This is an oldie but a goodie. William Vickrey was a Canadian economist and Nobel Laureate. He was well known for being critical of most things out of the Chicago School of Economics. This piece on 15 economic fallacies has been largely ignored, but the lessons are important and certainly as relevant today as they were in 1996 when Vickrey wrote them. Here are three of my favorites:
Myth 1 – Government deficits are inherently bad and burden our children.
“Deficits are considered to represent sinful profligate spending at the expense of future generations who will be left with a smaller endowment of invested capital. This fallacy seems to stem from a false analogy to borrowing by individuals.
Current reality is almost the exact opposite. Deficits add to the net disposable income of individuals, to the extent that government disbursements that constitute income to recipients exceed that abstracted from disposable income in taxes, fees, and other charges. This added purchasing power, when spent, provides markets for private production, inducing producers to invest in additional plant capacity, which will form part of the real heritage left to the future. “
As I often note, deficit spending adds to the private sector’s net financial assets. Now, this doesn’t necessarily mean that government spending is always good or efficient, but Vickrey clearly understood double entry bookkeeping. He understood that a government’s balance sheet was not like a household’s balance sheet and so we shouldn’t be so quick to jump to conclusions about the damage of government spending. Just as all private spending isn’t necessarily good, all public spending isn’t necessarily bad.
Myth 2 – In order to improve the health of the economy we must all save more so we can spend and invest.
“Urging or providing incentives for individuals to try to save more is said to stimulate investment and economic growth. This seems to derive from an assumption of an unchanged aggregate output so that what is not used for consumption will necessarily and automatically be devoted to capital formation.
Again, actually the exact reverse is true. In a money economy, for most individuals a decision to try to save more means a decision to spend less; less spending by a saver means less income and less saving for the vendors and producers, and aggregate saving is not increased, but diminished as vendors in turn reduce their purchases, national income is reduced and with it national saving. A given individual may indeed succeed in increasing his own saving, but only at the expense of reducing the income and saving of others by even more.”
This is a point I really hammer on in my book because it’s so common and so destructive. We often hear this fallacy of composition about saving more and how more saving means you can spend more later. Of course, if you save more of your income then someone else earns less income. In the aggregate this means that output will fall. Saving doesn’t lead to more future consumption. In fact, it is investment that adds to total aggregate saving.
Myth 3 – Inflation is always a bad thing.
“Inflation is called the “cruelest tax.” The perception seems to be that if only prices would stop rising, one’s income would go further, disregarding the consequences for income.
Current reality: The tax element in anticipated inflation in terms of gain to the government and loss to the holders of currency and government securities, is limited to the reduction in the value in real terms of non-interest-bearing currency, (equivalent to the increase in the interest rate saving on the no-interest loan, as compared to what it would have been with no inflation), plus the gain from the increment of inflation over what was anticipated at the time the interest rate on the outstanding debt was established. On the other hand, a reduction in the rate of inflation below that previously anticipated would result in a windfall subsidy to holders of long-term government debt and a corresponding increase in the real impact of the debt on the fisc.”
In a fiat monetary system with endogenous money the money supply is just about always expanding. That is, we are constantly creating money via bank loans or other sources in order to meet our economic goals. When used productively, this increase in the money supply does not hurt our living standards. In fact, so long as our incomes keep up with the rate of inflation then we are likely to be better off even with some inflation because we not only have a higher income, but we have the productive resources we created from using the newly created money. Inflation does not represent our standard of living. You must keep things in the right context.
Read all the myths here.
H/T Lars Syll
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.
Great find Cullen.
Can you tell me if my line of thinking here is a fallacy (I will call my potential fallacy “monetary crowding out in fiat system”). If we look at the monetary interest paid on debt as a percentage of GDP, we see that the total interest paid on debt is recent lows (currently at 15%). Monetary interest peaked in 80s at 30% (the series doesn’t starts at that point). The drop in monetary interest fell to 15% largely because interest rates have fallen since the 80s. And this drop in in monetary interest occurred even though the aggregate debt levels as a percentage of GDP have risen. (TCMDO/GDP).
