“Spending” isn’t consumption

Sloppy use of terminology leads to sloppy analysis.  One of the things that really drives me crazy is when people equate “spending” with consumption.  Why does this matter?  Consider whether you’ve ever heard the something like the following:

“Around the middle of the decade Americans went on an orgy of spending on new homes; it’s time to tighten our belts and cut back on consumption.”

There is an argument for cutting consumption, but it has nothing to do with building too much housing, and it’s probably wrong in any case.

1.  Spending on new homes isn’t consumption, it’s investment.  Period.  End of story.  Some commenters will insist that new homes are not capital goods.  That’s crazy, I live in a 90 year old home.  How many factories last for 90 years?  How many trucks?  How many jetliners?  Homes aren’t just capital goods, they are super capital goods, the most capital-like of all capital goods.  And no, the fact that they are often owner-occupied, and not rented out, makes no difference.  If you insist homes are consumers goods I will regard you as economically illiterate.  You’ve been warned.

2.  Suppose we built way too many houses in an frenzy of irrational exuberance.  What then?  Let’s first consider a closed economy model.  We should increase non-housing production.  We should probably also increase total production, as poorer people generally want to work harder.  But let’s suppose I’m wrong, and use the worst-case scenario for my argument.  No extra work effort.  In that case, if we decide to produce say $400 billion less in housing, we might decide to build another $400 billion in non-housing goods, i.e. consumer and non-housing capital goods (private or government.)  It might be another $250 billion in business capital and another $150 billion in consumer goods.

3.  Thus the optimal response to a spending frenzy on housing isn’t tightening our belts, it’s loosening our belts.  The housing frenzy involved too much investment, and hence too much saving.  Yes, saving really, really does equal investment.  To make up for too much saving, we need to save less and spend more.  We should have had a monetary policy that makes that happen, but of course we didn’t.

4.  I’m sure by now you are screaming at the monitor that I forgot the current account deficit.  That could change things, but I doubt it.  It’s certainly true that if we made two mistakes, a housing orgy and an current account fiasco, then we should fix both problems.  But what makes people think there was any big problem with our current account?  I predict it will go back into large deficit as the economy recovers.  Why shouldn’t it?  As long as the US can run up massive debts, and yet face no net outflow of investment income, I’d expect us to keep doing that.  For my entire life I’ve been told that the day of reckoning is coming for the current account, and it never happens.  I’ll believe it when I see it.

5.  If I’m wrong about the current account, we’ll want to re-allocate that $400 billion to business investment, exports, and consumption, in some combination.  So the net effect on consumption is ambiguous.  But if I’m right that the US current account will continue to be all talk and no action, and that we’ll keep running deficits, then my analysis in parts 1-3 still holds, with the proviso that the excess saving was done by both Americans and Chinese.  But we’ll still want to loosen our belts by saving less.

Why does everyone else get this wrong?  Perhaps it’s nothing more than confusing the terms ‘spending’ with ‘consumption.’  One can spend on either consumer or investment goods.  When you spend on investment goods, it’s called saving.

There should be nothing controversial about this post–it’s all straight out of econ101.  But then we know that our profession likes to abandon textbook economics whenever it conflicts with their prejudices.  So I wouldn’t be surprised to get a bit of push-back in the comment section.

PS.  Krugman’s right that we should not react to the housing bust by spending less.  But this is not because the individual family is unrepresentative of the macroeconomy.  What’s right for the individual is right for the overall economy.

PPS.  I still think we save too little.  But for tax distortion reasons, not because of the housing bubble.


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191 Responses to ““Spending” isn’t consumption”

  1. Gravatar of brian t brian t
    14. March 2012 at 05:38

    The way it looks to me, many people poured money in to houses, in the *belief* that they were investments, so in that sense I suppose you can call them investments. However, many of those people have since found out that they they’re going to make no return on their “investment”, or are going to lose money on it. And even if they occupy their “investments”, most new-build houses are not going to last 90 years. They’re “built to a price” and will be lucky to make it to 1/3 of that. They will cost more and more to maintain over time, until it’s no longer cost-effective to keep them. In other words: like other forms of capital investment, these “investments” suffer from depreciation!

  2. Gravatar of John John
    14. March 2012 at 05:42

    Spending on homes is investment. Living in them is consumption of the equivalent value in rent. Ergo, living in a house which has a high rental value is excessive consumption.

  3. Gravatar of dwb dwb
    14. March 2012 at 05:44

    1. there is no overbuild of housing. I see this a lot, even on blogs I respect like CalculatedRisk. People gotta live somewhere, there are 12 million (ish) new faces in the last 4 years (ive probably underestimated) and rental rates are rising. We’ve actually built about 1 MM new homes in the last three years. sure, the relative price between rentals and owner-occupied houses needed to adjust cause lending standards were stupid and the actual cost of financing the latter should have been higher.

    2. 70% of the trade deficit is oil. Exclude oil and we are pretty flat. We have a gazillion years of cheap shale gas, and now shale oil as well. eventually the relative price of oil will be high enough to start incenting people to run cars and heat more homes with gas (honda is going to start pushing this more). the electricity industry has already been shuttering coal plants in favor of gas plants for electricity cause its cheaper.

    the consequences of a high trade deficit are high oil prices, which encourage a shift away from oil. so its self correcting, not a reason to think we are headed for the zombie apocalypse.

    should i view the housing issue too as a “supply” shock in the sense of screwed up relative prices due to messed up lending standards? If so the correct action in 2007 would have been for the fed to step on the gas and stabilize nominal income, not target inflation or deflate the “housing bubble.”

  4. Gravatar of Lee Kelly Lee Kelly
    14. March 2012 at 05:53

    The confusion between consumption and spending is also where the paradox of thrift comes from.

  5. Gravatar of Ritwik Ritwik
    14. March 2012 at 05:54

    “To make up for too much saving, we need to save less and spend more”

    No one can avoid sloppy reasoning it seems.

    Unless, of course, you are arguing that we should consume far far more to make up for the desired shortfall in ‘saving’.

    Countercyclical consumption with a multiplier > 1.

  6. Gravatar of RebelEconomist RebelEconomist
    14. March 2012 at 05:55

    Damn, brian t beat me to it! I think the feeling is that spending on low return investment like excessively large and fancy homes in inconvenient places displaced more sensible saving like infrastructure maintenance or building net foreign assets. Now that this mistake has been realised, people have realised that their stock of saving (within which the homes have much lower value than their historic cost) is below target, and they want to get back on track.

