A microeconomic perspective on the “loans create deposits” meme

By Joseph Laliberté

A private bank’s “cash and cash equivalent” position as shown on its balance sheet typically includes its deposits with other banks, excess reserves at the central bank and vault cash.  In financial accounting, the cash flow statement illustrates the main elements impacting the cash and cash equivalent position of a business between the beginning and the end of a given period.

Perhaps one of the most fascinating aspect concerning the obsession of mainstream macro economists with banks’ cash and cash equivalent position (excess reserves, in particular) is the near irrelevant status this component has in banking and financial circles.  Below is an extract from a letter of the German Banks Association (Bankenverband) to the International Accounting Standards Board (IASB) that illustrates perfectly the lack of interest that many have in regard to banks’ cash position:

One of the major objectives of the boards' proposals is to provide information which is relevant to predicting future cash flows.  We agree that the issue of liquidity presents a significant challenge for the banking sector.  Nevertheless, cash flow statements cannot help to assess future liquidity in any way.  No financial analyst, for example, has ever queried any of our member banks about, or given any great consideration to, the cash flow statement.  If the IASB has information pointing in another direction, we would be interested in the details. (emphasis added)

Illustrative of the non-importance of a bank’s cash flow statement is that the very definition of “cash and cash equivalent” used for the purpose of building the cash flow statement appears far from standardized across the banking industry.  Some banks, such as Deutche Bank, divide “cash and cash equivalent” on the asset side of its balance sheet into “cash and due from banks” and “interest-earning deposits with banks”. However, for the purpose of its cash flow statement, Deutche Bank defines “cash and cash equivalent” as “cash and due from banks” PLUS “interest earning deposits with banks” MINUS “term deposits with banks”.  For its part, the French bank Société Générale presents on the asset side of its balance sheet two categories (i.e., “cash, due from central banks” and “due from banks”) while for the purpose of its cash flow statement it defines "cash and cash equivalent" as follows: (“cash, due from central banks” MINUS “due to central banks”) PLUS (“due from banks” MINUS “due to banks”).  Closer to home, ScotiaBank defines “cash and cash equivalent” as “cash and non-interest-bearing deposits with banks”, thereby excluding interest-bearing deposits with banks, while National Bank includes cash and all deposits with financial institutions.  Go figure!  One would assume that banks would find it necessary to settle on a common definition of “cash and cash equivalent”, especially since we are often told by the financial press and many economists that this asset component is so critical in analyzing banks’ capacity to extend loans.

That said, even if all banks would settle on a common definition of “cash and cash equivalent”, this asset category would still say very little about a bank’s liquidity.  The reason for this is that any given bank could have a cash and cash equivalent position of zero and still be considered highly liquid thanks to its holding of cash management bills/T-Bills/government bonds. 

Furthermore, the cash and cash equivalent position says nothing about a bank’s capital ratio, the critical element in determining a bank’s capacity to extend credit.  Banks’ capital is allocated to balance sheet expansion through loan and deposit creation, not banks’ cash or reserve position.  As per the cash flow statement of a deposit-taking institution, net additional loans to customers are considered a use of funds, and net additional deposits from customers are a source of funds.  Therefore, once a loan is granted and the customer’s checking account is marked up by the same amount, the cash and cash equivalent position of the bank is left unchanged.  From a microeconomic banking perspective, loans create their own source of funds, or stated differently, "loans create deposits".  Assets-liabilities duration mismatch (interest rate risk) is of course an important consideration, and this is where the discussion ties in with the central bank’s decision on interest rate.

One last point that deserves to be highlighted is that, although a bank’s "cash and cash equivalent" position generally says nothing about its capital position and, consequently, its regulated lending capability, an increase in this asset item may sometimes reflect improved liquidity.  This was arguably the case with QE1 when the Fed purchased mortgage-backed securities (MBS) by crediting private banks’ reserve account at the Fed.  Moreover, if one assumes that with QE1 the Fed engaged in fiscal policy by overpaying for MBS (relative to their market value), then it could be argued that QE1 may have also helped to improve banks’ capital position as well as their regulated lending capability.

In the case of Canada, a QE1 style program was put in place, but since reserves were “mopped up” with the issuance of Canadian government bonds, there was no impact on banks’ “cash and cash equivalent” position, a situation that led to an improvement in their liquidity position (as it did in the U.S).  As for the matter of bank capital, contrary to the U.S., there was no direct injection of public funds to recapitalize the banking sector in Canada.  However, just like what happened in other jurisdictions, accounting authorities proved accommodative.  Changes to the Canadian Institute of Chartered Accountants Handbook in October 2008 allowed banks to re-classify financial assets from “held-for-trading” to “held-to-maturity” under specific circumstances.  Use of this re-classification put some banks on stronger regulated capital footing than would have been the case otherwise.