Obviously when interest rates rise, this “steals” away from corporations future profits or from consumers disposable income. This situation is probably not a problem for a long while if rates are low (below the 4% range). But because TCMDO (total credit) increases as at faster rate then GDP, isn’t here a potential for “crowding out” by monetary interest stealing more and more of future production as rates and total debt rises?
BTW. One positive note with the consumer since the 2007 boom is that despite poor “real wage growth” they do have more “real” disposable income.
That FRED graphic should show how much as a percentage of personal income the consumer has available to consume/spend after debt servicing interest costs, after tax outlays and after CPI changes. I’d argue in this regard the consumer has it “good” in this one regard either by fluke or design by the Fed and government.
Interest is just another form of income. If interest rates rise substantially then someone is earning a high income from this and someone is paying a higher fee for holding money. This doesn’t necessarily “crowd out” anything, but I guess it could if it causes undue pressure on any particular sector (like the household sector when housing prices began to decline in 2006).
I guess I am having a problem with Myth #2.
The degree to which you save vs discretionary spend has to be meaningfully tied to the comfort of your debt level.
If you are in deleveraging mode due to your mortgage situation, that had better take a very high priority (nondiscretionary spending comes first).
If you are in a comfort zone with your debt, then you had better address saving to be able to retire when you want to and how you want to. Here discretionary spending might be on par with savings or at a lower priority.
When both debt and savings are met, then sure discretionary spending can improve.
Also, and by the same token however, you must realize that prior to 2008 (from about 2000 on) spending by the HH sector was essentially debt-fueled based on the wealth effect of the typically largest asset in the HH sector – the house. That wasn’t sustainable. And so therefore, neither should production levels during that period be viewed in any meaningful as representing some sort of baseline.
The demand needs to be “right-sized” in order to reflect spending that isn’t fueled by debt in a sector that is mired in debt in this phase of the financial cycle.
This is a bit of a confusing point for most people. I explain it thoroughly in my book, but here’s the short version:
Saving is your unspent income. If you save more of your income in the current period then that means someone else is earning less income. Therefore, in the aggregate, your saving does not create MORE aggregate saving.
People often think that saving means we can invest more later. But if you save more then that obviously means that someone has less income to spend.
If you spend all of your income on current consumption (and so does everyone else) then you’re just consuming your income and not saving. Your spending is my income so this too doesn’t add to aggregate saving.
On the other hand, if you invest your income then you add to aggregate saving. Investment is spending, not consumed, for future production. So, if I build a factory then I haven’t dissaved because once my investment is done I still have a factory worth the same amount as my prior saving. But someone was the recipient of my spending which added to their income. Thus, in the aggregate, investment leads to more saving.
In sum, saving more doesn’t lead to more aggregate saving. In fact, it probably hurts the economy (all else being equal). So it’s actually investment which leads to saving.
The A2061C1 series is probably not what you want to use and neither is TCMDO because both are gross measures, not net measures. For this reason, it is not uncommon to remove financial sector debt from total debt because much of it represents double counting. Probably a more useful measure is the household debt service/disposable income: https://research.stlouisfed.org/fred2/series/TDSP
Thanks for posting this Cullen. Fallacy #2 reminded me of an op-ed piece in the WSJ a couple of weeks ago that touted a new kind of retirement account, inspired by something Canada implemented not that long ago. The “expert” writers were confident that more savings in such accounts would stimulate economic growth.
Apart from growing the number of “investment” accounts at banks, mutual fund companies, and brokerage firms, I couldn’t see just how those savings accounts would stimulate any real investment.
I like the simple explanation on Fallacy 8. (I’ve expressed a similar concern to you in the past.) My guess is that Warren Mosler would mostly agree with Vickery on this issue.
Lot’s of good stuff in the piece. Fallacy #15 is particularly interesting in light of the major focus on unemployment, under-employment, low labor participation rates, calls for minimum wage increases, outsourcing criticisms, etc.
