Mathew Forstater writes (7/20/95):
"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."
My response:
What is missing in the above argument is a recognition (which was
lost on Keynes) that the rate of interest is determined by the
savings desires of income earners and investment (borrowing) demands.
If savers want to save more at the going (average) rate of interest
than investors or borrowers want to borrow, the rate of interest
declines and the quantity actually borrowed INCREASES. (I illustrate
the point in diagrams as an appendix to my "Paradox of Thrift"
article in SEJ, p. 31.) Keynes's problem was to have included
"hoarding" in his definition of saving, and then make interest rate
determined by the supply and demand for cash (liquidity)! He thus
lost the coordination function of interest rates for the savings-
investment mechanism. (Steven Horwitz's contribution today addresses
this point. Also see p. 21 of my SEJ article.)
In his exasperation to clarify the above for Keynes, Dennis Robertson
finally appealed for the use of Latin, hoping that might help Keynes
better understand. As I quote him on p. 30 of my SEJ article,
Robertson says: Keynes fails to recognize the that "English words in -
ing sometimes dennote a process (requiring translation into Latin by
an infinitive or gerund) and sometimes denote the object to which the
process has been applied (requiring translation by a newter past
participle passive)" (Essays in Monetary Theory, 1940, p. 15).
The point is that "saving" is both a process and the object of that
process, by common usage. And investment is also a process. But you
can't invest that which has not been saved.
Mathew continues:
"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'sexpectations 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.
My response:
See the above clarification. The saving and investment functions
are separate. Changes in saving propensities cause movements
along the investment-demand schedule. You also can't get out of the
circle by refusing to address what is meant by "finance" or getting
rid of "inside money". Finance doesn't originate from thin air!
Sure, investment demand is a function of expected profits. But as
the saying goes, "If wishes were horses, beggars would ride them!"
Investors can't invest without someone supplying them with the
purchasing power they seek. Why don't you use the equation I
supplied yesterday: S = Y - C - pY = Change in Financial Assets. In
any case you'll encounter it in my SEJ article (pp. 19-20, 23 & 25).
The Robinson Crusoe economy model also intructs one on the primacy of
savings for investment. Try that too.
Mathew also correctly restates Keynes's failure to recognize in the
classical theory of interest and income determination the comparative
statics argument Keynes himself reperesents in the diagram on p. 180
of the General Theory. Thus the claim is frequently made that
increased investment leads (or may lead) to increase savings (since
savings depend on the level of income). And this obvious fact is
stated as if any classical or early neoclassical economist ever
denied it. Just look at the relevant chapters on savings in
Marshall's Principles, for example. Better yet see my collection of
the classical and early neoclassical statements to this effect in the
article "On Keynes's Misinterpretation of 'Capital' in the Classical
Theory of Interest," History of Political Economy, Fall 1990.
The simple point is that savings depend on the level of income,
expected real rate of interest, one's anticipation of the future,
including the willingness to endow one's dependents (one of Marshall's
illustrations), one's feeling of security, etc. Alas many of us
are still struggling to overcome what we learned from Keynes or
our teachers as the failure of the classics to appreciate that
savings depend on the level of income!
Sorry for the self-citations. I didn't mean to advertise my
publications. But what is the point hiding useful or relevant
information simply because it's in my name?
James Ahiakpor
CSUH, Hayward
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