Saturday, November 10, 2007

Rubin’s Fallacy and the Paradox of Thrift

When I choose my blog pseudo-name – PGL or ProGrowthLiberal – Angrybear suggested I was a Rubinesque Bear, that is, a believer that fiscal restraint could promote long-term growth through higher national savings. I hate to say this but Paul Krugman had to give a stern lecture to Robert Rubin over the simple issue of transmission mechanisms. Before we get to the details of international macroeconomics, let’s do an analogy drawn from the paradox of thrift.



Classical economists used to have faith that a rise in national savings would automatically lower real interest rates enough to increase investment demand such that the economy would stay at full employment. Keynes noted that sticky prices – or a decision by the Central Bank to peg interest rates – could frustrate this transmission mechanism, which would mean that the rise in the savings schedule could lead to a recession, which would result in less investment and savings. Without further ado, let’s turn the microphone over to Paul by first noting Rubin’s fallacy:

You could have had surpluses that affected the savings rate and would have helped the trade balance. I think you would have had more confidence in the policy framework and you would have had a better dollar,” he says regretfully. He pauses to reflect. “But we are where we are.”


Paul harkens to the doctrine of immaculate transfer noted by John Williamson as Paul notes that accounting identities do not induce expenditure-switching unless they are accompanied by changes in the real exchange rate. Paul also notes that a fall in national savings could lead to fewer imports if it means a recession. But aren’t we trying to avoid a recession as we find means of encouraging more investment and net exports? If so, we should be hoping for lower real interest rates and a real devaluation of the dollar.

7 comments:

Robert D Feinman said...

I'll ask the same question I always ask when the subject of "savings" comes up.
How do you define savings?

If I put my money into a bank, say, to "save" it then the bank gets to invest it. If I buy an expensive bauble then the seller gets to decide how the money gets spent. What's the difference?

Let's leave out the obvious issue of domestic vs foreign spending. That affects the balance of trade, not the "savings" rate. Whatever I do with my money, other then put it under the mattress, is going to generate some sort of economic activity.

I see a hidden moralistic assumption behind the term "saving". Expenditures the author thinks are a "good thing" are savings the rest is spending. Is there an objective measure, and if there is, why is one sort of money circulation better then another?

Myrtle Blackwood said...

Thanks, ProGrowth Liberal, for bringing this topic up.

It's ironic that whilst the Australian peoples' 'savings' have increased enormously so too has their level of debt.

Some of their 'savings' have been 'invested' in the purchase of housing and land. This has resulted in price inflation.

Another segment of 'savings' has been 'invested' in large scale clearance of native forests, genetically modified crops, creation of more and more patents and copywrights, CEO payrises, wars in the Middle East, financial derivatives, speculation etc.

Is there a 'paradox of investment'?

Anonymous said...

Me thinks that Mr. Feinman has a very astute point. Now I'm just a rank layman in regards to economics, so I was going to suggest that the argument sounds a bit like a game of semantics. What if this and what if that? Lots of supposition going on here, and as I've said in the past, that's the weak spot in economic theory. It seems that almost anyone can step up to the rostrum and take part in the debate given that the arguments don't seem to have any solid under pinning from quality quantitative data. I can't quite see the difference between money spent on a product versus money spent on a savings bond or account. I give up the use of the money for some other purpose, but someone else still gets to use it.

Anonymous said...

Seems to me Jack that in one case you have a claim to money as money (plus some increment of interest, so an 'expanded money') while in the other there is no such as the money has been transformed into the not-money of some particular commodity only convertible to money again if it is resold.

Still, in both cases savings circulates which in and of itself produces nothing unless/until invested into processes of production.

Anonymous said...

juan,
They still seem to be the same from the perspective of what use the money is put to after one either saves it or spends it. I assume that saved money is recirculated by the receivers of the savings in order to generate the interest income that is expected to be earned. Spent money is already in the circulation process. To the saver vs the spender there is a difference, but the money itself still is being kept in process. Just keep it out of the mattress.
Did you read or see the news item regarding the apartment break in in NYC the other night. The intruders ransacked the place until they found the elderly occupants' horde,
some $70,000 in cash. Now the money is being put back into circulation. Bad for the elderly couple, for sure. But good??? for the economy?

Anonymous said...

agree, which is why i'd added "in both cases savings still circulates..."

to which i could have further added that, through credit multiplication, that circulation can increase the quantity of money, the vast majority of which is credit money created in the process of borrowing/lending/...
accumulated debt v ability to service now becomes a limit

Myrtle Blackwood said...

And when the limit of debt has been reached savings and investment both disappear at once!

Public School Funds Hit by SIV Debts Hidden in Investment Pools
http://www.bloomberg.com/apps/news?pid=20601170&refer=home&sid=aYE0AghQ5IUA
By David Evans. November 15th 2007