Rogoff and Reinhardt Scandal
John Maynard Keynes on Saving and Investing
Lead with Fiction is not Fact
An Excel spreadsheet proved too much for the authors of "This Time is Different," the definitive study which purported to prove the connection between high government debt and poor economic performance.
Carmen Reinhardt and Kenneth Rogoff rode their data set to the conclusion that when a country's debt to GDP ratio reaches 90%, growth goes negative. Researchers at the University of Massachusetts Amherst and its Political Economy Research Institute (including Bob Pollin who has appeared here several times) demonstrated the study and its conclusions were fallacious. Debt to GDP above 90% does not lead to a collapse in growth, by Rogoff and Reinhardt's own data. That data is of questionable application, but so-called coding errors, inappropriate weightings and selective inclusion of data skewed the results to the wrong side. Wrong as in erroneous, mistaken, incorrect.
The most cited study in the austerity debate, the source for the book, "This Time Is different," a snarky title for a book which suggested that fiscal prudence by government was to cut back in a downturn, shrink your way to growth. False. Not True.
Economies with debt to GDP above 90% do not experience statistical significant slowing.
For a long time people have objected vigorously to the Reinhardt-Rogoff studies on other grounds: (1) Correlation is not causation -- declining economies can create high debt to GDP at least as well as high debt to GDP can create declining economies, or (2) Comparing 17th century monarchies on the gold standard with Twentieth Century industrial democracies with sovereign fiat currencies is nonsense.
DEMAND SIDE'S IDIOT.
Now those objectors can add to the criticism number (3) The data show no correlation, association or causation that is statistically significant. Economies over 90% do not shrink by 0.9%. They grow by 2.2 percent. Other numbers are off, too.
This is the evidence of weapons of mass destruction for the austerity hawks. This is the aerial surveillance with which Colin Powell went before the UN to demonstrate unequivocal evidence of WMD. The media ran with it. Then it was the Iraq War. Rogoff and Reinhardt were on every talk show in the nation with their proof of the problem of high debt. The media ran with it. Obama ran with it. Austerity advocates ran with it. Millions have been crushed.
MEDIA matters MONTAGE
This is humiliating for economists, not only Rogoff and Reinhardt, Harvard and xxxx. The talk shows and the austerity pundits and politicians are likely not humiliated. They have option A, pretend it is not significant and ignore it. They have option B, blame Rogoff and Reinhardt and ignore it. They have option C, blame all economics and draw in their cadre of insiders who know so much better than those pointy-headed academics.
FACT: We need direct investment in people and infrastructure, not tax give-aways and cutbacks.
FICTON: We can shrink our way to growth.
Hard to overstate the damage done.
Where else is there near complete misunderstanding? Correlation but no causation? But better, less sloppy research.
John Maynard Keynes
Savings and Investment.
Decades of students, tens of millions of business news consumers know that the nation has to save in order to invest, to put away the money needed for investment.
Wrong. The nation has to invest in order to have the money for savings.
Invest first? This is so out of line with conventional thinking that people tend to STOP thinking and reject it as soon as they hear it. But is it really? Or is the misunderstanding simply another manifestation of the wrong metaphor?
First the definitions. Savings equals Income minus Consumption. Savings is the amount not spent. You get an income, you buy your necessities and discretionaries. The amount you don't buy is your savings. You put that amount in the bank or under your couch. In money.
No fair saving it in the form of housing, old paintings, or cans of tuna fish? That is investing already, and by doing so, we haven't got to which comes first.
Guess what? Investment is also, by definition, the amount not consumed. You have consumption and you have investment. And it doesn't make any difference to the conversation how you define investment. Cars and houses can be investment, and dishwashers and cans of tuna fish for that matter. Business inventory, for example, is considered investment even when the business had no intention or desire to pile up unsold stock. Durables used over a long term by households may be investment to them, but not to the national income and product accounts.
So it is by definition that savings must equal investment.
Our question is which causes which?
Let's look at the metaphor again, which is the big conceptual or intuitive obstacle preventing us from seeing what is really there.
The economy as a household goes out and earns money, comes back and saves -- that is, doesn't spend -- some of that money. Ooops. that amount not spent was the neighbor's income. He sells his second car to meet the mortgage payment. Your saving had to be his dissaving.
Because there is no "out there" out there for the economy as a whole. The economy is a family farm, a closed system -- with caveats, big caveats, that we're not getting into today. If everybody can work and produce and trade with everybody else, the economy operates at full effectiveness. Barns are constructed in exchange for food or shelter or musical performances. But when somebody decides NOT to exchange his output for anther's, there is a shortfall in somebody's income. If everybody has more or less the same inclination, the system goes down to where everyone is so poor they cannot afford NOT to spend everything to survive. That is your prudent saving equilibrium. Penury.
Ride to the rescue the manager of the farm who says we need a better road or a new cellar and finances it by promises of the benefit from that road or cellar. If the amount he finances, the income that is put back into the system, exactly corresponds to the amount the individuals keep out -- save -- fail to consume-- the economy operates at optimum capacity. If it is not enough, the economy sags. If it is too much, the price of everything goes up.
