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Private Sector Saving is Not Saving Net of Investment

I’m highly sympathetic to Post-Keynesian economic perspectives. Post Keynesians generally prefer to work from an operational perspective so there is a strong influence on how the economy works at an operational level which includes a fairly thorough understanding of stock flow consistent accounting.  As I like to say, accounting is the language of economics so it’s pretty important to get the accounting right if you’re going to understand how the monetary system and the economy operate.

Anyhow, David Graeber had a popular video and op-ed in The Guardian the other day in which he appears to be using a line of thinking that is often commingled with Post-Keynesian Economics – Modern Monetary Theory (MMT).  Unfortunately, David made several errors in his video because he was using these MMT based misunderstandings (MMT responded to this, but made the same errors they always do).

MMTers have been harshly criticized (primarily by Post-Keynesians here, here and here for instance) for these errors and it continues to generate a good deal of confusion. The Graeber video generated a discussion on Twitter and here so let’s see if we can’t clarify some things.

In the video Graeber makes a series of bold statements about “accounting identities” and “simple math” when he refers to the government’s deficit.  He concludes saying:

“If the government balances its books it makes it almost impossible for you to balance your books”

This statement is wrong and misleading.  And David’s error stems from something we see in MMT on a consistent basis where they depict the economy through a 2 or 3 sector lens.  The cause of this error is the result of MMT’s alternative definition of “net saving”.  Now, in economics 101 net saving is consistent with the way the OECD defines it:

“Net saving is net disposable income less final consumption expenditure.”¹

MMT consistently uses the term in a different manner, however.  They take the 3 sector model of the economy (as seen in the Graeber video) and simplify it.  Not to get too wonky, but here’s how they get there:

GDP = C + I + G + (X – M)

Where C = consumption, I = investment, G = government spending, X = exports & M = imports

Or stated differently;

GDP = C + S + T
Where C = consumption, S = saving, T = taxes

From there we can conclude:

C + S + T = GDP = C+ I + G + (X – M)

If rearranged we can see that these sectors must net to zero:

(I – S) + (G – T) + (X – M) = 0

If we rearrange the above sectoral balances equation we can arrive at a very important identity:

(S – I) = (G – T) + (X – M)

If you assume a closed economy you could say:

(S – I) = (G – T)

This is precisely what Graeber does in his video.  And the conclusion is simple – private sector net saving (S-I) is a function of the size of the government’s deficit which leads one to think that the private sector cannot save unless the government is in deficit. Except that (S-I) is not “net saving” in any traditional economic perspective.  (S-I) is saving net of investment. It’s extremely misleading to define private sector “net saving” as (S-I) because Saving cannot identically equal (S-I) unless I is equal to zero.  Given that investment is the most important piece of Keynesian economics and the economy, it’s preposterous to present the economy in this manner because investment adds to private sector saving.

This error is common across MMT literature and is the result of the narrow manner in which they depict the government’s deficit. They explicitly write in academic literature that this two sector view is why the “government sector must be in deficit”. It’s one thing to say that government deficits can be beneficial or good. It’s an entirely different thing to argue that the government must be in deficit because of an accounting tautology that misconstrues the way in which the private sector net saves.

To be clear about this, the private sector’s saving (and savings) does not come primarily from the size of the government’s deficit. In fact, there is absolutely no need for the government to be in deficit if the private sector desires to net save. This is because the private sector’s saving comes mostly from INTRA-SECTOR claims with the household sector being the central net saver of significance relative to other entities. What matters most for economic health is not the derivation of public vs private sector, but the household sector versus government, foreign non-corporate and corporate sectors. By distilling households, non-corporations and corporations into one sector MMT creates a misleadingly narrow perspective of the macroeconomy and the many ways in which households net save versus other entities within the private sector.

For instance, pull up the Fed’s Flow of Funds report.  You’ll notice that households have a large financial and non-financial asset claim against other sectors (primarily the corporate sector).  The fact that the financial asset claims net to zero inside the private sector is meaningless.  It’s like saying that balance sheets balance (well, duh).  The key point is, private sector net saving is comprised of a huge component of non-financial assets (like houses) as well as financial claims against the corporate sector (as well as other sectors).  These assets only net to zero if you ignore non-financial assets (pretty sure no one ignores non-financial assets like houses after the housing crisis) or view shareholder’s equity as being a net negative for the economy (which is utterly ridiculous given that shareholder’s equity reflects the strength and quality of the private sector’s output).  After all, if I walked into a bank for a loan the bank wouldn’t turn me away saying “sorry pal, but your assets are netted against a corporation so we can’t make a new loan to you”.  That’s just not how the economy works in any realistic sense.

The MMT definition of “net saving” gives the reader an unbalanced and unrealistic understanding of private sector saving.  To be blunt, it is a useless definition and it should not be used.  But MMT does not care about that.  MMT wants to emphasize the importance of the budget deficit at all times. They want you to think that the private sector cannot flourish unless the government is constantly feeding it and supporting it with what they call “net financial assets”.  As if it is impossible for the private sector to be stable without a large and sustained budget deficit.  Yes, that theory works great except in the case of every hyperinflation or socialist run regime where these “net financial assets” significantly contribute to private sector instability.

In addition to assuming that a small budget deficit or surplus is necessarily bad, this ill-defined term leads to even larger errors.  For instance, it leads the reader to believe that Monetary Policy is ineffective because it cannot impact the “net saving” (as defined by MMT) of the private sector through their lens.  But this is completely wrong.  If you use the Fed Flow of Funds report and a traditional definition of net saving then it becomes clear that Fed policy, interest rate changes and QE can have substantial impacts on the valuation of private sector net saving.  As I’ve stated before, QE1 was essentially a form of fiscal policy because it increased the valuations of private sector financial assets by bolstering the financial system.  But if you defined “net saving” as (S-I) you would never see it that way.

Further, this leads one to believe that a small budget deficit or budget surplus leads to unemployment.  As MMTers say:

Involuntary unemployment is evidence that the desired H(nfa) of the private sector exceeds the actual H(nfa) allowed by government fiscal policy.”²

This is totally wrong.  As Keynes taught us long ago, involuntary unemployment is the result of a lack of private investment.  But since MMT nets out investment in their preferred definition of “net saving” they conclude that it’s the lack of government issued NFA that leads to unemployment.  So, a muddled mess of ill-defined terms leads to erroneous understandings and inappropriate conclusions about how the economy operates!

This only scratches the surface on the errors there.  There’s much more detail in the aforementioned critiques.  But the problem is clear – MMT has created its own alternative reality and set of definitions that mislead and misunderstand the monetary system.  There are parts of MMT that are very good (mostly the parts that are consistent with Post-Keynesian Econ), but many of these “newer” “understandings” are just muddled misunderstandings based on ill-defined terms.  Yes, they’re “correct” when viewed through the context of the MMT world, but the point is that the MMT world does not reflect reality and because of this it leads to conclusions like the one we saw in the Graeber video which are demonstrably false.


¹ – United Nations Statistics Division

² – A Critique of MMT