    On a very different point, I sometimes wonder about the use of the term “spending”, because it gives non-economists the impression that it involves the destruction, rather than the circulation, of money.

  7. Gravatar of Morgan Warstler Morgan Warstler
    14. March 2012 at 06:05

    “If you insist homes are consumers goods I will regard you as economically illiterate.”

    To unpack your preferences a bit, can you please describe the land value vs. the house value where you live?

    In Austin, TX there are plenty of $250K homes. Many are a $40K plot with $210K house. Many are $210K plot with $40K house (knockdowns are plentiful).

    “Investing” in houses in 2004-2006 was like investing long in NASDAQ in Jan 2000.

    Meanwhile investing in houses RIGHT NOW, bidding on 500+ units on a single “tape” from Fannie / Freddie / Bank etc. is completely different.

    I’m helping a group of investors on this right now.

    People who say housing is consumption mean:

    1. Most people sell before they can expect to have any equity built up.
    2. People need to be more mobile in modern economy.
    3. People shouldn’t expect increases in the value of their investment in near or mid term.

    You may live in a 90 year old house, but saying that doesn’t mean that anytime at any price someone buys that house they are making an investment.

    I get that you want to classify 15T of housing stock as something other than gobbling twinkies, but the average person is due the respect of you choosing your words more carefully.

    When you say investment, it carries positive connotations that the avg. person will not realize.

  8. Gravatar of Ryan Ryan
    14. March 2012 at 06:14

    Scott,

    Regarding your point #1, I completely agree. But, as a casual aside, how would you classify cottages? They look like capital, but they’re used mostly for entertainment purposes. Would this be a special class of investment, or a special class of consumption?

    Regarding your point #3, why do you suppose the problem was “too much investment?” A viable alternative viewpoint might be that there was no problem with the aggregate level of investment, but merely in the specific investments that were being made.

    For example, just because I shouldn’t have invested in two homes doesn’t mean I should have invested in one home plus a bunch of consumption spending – I might simply needed to have invested in one home and a couple of mutual funds.

    Right? What am I missing?

  9. Gravatar of Ron Ronson Ron Ronson
    14. March 2012 at 06:16

    I have been reading this blog for several months now. I love the logical clarity and the passion for which the NGDPT program is fought for.

    I am in agreement with the assessment that stabilizing NGDP over time will lead to optimum economic outcomes. By guaranteeing that the monetary authority will do what ever it needs to do to keep NGDP on its chosen trend the market itself is given the incentive to do most of the heavy lifting required. Intervention when it is required needs to be cause minimum deviation from the optimal free-market outcome.

    My one area of disagreement (or perhaps just confusion) is the policies the monetary authorities need to follow where intervention is actually needed. When NGDP is below trend you clearly favor monetary policies involving asset purchases that would (via the hot potato effect) eventually lead to the newly injected money increasing demand for real goods. While I can see that this would work, it still seems like an indirect approach that could (if the monetary authorities did not have credibility for its expectation settings to be believed) require a lot of asset purchases to be effective. If the aim is to stimulate demand why not take a more route-one approach and just use newly printed money to directly affect it ? Why not have a variable tax/subsidy on all sales to keep NGDP on track. When (as now) NGDP is significantly below trend then increase the subsidy. As we get closer to trend the subsidy is reduced. If in the future NGDP rises above trend simply turn the subsidy into a tax. Overtime the effect would be neutral and as the monetary authorities gain credibility for their NGDP target it would probably remain very close to 0%.

    This suggestion is derived from Russ Abbott’s paper “Regaining the Great Moderation” that you have mentioned a couple of time yourself. Perhaps there are some complexities that I have overlooked in implementation , but to a non-economists I think that this idea has the merit of being easily understandable and explainable to the general public and I would like to see it more widely discussed.

  10. Gravatar of Marcelo Marcelo
    14. March 2012 at 06:17

    “The truth, although nobody on the right will ever admit it, is that Friedman was basically a Keynesian “” or, if you like, a Hicksian. His framework was just IS-LM coupled with an assertion that the LM curve was close enough to vertical “” and money demand sufficiently stable “” that steady growth in the money supply would do the job of economic stabilization. These were empirical propositions, not basic differences in analysis; and if they turn out to be wrong (as they have), monetarism dissolves back into Keynesianism.”

    -Paul Krugman
    http://krugman.blogs.nytimes.com/2012/03/14/macro-retrogression/?smid=tw-NytimesKrugman&seid=auto

    To be presented without comment.

  11. Gravatar of Lee Kelly Lee Kelly
    14. March 2012 at 06:18

    ‘Spending’ means two things:

    (1) Using resources to produce goods and services.
    (2) Exchanging money for goods and services.

    In the first sense, saving is always equal to investment, because we save by producing capital or durable goods. In the second sense, saving is not always equal to investment, because we can refrain from both investment and consumer spending by holding larger money balances.

  12. Gravatar of marcus nunes marcus nunes
    14. March 2012 at 06:54

    The US became a net debtor at the same time the “Great Moderation” kicked in. That´s what you get for “rejuvenating”. You become “credit worthy” because you have a long and productive life ahead of you.
    Australia has never “aged”. It has run current account deficits for 150 years (and at times very large ones).

  13. Gravatar of ssumner ssumner
    14. March 2012 at 06:55

    Brian. I don’t agree that the houses will only last 30 years.

    John, The housing gets “consumed” whether someone lives there or not. Indeed faster if empty.

    dwb, Yup.

    Lee Kelly. Yes, that’s part of it.

    Rit wik, I don’t follow your argument.

    Rebeleconomist: You said;

    “Damn, brian t beat me to it! I think the feeling is that spending on low return investment like excessively large and fancy homes in inconvenient places displaced more sensible saving like infrastructure maintenance or building net foreign assets.”

    That’s exactly my point. So we spend less on those wasteful homes, and more on consumption and business investment.

    Morgan, Investment shouldn’t carry any positive connotations. It is what it is.

    Ryan, A cottage is investment.

    Mutual funds aren’t investment, they are saving. Yes, there may have been the right amount of investment but the wrong mix, but again, in that case we should not tighten our belts.

    Ron, Thanks for following the blog. The goal of any monetary policy should be to set the money supply such that the expected future level of NGDP is exactly equal to target NGDP. If you have this policy (and it’s the only sensible policy I can imagine) then you’d never have any need for fiscal policy. What could it add, if you are already expected to be on target?

    But I do like Russ Abbott’s ideas.

    Marcelo, That’s so far off base it ridiculous. Friedman rejected the IS/LM model, and so do I.