Investment is really productivity not consumed for future production. For people this “spending” is often time, as in if you spend your time learning about economics to increase your future production. Economists like to put this in terms of spending, as in by spending time learning about economics you are decreasing your current income, i.e. you are spending the lost income.
In parts of today’s economy this is very hard to estimate. Take for instance the use and development of software. Company A provides training to use complex software XYZ. This is an easy to calculate cost CT. Company B tells it’s employees they need to learn XYZ on their own away from work. EAch company sees the same increased future production as a result Pf, e.g. PfA, PfB. The measurable cost is CT. But the real investment is 2*CT.
As more of the economy is intellectually based (including services) it gets harder to estimate the real investment. Sure, people spend on education, but much of the real value comes from individual effort. A partial example are iPhone App development skills. Perhaps a majority of iOS programmers learned much of their skills by investing their time while not being paid to learn these skills.
It seems that deficits are financed by a windfall, falling from no-where. If paid with hard powered money, the disposable income will discount the inflationary erosion, and if paid with taxes, capital and consumption will be negatively affected by interest payment generated from debt financing. And since time is not free of charge, deficit financing no matter if it is debt or money, the negative wealth effect is obvious.
I think we have just talked past ourselves just a bit.
The problem that I am having with Myth #2 is that it paints a bad picture of savers.
It is not so much that I disagree with the premise. I actually do agree that, in aggregate, production would have to reduce in the face of a significant savings move by a large segment of the population. Companies would have to reduce investment thus reducing savings of participants involved in that planned investment. They would have to downsize to meet reduced demand leading to even more reductions in savings by those impacted and so on.
In fact we could take the argument even further and it sure is germane here.
Instead of saving, suppose those funds were redirected to deleveraging? It would have exactly the same effect on aggregate production & saving, no?
But the fact of the matter is, whatever the level of aggregate production is, it must be ‘right-sized’ to reflect a component of debt reduction (and the HH sector could sure use some of that), allocations towards savings as well as non-debt-fueled discretionary spending.
There has to be a balance that is struck here.
Saving is not evil.
Is that more clear? Or are the waters muddied even further?
No, productivity is just a measure of production efficiency. Investment is the act of spending for future production. Productivity has nothing to do with it. The measure of production’s efficiency has nothing to with the act of investing in the context of my comment. But since you learned the definition of productivity yesterday I wouldn’t expect you to know this. But it doesn’t stop you from trying to correct my work….
Most of this is well thought out, but I find a huge problem with #11 in which he says :”A far more effective measure would be to reduce or eliminate the corporate income tax”. If corporations paid no income tax it would lead to even further distortions of how people are compensated. The huge cost of our health care system is certainly partially the result of allowing deductibility (zero tax) on group employee health care premiums paid by the corporation. If you make the corporate tax zero, then far more things which benefit the employee will become corporate expenses unless the IRS guidelines in Pub 15-B go to zero fringe benefit exclusions.
During the 1930’s net interest was about 5% of GDP. Thru the decade of the 1940’s net interest fell rapidly to about 1.3 % of GDP in 1949. During the 1950’s and 1960’s net interest as a share of GDP increased to 4.5% in 1969. In the 1970’s it increased rapidly to about 7.8% of GDP in 1979 due to increasing interest rates. During the 1980’s net interest share of GDP continued to increase due to continued high interest rate of end the decade at 10.4%. In the 1990’s and 2000’s the share of GDP paid as net interest gradually fell to 3.8% in 2009. Since 2009 net interest has continued to fall (due to very low interest rates) and now stands at 2.7% of GDP. Interest rates would have to go up a whole lot to get us back to where we were in 1969.
myth #1 i’m still waiting for some of that disposable income to trickle down to me.
myth #2 didn’t we just have a recession caused by high debt?
myth #3 even if we believe in government stats, and accept the post 1990 inflation calculation methods as valid, wages are still not keeping up with inflation.
As far as I can tell ALL “Savings” are deposited into some form of financial instrument which has some risk based rate of return. There is no difference between “Saving” and “Investment”.
