7: The Meaning of Saving and Investment Further Considered

Keynes sets out to clarify his definitions relative to other meanings of the words. ‘Saving’ he takes as uncontroversial, meaning “the excess of income over what is spent on consumption”. [p. 74] The idiosyncrasies arise over ‘investment’ and ‘income’. As we saw in Chapter 6, these categories involve the difficult counterfactual involved in calculating user cost. Keynes went to some length in the appendix to explain how this counterfactual should be calculated, showing it is related to the interest rate, depreciation rates, spare stocks of capital goods, and expectations about how long those stocks will remain spare. We had the delightful maxim, “To-day’s user cost is equal to the maximum of the discounted values of the potential expected yields of all the tomorrows.”

Someone please correct me if I am wrong here, but as I understand it, the point of all this is to deal with the ambiguity in determining which of entrepreneurs’ expenditures are used in producing current output, and which are used to reproduce and expand the value of their capital. The way Keynes deals with it implies that an element of investment expenditure does not involve payments between entrepreneurs. It may partly involve part of what an entrepreneur pays workers in their own business. There is also more going on here than actual payments of money. Imputed losses in the value of capital are subtracted from the value of current output. This is not really controversial, but Keynes uses the concept of ‘user cost’ to include this along with actual payments between entrepreneurs for intermediate goods used up in the production process, because again, there is an ambiguity between what is an ‘intermediate good’ – whose value is included in the value of output – and what is replacing the value of capital used up. Fair enough. Some more confusion arises because in constructing aggregate supply price, Keynes wants to ignore those aspects of depreciation that do not impact on decisions about how much capacity to use in the current period. So user cost does not include depreciation that occurs whether or not the equipment is used. This extra depreciation is dealt with under the concept ‘supplementary cost’.

In this chapter, Keynes starts with investment.

In popular usage it is common to mean by this the purchase of an asset, old or new, by an individual or a corporation. Occasionally, the term might be restricted to the purchase of an asset on the Stock Exchange. But we speak just as readily of investing, for example, in a house, or in a machine, or in a stock of finished or unfinished goods; and, broadly speaking, new investment, as distinguished from reinvestment, means the purchase of a capital asset of any kind out of income. [p. 75]

He says that if this definition includes ‘negative investment’ such that sales of these assets cancel out purchases, it is equivalent to his definition. Of course, since every purchase of such an asset is somebody else’s sale, we are left with those assets which are produced in the current period, and have to deduct any destruction or deterioration of existing assets.

He argues against the idea that changes in stocks of unsold goods should be excluded from ‘investment’ (so that an excess of saving over investment equals an accumulation of unsold stock). Such an approach emphasises one particular influence on future decisions about how much production capacity to utilise, but Keynes argues that this influence should not be highlighted above other influences.

Next Keynes returns to income. He starts with some self-criticism of his definitions in the Treatise on Money and some criticism of D. H. Robertson’s approach – which he so kindly compliments as “a first approximation” to his own approach. Both of these alternatives are less familiar to us today than Keynes’ own – output minus user cost – so not worth dealing with here.

Then we come to the question of whether the necessary equality of investment and savings has anything in common with the “much vaguer ideas associated with the phrase ‘forced saving’.” [p. 79] It is true that an increase in output will involve an increase in employment and income measured in wage-units, which will redistribute income between borrowers and lenders and increase aggregate income measured in money, and through all this the amount saved will also change. We need to understand the rest of the theory before we understand the details. Here Keynes is simply arguing that ‘forced saving’ in the Hayek sense – saving forced by an increase in the quantity of money or credit – is not essentially different from any increase in income. ‘Forced saving’ really only has meaning if we specify a normal rate of saving, such as “what would be saved if there were full employment in a position of long-period equilibrium”. [p. 80] So Keynes would talk of forced saving in the case of inflationary additional expenditure when the economy is already at full employment and thus cannot increase real output any more. Inflation then may redistribute real income from consumption to saving by raising the price level. (This is discussed in Keynes’ later essay, How to Pay for the War.)