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Canada's fiscal stimulus: an interpretation

In a previous post, I suggested that Canada's fiscal policy response to the last recession consisted of an effective set of counter-cyclical economic measures.  To support this idea, I highlighted the fact that, as a result of these measures, Canada's level of public fixed investment increased to the highest level in three decades (see graph 1, click on graphs to enlarge).  Also, I suggested that this increase in fixed capital expenditures helped to mitigate the recession's effect on the level of employment.

Graph 1: Consolidated government fixed capital, 1961-2011, Source: Statistics Canada

This view appears to have caught on.  In his recent budget plan, Canada's Minister of Finance, Jim Flaherty, links the labour market's performance during the downturn to the federal stimulus put forth by Stephen Harper's Government after the last recession (see here):

Economic developments since the introduction of the stimulus phase of Canada’s Economic Action Plan underscore its success in protecting Canadian jobs through strong support to the domestic economy.  As a result...Canada has posted the strongest growth in employment among G-7 countries...

[G]overnment investments in infrastructure were key to the success of the Economic Action Plan...

The budget plan includes the following graphs to support the Government's case that its stimulus was effective in mitigating the impact of the recession:

Graph 2: Improvement in employment during recovery

Graph 3: Unemployment rate, Canada and United States, 2006-2011

Graph 4: Growth in real per capita disposable income, 2006-2010

In graph 2, we see that the improvement in Canada's rate of unemployment during the recovery was the highest among the G7 economies.  In graph 3, we see that the unemployment rate fared better in Canada than in the US.  In graph 4, we see that disposable income rose faster in Canada than in the other G7 countries during the recovery.

But is the increase in fixed capital expenditures really the result of federal government action?  In my earlier post, I was very careful not to associate the increase in fixed public investment in recent years solely with the policy measures put forth by the federal government.  Rather, I specified that it was the "combined success of the federal and provincial governments' stimulus measures" which contributed to the effectiveness of Canada's response to the recession.  In my view, suggesting otherwise would be misleading given that the data from the National Income and Expenditures Accounts shows that the largest share of fixed public investment in recent years has come from provincial and local governments (see graph 5).

Graph 5: Public fixed capital, all levels of government, 1961-2011, Source: Statistics Canada

That said, it would be equally incorrect to suggest that the federal government had no role to play in the recent increase in fixed public investment given that, in Canada, a large share of the income of provincial governments consists of fiscal transfers from the federal government to provinces.  As shown in graph 6, federal transfers represent an important source of income for provincial governments.  And interestingly enough, in recent years there has been a considerable increase in the amount of federal transfers to provincial governments.

Graph 6: Provincial government income from federal government, 1961-2011, Source: Statistics Canada

Does this suggest that the Harper Government is justified when it claims responsibility for the boost in capital expenditures in recent years?  It's hard to say for sure, but there is a good argument to be made that the Harper Government is partly responsible given this increase in federal transfers to provinces since the Tories took office.

Better yet, another explanation would be to propose that responsibility for the significant increase in public fixed investment in Canada in recent years rests instead with the fact that, between 2004 and 2011, the governments in power at the federal level were all minority governments, during which "concessions" were made to opposition parties on budget-related matters (i.e., in terms of additional program funding and increased federal transfers to provinces) as a way for these governments to remain in power. 

This view appears to be supported by the facts.  As you can see in graph 7, federal transfers to provinces increased significantly starting in 2005 following the election of Paul Martin's minority government.  The increase in federal transfers to provinces is especially noteworthy given that it resulted in the first significant increase in federal transfers to provinces (viewed as a ratio of total federal expenditures) since the early 1970s. 

Graph 7: Ratio of transfers to provinces/federal expenditures, 1961-2011, Source: Statistics Canada

Recall that, in 2005, the Martin Government required the support of the NDP to pass its budget, and that the "compromise" budget significantly increased the amount of funding for programs under provincial jurisdiction such as social housing and education.  But regardless of the nature of these transfers, this additional source of income increased the amount of financial resources available to provinces, enabling them to undertake increased investments in infrastructure and other fixed capital projects.