Cullen, it will never be possible to agree on these things because I don’t live in the artificial world of finance and you don’t understand basic Physics and Mathematics. Productivity is a noun which, according to my Oxford American Dictionary: Productivity (noun); The state or quality of producing something,
Interestingly, something can’t be both a state variable (a measure of a quantity; temperature, pressure, mass) and a measure of a quality (a measure of a process which is the instantaneous ratio of the flows, described by differential equations, over the state variables).
Even in the second version, productivity is just the instantaneous ratio of the time rate of change (dV/dt) of a somewhat arbitrary sum over all the coupled differential equations which describe a process. Let’s call this productivity. By itself, this is never a measure of “production efficiency”. It can only be a measure relative to other processes with at least the same output state variables.
Productivity in common economic usage is clearly dV/dt, and this should be clear from the common usage “productivity increased x% last year”.
So the differential equation for investment is productivity (dV/dt) minus the consumption rate (dC/dt) as I used it. You seem to be taking issue with centuries of standard mathematics. Or perhaps you just don’t understand differential equations.
This has nothing to do with MY understanding of physics and math. You’ve used BASIC economic terms incorrectly in multiple comments now. The fact that you’re now here redefining commonly used economic terms in mathematical terms is a joke. You intended to use the term production, but you used the term productivity, which is a measure of the quality of production. You didn’t understand this at first and now you’re backtracking.
You are making a mockery of basic economics. It would be like my saying that multiplication is splitting something into equal parts. You don’t even understand the most basic terms yet you come here on a daily basis insulting people and claiming to know so much when anyone who understands economics can see that your level of understanding is less than sub-par. Sorry to break it to you, but your use of big words and all that is not impressive when you can’t even get the basic economics right.
I get it. This is a hobby of yours. If I went on your website and started pretending to tell you how math and physics works then you’d probably laugh also. But the difference between me and you is that I am not arrogant enough to think that I know more about math and physics than someone who has studied it their whole life. But you come here on a daily basis to make a fool of yourself without knowing it….All the while insulting people’s intelligence and showing that, in addition to not knowing half as much as you think, that you’re just downright rude. Just stop.
PS – Using the Oxford dictionary to look up economic tersm is just one more telltale sign that you don’t know where to look for the right answers….
The “increase” of X% over last year strictly speaking is not productivity. The X% over last year increase would be the slope of productivity which you define as dV/dt.
But if you restate GDP in terms of investment and then simply the first differential using your definition of productivity based on I-C, you will end up with
dV/dt = dGDP/dt – dG/dt- dNX/dt
That is, the year over year change in productivity would be the year over year change in GDP minus the year over year change in government spending minus the year over year change in net export. ??? Taking this to the extreme, if a country imported everything and exported nothing and if the government ran a deep surplus the country would be improving productivity even with a negative GDP.
Not close and no cigar. Employee fringe benefits paid by a corporations are a cost to the corporation (just like salary and wages) and are included in the “cost of goods sold” category of the corporation income statement. Subtract cost of goods sold from sales gets you gross income. And subtract other expenses such as R&D and interest get you to pretax income. So fringe benefits will always be “tax deducible” in the sense the corporation will not pay any income tax on the employee benefits it pays for even if the rate is reduced to !%. IRS Pub 15-B provides guidelines to which employee fringe benefits should be reported to the IRS as additional income to the employees. In other words all employee fringe benefits paid by the corporation (or any business for that matter) are not subject income tax but some benefits may have to be reported as additional income paid to the employees (in addition to salary and wages) and subject to personal personal income tax.
Have you heard the stone soup story?
Sometimes people could cooperate to make a wonderful satisfying soup they can share, but they don’t because they are busy hoarding the makings. When that happens something that is not itself productive can persuade them to cooperate.
Other times they are satiated and want to hoard their resources to use later. When that’s true the stone soup does not get made.
It isn’t all one way. We might find a better way to get people to cooperate than deficit government spending, but we haven’t found it. We also haven’t found a way to get politicians to do the *right amount* of deficit spending. They are likely at any time to do too much or too little.