    Lee Kelly, Private saving may not equal private investment, but total saving always equals total investment.

  14. Gravatar of Martin Martin
    14. March 2012 at 07:11

    Scott,

    “Homes aren’t just capital goods, they are super capital goods, the most capital-like of all capital goods. And no, the fact that they are often owner-occupied, and not rented out, makes no difference. If you insist homes are consumers goods I will regard you as economically illiterate. You’ve been warned.”

    How would you draw the distinction between consumer durables and investment goods? As I would sooner call a house a super consumer durable rather than an investment good.

  15. Gravatar of RebelEconomist RebelEconomist
    14. March 2012 at 07:17

    No, Scott, I think you have missed the point. It is rational to spend less on consumption and more on investment (albeit including less if anything on investment in Mc Mansions) today because the capital stock is too low – ie at a dynamically inefficient level. And the capital stock is too low because the investment allocated to housing effectively had a huge depreciation rate; to put it more bluntly, it was largely wasted.

  16. Gravatar of johnleemk johnleemk
    14. March 2012 at 07:19

    Marcelo,

    From the little I know, it sounds like Krugman is describing Friedman’s early, original monetary crank thinking, where a computer controls the money supply and boosts it by a fixed amount. (By that token, one can easily debunk Keynesianism too — the original Keynesianism has been quite clearly empirically proven wrong, and it’s the additional gloss from folks like Hicks and later on the New Keynesians that have kept it relevant.)

    Seems like Krugman’s glossing over all of Friedman’s contributions to understanding (or remembering, since I doubt he was the first to glean this insight) the role of money in driving aggregate demand.

    If Friedman was wrong, and if monetarism just collapses into Keynesianism, then it just raises the question of why Keynesianism totally misidentified the cause of the Great Depression — unless now Krugman wants us to deny the economic consensus (traceable to Friedman’s monetary history) that the Great Depression was primarily caused by tight money.

  17. Gravatar of johnleemk johnleemk
    14. March 2012 at 07:21

    Scott,

    One point which I think your post didn’t sufficiently convey is that housing is an investment in providing housing services. One can consume housing services, but not housing itself; if you stop living in a house, that doesn’t make the house 100% unlivable forever more.

  18. Gravatar of ssumner ssumner
    14. March 2012 at 07:28

    Rebeleconomist, We should spend much more on non-residential investment, not total investment.

    I don’t agree that the spending on housing was largely wasted, the market doesn’t suggest that either. Much of the price decline is land prices–housing prices haven’t fallen that far.

    Johnleemk, That’s right.

  19. Gravatar of justin justin
    14. March 2012 at 07:31

    When occupants used HELOCs to change interior paint colors, buy plasma TVs, and take long vacations to Hawaii, was that not consumption?

  20. Gravatar of Becky Hargrove Becky Hargrove
    14. March 2012 at 07:34

    Let’s look at the example of housing to factory. (Warning, rant ahead) A factory accomplishes many things in terms of economic activity and housing is not allowed to. Here’s the problem for housing in terms of wanting to classify it as a capital good: people are still trying to take away all definitions of housing that do not involve sleeping in it, at night. Even in Houston in the seventies I ran into difficulties using part of a new house as a recording studio. One more divergence here and then I’ll focus: human capital is currently treated in the present the same as housing, as a dead end consumer investment that in no way increases overall ‘hot potato effects’ (okay, velocity) as a factory might. A minimum of economic effect is realized in rural areas where homesteads are possible, but even that is not equivalent to the overall economic gains once had by being able to live over one’s store.

    We don’t need debt jubilees or austerity. We need flexible ownership identities that mess with current ideas how spaces are ‘supposed’ to be used. What’s more, for every government this is a low cost solution. Every good building is a building that could potentially be used for something. Empty homes? Why can’t a local hospital use some of them as recovery areas for patients not yet well enough to go home, but costing too much to remain on the premises. Reduced velocity is a direct result of forced passive consumption, and consumption / production in highly specific and limited terms. The mental image of reduced velocity for me has always been a highway in Austin which cruises above lonely retail stores, then unexpectedly dead ends into a huge traffic jam for a good part of everyone’s workday. (end of rant)

  21. Gravatar of Martin Martin
    14. March 2012 at 07:44

    johnleemk,

    “housing is an investment in providing housing services.”

    I take it my gym membership is then an investment in providing gym services?

  22. Gravatar of Ritwik Ritwik
    14. March 2012 at 07:47

    Scott,

    Saving is identically equal to investment (per you, and the economics texts). Investment is a component of spending. If saving was to go down (‘we need to save less…’), how does spending go up?

    One explanation is you are committing the same ‘sloppy reasoning’ that you are trashing in other people and that is the title of your post.

    The other is that you are implying a state of the world where (this was my second point)consumption goes up by even more than ‘saving’ goes down. Thus, ‘countercyclical’ consumption to get out of the bust. with a multiplier of >1, i.e. for every unit of ‘saving’ that goes down, consumption must go up by more than one unit.

    Freaky mindgames, these.

  23. Gravatar of RebelEconomist RebelEconomist
    14. March 2012 at 07:49

    Good point on the decomposition of the value of housing, Scott. Living in the UK I have probably been too influenced by news stories about derelict housing projects in Nevada and abandoned houses in the rust belt!

  24. Gravatar of Morgan Warstler Morgan Warstler
    14. March 2012 at 08:10

    “Morgan, Investment shouldn’t carry any positive connotations. It is what it is.”

    I’ll tell Wittgenstein. He is probably getting tired of laying on his back.

    Do you have another argument?

  25. Gravatar of Jon Jon
    14. March 2012 at 08:14

    I agree building and maintaining a house is an investment. Living in that house is not; that’s consumption. The question ought to be what is the on-balance?

    When a house is first built the investment is maximal and the consumption is small in comparison. Over time the house will be consumed. This is what confuses people.
    –it’s the magnitude of the two effects being vastly different.

    Investment is deferred cosumption–that’s part of th point about the two brothers. When you build a house today you get to consume housing tomorrow. Moreover, you get lots of deferred consumption today but can only consume a little bit each year in the future.

    Commenters are also confused by who is doing the investing. The investors include and are principally the people funding the mortgage who basically have no voting rights but do have priority in liquidation. They sign up for this deal because the general partner (the homeowner) promises to buy the stream of output from the house.

  26. Gravatar of dwb dwb
    14. March 2012 at 08:22

    Investment is deferred cosumption-that’s part of th point about the two brothers.

    minor point, I would have said investment is stored consumption (or a mechanism to store it and produce it when necessary, like a power plant).

