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People, I beg you to just stop. All the textbooks say S=I, so I thought people accepted this. I guess they don’t. Let’s start with some basic misconceptions:

1. We are interested in national income and output, not individual accounts. Yes, an individual can save without any change in national investment. You might buy a stock or bond. But in that case someone sold you the stock or bond, so they dis-saved exactly what you saved. THE ACT OF SETTING ASIDE MONEY HAS NOTHING TO DO WITH SAVING. SAVING IS BUILDING CAPITAL GOODS.

2. Let’s consider three types of goods; food, cars and houses. The government considers food and cars to be consumer goods, and houses to be capital goods. In fact all goods could be viewed as capital goods, albeit goods that depreciate at vastly different rates. Since the GDP data is annual, we might want to consider goods to be “capital” if they lasted more than a year. So cars and houses ought to be capital, but I believe the government views cars and home appliances as consumer goods, perhaps because they are too lazy to do all the calculations for depreciation.

3. Consider a $20,000 car that lasts 9 years, and depreciates in a straight line (yes, unrealistic.) Assume it sells for $2000 scrap in year ten. You just graduate from college, and blow $20,000 out of your $50,000 income (cash) for a new car. Technically you’ve saved $18,000 that year (assuming the rest of your income is spent on perishables like food and concerts and haircuts and rent. Yet you haven’t set aside any money–you’ve “spent” it all. Your car depreciates $2000 in that first year, but $18,000 in value carries over into future years, where it can be used for transport or sold. That should be called saving.

4. In each future year your car provides $2000 in transport services, but there is no cash outlay, you are drawing on your previous saving/investment. That frees up your future income for other uses.

5. Interestingly the same is true for houses. So why is blowing $40,000 on a new BMW considered wasteful consumption for a new grad, whereas buying a house is viewed as an investment? The BMW purchase basically commits you to consume $4000 a year for the next 9 years. So it is an investment, but also an implied commitment to consume at a pretty high rate. In contrast, the real value of houses tends to hold up quite well. My 90 year old house is worth much more in real terms than when it was first built. Yes, there is some opportunity cost, (stocks are probably a better investment in the long run), but otherwise it’s easy to see a house as an investment.

6. People become very confused about saving during recessions, because they wrongly associate saving with “putting aside money” and recessions with “people not spending.” But if I put aside money by buying a stock from you, then national saving and investment don’t rise at all. If I blow $100,000 cash on a new house, then I’ve saved close to $100,000 that year (minus only the tiny depreciation.) SAVING IS NOT SETTING ASIDE MONEY, IT’S SPENDING MONEY ON CAPITAL GOODS. PERIOD, END OF STORY.

7. Well not quite the end. If people hoard cash or bank reserves, i.e. try to hold larger amounts of cash in real terms, that’s deflationary. That seems kind of like saving, at least like the false definition of saving that is “putting money aside,” but it’s actually a mostly unrelated phenomenon. In fairness to Keynesians, in my previous post I explain why periods where people desire to save more at a given interest rate, often are periods of recession, where M*V falls. So they have good instincts. But accumulating lots of non-monetary financial assets is not, in and of itself, (aggregate) saving, nor is it money hoarding. It’s just debt. Suppose I give my brother a $1 quadrillion IOU, and at the same moment he gives one to me, with the same maturity date. There sure is a lot more debt in the economy, but has anything changed? Physical goods (and services) and the medium of account—focus like a laser on those two things, and macro becomes incredibly simple.

PS. David, you have no idea just how far I’m willing to go. 🙂

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This entry was posted on January 12th, 2012 and is filed under Misc.. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response or Trackback from your own site.