Now, the above is a very rough sketch.  A more detailed look at the data is necessary to get a better picture of the fiscal dynamics underlying these figures.  Still, I think it's fair to say that the increase in public fixed capital investment in recent years is not solely the result of the stimulus measures put forth by the federal government during and after the last recession.  Rather, as I wrote in my earlier post, it is more likely because of the combined efforts of the federal and provincial governments.

Reference

Courant, P., E. Gramlich, and D. Rubinfield. "The stimulative effects of intergovernmental grants: Or why money sticks where it hits", Fiscal Federalism and Grants-in-Aid, P. Mieskowski and W. Oakland (ed.), Washington: The Urban Institute, 1979.

Europe! It's not too late to reverse austerity

The following article was written by the author of the Classic Indeed blog.  The article is cross-posted on both blogs.  Readers are invited to post comments on either blogs.

Months ago we outlined the challenges that presented themselves to Italy and Greece, and to Germany, France and the United Kingdom.  We opted against austerity, trusting that the technocratic appointments of Messrs Monti and Papademos could transform governments in Italy and Greece, and enable their respective legislatures to both recommend alternative and optimal public expenditure policies and to restrain policymakers from endorsing imposed fiscal restrictions while constraining budgets any further.

Unfortunately for the global economy and markets, Messrs Monti and Papademos initiatives did the contrary.  They aspired towards the heroic in adhering to a sub-optimal detriment and have now emerged as the scapegoats for political and investment désenchantées.

More ironic is that both men had very little to do with the original debacle.  They were recommended to their nation’s legislatures to clean up a mess.  Instead, as a result of attempting to implement austerity measures, they have generated more anxiety in world markets than expected.

Unfortunately, the recent economic deterioration and rising social tensions within their respective economies has become their responsibility, and the political disenchantment surfacing within the electorate is also their responsibility.  Worse still, the time for apologetics is long past and is now irrelevant.  At jeopardy is their leadership, the credibility they endorse for their visions of the future and the overall well-being of their citizenry.

Mr. Draghi and Mrs. Lagarde have voiced a redemptive message.  Both had professed that the worst was over.  For instance, in a speech on March 26 of this year, Mr. Draghi said the following:

“I would like to take this opportunity to provide you with my assessment of the current situation in the euro area and shed light on recent signs of improvements in the overall outlook.  I would particularly like to draw your attention to the effectiveness of the policy measures implemented by the Eurosystem, the EU institutions and national authorities.  And to remind you of the measures that we all must continue to pursue over the coming months and years with great diligence in order to continue on this path of stabilisation.”

As for Mme Lagarde, on March 18 of this year, the Managing Director of the IMF sought to reassure the audience of the 2012 China Development Forum with the following statement:

“There are signs that strong policy actions—especially in Europe—are making a difference. Financial markets have become a little calmer…”

Yet, Spanish yields are rising, as are those of Italy and Greece, and there is more and more talk of a potential third bailout for Greece although the IMF and the ECB have reassured the investment communities that changes in Greece are being introduced as promptly as possible and will be enacted effectively.

Any remnant stress in markets, according to the institutional duo is a result of the misperception by the interested communities that the consolidations proposed by the ailing economies cannot be achieved.

The emerging doubt on behalf of investment communities and investors in general should not be surprising.  After all, it’s their money and it’s their perception that underscores investment decisions.

One daresay that the investment community saw the collapse of the system much earlier than either the IMF or the ECB, although the leadership of the latter two has been proactive in attempting to stabilize investor sentiment and mitigate between some form of restraint and investment in growth and employment.  Notwithstanding, the reassessment that further bailouts will be necessary is now the swan song of European austerity politics.

Unfortunately, European policymaker perceptions of the bond markets are completely skewed as a result of their own biases.  What is difficult for them to appreciate is that there is no basis left for growth.  Unemployment is up, with Spain leading at 23.6% followed by Greece at 21.0%.  And in those Eurozone countries where unemployment rates are low, many of the employed are part-time workers and, as such, susceptible to labour volatility during these turbulent times.

Moreover, capacity utilization in the manufacturing sector over the last four quarters is dropping across the Eurozone at alarming rates.  Order books are not being filled as quickly as desirable, and their durations and size are shorter than required to support additional investments.  As a result, business investment is stalling as management constrains expenditures and saves its liquidity for dividends in lieu of growth to stabilize share values, foreboding that equity markets react adversely to this dilemma and possibly falter.

