Forced Saving

My Treatise on Money (vol. i. p. 171, footnote) suggested that they bore some affinity to the difference between investment and “saving”.

• I am no longer confident that there was in fact so much affinity as I then supposed.

“Forced saving” and analogous phrases by Professor Hayek or Robbins have no definite relation to the difference between investment and “saving” in the sense intended in my Treatise on Money.

These authors have not explained exactly what they mean by this term, it is clear that “forced saving”, in their sense, is a phenomenon which results directly from, and is measured by, changes in the quantity of money or bank-credit.

A change in the volume of output and employment will, indeed, cause a change in income measured in wage-units; that a change in the wage-unit will cause both a redistribution of income between borrowers and lenders and a change in aggregate income measured in money; and that in either event there will (or may) be a change in the amount saved.

Since, therefore, changes in the quantity of money may result, through their effect on the rate of interest, in a change in the volume and distribution of income (as we shall show later), such changes may involve, indirectly, a change in the amount saved.

But such changes in the amounts saved are no more “forced savings” than any other changes in the amounts saved due to a change in circumstances; and there is no means of distinguishing between one case and another, unless we specify the amount saved in certain given conditions as our norm or standard.

Moreover, as we shall see, the amount of the change in aggregate saving which results from a given change in the quantity of money is highly variable and depends on many other factors. Thus “forced saving” has no meaning until we have specified some standard rate of saving. If we select (as might be reasonable) the rate of saying which corresponds to an established state of full employment, the above definition would become:

“Forced saving is the excess of actual saving over what would be saved if there were full employment in a position of long-period equilibrium”.

This definition would make good sense, but a sense in which a forced excess of saving would be a very rare and a very unstable phenomenon, and a forced deficiency of saving the usual state of affairs.

Professor Hayek’s interesting “Note on the Development of the Doctrine of Forced Saving”[3] shows that this was in fact the original meaning of the term. “Forced saving” or “forced frugality” was, in the first instance, a conception of Bentham’s; and Bentham expressly stated that he had in mind the consequences of an increase in the quantity of money (relatively to the quantity of things vendible for money) in circumstances of “all hands being employed and employed in the most advantageous manner”[4]. In such circumstances, Bentham points out, real income cannot be increased, and, consequently, additional investment, taking place as a result of the transition, involves forced frugality “at the expense of national comfort and national justice”. All the nineteenth-century writers who dealt with this matter had virtually the same idea in mind.

But an attempt to extend this perfectly clear notion to conditions of less than full employment involves difficulties. It is true, of course (owing to the fact of diminishing returns to an increase in the employment applied to a given capital equipment), that any increase in employment involves some sacrifice of real income to those who were already employed, but an attempt to relate this loss to the increase in investment which may accompany the increase in employment is not likely to be fruitful. At any rate I am not aware of any attempt having been made by the modern writers who are interested in “forced saving” to extend the idea to conditions where employment is increasing; and they seem, as a rule, to overlook the fact that the extension of the Benthamite concept of forced frugality to conditions of less than full employment requires some explanation or qualification.

V

People think that that savings and investments can differ from one another.

This is due to an optical illusion from regarding an individual depositor’s relation to his bank as being a one-sided transaction, instead of seeing it as the two-sided transaction which it actually is.

A depositor and his bank can somehow contrive between them to perform an operation by which savings can disappear into the banking system so that they are lost to investment, or, contrariwise, that the banking system can make it possible for investment to occur, to which no saving corresponds.

But no one can save without acquiring an asset, whether it be cash or a debt or capital-goods.

No one can acquire an asset which he did not previously possess, unless either an asset of equal value is newly produced or someone else parts with an asset of that value which he previously had.

In the first alternative there is a corresponding new investment= in the second alternative someone else must be dis-saving an equal sum. For his loss of wealth must be due to his consumption exceeding his income, and not to a loss on capital account through a change in the value of a capital-asset, since it is not a case of his suffering a loss of value which his asset formerly had; he is duly receiving the current value of his asset and yet is not retaining this value in wealth of any form, i.e. he must be spending it on current consumption in excess of current income. Moreover, if it is the banking system which parts with an asset, someone must be parting with cash. It follows that the aggregate saving of the first individual and of others taken together must necessarily be equal to the amount of current new investment. The notion that the creation of credit by the banking system allows investment to take place to which “no genuine saving” corresponds can only be the result of isolating one of the consequences of the increased bank-credit to the exclusion of the others.