  27. Gravatar of Martin Martin
    14. March 2012 at 08:28

    dwb,

    “Investment is deferred cosumption-that’s part of th point about the two brothers.

    minor point, I would have said investment is stored consumption (or a mechanism to store it and produce it when necessary, like a power plant).”

    By that logic, buying a box of cereal and putting it on the shelves in the kitchen is an investment.

  28. Gravatar of UnlearningEcon UnlearningEcon
    14. March 2012 at 08:30

    ‘If you insist homes are consumers goods I will regard you as economically illiterate. You’ve been warned.’

    This is quite an imperious thing to say. I can only assume (hope) that you’re overstating your case to be controversial.

    In any case, houses don’t produce more goods so they can’t be regarded as capital goods…?

  29. Gravatar of KRG KRG
    14. March 2012 at 08:30

    The only way that people can pretend that housing is not an investment is if they ignore the basic human utility of having a place to live; the notion that an investment must always return more money, rather than understanding that any form of value to the person making it is a pretty noxious misconception that feeds speculation and hurts real investment.

    Heck, most of the arguments about calling this or that an investment here basically boil to to moral judgments of “I don’t we should value the benefits that people get from it.” which is about as counterproductive an attitude as you can get, because it’s just those differentials in personal valuations that make markets work in the first place.

    The worst of it is, the way the factors are stacked now in many of the basic formulas we make a big, confusing distinction on a very subjective matter (consumption vs capital investment) and blur the difference on the most important objective distinction (capital investment (investing money in producing or procuring goods and services) vs financial investment (investing money in directly producing debt and money)). Consumption should be more like a friction coefficient and even left out of the basics to focus on the factors that actually make a difference.

  30. Gravatar of KRG KRG
    14. March 2012 at 08:32

    @UnlearningEcon
    Do you feel you would be equally as able to produce things if you did not have a house or apartment to live in? If not, then houses _do_ help produce goods and services.

  31. Gravatar of Martin Martin
    14. March 2012 at 08:35

    KRG,

    “Do you feel you would be equally as able to produce things if you did not have a house or apartment to live in? If not, then houses _do_ help produce goods and services.”

    Same applies to buying food to eat, and I am pretty sure that counts as consumption.

  32. Gravatar of KRG KRG
    14. March 2012 at 08:40

    @Martin
    It’s only “consumption” if you’re overeating, making yourself sick and thus less productive, or throwing it out without ever eating it, unless you actively value each of those outcomes much more than what you paid for the cereal. Otherwise it absolutely should be considered investment.

  33. Gravatar of Pete Bias Pete Bias
    14. March 2012 at 08:42

    I have a chess set that will last 500 years, but I don’t think it’s a capital good. Time isn’t the issue. Capital used to mean “goods used to produce other goods.” Is that no longer the definition?

  34. Gravatar of John John
    14. March 2012 at 08:46

    People shouldn’t be spending more. They should be spending less on both capital and consumer goods in order to reduce their pathetic amounts of debt.

  35. Gravatar of dwb dwb
    14. March 2012 at 08:50

    @Martin

    By that logic, buying a box of cereal and putting it on the shelves in the kitchen is an investment.

    Inventory is considered investment.

    Now, there are lots of things that go on in my house that, if they had a market price and were reported, would be counted in GDP (my Pasta e Fagioli is far better than what you get in most restaurants in NY but i have not added to GDP when i make it and do the dishes, whereas in NY both the chef and the dishwasher’s labor get included in GDP as wage income).

    some things get counted (or not) due to practical limitations, not conceptual unsoundness. those canned goods got counted in final sales when i bought them, even though technically there is no difference between me inventory-ing them on my shelves unconsumed and Campbell’s inventory-ing them before they sell them to the grocery store.

  36. Gravatar of KRG KRG
    14. March 2012 at 08:58

    @John
    If people aren’t spending money on those, then no one can make any income to pay down their debts. What we actually need is loose enough monetary policy so that there’s enough money circulating for people to buy enough to generate the income to pay down private debts rather than requiring people to take on debt just to provide the level of spending required to keep the market liquid. It’s only when we’re running short on our ability to keep up with production demands that we need to use debt pressure to reduce spending. (Something that’s less and less possible give the ability of modern technology to automate physical production, nevermind effectively infinite digital production capabilities)

  37. Gravatar of UnlearningEcon UnlearningEcon
    14. March 2012 at 09:16

    @KRG

    The definition of a capital good is one that produces other goods. Houses do not do that.

    As for ‘making it easier’, well, a lot of consumption goods could be argued to do that, but they still don’t produce anything themselves.

  38. Gravatar of Ron Ronson Ron Ronson
    14. March 2012 at 09:16

    Scott,

    Thanks for the reply.

    I have a followup question on:

    “The goal of any monetary policy should be to set the money supply such that the expected future level of NGDP is exactly equal to target NGDP”

    What difference does it make if this is achieved via fiscal or monetary means ? I can see that if the govt starts building bridges etc this will have an impact on how resources get allocated in the real economy. But if it is a question of whether the govt prints new money and distributes it via asset purchases rather than a subsidy on commercial sales (as Abbot suggested) its less clear to me why “monetary” is considered better than “fiscal”. Why is not just a case of choosing the option with the best chance of a) working and b) being political acceptable ?

    (I know my questions are off topic – I just woke up this morning thinking about this stuff)

  39. Gravatar of W. Peden W. Peden
    14. March 2012 at 09:22

    Marcelo,

    The “vertical LM curve” interpretation of monetarism is historically inaccurate; it nearly works for Friedman’s “The Demand Function for Money: Some Theoretical and Empirical Results”, but Friedman disowned that interpretation soon after in “Interest Rates and the Demand for Money”.

    Regarded as part of the quantity theory tradition (and if one defines that as the view that money is neutral in the long-run) then monetarism is best viewed as a combination of the quantity theory of money where the money stock is (a) demand-determined, (b) capable of being controlled by the state, (c) has a velocity which does not adjust to offset the effects on PT/PY of changes in M, and (d) has fluctuations in real terms which are important to understanding fluctuations in real output.

    Thus historically situated, it becomes apparent that the rise of New Keynesianism was (in part) the capitulation of Keynesians to the monetarist counter-revolution. Keynesianism absorbed monetarism in the sense that it was still called “Keynesianism” and some bits of Keynesianism (like a famished version of the liquidity trap and a focus on the price of credit rather than the quantity of money) were salvaged.