What most pundits expected from the emerging markets may not be realized: trusting that BRIC plug the slowdown in Europe, with China leading the way.  Unfortunately, there is no plug.  Most informed observers now mitigate between a slowdown and an ease in aggregate demand, with China’s future growth rates in question.  Projections for the region suggest that China’s growth potential could be in the midst of a major contraction with rates dropping to 7.5% from anticipated 8% and over.

Given the above, the most difficult challenge in domestic politics is for any Government to admit that it followed the wrong track.  There is no shame in being part of a bigger bloc of nations that propound fiscal consolidations even if austerity is showing itself as being the ineffective solution to the Eurozone’s financial crisis, a crisis which is now becoming an economic and political crisis.

It actually takes great courage in admitting that the austerity programs recommended may not work out.  The experiences of other nations in the matter, elicit danger signals that can’t be overlooked.  In such a case, the consolation is that if one’s admission is timely, the Government may come out of an unfortunate situation looking respectful and remarkably diligent.  There is still time for Europe to turn back its political agendas before turning the wrong corner.

The FRB blog invites your comments. Please share your thoughts below.

Canada's unemployment rate falls to 7.2%

The March edition of Statistics Canada's Labour Force Survey brought some good news today.  Canada's unemployment rate fell 0.2 percentage points in March and is now at 7.2 percent.  The Survey indicates that employment increased by over 80,000, with most of these being full-time positions (approx. 70,000).

From a national standpoint, this is good news, especially considering that the majority of these gains come from the private sector.  Also, it's important to note that there was a positive pick-up in new jobs stemming from the manufacturing sector (approx. 12,000).  Increased private sector job creation is a welcome trend, especially given the upcoming public sector job cuts in the coming months and years.

Notwithstanding this good news, Canada's labour market is still facing some significant challenges ahead.  The rate of government spending is growing at the slowest pace in nearly a decade, and may even turn negative as a result of public sector spending cuts.  Also, consumer spending and credit are slowing significantly, suggesting that overall growth is unlikely to come from households in the near term.  And, finally, with increased exports unlikely to give a boost to Canada's economy in the near-term, it's not at all obvious that today's good news marks the start of a positive and sustainable new trend for the Canadian labour market.

Music break: FRB anniversary edition

I wish to mention that a few weeks ago was FRB's first anniversary. To mark this occasion, I want to extend my gratitude to readers for their continued support and contribution to this site by dedicating this music break to all FRB readers. I hope it is inspiring.

It's another selection from Miles's '67 Tour. Make sure to check out Williams on drums: "he was a babe at the time", as one of my very first followers once astutely remarked. NOD to you...

Steve Keen, terminology and the Walras-Schumpeter-Minsky Law

A quick post. Steve Keen believes that aggregate demand is income plus change in debt, and that this demand is spent not just on goods and services but also on buying financial assets.  For Keen, this view of aggregate demand is at the heart of what he calls the Walras-Schumpeter-Minsky Law.

Now, although I find much insight from Keen's work (especially his belief that the main source of struggle in the economy is between financial and industrial capital), I simply do not understand why he has to re-invent terminology this way.  Also, there are problems with looking at aggregate demand in this fashion.  Economist Marc Lavoie expressed caution with Keen's definition of aggregate demand last year in a commentary on the (always relevant) Relentlessly Progressive Economics Blog.  Lavoie summarized his thoughts on Keen's view that aggregate demand is equal to GDP plus the change in credit as follows:

This does not make much sense to me.  There is also a certain amount of double-counting since investment is often financed by credit.  Furthermore, if I get one million dollars in loans to purchase a house, credit goes up by one million; and if the seller of the house puts the proceeds in a bank account, this will have no effect whatsoever on GDP or economic activity. It may only have an impact on the price of houses.

But, for me, the problem with Keen's definition really remains one of terminology. In economics, practitioners should really strive to use commonly used terminology.  If not, then discussions on important policy issues become impossible since the focus tends to get bogged down on unimportant and time-consuming language concerns rather than on the issues that really matter.

Careful with the saving terminology: a reply to JKH

By Joseph Laliberté and circuit. The authors reside in Canada and come from two different heterodox backgrounds, namely, MMT and the post-Keynesian/circuitist tradition.