If the grant of a bank credit to an entrepreneur additional to the credits already existing allows him to make an addition to current investment which would not have occurred otherwise, incomes will necessarily be increased and at a rate which will normally exceed the rate of increased investment. Moreover, except in conditions of full employment, there will be an increase of real income as well as of money-income. The public will exercise “a free choice” as to the proportion in which they divide their increase of income between saving and spending; and it is impossible that the intention of the entrepreneur who has borrowed in order to increase investment can become effective (except in substitution for investment by other entrepreneurs which would have occurred otherwise) at a faster rate than the public decide to increase their savings. Moreover, the savings which result from this decision are just as genuine as any other savings.

No one can be compelled to own the additional money corresponding to the new bank-credit, unless he deliberately prefers to hold more money rather than some other form of wealth. Yet employment, incomes and prices cannot help moving in such a way that in the new situation someone does choose to hold the additional money. It is true that an unexpected increase of investment in a particular direction may cause an irregularity in the rate of aggregate saving and investment which would not have occurred if it has been sufficiently foreseen. It is also true that the grant of the bank-credit will set up three tendencies

1. for output to increase
2. for the marginal product to rise in value in terms of the wage-unit (which in conditions of decreasing return must necessarily accompany an increase of output), and
3. for the wage-unit to rise in terms of money (since this is a frequent concomitant of better employment); and these tendencies may affect the distribution of real income between different groups.

But these tendencies are characteristic of a state of increasing output as such, and will occur just as much if the increase in output has been initiated otherwise than by an increase in bank-credit. They can only be avoided, by avoiding any course of action capable of improving employment. Much of the above, however, is anticipating the result of discussions which have not yet been reached. Thus the old-fashioned view that saving always involves investment, though incomplete and misleading, is formally sounder than the newfangled view that there can be saving without investment or investment without “genuine” saving.

The error lies in proceeding to the plausible inference that, when an individual saves, he will increase aggregate investment by an equal amount. It is true, that, when an individual saves he increases his own wealth. But the conclusion that he also increases aggregate wealth fails to allow for the possibility that an act of individual saving may react on someone else’s savings and hence on someone else’s wealth.

The reconciliation of the identity between saving and investment with the apparent “free-will” of the individual to save what he chooses irrespective of what he or others may be investing, essentially depends on saving being, like spending, a two-sided affair.

The amount of his own saving is unlikely to have any significant influence on his own income. But the reactions of the amount of his consumption on the incomes of others makes it impossible for all individuals simultaneously to save any given sums. Every such attempt to save more by reducing consumption will so affect incomes that the attempt necessarily defeats itself.

The community as a whole cannot save less than the amount of current investment. Doing so will raise incomes to a level at which the sums which individuals choose to save add up to a figure exactly equal to the amount of investment.

The above is closely analogous with the proposition which harmonises the liberty, which

Everyone can change the amount of money he holds. This amount in total is exactly equal to the amount of cash which the banking system has created.

In this latter case, the equality is brought about by the fact that

The amount of money which people choose to hold is not independent:

• of their incomes or
• of the prices of securities
  • Securities are purchased as a natural alternative to holding money.

Thus, incomes and the prices of stocks necessarily change until the aggregate of the amounts of money which individuals choose to hold at the new level of incomes and stock prices have become equal to the amount of money created by the banking system.

This is the fundamental proposition of monetary theory.

Both these propositions come from the fact that there cannot be a buyer without a seller or a seller without a buyer.

An individual making small transactions relative to the market can safely neglect the fact that demand is not a one-sided transaction.

• But it cannot be neglected when we come to aggregate demand.

This is the vital difference between:

• macroeconomy and
• microeconomy
  • In this, we assume that changes in the individual’s own demand do not affect his income.

Author’s Footnotes

1. My method there was to regard the current realised profit as determining the current expectation of profit.

2. Vide Mr. Robertson’s article “Saving and Hoarding” (Economic Journal, September 1933, p. 399) and the discussion between Mr. Robertson, Mr. Hawtrey and myself (Economic Journal, December 1933, p. 658). 3. Quarterly Journal of Economics, Nov. 1932, p. 123. 4. Loc. cit. p. 125