    Here’s the proof: if one asked James Tobin whether or not modern textbook macro was closer to Keynesianism or monetarism, then what would he say? My guess is that he’d chastiste economists like Paul Krugman as scientifically illiterate Friedmanites.

  40. Gravatar of Martin Martin
    14. March 2012 at 09:23

    dwb,

    “Now, there are lots of things that go on in my house that, if they had a market price and were reported, would be counted in GDP (my Pasta e Fagioli is far better than what you get in most restaurants in NY but i have not added to GDP when i make it and do the dishes, whereas in NY both the chef and the dishwasher’s labor get included in GDP as wage income).”

    It is not about whether you experience it as better than what is available outside. What matters for GDP is that you’re able and willing to sell it.

    If you are unwilling to sell it, it means that your opportunity cost is higher than the price you could fetch for it. If you are unable to sell it, it means that your price is too high. Either way no value has been created by that activity. There is no surplus. What you do at home is leisure and is indistinguishable from me sleeping in on Saturday’s: I am not willing to sell that time, nor is anyone willing to pay me to sleep on Saturday morning.

    Sure we could add the value of leisure to GDP, but I don’t see what the point of that would be.

    “some things get counted (or not) due to practical limitations, not conceptual unsoundness. those canned goods got counted in final sales when i bought them, even though technically there is no difference between me inventory-ing them on my shelves unconsumed and Campbell’s inventory-ing them before they sell them to the grocery store.”

    Technically not. Economically, yes. Are those canned goods and input in production? I am guessing no. They’re final sales, because you buying those goods is where the production process ends. At the moment you bought those goods, those goods transformed from an input into an output.

  41. Gravatar of W. Peden W. Peden
    14. March 2012 at 09:28

    Friedman also won the battle on liquidity preference or so I hope i.e. I hope that modern economists don’t still try to analyse people’s preferences for holding money as a choice between bonds and money.

    Where the old monetarists lost was (1) on the precise behaviour of V in the short run, and concomitantly (2) on the superiority of monetary-aggregate rules. They also failed to score a decisive win on the money-income causality debate.

  42. Gravatar of Brito Brito
    14. March 2012 at 09:33

    “1. Spending on new homes isn’t consumption, it’s investment. Period. End of story. Some commenters will insist that new homes are not capital goods. That’s crazy, I live in a 90 year old home. How many factories last for 90 years? How many trucks? How many jetliners? Homes aren’t just capital goods, they are super capital goods, the most capital-like of all capital goods. And no, the fact that they are often owner-occupied, and not rented out, makes no difference. If you insist homes are consumers goods I will regard you as economically illiterate. You’ve been warned.”

    You talk about textbook economics but this does not appear anywhere in any textbook ever, this is in fact extremely confusing to people currently reading economics textbooks (i.e. me, at a postgraduate level). Capital (K) enters a production function (e.g. a Cobb-Douglas), it is very difficult to see how housing enters a production function in anything other than an extremely abstract sense.

    The point you’re missing about the too much saving argument is that, yes too much saving did occur, but the saving occurred in China and in the east, it absolutely did not occur in the US. I’m sorry Scott but what you’re saying is almost the utter antithesis of what I’m learning in my textbooks and lecture notes, the housing bubble is explicitly defined in the context of a consumption boom. When Bernanke refers to a savings glut, it occurs in the east, not the west.

  43. Gravatar of Vivian Darkbloom Vivian Darkbloom
    14. March 2012 at 09:38

    OK, so I purchase a house (and lot) that is supposedly worth $250K and finance the entire amount. A year later, I take out a $50K home equity loan on the fictive increase in value and blow it on a wild weekend in Vegas. A year later, the market value of the house is $150K. Multiple this by 100 million or so.

    Is this net investment? The theory about “investment” versus “spending” is fine; but whether you’ve got an actual net investment is only as good as your accounting and in accounting for this I think that “net” is an adjective that is strangely absent from this analysis. Until people have equity in their homes,they have not produced any net investment.

  44. Gravatar of Dave Schuler Dave Schuler
    14. March 2012 at 09:42

    One minor quibble:

    How many factories last for 90 years?

    Most of theme. In the 1960s I worked in a steel mill that had been built in the 1890s. It’s still operating.

  45. Gravatar of Eric Morey Eric Morey
    14. March 2012 at 09:55

    Scott,

    I’m really trying but when you say things like, “saving really, really does equal investment”, followed later in your comments with, “Mutual funds aren’t investment, they are saving”, you loose me. Can you reconcile the seeming contradiction?

    There seems to be some conflation between the investment in and consumption of a house. I could use some clarification here as well.

  46. Gravatar of Martin Martin
    14. March 2012 at 10:00

    Brito,

    “You talk about textbook economics but this does not appear anywhere in any textbook ever, this is in fact extremely confusing to people currently reading economics textbooks (i.e. me, at a postgraduate level). Capital (K) enters a production function (e.g. a Cobb-Douglas), it is very difficult to see how housing enters a production function in anything other than an extremely abstract sense.”

    Imagine a one household, one firm economy where the firm has a two input (capital and labor) cobb-douglas production function exhibiting constant returns to scale. The firm produces output, C and the household has a utility function U(C,1-L). Where are you going to place the buying of a house? C or K?

  47. Gravatar of Greg Ransom Greg Ransom
    14. March 2012 at 10:04

    Exactly, as explained by the 800 lb. gorilla of capital theory, Friedrich Hayek, in his _The Pure Theory of Capital_.

    “Spending on new homes isn’t consumption, it’s investment. Period. End of story. Some commenters will insist that new homes are not capital goods. That’s crazy, I live in a 90 year old home. How many factories last for 90 years? How many trucks? How many jetliners? Homes aren’t just capital goods, they are super capital goods, the most capital-like of all capital goods.”

    Specifically, houses are non-permanent, extremely long period production goods.

  48. Gravatar of Greg Ransom Greg Ransom
    14. March 2012 at 10:10

    “too much investment” = unsustainably choosing longer production processes promising superior output (e.g. houses) over sustainable shorter-period production processes.

    re-coordination = shortening the time structure of production via shifting resources and labor and capital organization toward shorter production processes.

    It doesn’t have much to to with spending too little or spending too much — it has to do with _misallocating_ resources across time.

    Scott writes,

    “Thus the optimal response to a spending frenzy on housing isn’t tightening our belts, it’s loosening our belts. The housing frenzy involved too much investment, and hence too much saving.”

  49. Gravatar of Greg Ransom Greg Ransom
    14. March 2012 at 10:13

    “too much savings” = dedicating far too many resources to long period production processes

    Reducing savings simply means dedicating more resources toward shorter term production processes.

