Modern Monetary Theory is a term that one encounters with increasing frequency. It is often applied to a specific policy, such as advocacy of expansionary fiscal policy. But that’s not a very useful definition. Lots of economists now advocate expansionary fiscal policy in the current environment of very low interest rates and high unemployment.
MMT is more than fiscal stimulus; it is a model of the macroeconomy. In order to better understand the MMT model I’ve been reading “Macroeconomics”, an undergraduate textbook written by William Mitchell, Randall Wray and Martin Watts. You probably won’t be surprised to learn that it’s not my cup of tea. But I don’t want to be unfair in my appraisal, so I’ll discuss a point of confusion here (and another today over at MoneyIllusion), and try to elicit feedback from those better schooled in the model. Am I being unfair? If so, what’s the intuition that I’m missing?
On page 85 they present a national income account equation (which is accurate), and then provide a peculiar interpretation:
(6.4) (GNP – C – T) – I ≡ (G – T) + (X – M + FNI)
The terms in Equation (6.4) are relatively easy to understand now. The term (GNP – C – T) represents total income less the amount consumed by households less the amount paid by households to government in taxes net of transfers. Thus it represents household saving.
The left-hand side of Equation (6.4), (GNP – C – T) – I, thus is the overall net saving of the private domestic sector, which is distinct from total household saving (S) denoted by the term (GNP – C – T).
Everything is correct until the final sentence. It does not represent net saving. Once you subtract investment from household saving you end up with the sum of the government deficit (defined as a positive number) and the current account balance (the net inflow of foreign saving.) That’s not net saving as conventionally defined, which is equal to net investment is a simple economy with no government or trade.
Because this might be confusing to readers, let’s consider their model in a closed economy context, for instance, how would it apply to the global economy as a whole? In that case, you could drop the current account balance (zero for the globe by definition) and you’d end up with:
(GNP – C – T) – I ≡ (G – T)
The claim is that net saving equals the budget deficit in a closed economy. Unless I’m missing something, that’s a really weird definition of net saving, completely unrelated to how mainstream economists (of all stripes) define saving.
And it’s not just me; Robert Blumen reaches a similar conclusion:
Modern monetary theory, which is now experiencing its fifteen minutes of fame, contains a number of strange and counterintuitive propositions.1 Proponents claim that these propositions are not an economic theory, only an accounting identity. One of these is that the private sector can save only if the government runs a deficit.
Within the self-consistent, tail-chasing world of MMT, these statements are true by definition. However, when MMT aphorisms are interpreted using their normal meaning in the English language, their conclusions are not only false, but foolish.
Now you might argue that it’s a free country and people are entitled to define terms in unconventional ways. Nonetheless, I have two objections to the way they define net saving.
1. This is an introductory economics textbook. Students that learn this definition of saving would be utterly confused by the way the term ‘saving’ is used in any other economics class, or in the broader society. Thus by their definition, net saving would always be exactly zero in any closed economy with no government, or any closed economy where the budget was always balanced. And yet people would still be saving in that situation (in the conventional sense), as net saving would equal net investment. To give you a sense of the magnitudes involved, suppose that the global budget deficit is 3% of global GDP and global net investment is 20% of global GDP. Then net household saving would be 3% of GDP as defined by MMTers, and 23% of GDP as defined by other economists. That’s a radically different definition.
2. My bigger objection is that they seem to draw meaningful causal implications from this peculiar definition of saving. This isn’t just a typo, one minor glitch in an otherwise straightforward textbook, this definition informs much of the subsequent analysis. Thus on page 96 we see the following:
Since the accumulation of a stock of financial wealth results from a surplus, that is, from a flow of saving, we can also conclude that causation tends to run from deficit spending to saving.
This is actually correct if you define “saving” according to the second equation above, but it’s an utterly meaningless statement. After all, in a closed economy context, “net saving” is just another term for “budget deficit”. In an open economy context, “net saving” is just another term for “budget deficit plus current account balance”. In plain English, students are being informed that causation tends to run from deficit spending to deficit spending! True, but utterly without significance.
Identities like C+I+G = GDP or M*V = GDP can be useful if used correctly, as a foundation for a behavioral model that tries to compare a policy related term (M or G) with an interesting goal variable (GDP). However both sides of the closed economy equation above are the budget deficit; there is no goal-related variable.