The last section is very interesting; Keynes discusses banking here for the first time. Any individual act of saving is by definition the acquisition of an asset, either by producing it, or, more probably, by buying it from someone else, in which case the other individual is necessarily selling an asset. This is true even in the case of bank deposits. Effectively, by depositing income in the bank, the individual buys an asset from the bank. This fact sometimes causes confusion, because in ‘selling’ the deposit, the bank does not automatically lend the money it receives in exchange to another party. So the bank appears as a black hole where savings can go without necessarily being invested immediately. Or, a bank can extend credit to (i.e., buy an asset from) an entrepreneur without first having sold a deposit asset to (and received money from) another party. This is because – though Keynes doesn’t make this explicit – banks can be confident that they will not be called on to convert all (or even many) of their deposit liabilities into cash at once, so can ‘sell’ several times their cash reserve base as deposits. This does not violate the law that any asset sale is also a purchase, because when a bank lends to a customer, it is at the same time buying an asset (lending the loan) and selling an asset of the same value (creating the deposit whose form the loan initially takes). But in any period net lending to the bank (saving in the form of new deposits other than those created by the bank in extending loans) need not be equal to net lending by the bank.

Nevertheless, this does not modify the necessity for aggregate savings and aggregate investment to be equal in any period. Take the bank’s extension of credit as the first step in the causal chain. There has been no prior saving, but an entrepreneur borrows money to spend on investment. Effectively, new purchasing power has been created out of nothing by the bank. As the entrepreneur spends this money, incomes will be increased, and the receivers of the additional income choose how much to spend and how much to save. No-one is forced to save, though higher incomes tend to increase savings. “Yet employment, incomes and prices cannot help moving in such a way that in the new situation someone does choose to hold the additional money.” [p. 83] The additional investment made possible by the bank loan will generate savings to match it, or it will come at the expense of other investment. It is logically necessary.

Conversely, there is no guarantee that an individual attempt to save will generate new investment, because the purchase of assets could be matched by somebody else selling an equivalent value of assets in order to consume.

The reconciliation of the identity between saving and investment with the apparent ‘free-will’ of the individual to save what he chooses irrespective of what he or others may be investing, essentially depends on saving being, like spending, a two-sided affair. For although the amount of his own saving is unlikely to have any significant influence on his own income, the reactions of the amount of his consumption on the incomes of others makes it impossible for all individuals simultaneously to save any given sums. Every such attempt to save more by reducing consumption will so affect incomes that the attempt necessarily defeats itself. It is, of course, just as impossible for the community as a whole to save less than the amount of current investment, since the attempt to do so will necessarily raise incomes to a level at which the sums which individuals choose to save add up to a figure exactly equal to the amount of investment. [p. 84]

Again, saving and investment are logically, definitionally equal. This in itself cannot tell us that changes in one cause changes in the other, though Keynes tends to give causal priority to investment. We need to move on to the behavioural part of Keynes’ theory to understand why; now we are done with definitions.

On a side-note, Victoria Chick argues in her 1985 essay “The Evolution of the Banking System and the Theory of Saving, Investment and Interest” that “the reversal of causality in the saving-investment nexus proposed by Keynes [1936] should not be seen as correct theory in triumph over error but as a change in what constituted correct theory due to the development of the banking system.” [pp. 193-94 in her essay collection On Money, Method and Keynes] Although Keynes puts it as a logical argument, it was necessary that the banking system reach a certain level of development before bank lending could initiate the causal chain creating saving. Before bank deposits were established as means-of-payment and the central bank established as lender-of-last-resort, banks could not confidently expand lending beyond the reserve base. Therefore they needed an increase in deposits before they could expand lending. Again we have a question of whether Keynes is making a logical argument or an institutional one. Clearly the argument in the definition chapters is logical in content, but his examples do suggest institutional considerations as well.

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Published in: on 12 October, 2007 at 2:41 pm  Leave a Comment  

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