    It really doesn’t have anything to do with “spending” more or less.

    This is production theory / capital theory 101.

    And economists DON’T KNOW ANY CAPITAL THEORY.

    Just reporting the fact.

    Economists are responsible for their ignorance on this topic, I’m not.

    Scott writes,

    “To make up for too much saving, we need to save less and spend more.”

  50. Gravatar of Brito Brito
    14. March 2012 at 10:16

    Martin, C.

  51. Gravatar of Greg Ransom Greg Ransom
    14. March 2012 at 10:17

    No, the Paradox of Thrift comes from the failure to know your capital theory.

    You can identify Keynes’ deep ignorance of this subject every time he discusses Bohm-Bawerk or Austrian capital theory in his “General Theory”, which he does repeatedly, repeatedly displaying his complete ignorance of the logic of choice involving production plans laid out by Bohm-Bawerk and Hayek.

    Lee writes,

    “The confusion between consumption and spending is also where the paradox of thrift comes from.”

  52. Gravatar of Don Geddis Don Geddis
    14. March 2012 at 10:19

    @ Vivian Darkbloom: You buying an existing house has no impact at all on net national investment. That’s just a transfer of numbers (and property ownership) from one citizen to another. The investment is BUILDING a NEW house. The question is whether housing was “overbuilt” during the early 2000’s, and even so, whether that would have been “overconsumption” or (as Scott suggests) “overinvestment”.

    The “real” economy doesn’t involve “money” or numbers in a bank account. Those are just intermediate tools. The real economy is about physical atoms, configured in valuable shapes and located in valuable places.

  53. Gravatar of Brito Brito
    14. March 2012 at 10:21

    Greg Ransom, nobody here cares about your Austrian heroes, literally nobody.

  54. Gravatar of Lee Kelly Lee Kelly
    14. March 2012 at 10:31

    Greg,

    The paradox of thrift is mostly due to a confusion between consumption and spending. That is, it assumes that an increase in saving (i.e. a decrease in consumption) implies a decrease in spending. Hold the money supply and prices constant, and the result is that attempts to save are mutually frustrated by a shortage of money. There’s a nugget of truth in there, but the implicit assumptions depend on a dysfunctional monetary regime. Also the paradox of thrift has nothing inherently to do with thrift, since it is compatible with a world where total saving is declining.

  55. Gravatar of Greg Ransom Greg Ransom
    14. March 2012 at 10:33

    If you have saved for a longer period of time by putting resources into a longer time consuming production process (e.g. a house), then to save less, you need to shift resources toward shorter period production processes (e.g. the production good we call a tooth brush).

    If you sacrifice across time by dedicating resources to longer term production processes in order to reap superior output, you are SAVING more, and you are investing more.

    THE LOGIC OF CHOICE IN THE DOMAIN OF PRODUCTION IS DIFFERENT THAN ACCOUNTING.

    No one will dedicate resources in lengthier production processes unless those longer time consuming processes promise superior output.

    If the price of borrowing in order to invest across time _shifts_ then you will get more or less long period investment, you will get longer or shorter production processes, you will get more houses and less tooth brushes, or more tooth brushes and fewer houses.

    This is capital theory 101 — and economists don’t know the first thing about the logic of choice in the domain of production goods.

    Which tells you a lot when it comes to understanding why the macroeconomists running the Fed & setting the “conventional wisdom” keep driving the truck into a brick wall.

  56. Gravatar of Martin Martin
    14. March 2012 at 10:39

    Brito,

    “Martin, C.”

    I try to think about this from an accounting perspective. Where you classify something based on purpose.

    For example, when as a small company you buy ink cartridges for your printer, you could activate them on your balance sheet and depreciate them over their period of use, but that period is so short, that you might as well activate and depreciate it immediately.

    Or take the the laptop I am currently working on. I could activate it on my balance sheet and depreciate it over four years to zero, or I could depreciate to zero the year I bought it in. In the former case it would yield consumption services for four years (four accounting periods) and in the latter case it would yield only consumption services for one period.

    What’s more reasonable depends on your purpose and your time horizon.

  57. Gravatar of Becky Hargrove Becky Hargrove
    14. March 2012 at 10:39

    I’m all for homes as investment. Who is ready to start designating home business zones in our cities? Scott, I remember an earlier housing post that was just as combustive as this one.

  58. Gravatar of Lorenzo from Oz Lorenzo from Oz
    14. March 2012 at 10:42

    Unlearning econ: The definition of a capital good is one that produces other goods. So, shelter is not a good? Or have you just entirely cut out the services from the economy.

  59. Gravatar of Martin Martin
    14. March 2012 at 10:47

    Lorenzo,

    “Unlearning econ: The definition of a capital good is one that produces other goods. So, shelter is not a good? Or have you just entirely cut out the services from the economy.”

    Oil produces a convenience yield, that’s the value of having the good on hand, in inventory. Having goods at home, arguably produce a “convenience yield” as well, the size of which is probably a function of your proximity to the supermarket and its opening hours. Does that turn all the goods in my house into capital goods?

  60. Gravatar of Lorenzo from Oz Lorenzo from Oz
    14. March 2012 at 10:48

    Martin: I take it my gym membership is then an investment in providing gym services? No, it is renting use of someone else’s investment. Same thing as your monthly housing rent, except more people can lease use of the gym at the same time. After all, the implications for ownership are exactly the same.

  61. Gravatar of Lorenzo from Oz Lorenzo from Oz
    14. March 2012 at 10:54

    Martin: since oil is not a capital good, but an intermediate good (one used up in the processes of production), I fail to see how the advantages of availability makes something so. (Inventory is an asset in an accounting sense, but that also does not make it a capital good.)

  62. Gravatar of Martin Martin
    14. March 2012 at 11:00

    Lorenzo,

    The value of an asset is the Cash Flow from that asset discounted to infinity. Let’s assume Cash Flow is the same each period, then CF/r = Value of the Asset.

    Now let’s assume a perfectly competitive gym membership market. If I prepay my monthly gym fees for infinity, how is this economically different from fractional ownership?

    Same holds if I only prepay for a year or a month, fraction just gets smaller.

    If housing is an investment in housing services, then having a gym membership is an investment in gym membership. (This is what the comment replied to)

    Either housing is an input in production, K, producing C, or housing is consumption C.

  63. Gravatar of johnleemk johnleemk
    14. March 2012 at 11:05

    Martin, re the gym question — your gym membership is like paying rent. You are paying for your consumption of gym/housing services.