Introduction

Much discussion took place lately regarding the proper meaning of the term “saving”. The issue surfaced when supporters of “Modern Monetary Realism” (a MMT offshoot) called out supporters of Modern Monetary Theory over the confusion they sometimes entertain when defining this term. Specifically, MMR contends that some MMTers often confuse “saving” with “saving minus investment” or “S-I”. The MMRers stress, correctly in our view, that “S” corresponds to “saving” rather than “S-I”. The anonymous blogger JKH has written extensively about this aspect and has even authored a detailed paper on this issue. We highly recommend this paper, as it provides an in-depth analysis and summary of this whole issue.

That being said, we wish to start off by saying that, while one could blame MMTers for putting too strong an emphasis on “S-I” rather than “S” in their analytical framework, it would be wrong to suggest that MMT’s lead proponents (i.e., Fullwiler, Mosler, Wray, etc) are not aware of the intricacies of the “saving” definition. Also, although it is true that some MMTers may have been sloppy at times in their use of terminology (for instance, we know of examples where MMTers have incorrectly referred to “S-I” as “saving” or “net losses”), it is unfair to characterize MMTers as being the only ones who get the terminology wrong. As Scott Fullwiler repeatedly and correctly pointed out, most of us at one time or another are guilty of using unclear or incorrect terminology, especially when commenting on blogs.

The objective of this post is to clarify terminology and demonstrate that JKH’s own choice of words regarding the notion of “saving” is not entirely without fault and could, as a result, mislead some readers. But before doing so, we wish to stress that we fully support the goal of both MMT and MMR (and JKH) in trying to put forth a more technically-sound approach to macroeconomics and economic policymaking. Indeed, it is our hope that all commentators would settle on a standard set of terminology moving forward.

Net Saving or Net Lending?

It is well-known that MMR and MMT have more or less officially adopted Wynne Godley’s terminology. Accordingly, both MMT and MMR would contend that “S-I” should be identified as “net saving” (of which the origin is most likely shorthand for “saving net of investment”). However, in our view, this terminology is not the most appropriate and could result in significant confusion for readers given that the term “net saving” in the OECD’s System of National Accounts refers to something entirely different from “S-I”. The correct terminology for (S-I) is in fact “net lending” (or “net borrowing”). Blogger Neil Wilson has been explicit on this point in the context of the aforementioned debate. In our view, “net lending/net borrowing” of the private domestic economy could also be appropriately described as the “sector surplus/deficit” of the domestic private economy.

Therefore, on the basis of the Statistics Canada glossary (which is in line with OECD terminology), the following terminology will be used in this post when referring to saving and investment:

•  “S-I” is “net borrowing/net lending” of the domestic private sector (in the three sector model), where “S” is “gross saving” of the domestic private sector and “I” is “gross investment” (or gross fixed capital formation plus investment in inventories) of the domestic private sector. Gross saving does not include a deduction for capital consumption allowance (capital consumption allowance is known at the micro level as “depreciation”). Similarly, gross investment does not include a deduction for capital consumption allowance.
•  “Net saving” of the domestic private sector, unlike “gross saving”, includes a deduction for capital consumption allowance. “Net saving” for the domestic corporate sector (a subset of the domestic private sector) is approximately equivalent to undistributed corporate earnings.

From the above definition, it is quite clear that households/corporations deploy their gross saving, not their net saving. In fact, it could be said that if gross saving is above zero, then it will be deployed in assets (either actively, as in the case of deployments in equipment, or passively, as when leaving it in a checking account) or deployed to reduce liabilities (e.g., repaying loans). If gross saving is above zero, deployment will occur even if net saving is zero or negative due to deduction of capital consumption allowance (i.e., depreciation). Statistics Canada drives this point home when it describes how gross saving is derived from net saving:

Added to this item [net saving] are capital consumption allowances (CCA). The latter are a cost reflecting the reduction in the value of fixed assets used up in production during the period (i.e., depreciation). Even so, they constitute available resources, since in practice, CCA is merely an accounting entry.

This is consistent with the definitions used by the OECD, and fully consistent with the approach used at the micro (business) level. Indeed, a business could in fact generate significant amount of gross saving and deploy them in various types of assets (real or financial) or to reduce liabilities while simultaneously running down its accumulated net savings (i.e., running down its accumulated retained earnings). This is why we argue that JKH’s flow equation S=I+(S-I) is really about gross saving and gross investment, as he himself mentioned when he described this equation as one of “portfolio balance” in which “the two major categories for the application of saving are investment and net financial assets”.

Gross Saving or Net Saving?

On the basis of the above, we would contend that JKH and other MMRers have themselves entertained some confusion over their interpretation of “saving” in two important ways.