Now it’s possible that I’m missing something very basic here. But reread Robert Blumen’s appraisal; he’s saying the same thing.
I’ll reserve final judgment until I hear back from MMT commenters; perhaps I’m misinterpreting the textbook. My initial appraisal, however, is quite negative. Over at TheMoneyIllusion I ask for help in understanding their view of open market operations.
READER COMMENTS
Arnold Kling
Nov 23 2020 at 8:39am
Here is how I interpret MMT on this point.
Scott Sumner
Nov 23 2020 at 1:06pm
Arnold, That’s right. But that choice of terminology . . .
Colin, Are you saying they misinterpreted Godley, or that Godley explains why a seemingly odd definition is actually useful?
Market, Yes, that’s what they seem to be saying. But WHY? What’s the reason for saying budget deficits cause budget deficits, and then redefine “budget deficit” as “net saving”?
Colin Haller
Nov 24 2020 at 7:39pm
I’m suggesting the latter.
daniel kearns
Dec 1 2020 at 11:54am
Market, Yes, that’s what they seem to be saying. But WHY? What’s the reason for saying budget deficits cause budget deficits, and then redefine “budget deficit” as “net saving”?
I am sympathetic to what I perceive to be the goals of MMT (i.e., helping the poorer). My problem with MMT (other than the rather useless tendentious arguments about accounting definitions) is that defacto we already essentially have MMT in the deficit spending we have now. Changing accounting or economics textbooks is not going to change US government policy preferences.
Say we doubled deficit spending – where is that extra money going to go? I suspect for every extra head start dollar, somewhere between 20 and 50 dollars will go to a 800 ship navy, infrastructure, or tax cuts. Maybe MMTers believe if we only did enough trickle down, enough money would reach the poor. I don’t. Its not economics, and its not accounting – its politics.
Julius Probst
Nov 23 2020 at 9:17am
I have the impression that a good chunk of MMT rests upon a misinterpretation of Godley’s sectoral balances
https://en.wikipedia.org/wiki/Sectoral_balances
And labelling things differently than other people is also a common theme.
“No, it’s not monetary policy, we call it “fiscal policy” because we consolidate the government’s balance sheet and the Central Bank is part of the government.”
Stuff like that is not helping anybody.
And no, I am not trying to be mean, by the way. I don’t have a problem with heterodox approaches. Some post-keynesian literature is very interesting, and in a way Market Monetarism is heterodox as well.
robc
Nov 23 2020 at 9:53am
Your points all make sense, but I balked at Investments not being included in savings, because, ummm, that is exactly what saving are. At least, that is where (almost) all my savings go. I didnt need any fancier analysis to realize this is BS.
Colin Haller
Nov 23 2020 at 11:03am
I believe the premise that sovereign debt is by accounting identity equal to private net savings denominated in the sovereign fiat currency comes from the sectoral balances analysis of Wynne Godley. You might be better served to look there than in the Mitchell/Wray textbook.
Market Fiscalist
Nov 23 2020 at 12:32pm
MMT appears to focus only on the stocks and flows of government created financial assets. So net savings is simply an increase in bonds and money held by the public which of course is equal to the budget defect. Budget deficits make people richer and surpluses make them poorer (at least in nominal terms). Furthermore the composition of Total Savings (of government-created assets) is unimportant to private spending. The only way the government can affect private spending is by varying the size of the deficit.
Scott Sumner
Nov 23 2020 at 1:07pm
Arnold, That’s right. But that choice of terminology . . .
Colin, Are you saying they misinterpreted Godley, or that Godley explains why a seemingly odd definition is actually useful?
Market, Yes, that’s what they seem to be saying. But WHY? What’s the reason for saying budget deficits cause budget deficits, and then redefine “budget deficit” as “net saving”?
Garrett
Nov 23 2020 at 2:07pm
To make government expansion seem virtuous, an end in itself
Benoit Essiambre
Nov 23 2020 at 1:31pm
I once, years ago when MMT was rising in popularity, had a long debate with a MMTer and this is exactly where the discussion became weird and problematic to me.
This guy just wouldn’t accept a definition of savings that included economic investment while I was insistent that not only was it included but at the aggregate, global level, it is the only component that matters (the rest is financial promises, where one’s asset is someone else’s liability making them net out to zero on the aggregate).