Now look back. that investment -- the road or armaments against the neighbor's farm or the education of the kids -- allowed the full employment, AND allowed the not-consuming by individuals to be kept in a form which could be exchanged at a later date. (And beware, the society will have to continue to invest over time in order to ratify those savings.) Without that investment, incomes fall to the point that not-consuming is wiped out by necessity.
Footnote: And see that the selling of the second car makes no difference to either saving or investment on net. One person is selling. Another is buying. Investing, disinvesting. A wash.
Thus, when you hear that the government should be like me and my business. We're prudent. We don't operate in the red. When you hear that (well, first realize that a company without debt financing is not a common animal.) but realize that SOMEBODY has to be investing, operating in the red, or nobody can operate in the black. Incomes drop. The not-consuming sends those incomes down again.
This is not a one-time, pump-priming thing when you get an advanced economy. It is a big amount, this need for investment, because the prudence of not-consuming, or the wealth of some individuals, tends to become a bigger problem. Obviously, if you are financing a livable planet by not consuming, it IS prudent. If you are simply reducing the incomes of the least powerful, it is not so prudent.
It CAN be done by the Private sector. Entrepreneurs will see opportunity in a stable, expanding economy and will invest, creating incomes and savings. This is not to be trusted, as we have seen over the past 30 to 40 years. It is cyclical. The monetary authority's attempts to get the private sector back in the game, even after a big government bailout, have been frustrated by overcapacity -- what to invest in -- and by confidence problems.
There is no practical obstacle to the government's doing it. Political used to mean the art of the practical. Now it means how to obstruct the practical. The government can finance by borrowing, they can finance by taxing away the wealth of the non-participating idle rich, they can finance it by general taxation, they can finance it by simply printing the money. The purchase of treasuries by the Fed is pretty much a case in point.
But nobody is going to finance expansion by not consuming. Because it doesn't matter how you define investment -- as above -- cans of tuna, whatever.
The best thing, by far for investment-savings-incomes-survival would be to radically phase out the old, a grand creative destruction, of the fossil fuel economy. Open up a redesign of the whole system for people and business to work on, from cars to communities, energy to education.
Ah, we ran away with it.
What does Keynes say?
Whilst, therefore, the amount of saving is an outcome of the collective behaviour of individual consumers and the amount of investment of the collective behaviour of individual entrepreneurs, these two amounts are necessarily equal, since each of them is equal to the excess of income over consumption. Moreover, this conclusion in no way depends on any subtleties or peculiarities in the definition of income given above.
Provided it is agreed that income is equal to the value of current output, that current investment is equal to the value of that part of current output which is not consumed, and that saving is equal to the excess of income over consumption — all of which is conformable both to common sense and to the traditional usage of the great majority of economists — the equality of saving and investment necessarily follows. In short—
Income = value of output = consumption + investment.
Saving = income - consumption.
Therefore saving = investment.
Saving = income - consumption.
Therefore saving = investment.
The error lies in proceeding to the plausible inference that, when an individual saves, he will increase aggregate investment by an equal amount. It is true, that, when an individual saves he increases his own wealth. But the conclusion that he also increases aggregate wealth fails to allow for the possibility that an act of individual saving may react on someone else’s savings and hence on someone else’s wealth.
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.
The above is closely analogous with the proposition which harmonises the liberty, which every individual possesses, to change, whenever he chooses, the amount of money he holds, with the necessity for the total amount of money, which individual balances add up to, to be exactly equal to the amount of cash which the banking system has created. In this latter case the equality is brought about by the fact that the amount of money which people choose to hold is not independent of their incomes or of the prices of the things (primarily securities), the purchase of which is the natural alternative to holding money. Thus incomes and such prices necessarily change until the aggregate of the amounts of money which individuals choose to hold at the new level of incomes and prices thus brought about has come to equality with the amount of money created by the banking system. This, indeed, is the fundamental proposition of monetary theory.
(5) Changes in fiscal policy. — In so far as the inducement to the individual to save depends on the future return which he expects, it clearly depends not only on the rate of interest but on the fiscal policy of the Government. Income taxes, especially when they discriminate against “unearned” income, taxes on capital-profits, death-duties and the like are as relevant as the rate of interest; whilst the range of possible changes in fiscal policy may be greater, in expectation at least, than for the rate of interest itself. If fiscal policy is used as a deliberate instrument for the more equal distribution of incomes, its effect in increasing the propensity to consume is, of course, all the greater.
We must also take account of the effect on the aggregate propensity to consume of Government sinking funds for the discharge of debt paid for out of ordinary taxation. For these represent a species of corporate saving, so that a policy of substantial sinking funds must be regarded in given circumstances as reducing the propensity to consume. It is for this reason that a change-over from a policy of Government borrowing to the opposite policy of providing sinking funds (or vice versa) is capable of causing a severe contraction (or marked expansion) of effective demand.