Home > Main > I does not equal S

I does not equal S

August 26, 2011

One of the things about the world is that some facts are more fundamental than others.

Economists get these facts wrong all the time.

Specifically, many people think that I = S, or Investement = Savings

S does not equal I.  If you think S = I, you’re getting the accounting wrong. It’s a fundamental mistake that makes every thing that follows horribly misguided.

S can only equal I if we assume there is no government.

But we know:

  1. Governments are nearly always the institution that issues money.
  2. Governments can throw people in jail if they don’t pay their taxes in very specific ways with the money they issue.
By assuming the government out of the equation, you’re assuming that the most important and largest player in the world of money doesn’t exist.
I don’t know why you’d want to start from such a stunted version of the world.
If you assume the government away before you do the economics, you’re getting the accounting wrong.  
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  1. Clonal Antibody
    August 26, 2011 at 10:32 pm

    Mike,

    A big difference between what is commonly considered savings, and what economists consider to be savings.

    Common understanding of saving – money earned but not spent.

    Macroeconomic understanding of saving – Goods produced but not consumed. Y generally consists of goods and services produced. Goods can either be saved or consumed. I would maintain that services by their very nature, cannot be saved. In other words, the very act of producing a service results in its immediate consumption.

    This leads me to believe that the macroeconomic identity that economists generally use is from a moneyless economy. As soon as money is introduced into the system, I would maintain that the generally used macroeconomic identity no longer holds – therefore, we have to figure out a way to modify the macroeconomic identity (it is possible, that if money was considered finite, and could not be hoarded, and was freely exchangeable at fixed prices for goods and services (in other words, the economy was at “equilibrium”) the equation may possibly hold. But in a fiat currency regime, and with the economy being always in a state of non-equilibrium, I will contend that the only way to look at the economy, is by using stock flow models used by the likes of Steve Keen and Prof Yamaguchi

  2. August 27, 2011 at 1:28 am

    It’s worse than that of course because it is a matter of definition whether something is investment or consumption.

    In accounting terms have you ‘capitalised’ an expenditure? If you don’t then it doesn’t show up as investment.

    Something like training for example, which is actually treated as a consumption good in the data!

    • beowulf
      August 27, 2011 at 12:33 pm

      “Something like training for example, which is actually treated as a consumption good in the data!”

      Reasonable minds differ, I suppose, OMB considers training an investment.
      “The analysis also incorporates newly released public investment data from the Office of Management andBudget. Previously, the data only disaggregated public investments by category—physical capital investment, education and training, and R&D—and subcategory—highways, health, veterans, etc.
      http://webcache.googleusercontent.com/search?q=cache:GZcn_ti1LokJ:www.epi.org/page/-/EPI_PolicyMemorandum_187.pdf

  3. JKH
    August 27, 2011 at 8:19 am

    I was thinking about this very point after expending mass keystrokes on Nick’s post.

    Here’s what I think happened on that post:

    Nick clearly has a problem with those who emphasize the importance of accounting basics. In particular, he has declared war on those “followers of MMT” who he has judged are totally confused about the difference between accounting and supply/demand economics.

    He elected to write a post to cut through that “confusion”.

    In order to illustrate the difference, he chose to streamline a national income model down to the barest of bones, where following the elimination of some important real world complications, S = I. You can do that by choosing the case where the government budget and the current account are both in balance.

    Doing that, you get Y = C + I = C + S; therefore I = S.

    So I = S in that streamlined version of national income.

    From there, Nick went on to develop the relationship between the supply/demand determination of I and S, versus the ex post accounting identity of S = I, in the context of that streamlined model. And yes, it’s true that S = I, continuously, in such a model. That doesn’t prevent Nick from fidgeting around with supply/demand relationships, in a way that is OK from an economic theory perspective, I’m sure. The two are not necessarily incompatible.

    Here’s the problem:

    Nick’s battle as he chose it is primarily with “MMT followers”. There’s no doubt about who he’s talking about.

    Just about anybody who’s interested in MTM is familiar with the importance of the idea that government creates net financial assets for non government, in order to respond to the demand for net saving. This is obviously consistent with budget deficits. Right there, then, we have a very basic economic demand force that is intrinsic to the MMT view of the world.