Ahmed Fares
Nov 23 2020 at 3:15pm
Hi, MMTer here.
Right off the bat, we get this straw man argument from Robert Blumen:
“One of these is that the private sector can save only if the government runs a deficit.”
This is what MMT actually would say (for a closed economy):
“One of these is that the private sector can NET save only if the government runs a deficit.”
What MMT actually says, which is the point that most economists miss, is that it is the non-government sector which determines the government’s fiscal balance. If the non-government sector desires to net save, i.e., save in excess of investment, which it usually does, then the government must run a deficit. It will do this in one of two ways. If it does nothing, then the economy will enter a recession, tax revenues will fall while welfare payment rise, and the deficit increases that way. The other way is for the government to run a deficit and keep the economy at full employment, and the deficit rises that way.
Either way, the government MUST satisfy the non-government sector’s desire to net save. It has no choice in the matter.
By way of example, if there is $100 of investment in the economy and the non-government sector desires to save $120, then the $20 will end up as unintended inventory investment, which leads to unemployment and the accounting identity is satisfied that way. What the government should do is run a deficit of exactly $20 to satisfy that net-saving desire of $20, and thus prevent unemployment.
Yes, I know. That sounds like the Keynesian prescription with Abba Lerner’s Functional Finance as opposed to Sound Finance thrown in, which it is. MMT ties a lot of ideas from other economists together. To these ideas, MMT adds the Job Guarantee (JG) to once and for all eliminate the scourge of unemployment, and anchor inflation.
Benoit Essiambre
Nov 23 2020 at 4:29pm
“One of these is that the private sector can NET save only if the government runs a deficit.”
The private sector is not net saving since it is accumulating an aggregate tax liability equal to its government assets, same as if it was accumulating a financial asset backed by private entities. The government has to collect taxes to pay its debt. Even if you play tricks by saying the government is going to pay debt by printing money, that’s not a true saving. Assuming aggregate demand is already adequately high, the private sector is just going to pay through excessive inflation instead of taxes.
Only economic investment is net saving that can be consumed without anyone paying for it (by drawing down the physical inventory).
MMTers always point to Japan and such asserting governments can print to pay down debt without causing inflation. But that’s because Japan has had insufficient AD for a long time. Don’t conflate two problems. Government debt is not saving. Yes you should solve the AD problems and while you are solving them it may temporarily look like printing is a free way to pay for debt… temporarily.
Ahmed Fares
Nov 23 2020 at 7:48pm
The following is quoted from William Vickrey (Fifteen Fatal Fallacies of Financial Fundamentalism)
Fallacy 1
Deficits are considered to represent sinful profligate spending at the expense of future generations who will be left with a smaller endowment of invested capital. This fallacy seems to stem from a false analogy to borrowing by individuals.
Current reality is almost the exact opposite. Deficits add to the net disposable income of individuals, to the extent that government disbursements that constitute income to recipients exceed that abstracted from disposable income in taxes, fees, and other charges. This added purchasing power, when spent, provides markets for private production, inducing producers to invest in additional plant capacity, which will form part of the real heritage left to the future. This is in addition to whatever public investment takes place in infrastructure, education, research, and the like. Larger deficits, sufficient to recycle savings out of a growing gross domestic product (GDP) in excess of what can be recycled by profit-seeking private investment, are not an economic sin but an economic necessity. Deficits in excess of a gap growing as a result of the maximum feasible growth in real output might indeed cause problems, but we are nowhere near that level.
Even the analogy itself is faulty. If General Motors, AT&T, and individual households had been required to balance their budgets in the manner being applied to the Federal government, there would be no corporate bonds, no mortgages, no bank loans, and many fewer automobiles, telephones, and houses.
Fallacy 3
Government borrowing is supposed to “crowd out” private investment.
