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Revisiting S = I + (S-I)

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Hi Cullen. This is an “old” topic and you have covered it well. It’s the S = I + (S-I) discussion. While I think I understand it, there still seems to be much confusion on the subject and I want to make sure I am not one of the confused. When I discuss it with others and try to keep it simple, I worry that I am making it too simple and thus overlooking something. I say (S-I) is financial savings which equals the government deficit. I is real (often physical) savings created by investment. The latter usually dwarfs the former and, more importantly, it is the primary source of innovation, productivity and our standard of living. That is, since there is both a buyer and a seller in an “investment” transaction, such a transaction is financially neutral. But this saving is real and tangible. In the end, we live in the “real” world, so to speak. Is this depiction of I (Investment) reasonable? Thanks much for any help.

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Posted by Charles DuBois
Posted on 04/10/2017 9:39 PM
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You’re not exactly right here. First off, dump the G. Government spending is either government consumption or government investment. So define C=C_p+C_g and I=I_p+I_g.

Then, Y=C+I+NX=C+S which implies NX=S-I. S=I+(S-I)=I+NX. It means the savings of an economy is equal to the investment plus the current account balance. That’s it.

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Posted by Suvy Boyina
Answered on 04/10/2017 10:17 PM
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    Thanks much for the quick response and for adding in the impact of the external sector – which I overlooked. However, unless there is a balanced budget, wouldn’t the government sector play a role as well? That is, to extend your conclusion, “the saving of an economy is equal to the investment plus the current account balancer plus the government deficit”. The investment part is “real” while the current account and government deficit part of private savings is financial. Or at least that is my understanding. Thanks.

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    Posted by Charles DuBois
    Answered on 04/11/2017 10:31 AM
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      The thing that sparked this was the way MMT advocates would say that private sector savings equalled the government deficit. MMTers often said that the private sector could not “net save” without a govt deficit. This is true only in a very narrow and silly sense of things.

      Obviously, most of our savings is made up of financial and non-financial claims against ourselves within the private sector. If I create a factory that makes widgets then I might finance that physical asset with financial assets. These claims will balance in the sense that assets minus liabilities equal net worth. In the private sector the most important value there is the market value of our assets minus liabilities. In other words, we want our claims to have a net positive position WITHIN the private sector. This means our assets are more valuable than our liabilities. We don’t need a deficit to achieve this. All we need is productive people and companies.

      The point of the S=I discussion is that Investment is what creates this private surplus of net worth. It is ultimately the backbone of the entire economy. Without it the private sector is nothing no matter how much the govt spends. In fact, I’d argue that in most cases, a deficit without significant private sector I is a perfect recipe for high inflation and even hyper.

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      Cullen Roche Posted by Cullen Roche
      Answered on 04/11/2017 12:27 PM
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        Thanks, Cullen. Yes, of course, investment is the key to innovation, productivity and our standard of living. I was just trying to verify that government deficits add to financial savings while investment adds to real savings. That is, if an investment in a “machine” is made, the buyer has a reduction in financial assets – the seller has an increase in financial assets. So no change in financial assets. But the economy is one “machne” richer.
        So the saving creating by this investment is “real” not financial. And it is the real which counts the most. That’s all I was trying to verify. I read about this subject and usually this distinction is not made – which results in muddled thinking IMO. I just wanted to make sure my thinking was not muddled or missing something. Thanks.

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        Posted by Charles DuBois
        Answered on 04/11/2017 1:16 PM
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          There’s no real difference except in the way the new financial assets are created. The private sector does most of its net borrowing in the process of creating new things. Mostly houses. So, when the private sector borrows and creates new financial assets in the process we’re creating a real asset (like houses) and financial assets. Even the basic process of building a new home is incredibly productive since so much technology and new production goes into a home. Over time the market value of home tends to increase so this is a big piece of private sector net worth. So, even in financial terms the production of something like a house tends to add to both financial and non-financial net worth.

          The govt doesn’t always spend to produce productive output. In fact, a lot of govt spending is necessarily unproductive. Building bombs for instance is a rather unproductive form of output except in intangible terms (like domestic safety, which I am not downplaying, but rather pointing out is not necessarily productive). The govt does a huge amount of productive spending on things and the US govt in particular has contributed some amazing innovations over time, but as a base case it’s pretty safe to say that govts don’t generally spend in a productive manner. The private sector tends to spend in a productive manner and the govt facilitates the stability of this productivitity by certain things like protecting the country and responding in a countercyclical manner to private sector excesses.

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          Cullen Roche Posted by Cullen Roche
          Answered on 04/11/2017 1:23 PM
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            Well, if government deficits are an investment since it is income that is not consumed (savings), then such is not typically going to increase productivity since such output is typically very overpriced or destructive. I think you just need to look at Japan to see what happens when deficits are higher than real productivity. Since they don’t have a military, it’s interesting to ponder what would have happened with all that “free money” if they did.

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            Posted by MachineGhost
            Answered on 04/11/2017 11:24 PM
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              Cullen thanks much. That was very helpful clarification. As you point out, investment does not only increase “real” saving but also,over time, it can directly or indirectly, increase financial wealth.

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              Posted by Charles DuBois
              Answered on 04/13/2017 9:50 AM
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