proportion between the public’s abstention from consumption and the supply of credit.
It might be objected that the supply of credit is surely a function of savings in this sense, even if it is not a function solely of savings. True enough. But having departed this far from the basic Ricardian-realist framework, what benefit is there to retaining its terminology? Even if we are to accept the consistency if this definition, given that the loanable funds supply/demand construction is liable to a Ricardian-realist interpretation, what analytical purpose does the term “savings” serve that isn’t more precisely communicated by something like “the demand for bank liabilities”?
In any case, even if we do interpret savings this way, it seems rather odd to say that “economic growth only comes from savings”, i.e. from the demand for bank liabilities. Especially given the possibility of “dead” savings, it would be more apt to say that “economic growth only comes from investment”, or even (if you feel like fighting a Ricardian) that “economic growth only comes from fractional-reserve banking“.
Coming soon: a replacement for the canonical loanable funds model that takes seriously the inherent monetariness of bank credit.