The current reality is that on the contrary, the expenditure of the borrowed funds (unlike the expenditure of tax revenues) will generate added disposable income, enhance the demand for the products of private industry, and make private investment more profitable. As long as there are plenty of idle resources lying around, and monetary authorities behave sensibly, (instead of trying to counter the supposedly inflationary effect of the deficit) those with a prospect for profitable investment can be enabled to obtain financing. Under these circumstances, each additional dollar of deficit will in the medium long run induce two or more additional dollars of private investment. The capital created is an increment to someone’s wealth and ipso facto someone’s saving. “Supply creates its own demand” fails as soon as some of the income generated by the supply is saved, but investment does create its own saving, and more. Any crowding out that may occur is the result, not of underlying economic reality, but of inappropriate restrictive reactions on the part of a monetary authority in response to the deficit.
source: http://www.columbia.edu/dlc/wp/econ/vickrey.html
Benoit Essiambre
Nov 23 2020 at 11:02pm
This is all true but it doesn’t make government debt be net aggregate private savings.
Note the emphasis on public investment in these unnecessarily wordy paragraphs. That’s because the part of government spending that is investment does indeed add to net savings (like private investment does). But it’s important to mention that the larger part that is immediately consumed as government services does not.
Pretending that government debt is a necessity that enables private savings is smoke and mirrors in an attempts to disregard the significance of what the government actually does with the money, of whether it invests it or consumes it, while glossing over the important contribution of private investment.
In reality savings are enabled by both private and public investment. There are legitimate debates on whether one side is better at it than the other. Is it possible MMTers are trying to avoid having that debate by misdirecting attention to relatively unimportant technical details of government debt accounting while downplaying the impact of economy wide private investment that often happens without any government intervention?
No one is saying the government should have no debt either. The comparison to corporate debt makes no sense unless you’re saying that corporations should also grow unlimited debt without considerations for stabilizing it eventually.
Even your excerpt says [The MMT approach] “might indeed cause problems, but we are nowhere near that level.” That’s easy to say just after a period where globally AD has often been too low. This doesn’t make MMT right through longer human history. It just means that temporarily, it’s more right than usual. There are good arguments for the idea that if central banks had not been so overly stingy in printing in the past decade or two, MMT would likely have been wrong for almost all of history as we would have been at that full employment level where further debt “might indeed cause problems”.
Colin Haller
Nov 24 2020 at 7:44pm
You assert that the sovereign MUST repay its debt, despite all of the evidence to the contrary.
Why?
Benoit Essiambre
Nov 24 2020 at 8:06pm
I asserted no such thing. I said that when the aggregate private sector wants to redeem money that it lent to the government, the government must pay that amount of its debt (by definition). To do so, the government must tax the private sector by that same amount (or print regardless of whether the timing warrants additional printing). What good are savings that will just be taxed away if there is an attempt at redeeming them? Should these type of assets even be called savings? Standard economics doesn’t think so, at least not at the aggregate level.
Scott Sumner
Nov 23 2020 at 6:55pm
Ahmed, You said:
“What MMT actually says, which is the point that most economists miss, is that it is the non-government sector which determines the government’s fiscal balance. If the non-government sector desires to net save, i.e., save in excess of investment, which it usually does, then the government must run a deficit.”
That’s what I was afraid of. The budget deficit jumped much higher after the Trump tax cut, even though the economy was booming. Was that because the public suddenly decided it wanted more safe assets in 2018-19? I very much doubt it.
The demand for any asset depends on its price. The public might have a demand for more government bonds at one price, but not another.
You also miss that the government has many ways of addressing an increase in demand for safe assets. Thus an expansionary monetary policy can reduce the demand for safe assets, and thus reduce the need to run budget deficits. You don’t have to run a budget deficit just because people wish to hold more safe assets at the going rate of interest. Cut the market interest rate or raise the natural interest rate.
Ahmed Fares
Nov 23 2020 at 8:32pm
“Was that because the public suddenly decided it wanted more safe assets in 2018-19? I very much doubt it.”
First, the sectoral balances equation, from the perspective of the government:
(G – T) = (S – I) + (M – X)
What was the external sector doing at that time? Here is a quote from Forbes:
“The U.S. trade deficit exploded in 2018, reaching $878.68 billion. It had not topped $800 billion since 2008, though it has increased seven of the last nine years. The previous record year was 2006. Somewhat surprisingly, the reason for the 12-year drought for a record for total trade, total exports, total imports and trade deficit in one year was, in fact, the much-maligned trade deficit.”
Also, here’s a graph from Trading Economics. I notice a huge jump in the US current account deficit is that time period you mentioned:
https://tradingeconomics.com/united-states/current-account
Ahmed Fares
Nov 23 2020 at 9:20pm
Further to my comment:
“Cut the market interest rate or raise the natural interest rate.”