    You can streamline this MMT oriented model as well, by assuming the foreign sector is in balance (but not the government sector).

    Then you get (G – T) = (S –I)

    The MMT policy inclination is that (S – I) should be > 0, almost always, in such a streamlined model. In other words, S should not be equal to I, from a sector financial balances perspective.

    So the paradox of Nick’s post is that he attempted to illustrate the difference between accounting and supply/demand economics. But he should never have done it under an (S = I) template, given his target audience.

    That just totally confused everybody, because the relationship between S and I is very specific to sector balance assumptions, and sector balance assumptions are very specific to MMT policy inclinations.

    Nick attempted to illustrate the difference between accounting and supply/demand economics in a way that contradicts the very supply/demand sectoral forces that are basic to the MMT interpretation of economics.

    I was thinking of posting something like this at Nick’s, but then I thought, why bother?

    • TC
      August 27, 2011 at 1:08 pm

      I was late to the party over there, so I didn’t bother either.

      I thought it was totally hilar that Nick would try to smack down the mere accounting of MMT with an example that gets the accounting totally wrong from the MMT perspective. He assumes away government. It’s missing the point of MMT and money on a such a fundamental level that I don’t have words to describe the miss. “Epic Fail”?

      I don’t think it was intentional. I think he was really trying to help out. The worst part is that Nick is clearly hugely smart. I don’t know how he could miss something like this. We can tell he’s sharp from the easy manner that he derives one of the major models in economics in about 4 paragraphs with perfect clarity. He’s awesome.

      But when he missed that point, I was floored. This isn’t his first exposure to this stuff. I got MMT in about 20 minutes, then spent 2 years thinking it through to really get it.

      The MMT crowd has to talk about accounting all the time because they are getting the accounting wrong from our perspective. But that doesn’t mean our models are devoid of supply and demand.

      The foreign sector is not fundamentally important to money. We can assume away the foreign sector without many consequences.

      We cannot do the same with the Government sector. The government sector is fundamentally important. Government is the entity that issues the money that is the unit of account for every calculation in the economy. Government can issue more currency at will, and can spend until hyperinflation results. It can stop spending all together at will. It can force citizens to pay it in the script it issues at risk of liberty and in some cases life.

      Assuming the government away is like being a rocket scientist and saying “Assume there is no gravity”. It’s “not even wrong”, as me and Peter D like to say.

      I thought your comment at Nick’s on the only way to do economics is to work from a common framework of accounting was spot on. Economics – for some reason – thinks that they don’t need to follow the rules of accounting, or know practices of banking very well. Yet these two professions are the ones who also deal with money on a very profound level.

      I’m in the middle of a post about how the IGBC isnt’ economics according to Nick. It doesn’t have any demand for net financial assets. If you look at the math, it’s accounting. There is no economics at all in the IGBC.

      Once you add even a bit of demand for net financial assets, you get something like the fiscal theory of the price level. But even the FToPL is only 1/2 of what is needed.

      The FToPL misses big parts of the demand for net financial assets. MMT and the FTPL are not the same. FTPL is a stunted model compared to MMT because of its accounting mistakes on the differences between bonds and money.

      Then, look at the crowding out models. They have zero demand for net financial assets in them. By the standards Nick sets out in his post, most of economics isn’t economics. They miss the major parts of the demand for what is the most important financial asset in any economy, tradable government guaranteed savings accounts.

      Here’s my question – if Nick Rowe isn’t getting this, how are we going to convince the dumb guys? I don’t have an answer for that.

      • JKH
        August 27, 2011 at 3:50 pm

        You’re probably familiar with the CFA (Chartered Financial Analyst) program. Maybe you’ve done it. When I did it, some time ago, the curriculum was organized according to 7 modules of study – debt analysis, equity analysis, portfolio analysis, quantitative analysis, ethics, economics, and accounting – as I recall. Maybe it’s the same these days.

        What I liked about it then, and still do, was its perspective of different views on what ultimately becomes the same subject – understanding the world of capitalism around us. Of course, the CFA program is geared specifically toward the education of the financial analyst, but the relevant subject in total is much broader. I always thought it was a pretty intelligent, eclectic approach to education for a specific purpose.

