Saving Part 2

Remember Bob, the saver in Orderlyland who caused the economy to slow down?  Let’s suppose he moves to Dynamicland, excited by the prospect of the new goods being developed.  Like Orderlyland, Dynamicland’s money supply is all cash so the only way for Bob to save is to store his cash in a shoebox under his bed.

In Orderlyland, the national monetary savings had to be zero because there’s a fixed money supply – if one person ends the year with more money, someone else must have less.  The only way the nation could save was through an increase in stocks of unsold goods, which was actually caused through the paradox of thrift when Bob started to save.  In Dynamicland this doesn’t apply because the money supply does increase.  So in fact, someone somewhere has to end the year with more money than they started because there’s more money in circulation – it isn’t simply balanced by someone else dissaving.

While this is true, the only reason that extra money is worth something is because of the increase in productivity of the economy.  If this increase had not taken place the increase in the money supply would simply have caused inflation, so in terms of the ability to buy real goods no-one would be any better off.

When you think about it, the wealth of the nation has increased because of increases in productivity:  some people can end the year with greater wealth without this being at the expense of someone ending the year with less wealth.  The nation’s fixed capital at the end of the year is capable of producing a greater volume of goods for the same input than was possible at the start of the year, and there will also be greater stocks of inventory to match the increasing throughput of production.  It is this stock of unconsumed goods (both inventory and fixed capital) that represents the country’s national saving.  Without it, any increase in monetary savings is cancelled out by rising prices.

Saving is defined as the difference between disposable income and expenditure on consumption.  (I did say this in the first post on saving, but I don’t blame you if that didn’t stick in your head!)  So you don’t actually measure saving over a year by looking at the difference in value of people’s savings at the start and end of the year, you look at the difference between disposable income and consumption expenditure.  But because fixed capital is not “consumed” in the production process (see the post on investment if you’re not clear on this), investment expenditure is not expenditure on consumption.  Similarly, an increase in inventory is, by definition, an increase in goods that have not yet been consumed.  These “unconsumed” goods represent national saving.

Does this greater capacity for saving in Dynamicland mean that Bob can save without causing the paradox of thrift?  Afraid not.  The Government is increasing the money supply to keep pace with increasing productivity, and needs that money to keep circulating in the economy.  By saving, Bob is pulling that money out of circulation again.  It has exactly the same effect is if he was burning the cash, rather than storing it!

So in this model, national saving is only possible because the productivity of the economy is increasing.  Individual saving does not contribute to national saving, it slows the economy down through the paradox of thrift and leads to dissaving elsewhere.  We need to keep these 2 concepts clearly in focus, and see what happens in the coming weeks as we add banking and then financial assets into the model.  Before we do that, I just want to make a comment next week on the unrealistic nature of the Dynamicland model.

(Look, I know I’m taking this slowly, but I do think it’s going to pay off if you are really clear on these concepts when we get into the detail of how the economy actually works.)

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