The following is quoted from an article by MMT economist Bill Mitchell titled: “Monetary policy is largely ineffective”:
“There are distributional factors involved. Creditors and those on fixed incomes lose out when there is an interest rate cut, while debtors benefit. What is the net outcome of those offsetting impacts? There is deep uncertainty about the net outcome and non-definitive empirical research results available.
The expansionary argument rely on the assumption that debtors have higher propensities to consume out of each extra dollar available to them than creditors. But what about those on fixed incomes? Many of them are retirees with limited means and a cut in rates reduces their incomes and thus their spending.”
Further down in the same article:
“Third, monetary policy is untargetted in a regional or cohort sense. It can only impact on interest-rate sensitive spending. It cannot help a specific region that is in recession if its industrial base is declining or impacted by a slump in overall spending.
It cannot help low income earners who have high propensities to consume but may not have any debt.
Fiscal policy can not only target demographic groups but can also focus on specific regions.
Fiscal policy has the dual capacity to alter the level of total expenditure and the composition of that total. The latter capacity allows it to have distributional impacts while maintaining an appropriate full employment level of overall spending.
Monetary policy has no such capacity.
For all these reasons, a reliance on monetary policy is unlikely to deliver desirable outcomes.”
source: http://bilbo.economicoutlook.net/blog/?p=30594
Scott Sumner
Nov 24 2020 at 12:01am
Much of your comment is off topic. I don’t doubt that fiscal policy can have distributional effects that monetary policy does not. But that’s not the issue I’m addressing. My point is that the government doesn’t have to run a larger deficit just because the public wishes to hold more safe assets. They may want to run a deficit for a variety of reasons, but they are not forced to.
As far as monetary policy being powerless—that’s just false, as I explain in my recent MoneyIllusion post.
Monetary policy doesn’t work by affecting interest rates, it affects NGDP. So it makes no difference how responsive the economy is to a change in interest rates.
Ahmed Fares
Nov 24 2020 at 3:17am
“My point is that the government doesn’t have to run a larger deficit just because the public wishes to hold more safe assets.”
To be clear, I said nothing about the public wishing to hold more safe assets, but rather that they wanted to net save, i.e., S > I. It could just as easily come about from a dearth of investment.
To use a simple example, if I desired to save $100 in a given time period in which there occurred $80 of investment, then my net saving desire is $20. Now multiply that across the economy.
What MMT says is that the public typically desires to save more than the amount of investment that takes place in an economy, and that the government should satisfy that net saving desire by running deficits of the good kind, before a recession causes it to run deficits of the bad kind.
And if I understood you correctly, you believe that an expansionary monetary policy can, using my example, drive down my saving desire to say $90 and drive up investment to $90, such that you eliminate that net saving desire and avoid running a deficit. And that you can do that without creating asset bubbles in the process, as low interest rates have been wont to do. Or to deprive some senior of interest income in their retirement.
Which is why monetary policy has been referred to as a “blunt instrument”.
robc
Nov 24 2020 at 9:01am
That is wrong and part of the point of the initial argument. INVESTMENT IS SAVINGS, so net savings cannot subtract out I.
MMT is using the term wrong. They can try the “we define it this way” but that doesnt work as it goes against what everyone else thinks the term means.
Even after reading the Steve Waldman link below, which helped somewhat, I can’t wrap my mind around exactly what S – I represents. I thought I had a bit of a clue until I started reading the comments on that link.
The best I can come up with is money stuffed under the mattress or gold buried in the back yard?
Ahmed Fares
Nov 24 2020 at 2:50pm
robc,
“INVESTMENT IS SAVINGS”
Yes, always, and to the penny.
For a closed economy, investment equals saving for the whole economy. For an open economy, it includes the external sector. This is why the US for example has higher investment than saving, while countries like China have higher saving than investment. Investment and saving balance at the global level.
For a closed economy, this is the sectoral balances equation:
(G – T) = (S – I)
The private domestic sector net saves, i.e., (S > I), in exactly the amount of dis-saving by the government, i.e., (G > T), i.e., a budget deficit. The portion of saving net of I is Private Sector Net Financial Assets (PSNFA).
robc
Nov 24 2020 at 4:38pm
I get the math, but it doesn’t change anything. Subtracting out I isn’t net savings, it isnt savings at all. I is part of savings so you can’t net it out.
