For the sake of argument, let's put aside the endogenous money/financial 
innovation argument (what James Ahiakpor somewhat unfairly calls the 'thin 
air' view) for a moment.  Because there is something else here that is 
getting glossed over. 
 
I said (something like): Banks seeking profits accommodate the demand for 
credit by investors and thus underwrite production; new incomes are 
generated, and savings rise, which are deposited in banks, replenishing 
deposits which were depleted as well as creating new ones. 
 
James said (something like): But the initial investment in your story had 
to be financed by savings. 
 
So why can't I reply?: Yeah, but where'd the savings come from?  It had to 
result from some previous productive activity. 
 
To which James could reply: Yes, which was financed by savings! 
 
Me: Exactly! which resulted from productive activity! 
 
J: Egg! 
 
M: Chicken! 
 
etc., etc. 
 
This was the point I was trying to make when I refered to a circular 
process.  Certainly there is no more support in what we have said so far 
for arguing that savings is 'logically prior' to investment than there is 
for the reverse proposition. 
 
But is it merely a chicken and egg story?  I don't think so. 
 
Because to say that the process entails circularity does not assign 
identical weight or causal determination to all the variables. 
 
For Keynes, the driving force is investment *demand*.  The demand for 
finance requires that investors' expectations be such that they are ready 
to act.  The mere existence of savings does not guarantee that investment 
will actually take place.  But that savings will result from investment 
(via changes in income) is reliable. 
 
The conventional view is that the existence of savings will call forth 
investment via variations in the rate of interest.  This may be the crux of 
the matter: to what degree one believes that a) when S>I interest rates 
fall and b) a fall in the rate of interest will result in new investment 
demand that will soak up the excess savings.  If one puts their faith in 
the neoclassical theory of interest rate determination and in the belief 
that investment is interest- elastic, and abstracts from other factors such 
as those Keynes emphasized, then you have your story. 
 
For Keynes, capitalism is a demand constrained system.  This means that it 
can also be a demand-led system.  The key independent variable is 
investment demand.  What determines investment demand?  For Keynes, 
interest rates are only part of the story (and not the most important 
part). 
 
Banks can't lend just because they have available savings.  They have to 
have someone to lend to - there must be a demand for credit (and lender's 
expectations of profitability are also important here, they have to cover 
the costs of finance, etc.). 
 
So, savings does not necessarily lead to investment (investment depends on 
expectations of both investors and lending institutions, which are 
influenced by many factors- expected profitability, business and political 
climate, etc., etc.).  But investment does lead to savings.  Finance only 
makes investment *possible*, but investment will always create new savings. 
 
The circle can be broken at that very point: the weakness of investment 
demand even in the face of existing finance. 
 
Since James was so tickled by the earlier quote I provided, I'll try to dig 
up the one where Keynes says lower interest rates can even result in higher 
savings- you know, the one where he says that *if* lower interest rates 
induce investment, that higher investment will lead to higher savings. 
 
By the way, James, I will look up both your articles you mentioned when I 
get a chance. 
 
___________________________________ 
 
Mathew Forstater      Department of Economics 
        Gettysburg College     Gettysburg, PA  17325 
 
tel: (717) 337-6668   fax: (717) 337-6251   e-mail: [log in to unmask]