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.


I have been noticed that there is a speech online – h/t to Erik Jochem – from the year 2000 in which Frits Bolkestein discusses “Building a liberal Europe in the 21st century”. It took place at the University of Freiburg, where ordoliberalism reigns supreme. Here is a very interesting excerpt with some of my highlighting in bold (source):

Theory teaches that there are a number of mechanisms in a currency union that allow the system to absorb any asymmetrical economic impacts. The scope for the first of these – financing extra public expenditure by public borrowing – has been substantially reduced by the stability pact.

Member States will no longer be able to finance extra spending by increasing their budget deficits, which is a good thing in that it will compel them to exercise budgetary discipline. Each Member State must therefore endeavour to keep its budget more or less in balance or even to have a surplus. Any surpluses should be used to build up financial reserves that can be drawn on in times of difficulty.

Another mechanism for absorbing asymmetrical economic impacts is the mobility of labour. It has proved difficult in practice to increase the mobility of labour between Member States. A mere 2% of EU citizens seem prepared to seek work in other parts of Europe. Obviously, mutual recognition of qualifications and harmonisation of social and employment legislation will eliminate a number of major barriers, but this will have little impact in the short term. There are cultural and linguistic obstacles that are difficult to eliminate and that will continue to be too high a threshold for many to cross.

Nor will a third mechanism, that of transfer payments, offer a solution – at least in the short term. The EU’s budget is exceptionally modest in terms of Gross European Product. To give you an idea: the total EU budget is smaller than Germany’s social security budget, and most of the uses are fixed. More than half of the budget goes on the Common Agricultural Policy, and a not inconsiderable proportion of what is left goes to the Structural and Cohesion funds. No money is available, therefore, to help Member States to cope with a crisis, unless they are prepared to increase their contributions to the EU budget. It is doubtful, however, whether there is the necessary political will to re-open negotiations on this question so soon after the Berlin summit.

Because of the ineffectiveness in the short term of the first three mechanisms, it is absolutely vital that we take the fourth one seriously. This fourth instrument – increasing the flexibility of the labour market through wage and price flexibility – is the only way in which we will be able in the short term to cope effectively with an economic crisis. The remarkably swift recovery of the economies in the Far East was due in no small measure to the preparedness of the populations to take on any available work, and if necessary to do the same work for less pay. In Europe the labour market is getting increasingly bogged down in a morass of social regulations. If we want to increase flexibility, it would probably be a good idea to go through the 70 000 and more pages of Community “acquis” with a fine-tooth comb to see whether or not there is some labour legislation that can be scrapped because it has too negative an effect on flexibility or has simply ceased to be relevant.

Often, I hear economists saying that they never realized that adjustment in the Eurozone would come via lower wages. Bolkestein was a member of the European Commission responsible for the Internal Market and Taxation, so an insider who should have been listened to. Of course, the Euro started in 1999 with fixed exchange rates and then in 2002 with cash, but I do not recall anyone from the political elite in Europe criticizing this “fourth instrument”. Europeans in their response to the economic crises were led by ordoliberalist thought, and it is high time to acknowledge the disastrous consequences and come up with a new idea of how to run Europe and the nations that it contains.

Posted by: Dirk | January 24, 2018

German GDP for students of economics

I just stumbled over a very nice figure from Destatis, Germany’s statistical office. It shows GDP and how you arrive at the correct number using the production, expenditure and income approaches. Here it is:

My favorite approach is to use the middle and right columns. In order to grow the economy, stuff has to be produced. If that is a good assumption, then we can ignore the left column for the moment. Now, the question of GDP is decided by expenditures, which create income. The second and third column are intertwined. Expenditure is to some extent financed by income, to some extent by increasing (short-term) debt. For instance, probably most of consumption is financed by income, most of capital formation by decreasing saving or increasing debt.

Put that way, it becomes clear that a rise in debt will generate more GDP if the deposits borrowed (through loans, issue of bonds, etc.) are spent on goods and services. Therefore, especially lending in the real estate sector is expansionary. This is one of the main drivers of investment, which itself is the most volatile component of GDP.

Posted by: Dirk | January 23, 2018

The Euro – Evolution and Prospects (2001/2018)

Having just taken a quick look at the CEPR publication “Reconciling risk sharing with market discipline: A constructive approach to euro area reform” (link), I am reminded that many economists still do not grasp the functioning of the fiscal and financial system. The paper is full of theoretical flaws and the policy advice hence is mistaken. Instead of letting markets have more power and government less, I think that we should do one of two things:

  1. Give sovereignty back to national governments by allowing them to finance their spending in a way that bankruptcy is not an option.
  2. Create a European fiscal institution – or Treasury – which sells bonds that are risk-free and that deals with unemploymnt in the Eurozone, filling in the role of deficit spender.