And that doesn’t answer my question of what S-I represents. Ignore aggregation, what is my personal S-I represent?
And why not call it “safe asset accumulation” as Scott suggests or anything else at all, instead of net savings, which it isnt?
Steve Waldman
Nov 23 2020 at 5:44pm
Scott,
Probably badly(!), but I once tried to translate this MMT idea to a more general audience.
Scott Sumner
Nov 23 2020 at 6:46pm
Thanks Steve, That’s much clearer than the textbook. If net saving had been called “safe asset accumulation” it would have addressed my first objection above (the issue of net saving being confusing to students who planned to take other econ courses.)
I still have a problem with the causality claims in the textbook.
David Joy
Nov 23 2020 at 7:55pm
This is from an old (1991) copy of the Begg, Fischer & Dornbusch textbook, page 362 (for a closed economy):
“Taking firms and households together, the net withdrawals from the circular flow S – I (the financial surplus of the private sector) must be exactly offset by the net injections…from the government sector (the financial deficit of the government). The private sector as a whole can run a surplus only if the government runs a deficit, and vice versa.”
Is the problem the reference to the financial surplus of the private sector as net saving of the private sector? I don’t see the issue…
Scott Sumner
Nov 24 2020 at 12:30pm
But what you call a “surplus” is nothing more than the government deficit. It’s an identity.
Sam Levey
Nov 23 2020 at 7:59pm
I’m an MMTer. Hopefully this should be easy to clear up.
The definition of “saving” you’re probably thinking of is about real resource consumption, i.e. saving = income (production) not consumed.
The definition of “saving” being used in the excerpts from the book are about financial saving, i.e. spending less than your income, and as a result accumulating financial assets.
For a closed economy with no government, it’s impossible for the private sector as a whole to spend less than its income in financial terms, because that income comes from the spending. While individuals inside the private sector can accumulate financial claims against each other, when considering the sector as a whole these net out to zero (1 claim = 1 person claimed). The only way the sector as a whole can accumulate (net) financial claims is if there is some other sector against which it can run surpluses.
In the simplest heuristic versions of NIPA, saving is something only households do, while only firms do investment and it’s all financed by borrowing. So in that case, the surplus in the household sector exactly equals the deficit run by the firm sector. And so if those are the only two sectors, then jointly they are always running a balanced budget, spending exactly their income.
As for causality, the basic idea is that causation tends to run from spending to income, because it’s much easier to choose how much to spend than to choose how much people pay you. But, “it takes two to tango,” and that shouldn’t be read as a hard rule. In some cases, one’s desire to run a surplus can cause somebody else to run a deficit – think ‘automatic stabilizers.’
For questions about finer points of MMT, I’d encourage readers to check out this resource, entitled ‘MMT for Mainstream Economists’: https://deficitowls.wixsite.com/mmt4mainstreamecons
Scott Sumner
Nov 24 2020 at 12:28pm
Thanks Sam. If I understand things correctly, then MMTers are making two claims using awkward language. First, they are defining saving in a very unconventional way, which will be confusing to students who use this book if they later take some other economics class. Why not use a more descriptive term than “net saving”? Throughout the book, every time I see the authors use the term “saving” I must remind myself that this term has nothing to do with actual saving, and that they are talking about the budget deficit, or the budget deficit plus the current account.
Second, this discussion of people “wanting” to save more than they invest is very misleading. Suppose I said the fact that IBM sold $5 billion in bonds showed that the public “wanted” IBM bonds and the company was meeting their needs? (You focus on T-bonds because government borrowing is a policy tool and IBM borrowing is not.) Rather I think what MMTers are getting at is that at a certain interest rate and (full employment) aggregate income level, the public may desire to save more than they invest, and that the government should dissave to accommodate those “wants”. I think that argument is wrong, but it’s basically the Keynesian paradox of thrift model you see in many intro textbooks. The presentation here is far more confusing to students than even the Keynesian cross. I don’t like the Keynesian cross model in substantive terms, but it’s a clearer way of making this argument.
Ahmed Fares
Nov 24 2020 at 3:30pm
“Throughout the book, every time I see the authors use the term “saving” I must remind myself that this term has nothing to do with actual saving, and that they are talking about the budget deficit, or the budget deficit plus the current account.”