First, JKH rarely specifies whether he talks about gross saving or net saving. Second, and more importantly, JKH at times seems to switch from gross saving to net saving in the same paragraph or in the same text. Nowhere is this confusion more apparent as in the comments by JKH that were published on the CNCB website. In those comments, JKH writes that:

Saving is described in proper accounting terms as funds sourced from income by virtue of being saved from income. The eventual deployment of that source of funds is described properly as a use of funds — whether such deployment and use occurs in the form of a bank deposit, a bond, a stock, newly produced residential real estate, or newly produced plant and equipment. The deployment or use of funds is separate from the act of saving itself.

In the paragraph above, JKH is referring to “deployment” and “use of funds” and, as such, ought to be talking about gross savings. Then, in the subsequent paragraph, he states the following:

In summary, the consolidated private sector account obscures, not only the view of saving as it materializes within a given accounting period in bifurcated fashion across household and corporate sectors separately, but also the view of total private sector saving as it is projected fully into the household balance sheet, when captured as a cumulative measure over a sequence of such accounting periods.

In the paragraph above, JKH should really be talking about net saving given that, after all, it is net savings that could be seen as “being projected fully into the household balance sheet, when captured as a cumulative measure over a sequence of such accounting periods”.  On this point, we think that JKH has unfortunately erred in his flow-stock reconciliation.  Flow is about the deployment (i.e., use of funds) of gross saving, as mentioned above. Stock is about cumulative net saving, as capital consumption allowance (depreciation) is netted out from both the asset side and the equity side when reconciling the flow to a balance sheet.  As you can see from the chart below showing corporate gross saving, net saving and net lending, from an empirical standpoint, this is not a minor point. Indeed, using Canada as an example, there is a very significant difference between the level of corporate gross saving and net saving in the national accounts (click on chart to expand).

Source: Statistics Canada and authors' calculations

Granted, the difference between gross saving and net saving will vary greatly between industries. For instance, in the service industry such as banking, the difference could be relatively small, but in capital intensive industries such as car manufacturing or oil and gas extraction, the difference could be very substantial.

Similarly, JKH repeats this error in his paper by again not specifying whether he refers to net saving or gross saving and by confusing the act of deployment of gross saving with net saving:

In summary, saving is a subset of income. It is a flow, not a stock. It is the residual of after-tax spending on consumption. (In the case of corporations, it is undistributed profit after the payment of all expenses including taxes and depreciation.) Saving is not the actual deployment of funds into asset acquisitions or liability reductions. Those events are defined subsequent to the fact of saving.

In the above paragraph, JKH is referring to the deployment of gross saving (i.e. use of funds) while also referring to “net saving” when he writes that, for a corporation, saving “is undistributed profit after the payment of all expenses including taxes and depreciation”.

Concluding remark 

Is JKH aware of the conceptual shortcuts he has employed when talking about the term “saving”? He is. At least one of the authors of this post has had exchanges with him on blogs about this issue and he has always been gracious and meticulous in his responses. So we are not about to claim that JKH does not know how to do proper stock-flow reconciliation.

Did JKH simplify his savings terminology so that his message about saving versus net lending is easier to assimilate for a general audience? We would say yes. And herein lies the paradox of academic expression. As a general case, we should always strive to be as precise as possible in terms of terminology or expression. But the necessity to get your message across to a general audience is bound to collide with our utopian goal to be perfectly and academically precise in the use of words.

So, in conclusion, we would argue that in trying to convince us that “saving” is different from net lending for the private domestic sector, JKH ended up using arguments that could be viewed as counter-productive in that they blurred the distinction between gross saving as it is deployed (use of funds) and recorded on a cash flow statement, and net saving as it is accumulated (as a stock) and recorded on a balance sheet.

Alexander Field on crowding out and the role of public investment

In this new interview by the Institute for New Economic Thinking (INET), economist Alexander Field explains the role that public investment has in improving the productivity of the private sector during periods of slow economic growth. I thought it would make for a good follow-up to my previous post on the topic of crowding out.

On the issue of whether public expenditures resulted in the crowding out of private spending during the Great Depression, Field argues that:

"There's a clear and compelling argument about crowding out. It's really only relevant either from a theoretical or practical standpoint if the economy is close to potential or natural output. But then, as now, we were not close to full employment so there's no real problem in terms of monetizing government deficits.  It's not going to create an inflationary problem and it's not going to push up real interest rates"

You can find the rest of the interviews in this series on the INET website here.  Also, I previously discussed the productivity-enhancing properties of public investment here and here.