I have just read the 2001 book “The Euro – Evolution and Prospects” by Philip Arestis, Andrew Brown and Malcolm Sawyer. The authors write on page 121:

The euro has, of course, ushered in a single monetary policy. At the same time it has constrained national fiscal policy (via the Stability and Growth Pact) and it has made exchange rate revaluation impossible for the individual EMU countries. It is widely recognised that this arrangement requires a high degree of convergence of the patently very diverse economies of the Eurozone. Without such convergence, it will enforce inappropriate economic policies on its member states, constrain automatic and discretionary fiscal stabilisation, and negate room for manoeuvre in the face of economic asymmetries. In addition, a heavy burden of co-ordination is placed upon the European Central Bank (ECB) and the Eurosystem, through the need to pursue a coherent monetary policy, and to be perceived as so doing. The question of the performance of the Eurosystem and the ECB will first be addressed below, then the issue of convergence will be taken up.

This seems to me a prescient analysis, which of course does not square at all with the proposals that the authors of that CEPR paper make. It is time to give more freedom to the fiscal parts of the Eurozone institutions, not less. If you are not thinking in that direction, I believe that nothing good can come out of it.

Europe is not about risk-sharing with market discipline. It is about ensuring the economic and social well-being of its citizens. We tried risk-sharing with market discipline, and we failed. Governments should not be punished by financial markets, but by voters. Time to move on. The authors of that book write on their last page:

[P]olicy must be enabled to play its vital role in overcoming aggregate demand asymmetries and uneven processes of cumulative causation through coordination of fiscal and omnetary policy, within a transformed institutional setting.

That’s what we need to do.

Posted by: Dirk | January 22, 2018

Lecture tonight at Hamburg University

Tonight at 6PM I will give a lecture with the title Modern Money Theory and European Macroeconomics – an Alternative to the Policy of Austerity?. It takes place at room S27 at Von-Melle-Park 9, Hamburg University. The lecture is part of a series organized by AK Plurale Ökonomik Hamburg and will be held in English. More information is available here.

Posted by: Dirk | November 14, 2017

Why Latin American Nations fail – new book

I have seen that Matías Vernengo and Esteban Pérez Caldentey have edited a new book on Latin American development, or rather, it’s failure to develop properly. The book is available here, where the introduction can be read for free. The book is especially interesting because it is a reply to the New Institutionalist approach, which is severely flawed according to the authors. In a teaser article at the WEA, they write:

Given their importance, we believe institutions deserve a broad, critical and multidisciplinary approach beyond the property rights approach, which could then provide a basis for alternative policy recommendations. This is what we try to show in the book and in its different sections and chapters. The book is divided into two sections. The first highlights several key problems associated with New Institutionalist arguments and, in particular, with the way it is applied to view and understand Latin American development.

The New Institutionalist approach provides a limited view of comparative historical analysis failing to read and understand history on its own terms. An illustrative example is Acemoglu and Robinson´s characterization of the Spanish and English colonizations as being extractive and inclusive respectively when in fact the historical record shows that both types of colonizations were at times extractive and inclusive. The more recent historical experience of Japan in the post-WWII era, South Korea and some other Asian nations such as Singapore shows that economic success was not based on inclusive institutions.

Also, the New Institutionalist view overplays the role of the market and downplays the role of the state in the process of economic development. Several institutions of the developmental state that promoted industrialization, including the bureaucracies that managed macroeconomic and commercial and industrial policies, development banks, publicly funded or directly public universities and research institutes were central in many experiences of development, and were also part of the Latin American experience until the debt crisis of the early 1980s. The reversal of many of these policies after the crisis, and the predominance of the Washington Consensus, have not led to vigorous growth as New Institutionalist views would have indicated.

The discussion of Acemoglu and Robinson – authors of “Why Nations fail” – should be very interesting.

Posted by: Dirk | October 17, 2017

MMT, Tajikistan and foreign bond investors

One criticism of Modern Monetary Theory (MMT) that I hear very often is that it applies only to the US or the countries with hard currencies that can issue bonds on international bond markets. Apart from the fact that selling bonds to foreigners is not a plus – unless you need foreign exchange – there is a market for lower-income emerging economies indeed, as the NYT reports:

This year, lower-income emerging economies are expected to issue close to $10 billion in government bonds, according to the I.M.F., more than the past two years combined.