        And what I’d point out in particular is how economics and accounting are aligned pari passu – “intellectual partners” – as it were, according to the organization of that program. I thought this was highly intelligent organization.

        Both economics and accounting are put in larger context.

        Context is inherently humbling.

        And when you think about it, MMT, beyond its relatively enlightened approach to the relationship between economics and accounting, has also taken on partners that reflect the financial analysis space – e.g. Mosler, etc.

        By contrast, I see the problem with mainstream economics today, as reflected in the academic blogosphere, as one of excessive inwardness and intellectual self-absorption, and even hubris.

        Nick certainly does not view accounting as an “intellectual partner”.

        My sense is that he will never get past this. He’s got too big a mission in what he’s trying to do now in terms of revolutionizing the way in which mainstream economics is taught, which I think is what he’s trying to do with his blog, effectively.

        And there’s an interesting comparison between Nick and Steve Keen. Both tend not to emphasize anything dramatically different or important about the government sector in the way in which they look at the world, top-down.

        • TC
          August 27, 2011 at 10:13 pm

          I also went through the complete CFA program.

          I used to tell people the best part of going through the CFA program is that you can then talk to anyone who works in finance about their job, and you’d have a decent idea of what they did in their job on a daily basis. You couldn’t do their job, but you wouldn’t be lost either.

          And it’s an awesomely large world of capitalism and money, of which economics, finance, accounting, banking, speculation, entrepreneurism, and many more things have important ideas and practical methods to contribute. Like you say, humbling.

          But of all of these, accounting is fundamental. It’s the algebra of money that must be followed. If you’ve read Neal Stephenson’s Anathem, he talks about how 2 + 2 must be true even outside this universe. Accounting is nearly on that level of truth. It’s a deeper truth than economics or finance.

          Accountants rule the world. They are the people who tell the lawyers to go and forclose, or say “yes, we will lend to you.” It’s interesting the first recorded words of freedom are “debt-freedom”. Debts require accounting to be debts.

          Mosler is always talking about “operational realities”. I am coming to think this means “micro foundations of a macro theory”, but from a completely different perspective than Chicago econ.

          That’s one more idea that MMT dangles infront of us – the potential of a unified theory of economics and money.

          Ugh -so much. this doesn’t even get to Tom H.’s excellent point that MMT is at the cutting edge of the Minsky control fraud concept. Or the Steve K non-government approach. It’s not just non-government, its no foreign sector either.

          I am a charterholder ( as per ethics lol) and

      • RonT
        August 31, 2011 at 8:06 am

        “The worst part is that Nick is clearly hugely smart. ”

        Yeah yeah, I heard it like 10x already. How smart is not to get how banks work after you have been explained this over and over?

        Observing Nick I see a pattern (and not a very smart one):

        * He cooks up an argument critiquing MMT
        * He is proven wrong or that he misrepresented MMT
        * He calls MMT a cult and a bunch of idiots.
        * He cooks up an aqrgument critiquing MMT
        * He is proven wrong or that he misrepresented MMT

        … and so it goes.

        How smart is that?

        ps. Sumner does the same. Another “smart” guy.

        • TC
          September 1, 2011 at 3:49 pm

          Well, he might be missing MMT, but his recent post on behavioral economics is pretty clever. It’s probably a very subtle commentary on the discussion over here about theory vs. empirics. MMT is light on theory in his mind but strong on empirics.

          Also, lots of economists – and it seems like Nick is one in this general group – think in terms of models. MMT is just another model to him to critique.

          We’re saying “economics needs to follow the accounting, and there are a few other basic facts that greatly limit the interpretation of the accounting.” He’s probably thinking, “Well, there are other assumptions that make sense besides the ones MMT uses, so I’ll just keep going my way.”

          At least he’s engaging. Sumner doesn’t even bother to think through MMT. I think Nick’s at least trying a little. And Nick, I hate talking about you like you’re not here! 🙂

        • hongkong
          September 2, 2011 at 1:43 am

          tha was Frances Wooley’s post on behavioural economics, btw..

        • TC
          September 2, 2011 at 8:37 am

          You’d think this TC guy would be more careful. 🙂 Thanks!