You left out investment. Also, saving is not the budget deficit, that would be net saving, which also has to include the current account as you mentioned.
Here is the sectoral balances equation from the view of the private domestic sector:
(S – I) = (G – T) + (X – M)
S = (G -T) + (X – M) + I
So that means that saving is the sum of those three terms on the right side, with net saving being the sum of the first two terms on the right side, i.e., financial claims against the government or the external sector. So net saving means we simply net out investment to leave us with those two other terms. The word “net” means we subtracted something out, which in this case is investment.
So when we say “net saving”, we mean (S > I), as in the first equation above.
When we say “saving”, we mean S, as in the second equation above.
robc
Nov 24 2020 at 4:42pm
But netting out is to subtract something that isn’t really a part of the whole.
When I go from gross to net pay, I start with the total amount my employer pays me, but then I net out things I dont receive. So net pay is the size of the direct deposit I receive.
Or gross income on my tax form is my total income. Net income is netting out deductions I dont have to pay taxes on.
“net savings” isnt. I is actually savings that I am saving, so cannot be netted out and still call the term savings. Most savings is investment, so netting out the vast majority of savings and still calling the term savings is missing the entire point of the term savings.
robc
Nov 24 2020 at 4:43pm
Some may say this is just a semantic argument, but it is important or it leads to motte and bailey type arguments.
Ahmed Fares
Nov 24 2020 at 6:39pm
robc,
Imagine you and I are on a desert island. We gather fish and coconuts which we consume. In my spare time, I make a fishing net.
Investment equals one fishing net, my saving equals one fishing net. S = I
Suppose that for some reason you write me an IOU for two coconuts, to be given to me some time in the future which you have not yet gathered. My saving is now one fishing net plus two coconuts. My net saving is two coconuts.
Note that investment still equals saving for the whole island. There is one fishing net which is investment and my claim to that fishing net which is my saving. I have however net saved two coconuts, because you ran a deficit of two coconuts.
(S – I) = [1 fishing net + 2 coconuts] – [1 fishing net]
This leaves 2 coconuts as net saving for me. You simply have a deficit of 2 coconuts.
Now the reason that we break that apart in MMT is to show what happens when the private domestic sector desires to save more than the investment that has taken place in an economy, and the government doesn’t write those IOUs, which I explained in my previous comments.
I’ll write a separate comment again for that.
Ahmed Fares
Nov 24 2020 at 6:49pm
robc,
The following is excerpted from an article by “heteconomist” (Dr. Peter Cooper):
“Having acknowledged that there are real limits to government deficits (it was never denied), MMT nevertheless makes clear that government deficits are the norm, not the exception. This does not mean that government deficits of any size are okay. They must be consistent with private-sector net-saving intentions. It simply means that ongoing government deficits of some size will be the appropriate policy under normal circumstances. The reason for this is that the non-government sector typically desires to net save. This means, as a matter of accounting, that the government must run deficits.
In aggregate:
Government Balance + Non-Government Balance = 0
This is an identity, true by definition. The financial balance of the non-government sector matches the government’s balance dollar for dollar. Non-government can only maintain a surplus (positive balance) if the government runs a deficit (negative balance). The financial wealth of non-government is nothing other than the accumulated deficits of the government sector.
For an open economy, such as an individual trading nation, the non-government sector can be disaggregated into the domestic private sector and foreign sector. As a matter of accounting:
Government Balance + Domestic Private Balance + Foreign Balance = 0
The majority of nations run current account deficits. For these nations, the foreign balance is positive and government deficits are required if non-government is to maintain a financial surplus. Ongoing government surpluses are only sustainable in a few small trade-surplus nations with current account surpluses sufficiently large to offset the net-saving intentions of domestic households and businesses.
