resilience, not stability

Debunking the ‘Savings Glut’ Thesis

with 20 comments

Some excellent recent research debunking the savings glut thesis: Borio and Disyatat, Hyun-Song Shin, Thomas Palley.

The Borio-Disyatat paper is especially recommended. It explains best why the savings glut thesis itself is a product of a faulty ‘Loanable Funds’ view of money. Much more appropriate is the credit/financing view of money that Borio and Disyatat take. The best explanation of this credit view is Chapter 3 (’Credit and Capital’) in Joseph Schumpeter’s book ‘Theory of Economic Development’. As Agnès Festré notes, Hayek had a very similar theory of credit but a very different opinion as to its implications:

both Hayek and Schumpeter make use of the mechanism of forced saving in their analyses of the cyclical upswing in order to describe the real effects of credit creation. In Schumpeter’s framework, the relevant redistribution of purchasing power is from traditional producers to innovators with banks playing a crucial complementary role in meeting demand for finance by innovating firms. The dynamic process thus set into motion then leads to a new quasi-equilibrium position characterised by higher productivity and an improved utilisation of resources. For Hayek, however, forced saving is equivalent to a redistribution from consumers to investing producers as credit not backed by voluntary savings is channelled towards investment activities, in the course of which more roundabout methods of production are being implemented. In this setting, expansion does not lead to a new equilibrium position but is equivalent to a deviation from the equilibrium path, that is to an economically harmful distortion of the relative (intertemporal) price system. The eventual return to equilibrium then takes place via an inevitable economic crisis.

Schumpeter viewed this elasticity of credit as the ‘differentia specifica’ of capitalism. Although this view combined with his vision of the banker as a ‘capitalist par excellence’ may have been true in an unstabilised financial system, it is not accurate in the stabilised financial system that his student Hyman Minsky identified as the reality of the modern capitalist economy. Successive rounds of stabilisation mean that the modern banker is more focused on seeking out bets that will be validated by central bank interventions than funding disruptive entrepreneurial activity. Moreover, we live in a world where maturity transformation is no longer required to meet our investment needs. The evolution and malformation of the financial system means that Hayek’s analysis is more relevant now than it probably was during his own lifetime.

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Written by Ashwin Parameswaran

November 22nd, 2011 at 5:49 am

20 Responses to 'Debunking the ‘Savings Glut’ Thesis'

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  1. I’m not sure the whole situation is due just to stabilisation. If as you say we’ve little need of maturity transformation (assuming presumably financial markets retain liquidity and depth) then we’ve been stuck in a rut of ‘simulating’ a gold standard type economy using fiat money.

    That is as much to do with the human instinct to be conservative as it is to do with the human instinct to stabilise.

    Perhaps they are ultimately nearly the same thing.

    Liminal Hack

    22 Nov 11 at 7:19 am

  2. “That is as much to do with the human instinct to be conservative as it is to do with the human instinct to stabilise. Perhaps they are ultimately nearly the same thing.”

    I think you’re right but that’s a much larger can of worms! I hope to get to discussing such issues at some point of time.

    My main point with that line was just that Schumpeter’s vision of banking as the brave allocators of purchasing power to creatively destructive entrepreneurs is not an accurate description of our current system.


    22 Nov 11 at 8:01 am

  3. Or indeed any past system as I think we agreed before!

    Off topic, here is an FTAV piece that’s right up your street:


    22 Nov 11 at 11:14 am

  4. “Or indeed any past system as I think we agreed before!”
    I am increasingly of that opinion but I’m giving Schumpeter the benefit of the doubt :-). And it is certainly plausible that in Schumpeter’s time, the credit elasticity and maturity transformation had a positive impact on wealth creation even if it was at the expense of system resilience.

    Thanks for the link – makes some good points.


    22 Nov 11 at 11:27 am

  5. Another OT link: Andrew Heldane on the financial system’s (lack of) contribution to output. I don’t remember who said it, but “paying a group of people to sit around the poker table,” should not be confused with real economic activity.