      • beowulf
        September 2, 2011 at 10:45 am

        “Here’s my question – if Nick Rowe isn’t getting this, how are we going to convince the dumb guys? I don’t have an answer for that.”
        As for the dumb guys, read Drew Westen (who’s both a shrink and a political consultant) who wrote the book “The Political Brain”.
        http://www.huffingtonpost.com/drew-westen/democrats-identity-_b_880135.html

        In politics, you always concede the principle. Telling someone they’re wrong, particularly someone with a distinguished career in the field, is no way to win heart and minds.
        A better tack to take is asking MMT skeptics (obviously some are more open-minded than others):
        What MMT policies, fiscal or monetary, would they support if they could embed automatic triggers or circuit breakers to stop MMT’s (from their view) inevitable pitfalls?

        From there the debate could shift to, what triggers they’d use and what parameters (inflation surely but CPI or TIPs spread? what about changes in unemployment, GDP, budget deficit, trade deficit, housing starts, etc?). The triggers have to be something tangible like market prices or govt data and not something ethereal like “uncertainty”. “5 year TIPs spread moves above 4%” is trigger, “heightened inflation expectations” is not.

        By moving from theory to policy, it doesn’t put anyone (on any side) on the spot to admit they were wrong. After all, if the policies were successfully enacted, its the nature of man that any positive results will be taken by each side as confirmation that they were right and its a good thing the other guy listened to them. :o)

        • TC
          September 2, 2011 at 11:50 am

          But this technique would ruin my reputation! How in the world could I be the Straight-Talking Traders Crucible if I didn’t go after these guys with a torch?

          🙂

          Probably a good idea.

  4. JKH
    August 27, 2011 at 9:30 am

    P.S.

    “You can do that by choosing the case where the government budget and the current account are both in balance.”

    Actually, they’re assumed away entirely, in order to get Y = C + I, etc.

    • August 29, 2011 at 8:45 pm

      What is it with economists who like to just create alternate realities for their economic models? Robert Murphy likes to create coconut islands, Scott Sumner likes to remove the govt from his models and Nick Rowe likes to just get rid of govt all together.

      It would be funny if it wasn’t so horribly misleading….

      • August 30, 2011 at 1:24 am

        Oy, that should read – Sumner likes to remove the banking system from his models….

  5. Clonal Antibody
    August 27, 2011 at 9:49 am

    To really understand why economists have it so wrong, read Phil Pilkington’s interview of economic anthropologist Dave Graeber

    Philip Pilkington: Let’s begin. Most economists claim that money was invented to replace the barter system. But you’ve found something quite different, am I correct?

    David Graeber: Yes there’s a standard story we’re all taught, a ‘once upon a time’ — it’s a fairy tale.

    It really deserves no other introduction: according to this theory all transactions were by barter. “Tell you what, I’ll give you twenty chickens for that cow.” Or three arrow-heads for that beaver pelt or what-have-you. This created inconveniences, because maybe your neighbor doesn’t need chickens right now, so you have to invent money.

    The story goes back at least to Adam Smith and in its own way it’s the founding myth of economics. Now, I’m an anthropologist and we anthropologists have long known this is a myth simply because if there were places where everyday transactions took the form of: “I’ll give you twenty chickens for that cow,” we’d have found one or two by now. After all people have been looking since 1776, when the Wealth of Nations first came out. But if you think about it for just a second, it’s hardly surprising that we haven’t found anything.
    .
    .
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    .

    • TC
      August 27, 2011 at 1:11 pm

      I thought that interview was fantastic. The idea of barter is great – but anyone that’s actually tried to do it knows the difficulty of barter. It cannot work in societies much larger than a small village.

    • beowulf
      August 28, 2011 at 3:18 pm

      “The story goes back at least to Adam Smith and in its own way it’s the founding myth of economics. Now, I’m an anthropologist and we anthropologists have long known this is a myth simply because if there were places where everyday transactions took the form of: “I’ll give you twenty chickens for that cow,” we’d have found one or two by now.”

