The Central Flaw in Krugman’s Argument Against Keen
The key failing in Krugman’s response to Steve Keen’s response to Krugman’s paper (PDF) is here:
If I decide to cut back on my spending and stash the funds in a bank, which lends them out to someone else, this doesn’t have to represent a net increase in demand.
Krugman assumes here that people have to save (spend less) in order for other people to borrow. It’s actually the fundamental assumption, the sine qua non, of his paper (and of Krugman’s beloved IS-LM — the linch-pin of “New” Keynesianism — created by Hicks to subsume Keynes into neoclassicism, and later disclaimed and discredited by Hicks as a “classroom gadget”; see my post, and Philip Pilkington here).
But that’s not how things work (and it’s the very assumption that Keen is disputing). I tried to explain this in clear and simple terms here:
Think about it:
You get $100,000 in wages. Your employers’ bank account is debited, and yours is credited. Your bank can lend against your higher balance; your employer’s bank can’t. Net zero.*
You spend $75,000. It’s transferred from your account to other people’s/businesses’ bank accounts. Their banks can lend more, yours can lend less.
Is the total stock of loanable funds affected by whether the money is on deposit at your bank, your employer’s bank, or the banks of people you bought stuff from? No.
Meantime, you don’t spend $25,000. You “save” it. The money sits there in your checking account. If the action of spending — transferring money from one account to another — doesn’t change the total stock, how could not transferring money do so? Your bank still has the money, which it can lend out. Other banks still don’t, and can’t.
So here’s how the argument plays out:
Krugman assumes that people need to save in order for others to borrow.
Keen points out that they don’t.
Krugman explains that Keen is wrong by … assuming that people need to save in order for others to borrow.
And so the world goes round.
Cross-posted at Asymptosis.
Steve
I don’t know anything, so talk slow.
Your result is counterintuitive, so you might need to explain the mechanical details a bit for those of us who don’t understand.
What I see is this; At time T there is X amount of “money” in the nation (leave the world out of this for now). Not counting cash in your pocket, all of that money is in a bank somewhere, and the bank can create money by lending against it (“it” being the money the bank owes you, its “reserve.”)
okay, fine, assuming all of that money changes banks, the amount X remains fixed, for the instant “T”.
fully loaned against, fully borrowed. now what?
that is, if you want to increase savings… borrowing… investing… from this point what do you do?
I am inclined to think the problem is that “savings” doesn’t mean “money in the bank,” it means money deferred from present consumption, either “invested” in “present consumption for creating capital goods” or just “left under the mattress against the day when it is needed. so i am inclined to think that it is not “you” who need to “save so that others may borrow.” it is the banks.
now we know that a bank could “lend” an infinite amount of money as long as it had a way to protect itself from a “run.” but we also know that an infinite amount of money would soon exceed the capacity of “the economy” to produce goods and services leading to inflation and all the evils attendant thereto.
so i think there must somehow be a balance between money “saved”.. not spent… and money “borrowed” … spent by someone else.
that’s a “balance” not an equality. we all know that banks create money by lending it against anticipated increases in production.
what happens when the money is siphoned off into financial “markets” is a question for another day.
“that is, if you want to increase savings… borrowing… investing… from this point what do you do?”
Produce more income, and increase expectations of future income. (Aside: remember that expectations are built largely on current conditions, because they’re our best predictors of future conditions.)
People and businesses buy, spend, borrow, lend, invest, and consume when their incomes and projected incomes are high.
Saving is just a residual of that income — what’s left over after spending. Increase incomes and you increase everything — including saving. (Even while saving as a proportion of income either declines or increases.)
Aren’t you agreeing with Krugman’s conclusion? (If not his argument.) Isn’t your point that simply shifting money around does not necessarily increase the amount of lending? That is, it does not necessarily increase the amount of money in circulation during any interval of time, and hence, the aggregate demand?
