Savings That Would Otherwise Go

Some time back, Paul Krugman wrote of a Dark Age of Macroeconomics. Specifically:

First Eugene Fama, now John Cochrane, have made the claim that debt-financed government spending necessarily crowds out an equal amount of private spending, even if the economy is depressed...

Krugman quotes Fama:

The problem is simple: bailouts and stimulus plans are funded by issuing more government debt. (The money must come from somewhere!) The added debt absorbs savings that would otherwise go to private investment...

Fama doesn't say the savings might otherwise go to private investment. He says those savings unquestionably would be put to that use, if only the government didn't borrow the money. But when the economy is depressed and investment spending is falling, confidence like Eugene Fama's is unwarranted.

And Krugman quotes Cochrane:

First, if money is not going to be printed, it has to come from somewhere. If the government borrows a dollar from you, that is a dollar that you do not spend, or that you do not lend to a company to spend on new investment. Every dollar of increased government spending must correspond to one less dollar of private spending...

Cochrane, like Fama, expresses full confidence that every available dollar of savings will be used to fund new investment, if only the government doesn't get to it first. His confidence, like Fama's, is unwarranted. But Cochrane also commits word-crimes.

Cochrane uses sentence construction -- word order -- as a substitute for chronological order: If the government borrows a dollar from you, that is a dollar that you do not spend... Cochrane makes it sound as though government has dibs on my paycheck.

Only the withholding, Big-C, only the withholding. The rest of it comes to me. And the government can not touch that part of my income before I make my spending and saving decisions. It is a cheap trick, Cochrane's use of word-order as a substitute for chronological order, and it deserves nothing but scorn.

Krugman writes: "There’s no ambiguity in either case: both Fama and Cochrane are asserting that desired savings are automatically converted into investment spending, and that any government borrowing must come at the expense of investment — period."

Krugman is right to doubt the "automatic" conversion of savings into investment spending. But for the sake of accuracy, perhaps the phrase "fully converted" would be more apt than Krugman's "automatically converted."

Full, prompt conversion of savings into investment spending cannot be taken for granted in the slump. When people are worried and saving more, and businesses are worried and investing less, there is a mis-match between savings and investment. At such times, there is no guarantee of full, prompt, automatic conversion of savings into investment spending.

At such times, it is not wise to leave things to chance. That is precisely what Keynes pointed out so many years ago:

Those who think in this way... are fallaciously supposing that there is a nexus which unites decisions to abstain from present consumption with decisions to provide for future consumption....

Are savings fully and promptly converted into investment spending? The answer depends upon economic conditions. When the economy is healthy and growing, yes: We can trust that all or nearly all savings will be recycled back into the spending stream as investment or as some other use of credit.

But when the economy is in a slump? No. Investment spending is being reduced at just the time when people are saving more.