Put it this way — mostly, we think we create wealth by working hard and producing stuff. We can divide the wealth into two kinds — there’s stuff we make so we can have it, because we want it. And then there’s stuff we make so we can use it to make stuff we want.
When you have money, you can use it to get other people to make stuff for you. You get to choose what.
Saving means you get less stuff you want now, hoping that you can instead get stuff later. One way to do that is to hoard stuff. Like, you buy a lot of MREs you can eat any time and store them in your basement, instead of buying filet mignon and eatin it now. But if you wait too many years to eat your MREs they won’t taste as good.
Another way is you don’t spend your money but wait, hoping it will still be worth something when you want to spend it. You are using your choice to tell people not to make stuff now, but later you’ll want them to make stuff for you. Don’t make wealth now, make it later.
But other people might spend money to consume or invest, in your place. If they do then it doesn’t hurt anything much that you told people you don’t want them to create wealth and get a share of it now, you want them to owe you now and later you’ll let them create wealth and pay off their debt.
In the Depression we had lots of resources to exploit and lots of people who could create wealth, but we couldn’t get it organized to do that. In WWII we created lots and lots of bombs while people didn’t consume much — but they were paid and they put their money into war bonds that represented their right to consume later.
Investment doesn’t *have* to be driven by consumption now. But when it is, limits on what people are willing to consume will limit investment too.
“This added purchasing power, when spent, provides markets for private production, inducing producers to invest in additional plant capacity,” –
Let us know when that power reaches its full potential for us consumers, pretty sure even with being in the top 10% of earners, I still watch every penny – carrying zero debt. Savings? LoL losing 2% YoY is great!
because wages haven’t kept up (and really haven’t for a long time now) is why all of us think if just inflation would stop.
problem is with no inflation there will be no increase in incomes (of course this doesnt apply the 1%. even in the midst of a depression they still had increases. the rest of us? not so much)
the high debt was a problem because it was being used to offset low wages. and when the 99% discovered that, they came to screeching halt on any spending. along with wall street and banksters they found out you could loan money on houses based on if debtor could breath
well if you save in a ‘savings’ account, if the financial institution isnt doing loans, then its not doing ,much investment in any thing. and if ever body is saving and nobody is buying, then other than interest, there is really no investment is there
and basically we just went through another depression. and just about every one went into full on savings mode. all at the same time. which meant as you noted companies did it too. which lead to even less spending. leading to job loss.
What kind of financial institution takes in “Savings” deposits, pays interest to the depositor and doesn’t do anything with the money? Banks, credit unions, brokerage firms, which take in deposits turn right around, aggregates those deposits, and lend them out several times over (consistent with reserve requirements) at higher interest rate to credit worthy borrowers who then spend that money on goods and services to start, expand or maintain an enterprise or life style. The “Savings” don’t sit inert in some bank vault. Money never stops moving. All “Savings” are invested by someone. The original depositor has invested in a financial instrument which pays a (low) rate of return because it’s very low risk.
#3: Not only is it always expanding, but exponentially so. Most of the MMs (at least one of which hales from Chicago, and almost all of which are Friedman fans) don’t have a problem with inflation per se… and in fact are frustrated by their fellow monetarists who seem to focus this. Nick Rowe thinks it’s all about the marketing though… even though MMs and Keynesians are mostly on the same page on this, he thinks the MM’s can have a better marketing campaign:
one who doesnt have one that wants the money? if consumers stop consuming that removes consumers from potential customers. and it also removes business since they no longer need to invest in their business now do they? since no business will actually do much if any thing if nobody is buying what they sell now will they?
Productivity is a noun which, according to my Oxford American
Dictionary: Productivity (noun); The state or quality of producing
You are trying to communicate with somebody who has a specialized vocabulary. When you use his words with other meanings, he will not understand.
It might be better to find new words for what you mean, words that are not already in use in his field.
If you can get past the word problems, maybe what you’re saying will make more sense to him. If he understands what you say and he likes it, he can translate it into terms other people in his field will understand.
But in the short run all this antagonism is not very productive.
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