@Min: “shifting money around does not necessarily increase the amount of lending”
But: increasing the amount of lending does increase the amount of spending. (Though, as I point out in the Asymptosis comments, it does not *necessarily* — certainly not 1:1. Keen understands clearly that the increased demand can “leak” into increased financial-asset prices instead of purchases of real goods, which drive increased production and incomes. So PV does not equal MY. Because financial assets exist.
At least from the standpoint of aggregate accounts, your $100,000 wage income is also irrelevant.
I think you’re confusing your individual act of saving with Saving. Aggregate saving increases when goods are produced and aggregate saving falls when goods are consumed. (Services, of course, are consumed at the time of production…)
At least from the standpoint of aggregate accounts, your $100,000 wage income is also irrelevant.
I think you’re confusing your individual act of saving with Saving. Aggregate saving increases when goods are produced and aggregate saving falls when goods are consumed. (Services, of course, are consumed at the time of production…)
At least from the standpoint of aggregate accounts, your $100,000 wage income is also irrelevant.
I think you’re confusing your individual act of saving with Saving. Aggregate saving increases when goods are produced and aggregate saving falls when goods are consumed. (Services, of course, are consumed at the time of production…)
But don’t you mean *net* financial assets, not *gross*?
But don’t you mean *net* financial assets, not *gross*?
But don’t you mean *net* financial assets, not *gross*?
Saving is just a residual of that income — what’s left over after spending
well then, in order to increase what is left over after spending you have to spend less.
or – of course you can increase income… but as far as i know the traditional way to do that is to “borrow and invest” some of that money “left over after spending.” the question is not whose bank is the money “in,” but what the money is spent on… “consumption” or “investment.”
not including “investment in the stock market” which appears to be just a way to absorb excess money so that it inflates stock prices instead of consumer prices or even capital goods prices.
the thing you cannot do is “increase income” just by giving people more money. unless they are going to use the money to create more product. or give it to someone who will.
Saving is just a residual of that income — what’s left over after spending. Increase incomes and you increase everything — including saving.
Have to partially disagree and go with coberly on this one.
First off, a whole lot of Americans saw their “incomes” as well as paper net worth go through the roof from 2000-2006 as a direct result of the housing bubble, which was itself a synthetic creation of Alan Greedspan’s 1% interest rate policy (now succeeded by ZIRP), regulatory capture at all levels, and the explosion of a completely deregulated derivates-based Shadow Economy –CDOs, MBSs, CDSs, etc.
Turns out, all that debt-based “income” wasn’t quite the same as real income from a genuinely productive goods-and-services creating job. At the same time, the U.S. savings rate plummeted to an all-time low, by some measures going negative when you account for MEW. So, “income” and net wealth increased (on paper) while aggregate savings dropped like a stone.
Big picture here is, it’s not just total income, savings or debt on the bank’s balance sheet that matters to the real economy (the one most people inhabit). It’s also how that income is generated, how much of that money gets spent (velocity), and where it goes (investment).
Working class citizens tend to do better when their income is earned from productive jobs, tend to spend a large % of it locally on consumption –goods and services that create other jobs in the community, and also tend to “save” by investing in U.S. securities and businesses.
Plutocrat-rentiers on the other hand, get most of their income is passive sources (capital gains, interest and dividends) that get taxed at a preferential rate or are tax sheltered via trusts, offshore holding companies, etc. They spend it globally –often outside the U.S.– gambling on whatever exclusive commodity or hedge fund that offers the best return for them. This does *not* tend to end up creating more American jobs for Joe the Plumber, despite what Joe seems to believe. They like debt-financed consumption and lower income for Joe, because they own this debt and that means capturing more rent for themselves.
D R,
Please ease up on the ‘post’ button, okay?
HARM
it may not be the post button. sometimes AB’s “system” does that to perfectly innocent folks. even me. the cure is to wait until it posts, then use the delete button to get rid of the extras.
don’t know what causes it. mostly i don’t have a problem.