      Assuming there’s never a Ron Paul presidential library, I know just the museum where a “Creation of Economics” exhibit would fit perfectly. :o)

      “The Creation Museum is an American museum located near Petersburg, Kentucky that presents an account of the origins of the universe, life, mankind, and man’s early history according to a literal reading of the Book of Genesis… In contrast to the overwhelming scientific consensus, exhibits promote young Earth creationist claims, including the idea that humans and dinosaurs once coexisted, and that dinosaurs were on Noah’s Ark.”
      http://en.wikipedia.org/wiki/Creation_Museum

  6. August 28, 2011 at 9:19 am

    Excellent discussion. Thanks for the reference to the economic anthropologist….

  7. oliver
    August 30, 2011 at 9:26 am

    There is often a funny moment in such discussions, as with this one at WCI, when knowledgeable people like yourself, JKH or Scott Fullwiler chime in. It seems, material and petty semantic differences can be put aside fairly quickly or, at least one politely agrees to disagree. At this point, I’m usually quite hopeful that, maybe this time, something will be achieved.

    But, instead of opening up the field for a broader, more comparative discussion, people such as Nick Rowe categorically refuse to engage anywhere beyond their self-defined comfort zone, leaving nothing but a gaping hole of non-communication. Sure, the scope of the discussion is defined by the blog post, but the absence of a common focus and an unwillingness to even temporarily ‘zoom out’, at the expense of certain details, is quite astounding. I guess my education as an architect is closer in its general approach to the CFA program you mention above than to academic economics courses. Shame, really.

  8. August 30, 2011 at 11:02 pm

    You guys really really wanted me to bring G-T back in? No worries. We just add a couple of lines of math and a couple of lines of extra words. No biggie.

    Accounting identity:

    Y=C+I+G or, defining S=Y-T-C, we can re-write this as: S-I=G-T

    Semi-equilibrium condition:

    1. Y=Cd+Id+Gd, where Gd is demand for newly-produced goods by the government. Output of goods = quantity of goods demanded (for consumption, investment, and by government)

    We can subtract T from both sides, to re-write this as:

    Y-T=Cd+Id+Gd-T

    subtract Cd and Id from both sides, to rewrite it as:

    Y-T-Cd-Id=Gd-T

    And, defining desired saving Sd=Y-T-Cd, we can rewrite this as:

    2. Sd-Id=Gd-T

    So 1 and 2 are just different ways of saying the same thing: “the output of newly produced goods is equal to the quantity of newly produced goods that people, firms, and government, want to buy (demand)”.

    The accounting identity is always true. The semi-equilibrium condition is not always true. It is almost never true in Cuba, for example, where there always seems to be excess demand.

    • August 31, 2011 at 2:00 am

      Isn’t that likely because there aren’t any stable equilibrium in a chaotic system. Therefore looking for one is largely futile.

      It’s a weather forecast, not a clock.

      • August 31, 2011 at 5:48 am

        More likely: Cuba printed more money than people wanted to hold, so they try to spend it (excess demand), but they hold prices fixed by law, to repress inflation, so the price level cannot adjust to equilibrate Sd-Id=Gd-T.

    • TC
      August 31, 2011 at 6:14 am

      lol. This is 1/2 of MMT. It isn’t far from this at all. MMTers would agree with this part and even say its crucial.

      MMT thinks about Treasury bonds as “tradable government insured term saving accounts”.

      It’s kinda like applying Mogdalini/Miller to the fiscal theory of the price level. The value of the firm is not impacted by how it’s financed.

      Equity = Cash, debt = Treasuries, but the value (aka Price level) isn’t impacted by how much of either there is in the world, only the total.

      Monetary Theory says the ratio of cash to debt matters a lot. MMT says it matters very little.

    • RonT
      August 31, 2011 at 8:13 am

      Nick,

      Y in your equations mean different things in different equations so equating them leads to error.

      There is Y_demanded and y_supplied:

      Y_demanded is how much investment and consumer goods the private secor puts up for sale demanding income.

      Y_supplied is how much money the private sector (and the govt) actually wants to spend to buy investment and consumer goods.

      In the same fashion, you Cd actually is two different numbers:

      C_supplied is the supplied income to be spent on consumer goods: that is actually the demand for consumer goods.

      C_demanded is the demanded *income* from selling consumer goods, so this is the supply of consyumer goods put up for sale.

      C_supplied and C_demanded are not equal, so denoting them as Cd leads to an error.

  1. August 30, 2011 at 12:11 pm
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