on 27-Jan-2019 (Sun)

How do we know that the payer must be either dis-saving or investing? The payer is purchasing something, and it must be either for consumption or for investment. If it is for consumption, then the payer is taking money out of savings to pay for it. If it is for investment, then the payer is investing.

To take a simple example, suppose you’re a freelance software developer, and a company pays you to develop some custom software for long-term use. From the company’s point of view, that’s investment. As soon as they pay you, they’ve made an investment, and you have saved the exact amount of the investment they just made. Savings equal investment.

Monetary policy is central bank actions that impact the supply and demand for base money. In the past they impacted the supply through OMOs and discount loans, and the demand through reserve requirements. Since 2008 they also impact demand through changes in IOR. Thus they have 4 basic policy tools, two for base supply and two for base demand.

Keynesians tended to assume that the Fed was easing policy between August 2007 and May 2008, because they cut interest rates from 5.25% to 2%. But we’ve already seen that a cut in interest rates is contractionary, ceteris paribus. To claim it’s expansionary, they’d have to show that it was accompanied by an increase in the monetary base. But it was not—the base did not increase—hence the action was contractionary. That’s a really serious mistake.

Of course, Keynesians often argue that an increase in interest rates is contractionary. Why do they say this? If asked, they’d probably defend the assertion as follows:

“When I say higher interest rates are contractionary, I mean higher rates that are caused by the Fed. And that requires either a cut in the monetary base, or an increase in IOR. In either case the direct effect of the monetary action on the base or IOR is more contractionary than the indirect effect of higher market rates on velocity is expansionary.”

And that’s true, but there’s still a problem here. When looking at real world data, they often focus on the interest rate and then ignore what’s going on with the money supply—and that gets them into trouble. Here are three examples of “bad Keynesian analysis”:

“He also writes: “Keynesian fiscal stimulus works by transferring idle money balances in exchange for bonds at liquidity trap interest rate and using the proceeds to finance expenditure that goes into the pockets of people with finite (rather than infinite) money demand.””

He’s saying fiscal stimulus makes velocity rise, if it works. That’s true.

Regarding the battle between fiscal and monetary policy; the fiscal authorities can move V by a few percentage points. the Fed can move M by a billion percent. Guess who controls M*V?

J Mann, Complicated question. If the bank is lending money out for home construction, then your saving is financiag gross investment. But banks also hold lots of government bonds, so you might just be (indirectly) lending money to the Feds. In that case your saving is offset by their dissaving.

ndy, You said;

“As a practical matter, if I choose to hoard money, I am saving. Depending on the central bank’s reaction function, I may be encouraging someone else to dissave by reducing their income, but for my part, I am saving, even if I don’t cause any capital goods to be produced. It’s meaningful to say that countries with trade surpluses are saving, even if they aren’t causing any capital goods to be produced.”

I’m going to quibble with both points. Global saving equals global investment. Everyone agrees that national saving differs from national investment by the CA. So no issues there. The saving of cash example is more complex issue. Cash can be viewed as government debt, or as a sort of capital good, like paper gold. Something that provides transactions services.

If it’s government debt then any extra cash you hold means equal dissaving by the government. National saving is unchanged. If it’s capital and your saving of cash causes the real quantity of cash to go up, then it is saving, but investment has also occurred. That interpretation makes most people queasy, but I throw it out there for completeness.