Duplicates fixed…perhaps a jskit server delay…there is a delete button for awhile on comment….
“But: increasing the amount of lending does increase the amount of spending.”
How do you mean that? People obviously borrow in order to spend. (Nick Rowe seems to think that people borrow for other reasons, but did not say what they were, when I asked a while back. ;)) I suppose that the main reason for borrowing is in order to spend. Maybe I will put a purchase on my credit card and not pay it off immediately. How do we express that in terms of causality? Does the spending increase the lending, or does the lending increase the spending?
I am thinking that to the extent your money is still in the bank it is “saved.” And to the extent it is still in the next guy’s bank, it is “saved.”
What makes the difference is whether the bank lends.. money it creates based on the “reserves”… your money in its bank…
Presumably the money could sit there, unlent, uninvested, or it can be “borrowed for investment.”
But it can’t be borrowed if it is not “unspent” in the bank (or created by the bank against “unspent” reserves)… or unspent in the next guys bank.
I am not by any means sure of this, but neither am I sure about Steve’s identity.
Anyone can create debt. If I loan you $1, then poof another $1 of debt. You take the dollar and open a savings account. Poof, another $1 of debt.
I really don’t see the significance.
Anyone can create debt. If I loan you $1, then poof another $1 of debt. You take the dollar and open a savings account. Poof, another $1 of debt.
I really don’t see the significance.
Anyone can create debt. If I loan you $1, then poof another $1 of debt. You take the dollar and open a savings account. Poof, another $1 of debt.
I really don’t see the significance.
DR
i am guessing the significance is that if you create debt, you don’t create “money,” because no one is going to take my iou to you in trade for whatever he is selling.
even putting your money in a savings account does not create the kind of debt that can be used for money… except to the extent that the bank can make loans against it as reserve.
Well
if all steve is saying is that the banks can lend you money that it doesn’t “have” and therefore wasn’t “saved,” i think that is standard banking… subject to reserve requirements if any. but it is not the sort of thing you can do without limit.
There is a limit BUT the limit is indefinite. No one knows what the limit is until the music stops.
“Of all Beings that have Existence only in the Minds of Men, nothing is more fantastical and nice than Credit; ’tis never to be forc’d; it hangs upon Opinion; it depends upon our Passions of Hope and Fear; it comes many times unsought for, and often goes away without Reason; and when once lost, is hardly to be quite recover’d.” — Charles D’Avenant
Sandwichman
but in the aggregate it does seem to have real effects which are reasonably predictable.
if i understand Greider (Secrets of the Temple) correctly.. and he isn’t saying it in so many words…
the inflation of the seventies was created by loose money managed by the Fed…
again, i don’t know anything, but what it looks like reminds me of a young Psychologist I knew who was going to teach his dog to come, using Behavior Modification. His theory was no doubt right, but his timing was bad and the dog ended up teaching the Psychologist to feed him treats for not coming.
thing is, i am quite sure you and Robert know how this stuff works…better than i do… as much as anybody… but the arguments seen so far are unconvincing.
Sandwichman
and yet in the aggregate it has measurable effects.
i am no longer sure we, I, am addressing Steve’s original proposition, nor could I tell by looking at the paper he cites in his next post.
“do people need to save in order for others to borrow?”
the answer seems obvious: i must refrain from “some” consumption (save) in order that you may consume (borrow) that which I have left on the table.
on the other hand, we know that banks can lend “money” that no one has “saved.” but we also know, think we know, that unless that borrowing leads to increased production we end up with “inflation.” Even with increased production, unless that product is “consumed” we end up with a crash and recession.
or maybe none of this is true, or maybe it is not the question Steve and Krugman and Keen are arguing about. Can’t tell from here.
MMT/PK is a religion/mysticism even more insidious than Austrianism. It must be opposed at every corner in every alleyway and ultimately driven down to a grim defeat.