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]