Whenever the non-government sector net saves (maintains a surplus), it is spending less of the monetary unit than it earns. The result is unsold output and a signal to firms to cut back production unless the government fills the demand gap through deficit expenditure. By doing so, the government is in a position to ensure all output is sold at current prices and that the non-government sector satisfies its net saving desires. If, instead, the government allows the demand shortfall to persist by not injecting sufficient expenditure of its own, firms will respond by cutting back production. There will be a contraction in output and income, thwarting non-government net saving intentions. If the non-government sector responds by redoubling its efforts to net save, the result is a further shortfall in demand, further contraction of income (as well as tax revenue), more frustration of non-government saving plans, etc. There is no end to the process until either the non-government sector accepts a smaller net-saving position or the government accepts a bigger deficit.”
source: http://heteconomist.com/krugman-and-galbraith-on-deficits/
Sam Levey
Nov 24 2020 at 10:57pm
“First, they are defining saving in a very unconventional way, which will be confusing to students who use this book if they later take some other economics class.”
The financial definition of “saving” highlighted in the excerpt is closer to what students have in their head walking in the door, and I’ll fight you on this one 🙂 It takes a lot of exposure to economics to come to understand saving as “resources not consumed.” Your average Joe on the street things of saving as “spending less than you earn.” To highlight the difference, consider the purchase of durable goods like a car or washing machine. In the ‘resources not consumed’ definition, these purchases do not reduce your saving, they just change the form of your saving from money to a long-lived physical asset. But your average Joe does not say “this washing machine is part of my life savings.” They say things more like “I used my savings to buy this car,” or “we saved up to finally buy a washer.” These purchases are understood in common parlance to be depletions of savings, because they reduce your financial balances. The same thing is true for homes, even if they are generally more understood to be part of household wealth. People would not say things like “We saved up for a down payment” if they considered that the home equity the down payment funded is still part of their “savings”!!
So, we’re really talking about a financial surplus: spending less than your (money) income (where “spending” is understood to exclude the purchase of financial assets, which don’t reduce your financial saving, but only change the composition of your financial portfolio). And in order for one unit to run a surplus, at least one other must run a deficit.
One more relevant fact here is that we don’t see investment as constrained by saving: “saving” doesn’t finance investment, “finance” finances investment! I wrote a bit about this here: https://medium.com/@slevey087/saving-and-investment-by-degrees-6ec2a050c5f0. For us the causation runs the reversed way, whereby an act of investment identically creates an exactly equal unit of saving, regardless of how it is financed.
So, “wanting to save more than they invest” is not particularly meaningful for us, but “wanting to run a surplus” or “wanting to accumulate financial assets” are.
robc
Nov 25 2020 at 8:33am
A house, washing machine, and a car are all consumption. Yeah, in a business setting, they would be assets that you would depreciate over time, but that is just slow consumption.
I have always said a house is just a car that decays slower. To prevent the decay in value, you have to pump a ton of money into it, and really, even that doesnt work. What isnt consumption is the LAND the house sits on, that is a real asset, and may be considered an investment (although I don’t like to think of it that way for homes, I say “property is an investment, your house and land is where you live”).
So the average Joe is using savings correctly when saving up for a car or a down payment.
The part that I object to in the MMT definition is netting out investment from savings. Net savings includes investment, I am not sure what should be netting out between gross savings and net savings, but it isn’t investment. S-I needs a different term — there are a number of good suggestions, but net savings is totally misleading.
Ahmed Fares
Nov 25 2020 at 2:37pm
robc,
“Net savings includes investment”
No, net saving excludes investment. Here’s the sectoral balances equation from my comment above:
(S – I) = (G – T) + (X – M)
Net saving is the sum of the stuff on the right side of that equation. As you can see, there is no “I” there, having been subtracted out, i.e., netted out, hence the term “net saving”, i.e., saving net of investment.
This is no different from when we speak of a corporation’s bottom line as “net income”.
As an aside, “saving”, not “savings”, is the correct term to use. Saving is a flow variable while savings is a stock variable. The saving of each period accumulates into that thing we call savings, in the same way that investment, which is a flow variable, accumulates into the capital stock, a stock variable. Or how deficits, a flow variable, accumulate into debt, which is a stock variable.
A flow variable is measured over a period of time while a stock variable is a snapshot of the economy at a single instant in time, usually at the end of a calendar year. All the terms in the sectoral balances equation above are flow variables. And in the same way that saving equals investment, savings equals the capital stock.
Jeff G.
Nov 27 2020 at 1:23pm
What about Scott’s claim that the MMT argument for government spending to fill the gap between full-employment “savings” and investment is equivilant to the Keynsesian Paradox of Thrift? Is that a fair comparison? If so, I think that would go a long way to bridging the semantic divide.
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