    Building a home, just like building a gym, is an investment.

  64. Gravatar of Martin Martin
    14. March 2012 at 11:09

    Lorenzo,

    “Martin: since oil is not a capital good, but an intermediate good (one used up in the processes of production), I fail to see how the advantages of availability makes something so. (Inventory is an asset in an accounting sense, but that also does not make it a capital good.)”

    Actually a good that is used up in the process of production is part of the working capital. The distinction between (fixed) capital and working capital is whether it lasts longer than one accounting period where the accounting period is considered equivalent to the period of production.

    If your definition of a capital good is that it yields services and the convenience yield of a good is a service, then nearly any good is a capital good.

    Now you might disagree that a convenience yield is a service, but having something on hand is something people are willing to pay for and it is – I am pretty sure it is – something a demand curve can be estimated for. If you don’t believe people are willing to pay to have something on hand: Domino’s Pizza.

  65. Gravatar of CKE CKE
    14. March 2012 at 11:12

    “The housing frenzy involved too much investment, and hence too much saving. Yes, saving really, really does equal investment.”

    Too much investment or too much investment in housing? There is a difference. In a sense, I suspect that society cannot “over-invest” per se. Since investment in productive capital is simply a trade between current consumption and future consumption, how can society possibly over-invest, assuming the trade is deliberate?

    On the other hand, one can certainly over-invest in a particular product: building more of a particular type of capital than can be productively used. This seems to be what occurred with housing. Once productive capital became effectively worthless when it was discovered that the supply of housing significantly exceeded what people wanted.

    Had that investment been in things that people continue to want or would want if it existed (more ipads or jet packs or who knows) then the capital created might still be productive and generating real income.

    Now given that once productive capital in the housing sector can no longer generate real income, it would seem to me the path to getting real income back is to increase investment in other things that people might want? And, that shifting a larger percentage of our now smaller real income toward consumption will slow our return to prior levels of real income.

    There are no crystal balls in this world, so people will likely continue to over or under invest at times. It might help if price signals were as clear as possible though.

    Herein lies my biggest question with NGDP following. A fall in real income resulting from over-investment should force a shift in relative prices as whatever good was overproduced should fall in relative value. Will holding NGDP cloud this shift in relative valuation/prices?

  66. Gravatar of D R D R
    14. March 2012 at 11:14

    “I’m really trying but when you say things like, “saving really, really does equal investment”, followed later in your comments with, “Mutual funds aren’t investment, they are saving”, you loose me. Can you reconcile the seeming contradiction?

    “There seems to be some conflation between the investment in and consumption of a house. I could use some clarification here as well.”

    1. Investment is spending on currently-produced capital goods. (Especially fixed investment, like a *new* home or factory.) If you buy a 90-year-old home that is not investment, because it already existed. However, a home is considered a capital good because it generates a consumption service (housing) when occupied.

    2. One does not “invest” in a mutual fund. (Unless you are the one having the building constructed to house the employees and are purchasing the computers and desks.) If you put additional money into a mutual fund, you are saving. It may be that the mutual fund will invest on your behalf, or loan funds out to someone else who will purchase new capital goods, but you– yourself– are not investing. Rather, you are making funds available for others to invest.

    3. S=I because of accounting. It must hold always and in every *closed* economy. It’s like a cardboard box full of packs of 54 cards. I know that no matter how many *packs* of cards are placed in the box or removed, there will be a multiple of 54 cards in the box. Similarly, no matter what goes on in a closed economy, any transaction may change S and it may change I, but no matter what S and I will change by the same amount.

    Dealing with China is another matter. S=I worldwide, but not necessarily for individual open economies.

  67. Gravatar of Martin Martin
    14. March 2012 at 11:16

    “Martin, re the gym question “” your gym membership is like paying rent. You are paying for your consumption of gym/housing services.

    Building a home, just like building a gym, is an investment.”

    Same, but shorter answer as above:

    What is the difference between prepaying my gym membership to infinity and using the same amount of money to buy part of the gym?

    Now what if I prepay to infinity – 1 day? What if infinity – 2 days etc.

    If a capital good is an investment in service, then a prepaid gym membership is a capital good.

  68. Gravatar of Major_Freedom Major_Freedom
    14. March 2012 at 11:42

    ssumner:

    Spending on new homes isn’t necessarily an investment. Period. End of story. Game over. Go home. You insist that new homes are capital goods? That’s crazy. It doesn’t matter if you live in a 90 year old home. I own a 135 year old book. Does that mean my book is a “super capital good”? No, it’s still a consumer good.

    The physicality and age of a good has NOTHING to do with whether or not it is a capital good.

    As with all things economics related, an economic good being a consumer or capital good comes down to the HUMAN element. That is the standard. The standard is not “out there” in the objects themselves. A good is a consumer good if it is purchased for the purpose of NOT making subsequent sales. It is bought, and then purposefully used up by the owner for his direct utility, who ends up with nothing to show for it thereafter (that’s not pejorative, it’s descriptive). A good is a capital good if it is purchased for the purpose of making subsequent sales. It is bought, and then purposefully used up by the owner for his indirect utility, who ends up with something to show for it thereafter, typically a profit. These goods are typically capitalized as assets on a business’ balance sheet.

    Homeowers who buy homes to reside in aren’t running a business. Their homes are not a productive asset that is capitalized on any balance sheet. They are not productively used up in bringing in subsequent sales. They provide direct utility to the homeowners. On the other hand, homeowners who buy homes to “flip” them, to sell later on to further buyers at a profit, THEN the home becomes a capital good. Why? Because it goes back to the human element, it goes back to the purpose with which the purchaser buys the house. The purchaser bought the house for the purpose of making subsequent sales.

    To repeat, consumer goods and capital goods are consumer goods and capital goods not because of what they look like, nor how long they last, nor anything to do with the physicality of them in any way. It has to do with the human element, the human purpose, the purpose to which the goods are put into use by the owner.

    It doesn’t matter how long a good “lasts”. The age of a good is irrelevant. Some capital goods like iron ore last centuries, other capital goods like raw chicken used in the production of hotdogs lasts a few days.

    How many trucks? How many jetliners? Homes aren’t just capital goods, they are super capital goods, the most capital-like of all capital goods. And no, the fact that they are often owner-occupied, and not rented out, makes no difference. If you insist homes are consumers goods I will regard you as economically illiterate. You’ve been warned.

    Homes are neither consumers goods only nor are they capital goods only. The same friggin house can be either a consumer good or a capital good, depending on why the house was purchased.