    David Pearson

    22 Nov 11 at 12:10 pm

  6. David – Thanks. Haldane is always worth reading.


    22 Nov 11 at 12:19 pm

  7. Ashwin – “maturity transformation is no longer required to meet our investment needs”

    If you had said “….meet our current investment levels” I would have agreed, but your construction sounds as if you believe our investment needs are being met by current levels of investment – and I thought you were sympathetic to the idea that we are actually seeing a deficiency in investment?

    Also – OT but I’m digging through your previous posts on cronyism. Do you go into detail anywhere on the main barrier mechanisms which the entrenched interests have set up to protect their rent-seeking? These ought to be well publicised and understood, now that there may be increasing traction with the 99% campaign. Patents are an example, but if you ask the average person in the 2nd-20th percentiles, they would say patents are important for promoting investment – etc..


    23 Nov 11 at 3:47 am

  8. Anders – I do believe we have an investment deficit but it’s a function of the ‘corporate savings glut’. Incumbent corporates are simply sitting on cash because they don’t have any incentive to indulge in disruptive innovation and new entrants in many industries face insurmountable challenges.

    Compared to Schumpeter’s era, we have an established, well-functioning system (pension funds,life insurers) to intermediate between household’s long-tenor savings needs and long-tenor investment demand. Banks by being allowed to maturity transform with a central bank backstop are simply sucking economic returns away from the household sector. Of course, governments will likely have to stop funding at long-tenor to fund current consumption – but in a fiat currency regime this is easy to implement.

    On the barrier mechanisms, I haven’t gone into detail anywhere – One of my many unfinished posts which will hopefully see the light of day soon. I’ve spent most of my time on the rents from the financial system primarily because I think the quantum is underestimated – especially when you incorporate the financialisation of the real economy.

    Briefly the other key mechanisms are patents, occupational licensing and much of the regulatory infrastructure. This is also a contributor for unemployment – if you are an employee at a large food company and get fired, you can’t simply just create your own small food business. The regulatory/licensing burden is immense.


    23 Nov 11 at 4:11 am

  9. Ashwin – agree that financial institutions provide a well-functioning conduit for households’ long-term capital holdings, but as I’ve mentioned previously, households want to hold assets not far off 100% of GDP in fully liquid, capital-protected form. I still don’t see why a Vickers-style ringfencing of deposit-taking banks, together with tax/capitalisation and liquidity backstop pricing set at appropriate levels to prevent the ringfenced banks “sucking economic returns away from” the non-banking sector, wouldn’t be an acceptable way of channelling this capital to corporates. Of course, to your first point, until we have rectified the landscape so that ‘exploratory’ investment picks up again, I accept that corporates don’t need banks to channel new capital from households their way.

    Look forward to seeing your piece on barrier mechanisms. The things you list sound vaguely progressive and beneficial for society, but perhaps that just reflects the progressive aims having been co-opted. A huge paradigm shift will be needed in order for the whole ‘Occupy’ movement, for example, not to slap down (in unholy/unwitting alliance with large corporates) any attempt to unwind any of these barrier mechanisms.


    23 Nov 11 at 6:11 am

  10. Anders – the 100% of GDP in liquid form can easily be met by T-bills or deposits backed by T-bills etc. Something like the old Postal Savings Bank system.

    My argument against any regulated solution is that banks will find a way to get around it. Tell them not to dabble in CDS and they’ll figure out a way to replicate the same exposure through repos and reverse-repos etc.

    Yes – the fact that so many of the “99%” think these mechanisms are structured to help them when their real purpose is to facilitate mass rent extraction is worrying (but predictable). The radical free market agenda and the radical progressive agenda are not that far apart – force all incumbent corporates to genuine market competition and rely on direct transfers/helicopter drops to pursue egalitarian goals.


    23 Nov 11 at 6:53 am

  11. Thanks – so you’re basically saying that there is a sector financial balances role for govt debt to exist (over and above notes & coins) – ie to soak up part of household capital. Fascinating to hear this espoused by a free-marketer. Of course this would only apply I suppose until corporates started investing again outside of their retained earnings.


