Posted by: Dirk | March 5, 2018

A short comment on Temin and Vines on Keynes

I have just read the 2014 book “Keynes – Useful Economics for the World Economy” by Peter Temin and David Vines. I must say that I like the book’s approach to the world economy, but I am dissatisfied with the treatment of the savings-investment identity. The trouble starts with Figure 5.1 on pages 45. A savings curve that rises with GDP, and investment + government spending that do not. Saving equals investment and government (I + G) spending in equilibrium. Hence, income adjusts so that savings equals I + G. There is just one problem: savings is the accounting record of investment and Keynes, in the General Theory, which is also the title of that chapter, spends a lot of effort to explain to his readers in chapter 6 that…

[w]hilst, therefore, the amount of saving is an outcome of the collective behaviour of individual consumers and the amount of investment of the collective behaviour of individual entrepreneurs, these two amounts are necessarily equal, since each of them is equal to the excess of income over consumption. Moreover, this conclusion in no way depends on any subtleties or peculiarities in the definition of income given above. Provided it is agreed that income is equal to the value of current output, that current investment is equal to the value of that part of current output which is not consumed, and that saving is equal to the excess of income over consumption — all of which is conformable both to common sense and to the traditional usage of the great majority of economists — the equality of saving and investment necessarily follows. In short—

Income = value of output = consumption + investment.
Saving = income – consumption.
Therefore saving = investment.

Thus any set of definitions which satisfy the above conditions leads to the same conclusion. It is only by denying the validity of one or other of them that the conclusion can avoided.

Not clear enough? Wait – there is more:

Saving, in fact, is a mere residual. The decisions to consume and the decisions to invest between them determine incomes. Assuming that the decisions to invest become effective, they must in doing so either curtail consumption or expand income. Thus the act of investment in itself cannot help causing the residual or margin, which we call saving, to increase by a corresponding amount.

That pretty much nails it. Saving is the accounting record of investment. Hence I=S at all times, with I in the driver’s. The only case in which an increase in S causes I to rise is a buyer’s strike leading to accumulated inventory. However, that is a very small effect.

So, Keynes and with him the authors take the wrong road when they wrote on page 55: “If the amount of total spending in the economy was determined by the balance between savings and investment at any interest rate…”. Total spending depends on investment, not saving. If you don’t understand this, you are kept in a neoclassical loanable funds world and your Keynesian ideas do not include endogenous money. In the modern world, banks finance investment, not savings. Hence new deposits are created when banks extend new loans. The borrower spends the money on investment, perhaps, and the receiving unit records an income that is not (yet) spent – savings!

As I said in the beginning, the later parts with the Swan diagram are rather useful, but the way that the savings-investment identity is used in the very important chapter prior to this leads me to discard the book – not Keynes’es General Theory, but that of Temin and Vines. For those with an interest in that particular brand of Keynesian theory – General Theory on loanable funds foundations – the book is a useful introduction. For those that want to understand how Keynes is relevant for the 21st century I would recommend reading the original books – now in public domain – or modern books from Post-Keynesian/Modern Monetary Theory authors.


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