Of all of them, a recent $500 million bond offering by Tajikistan, a landlocked former Soviet republic that has rarely interacted with global investors, was the most curious. Tajikistan is paying investors an interest rate of just over 7 percent for 10 years, and the deal was a quick and easy sell for the country’s bankers, with demand several times the amount of money secured.

This is not investment advice, but the point rather is: even small emerging economies can sell bonds to foreign investors. There is nothing magical about the US and other “hard currency” countries in terms of government bond issuance. The countries are special since forex markets trade their currencies widely, so that exchange rates are less jumpy. That, however, is a different point!

Posted by: Dirk | August 30, 2017

Keynes on Savings and Investment

Geoff Tily in his paper on Keynes (pdf) has this quote (from the Collected Writings):

S = I at all rates of investment. Y either definable as C+S or as C+I. S and I were opposite facets of the same phenomenon they did not need a rate of interest to bring them into equilibrium for they were at all times and in all conditions in equilibrium. (CW XXVII, pp 388–9)

This is very enlightening. The “General Theory” also contained the issue of savings and investment, but the quote above nails it. There is no “supply” and “demand” for capital, hence savings and investment do not need anything to move so that there can be equilibrium.

From my point of view, this is one of the strongest rejections of neoclassical macroeconomics and it stands until this day. In a monetary economy, there is no “savings good” that needs to be produced before it can be “invested”. I = S “at all times” – there cannot be a disequilibrium between saving and investment.

What is correct on the national level must hence be correct on the international level. We cannot have global excess savings, since they are always equal to investment. Mario Draghi, when he said last year … (my highlighting)

It is this phenomenon – the global excess of savings over profitable investments – that is driving interest rates down to very low levels. And so the right way to address the challenges raised by low rates is not to try and suppress the symptoms, but to address the underlying cause.

… is wrong about the inequality of savings and investment on a global level. However, he is right in seeing low interest rates as a symptom and not the cause. Lack of aggregate demand is what has led to low rates of inflation, and hence low interest rates in order to stimulate demand.

I just read the new book by Steve Keen, which is … a little red book. It is very readable and brings the reader up to the economic theory and reality of 2017. The focus is on private debt, and that is very important. The “smoking gun of credit” has been widely overlooked in the economics discipline over the last decades, which instead focussed on constraining public debt. For those that are interested in state-of-the-art economics of 2017, this is a very good book since it gives the reader some perspective at how we got where we are. What is disturbing is the fact that we did not rethink our economic theory and policy even though we clearly hit a wall in 2008/09. Most economies still rely on increasing private debt as the major mechanisms to ignite and sustain growth. The problem, of course, is that private debt cannot increase forever, and when it does not, a financial crisis plus a recession result. This, perhaps, would not be so bad, but the problem is that we are unlikely to repeat this cycle. Japan, so argues Keen, shows the way forward. The public will be afraid of debt, rightly so, and stop borrowing. This will change the way the economy functions since private sector spending will be reduced permanently. The public sector hence needs to increase spending to reduce resulting unemployment. It remains to be seen whether economists can make the intellectual jump into a new world of (private) “Debt Zombies”. Recommended!

German daily newspaper Die tageszeitung published my article on money creation last weekend (here). This is the translation from German into English (also available as a pdf):

(Translation of!5422477/ by Dirk Ehnts, author)

Debate on money creation at the ECB

Money is created from nothing

The consequences are shocking. The mainstream view of economics is wrong – says German central bank Deutsche Bundesbank. This is a revolution.

Modern capitalism is impossible without money. We do not exchange goods against goods, but we buy goods with money. The interesting question for economics is hence: where is money coming from? The Bundesbank has now delivered an answer that is revolutionary: money is created from nothing – by booking processes inside banks. This may sound abstract at first, but the consequences are far-reaching. The Bundesbank says that the mainstream theory in academic economics is wrong. Millions of students at universities learn a fairy tale.

This fairy tale is spread by, for instance, Gregory Mankiw, whose textbook „Macroeconomics“ has sold millions of copies and is widely used at German universities. For Mankiw, banks are just middlemen, called intermediaries: they allegedly get money from savers that they then pass on to other customers.

This idea might sound reasonable, but has little to do with reality. Banks do not need savers to extend loans. They are not intermediaries, but create money by themselves. The Bundesbank says that unequivocally. The prose is a bit awkward, nevertheless it is worthwhile to read the main passage: „If a bank extends a loan, she books the credit to the customer connected to the loan as his deposit […] This refutes a widely held erroneous view in which the bank acts as an intermediary in the moment of lending, in which loans can only be funded by deposits that the bank has received from customers before.“ Harvard professor Gregory Mankiw with his theory of intermediation, so says Bundesbank, subscribes to „a widely held erroneous view“.