    23 Nov 11 at 11:32 am

  12. To the extent that corporates need to invest outside their retained earnings, household long-tenor savings for retirement are more than ample. And it’s worth noting that in a less distorted market, the price signal can and will do the job of matching supply and demand. In some regimes, long-tenor funds may be costlier and in others they may be cheaper. Either way, I much prefer that scenario to the current one.


    23 Nov 11 at 6:02 pm

  13. I’d caution against assuming that the retirement saving rate will be sufficient. Under forthcoming demographic reality, saving for retirement should be consistently overwhelmed by dis-saving in retirement.


    24 Nov 11 at 3:23 pm

  14. I haven’t completely thought this through but to the extent there is a young population with a desire to save for a long tenor, there will be a corresponding source of risk appetite for long-tenor investment.

    Those who seek to dissave in retirement are really seeking to convert their old investments into current liquid short-tenor, low-risk assets, which is a different market.

    Also (being very speculative here), if we have a high proportion of aging consumers, won’t the need for long-tenor investment (as a proportion of GDP) itself go down?


    24 Nov 11 at 4:38 pm

  15. “Also (being very speculative here), if we have a high proportion of aging consumers, won’t the need for long-tenor investment (as a proportion of GDP) itself go down?”

    Absolutely, that’s what will keep interest rates low or negative. A large proportion of aging consumers is going to cause the economy to contract because everyone is thinking about the state of final demand when those consumers are gone.

    In theory there should be sufficient savings to meet genuine investment needs, but those savings would not attract a positive real or even nominal rate of interest.

    Perhaps we agree on this point?


    29 Nov 11 at 12:13 am

  16. Absolutely – I am frustrated with the cronyist nature of the Japanese economy. But there is no doubt that the demographic reality of the Japanese economy by itself implies a very low GDP growth rate, investment etc. Obviously, this does not imply that per capita GDP cannot grow at a modest pace and Japan hasn’t done that badly on that count. It has done worse than it should have because the older generation has clung on to their rents at the expense of the rest.

    I’m with you on the absence of positive nominal rates and obviously there is no golden rule that real rates cannot be negative either. But I do think that the average real rate in the absence of significant central bank intervention will not be significantly negative. Again I could be wrong here but the post-peak debt scenario in a credit economy probably has close to zero rates and around zero, probably small negative deflation.


    29 Nov 11 at 12:28 am

  17. Ashwin I agree with all the above except perhaps the last sentence. I think you could be right but it very much depends on the form of a stable political economy in that post peak debt scenario. And I don’t think we much if anything to guide us on what that would look like.

    FWIW I feel that the post peak debt economy is also a post-monetary economy.

    I have some rather speculative ideas what that might evolve into on my blog. It involves smart meters.

    Liminal Hack

    30 Nov 11 at 12:28 pm

  18. I agree that we have little to guide us on what this peak elasticity/debt economy will look like. I’m reasonably certain that the system will look nothing like the current one (especially with regard to existence of banks) but thats about it.


    1 Dec 11 at 4:03 pm

  19. No global glut of capital?

    No sure about that. Talk to any private equity guy, VC guy, real estate guy, mutual fund, etc etc, and they all say “too much money chasing too few deals.”

    Global savings rates are high, especially in Asia. People save regardless of interest rates, for college, retirement, the unexpected, or even for cultural reasons.

    I am not sure if there is a solution to this, in either free-market or government-imposed diktats.

    I do know the Fed needs to go to nominal GDO targeting, and that may help. Right now, the Fed and ECB need to print money to the moon.

    Benjamin Cole

    5 Dec 11 at 6:51 pm

  20. Benjamin – You may be misunderstanding the point of this post. I am simply stating that “excess” savings has very little to do with the boom preceding this crisis because in the current monetary system, the act of financing does not require a pre-existing pool of savings. This was a financing boom now followed by a financing bust. Again this is a very heterodox view of monetary theory – the Borio-Disyatat paper is excellent on this topic and the empirical evidence against concluding that excess savings was the culprit.


    6 Dec 11 at 9:49 am

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