Monday, 28 September 2015

Amazing discovery by Ann Pettifor.

The amazing discovery is that apparently we don’t need to save in order to make investments. Isn't that great? The UK can spend £30bn on the proposed HS2 rail project, plus the country can have oodles of new hospitals, motorways, houses etc, and according to Ann Pettifor no one needs to save or sacrifice consumption in order to do all that. I.e. no one needs to consume less beer, fuel for the car, etc.

Instant riches!!! Why Ann Pettifor hasn’t got a Nobel Prize for this discovery, I’ve no idea. Or rather I do have an idea: it’s all hogwash.

Her article (about 1,600 words and entitled "Savings and the Alchemy of Credit") comes in glossy brochure format, compete with lots of pictures of Ann Pettifor – one of them occupying the whole of one side of an A4 sheet (or whatever size the brochure is).

No doubt that’s partly vanity and self-promotion, but it’s actually a smart move on her part. Reason is that 90% of the human race are too dumb to read small print and get to grips with the ideas therein: but the above 90% do react positively to a human face (in the same way as babies do).

Pettifor’s basic argument.

Anyway, her basic argument is that commercial banks can simply create money out of thin air and lend it out to those wanting to invest (which is true). Thus apparently no one needs to save in order to fund investments. Indeed she could have gone further and pointed out that central banks and governments can do the same (as made clear by Keynes in the early 1930s). That is, government can just print money and spend it. In fact “print and spend” is what the latest fad, peoples’ QE consists of.

Now if the economy is NOT AT capacity, there’s no harm in the latter sort of money creation. I.e. it’s true that banks (central or commercial) can create money which is then spent. And CONSUMPTION can stay constant, while the investing is done by using the previously idle economic resources: under-employed labour, underemployed machinery, etc. So no one has to save in order to bring about investment.

However, if the economy IS AT CAPACITY, then there’s absolutely no way of enjoying that extra spending without causing excess inflation. That is, if the economy is at capacity, every extra £X pounds of investment requires £X of saving, if excess inflation is to be avoided. Or put another way, an extra £X of investment means £X less consumption. (The only exception to that is borrowing from abroad, but getting indebted to other countries isn't a brilliant idea.)

However, Pettifor unfortunately doesn’t get the latter “capacity” point. Thus her “too good to be true” Ponzi scheme doesn’t work.

If the economy is NOT at capacity.

Moreover, even if the economy IS NOT AT capacity, it is dodgy to say that investments can be made without any corresponding saving or sacrifice of consumption. Reason is that the stimulus or money printing used to get the economy up to capacity and do the investment could as an alternative be spent on consumption.

In that sense, investment cannot be done without saving or sacrificing consumption. Or to put it in economics jargon, the “opportunity cost” of the investment is the consumption forgone.

Incidentally, it could be argued that AP might have changed her mind since producing the glossy brochure work dealt with here, particularly since it was published in 2011. However, that does not seem to be the case to judge from this very recent tweet of hers.

Do commercial banks get us out of recessions?

Another weakness in Pettifor’s argument is thus. It is perfectly true (to repeat) that if the economy is not at capacity, the fact of commercial banks lending a lot more will help cure the recession and enable some “investment without saving”.

However, there is a big flaw in that idea, namely that commercial banks just DON’T LEND out “a lot more” in a recession. Far from it: they tend to cut lending in a recession. They exacerbate recessions, or to use the jargon, banks act in a “pro-cyclical” manner.

It would seem from the experience of the 1800s that economies do eventually escape recessions of their own accord . However what actually gets us out of recessions nowadays is the counter recessionary measures taken by governments and central banks. As to commercial banks, if the economy expands by X% as a result of government implemented stimulus, then commercial banks will follow suit and lend VERY ROUGHLY X% more, which of course helps.  However, commercial bank lending is very erratic.

Thus if you’re interested in reducing unemployment and escaping recessions, then you need to concentrate on what central banks and governments do, which is exactly what about 95% of economists do concentrate on.

Coming up in a day or two.

The final item in this glossy brochure production which is asking to have the piss taken out of it is the box on the last page entitled "Action points".

It contains a number of very worthy sounding objectives, e.g. that banks should not lend for speculation. Well, nice idea. But the trouble is where exactly do you draw the line between speculative and non-speculative activity? Even buying a house is speculative: its value might rise or fall. Starting a small business is certainly speculative.

Also apparently lending should be "wise". Great idea! Why did no one think of that before?

And loans should go into "economically productive investments". Who’d er thunk it?

I’ll consider the latter weighty questions in a day or two.


  1. I think you've misinterpreted her basic argument. She is referring to the national level. See the intro "argues that while savings may make sense at the individual level, government savings are not a precondition for investment – and prosperity"

    Regarding economies AT CAPACITY, when & where was unemployment at 0%?

    If an economy does run at capacity, and a bank creates credit out of thin air (what they do) then this is also inflationary. Surely the same goes for paying interest on bank reserves? So I'm not sure what the big deal is about the government doing the same. Especially if they simultaneously compensate for it in policy.

    1. I have no problem with your claim that she’s referring to the national level, and I didn’t intend to suggest above that she was referring to anything other than the national level.

      Re “capacity”, that’s generally taken by economists to refer to the minimum feasible level of unemployment before inflation kicks in in a serious way – roughly 2% - 6%, depending on the country involved. And that’s the sense in which I use the word.

      Re your 3rd para, I’m not entirely clear what you are saying. Re your first sentence there, I agree. As to whether paying interest on reserves is inflationary assuming the economy is already at capacity, that depends on the source of money for the interest payments. If it’s entirely new money created out of thin air, then clearly the effect is inflationary. In contrast, if the money comes from tax, then there’s no net effect on state spending, so there shouldn’t be much of an inflationary effect.

      Re your final two sentences, I don’t understand.

    2. It's not my claim of what she is referring to, it's hers! I quoted her intro from p1. You state that she could " have gone further and pointed out that central banks and governments can do the same". I thought that is what she was doing. Admittedly, her article is not the clearest thing I've ever read (and that is something coming from me!).

      Re 3rd paragraph - I think the final paragraphs are confusing to you because of how I read her article. I was merely saying I don't see the big deal with a government creating money compared to a bank creating credit, or the payment of reserve interest (which I thought was created rather than paid out of taxes in the US/UK - but anyway).

      Given that banks act in a pro-cyclical manner, it makes sense to regulate their lending and compensate for the lack of same in a downturn.

      Or as Pettifor puts it "To prevent such falls in economic activity, governments should aim to counteract the impact of excessive saving, support the private sector and maintain economic activity by increasing spending during an economic downturn. But it also needs to regulate banks more effectively to prevent the reckless lending
      that was responsible for the recent financial crisis."

      I think our main disagreement is the reading of the article.

      Thanks for your response, and your wonderful blog. I enjoy pretty much everything but do wonder when you lean a little Tory ;-) Genuinely though - it's thanks to apolitical economists like yourself, Baker and Wren-Lewis that anyone can learn anything about economics. (not that I have).


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