New money is born

Words like credit or deposit sound complicated, but one can imagine money creation like a scoreboard in a football stadium: first goals are scored, then the scoreboard is adjusted accordingly.

This is how banks, work, too: first, the bank signs a loan contract – and then the money is added to the client’s account. The money did not exist before, it is created through the extension of a loan.

Let us assume, that a customer applies for a loan of a thousand euros to buy a used car. Then the bank tops up his account. Done. New money is born. When the client repays the thousand euros – the money is gone again.

This insight has enormous consequences, because the Bundesbank says: the relationship between debts and savings is rather different from the view of the „Swabian housewife“. This figure of speech, which is generally known, thinks that saving is always good – and debs are to be avoided. The German language also suggests that loans are evil. The German word for debt – Schulden – instantly reminds one of the idea of moral sin – moralische Schuld. Who takes out loans is quickly regarded as disreputable.

 Two practical questions

As the Bundesbank has shown, loans are the driver of the economy. Without them we would have neither investment nor economic growth. Only when loans are taken out savings can be created. The world of the Swabian housewife is turned topsy-turvy: savings are accommodating items, seen from macroeconomic accounting.

Let’s stay with the banal example or a car purchase. When someone borrows a thousand euros to buy a used car – then money is created, which then is transferred to the seller, who now has additional savings of a thousand euros. These savings were created from nothing just like the loan. Or, in economese: The debt of one person are the financial wealth of another.

Two practical questions remain: If banks do not need savings to extend loans – why do we save at all? And why, at least in the past, high rate of interest were paid for savings deposits, if these are essentially superfluous?

To start with the savings: most Germans do know instinctively why they would like to save some money. They make provisions for the future. They save to buy a house, for old age or to finance their kids’ education. Firms also like to save. Profits only arise if income is higher than expenditure.

The Germans are saving

Households and firms hence save even when interest rates are low or zero. We can see this phenomenon now: Whereas many banks offer negative interest rates or raise account fees, the Germans continue undauntedly.

This leads us to the second question more urgently: why are there interest rates in the first place, if savings takes place anyway – and banks do not need those savings to extend loans?

The interest rate is a brake for credit creation and inflation. If money is created from nothing through the issuance of loans, then theoretically an infinity of money could be pumped out into the world. When people consume and invest without limited, at some point all factories and workers will be busy, and inflation starts to rise.

This is when central banks intervene: They raise the interest rate as soon as high inflation seems to occur. With interest rates rising, taking out more loans will not be attractive. Money creation is stopped for the time being.

What follows from this?

The Bundesbank has entered history books with her account of money creation – in Germany. Truth is, other central banks were quicker. The Bank of England wrote on her homepage in 2014 how money is created from nothing.

What follows from this politically? The Bundesbank remains silent on this issue. However, it is obvious that finance minister Schäuble’s „policy of a black zero“ – a balanced government budget – is just as wrong as the austerity policies of the Eurozone.

Recalling the Bundesbank’s presentation: Savings can only be created when loans are extended. Debt and wealth belong together. But this reality is ignored by most Germans and their finance minister. They rather trust their guts: They would absolutely like to save – but also reduce their public debt. That does not work. If Schäuble saves and avoids any creation of debt he prevents his citizens from building up new wealth.

It’s even worse in the Eurozone: The crisis countries are forced to slash their government spending and are supposed to not incur any new debts but pay off old ones. This also will not work.

Schäuble should start to borrow

Where do incomes come from which are needed to repay the debts? Who repays debts in matter of fact is saving. But savings can only exist if someone increases his debts.

Mainstream economists often mock this statement by claiming that it would be nonsense to fight a debt crisis with new debts. It may be paradox, but this is how the world of money works, as the Bundesbank has explained to us.

ECB president Mario Draghi, an experienced central banker, has understood much earlier than the Bundesbank that new public debts are needed. No speech, in which he does not call on the economically stronger Eurozone countries, mostly Germany, to engage in fiscal policy. What means is: Schäuble should finally take out new loans. There are enough investment projects worthy of financing. Everybody agrees that the internet is the economic future – yet powerful internet connections are lacking in many locations in Germany.

Also, there now is a brand-new investment project, which is mandatory: all university libraries need new textbooks on macroeconomics. Mankiw and the other mainstream economists have finally been paid off, since the Bundesbank spoke its mind.



works at the chair for macroeconomics at Technical University Chemnitz with a specialization on international economic relations. Routledge published his book „Modern Monetary Theory and European Macroeconomics“ in 2016.

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