    To make this sink in, consider a hammer. In your silly worldview, you’d be compelled to label a hammer as either a consumer good or a capital good, without making any reference to the human element, the purpose for why the hammer was bought, and what it is being used for. No matter what you call it, consumer or capital good, you’d be wrong, because a hammer is neither, without connecting it back to the human element, the purpose for why it is bought.

    A hammer that is bought by a construction company is an asset, and is capitalized on their balance sheet under “equipment.” It is a capital good in this situation, because the purpose of purchasing the hammer is to bring in subsequent sales, such as new office buildings, or new homes, or whatever. That same hammer that is bought by someone who is going to hang pictures on their living room wall is a consumer good, and is not capitalized on any balance sheet. It is a consumer good in this situation, because the purpose of purchasing the hammer is not to bring in subsequent sales revenues, but to be a constitutive aspect of providing utility for a direct end.

    A pick up truck that is bought by an individual for the purposes of leisure is a consumer good. That same pick up truck that is bought by a construction company to deliver materials, and used for the purposes of bringing in subsequent sales revenues, is a capital good. It becomes an asset on the business’ balance sheet. It is capitalized.

    According to your incorrect and fallacious worldview, we’d have to label the hammer and the pick up truck as either consumer or capital good according to what they look like, what they are in themselves. This is the wrong method to use, because the nature of economic goods goes back to the human element, not what the economic good looks like.

    See, your position is easily confused. What if a house was made of a temporary, shoddy material that lasted only a few weeks before becoming useless, like a ham sandwich in your refrigerator? Would the house still be a capital good? Yes? Then why not the ham sandwich too? That’s what happens when you focus on age.

    You can dispense with the hilarious stomping of your feet in calling those, who clearly know more about the nature of capital and consumer goods than you, “economically illiterate.” I will warn you that YOU are economically illiterate by labelling goods as consumer or capital according to their mere appearance, rather than their use.

    Don’t you know that economics is the science of human action, and not the science of metallurgy, or chemistry?

  69. Gravatar of Vivian Darkbloom Vivian Darkbloom
    14. March 2012 at 11:43

    @ Don Geddis

    Feel free to assume that in my example the house “invested in” is a newly constructed one.

    What is the net investment?

  70. Gravatar of Major_Freedom Major_Freedom
    14. March 2012 at 12:08

    ssumner:

    Suppose we built way too many houses in an frenzy of irrational exuberance.

    Irrational exuberance? This accusation is just the result of denying the artificially low interest rates and massive credit expansion that fueled the housing bubble.

    You can’t call investors and homeowners “irrational” for responding rationally to prevailing low interest rates and large globs of cheap money from the banking system. How in the world are investors and homeowners supposed to know the actual state of the economy’s capital and real savings? In a free market, responding to prevailing interest rates and availability of credit cannot possibly generate a huge housing boom, because the more resources that get plowed into housing, the higher interest rates elsewhere become, which will soon put a stop to any further resource reallocation. With the central bank preventing market interest rates from occurring, there was no price signal for investors or homeowners to stop. The price system is the only thing that a division of labor economy has for individuals to rationally coordinate their disparate actions with everyone else.

    “Irrational exuberance” is nothing but the corpse of Keynes’ “animal spirits” making a reappearance. When economists such as yourself who are entirely ignorant of the concept of economic calculation, of how the price system being hampered by the central bank prevents factor owners from allocating resources efficiently, in accordance with real savings rates and real consumer preferences, begin to ask yourselves how it is that a housing boom occurred, you have no clue and you have to invoke mystical, undefined, fuzzy and arbitrary concepts like “animal spirits”, or “irrational exuberance.”

    There is no such thing as irrational exuberance in the free market. The more bad decisions made by people, the stronger the price signals get that serve to send signals to investors to reverse those bad decisions. With a hampered price system, as exists with central banking, those signals become distorted and investors are no longer served with correct price information. They are served with distorted price information that misleads investors as a class into making the wrong decisions without being punished for it until it’s too late.

    What then? Let’s first consider a closed economy model. We should increase non-housing production. We should probably also increase total production, as poorer people generally want to work harder.

    Notice your dictatorial, Soviet Commissar language. “We should” build this, “we should” build that. You say this completely independent of how it is people are even able to know when to do this and when to do something else. You market monetarists are not presenting investors with a free market price system, and so declaring ex cathedra that investors should build more houses by fiat decree, or fewer houses by decree, is the result of you not understanding that the price system COULD have done this for everyone, if only the central bank stopped messing with market interest rates and money production.

    Since you are completely ignorant of the concept of economic calculation, and your advocacies of central banking leads to so many problems, you are relegated to having to “fix” things by fiat decree. “Thou shalt build more non-house goods, and thou shalt build fewer houses, to fix the problem of too many houses.” Meanwhile, all along, which never stopped, the central bank is bringing about more investment errors, and so we will simply end up in the same spot once again of you being completely ignorant, and you chalking the problems up to “irrational exuberance” once again, even though once again investors were just responding rationally to prevailing interest rates and credit expansion.

    But let’s suppose I’m wrong, and use the worst-case scenario for my argument. No extra work effort. In that case, if we decide to produce say $400 billion less in housing, we might decide to build another $400 billion in non-housing goods, i.e. consumer and non-housing capital goods (private or government.) It might be another $250 billion in business capital and another $150 billion in consumer goods.

    Who in the world is this “we” you are talking about, and why would ANY producer build fewer homes or more of other goods, unless it is relatively more profitable to do so? Investors chase profits. They don’t chase to stabilize the economy. In a free market, profit chasing does stabilize the economy, but the way you’re talking makes it seem like investors have some sort of moral obligation to invest according to your ex cathedra decree. You’re hiding this dictator wannabe mentality in your usage of the word “We.”

    The market doesn’t work the way you believe it works. Investors chase profits. When interest rates are lowered by the central bank, do you know what they tend to do? They don’t all know that it’s all a rube of the central bank. They don’t know what the true interest rates are. So they invest according to what the rates nominally are. With lower interest rates, they tend to invest in more capital intensive projects at the expense of other less capital intensive projects. This is a problem if consumers aren’t releasing enough scarce factors into the capital goods stages by way of reducing their present consumption and making it unprofitable to invest as much factors into the production of present consumer goods.

    You have no way of reconciling your ostensible free market demeanor, with your clearly dictatorial “We should build more of this and we should build less of that” mentality. Let the people decide, and let them decide by way of operating in a free market money standard.

    Drop the NGDP fetishism. It is obviously clouding your brain.

  71. Gravatar of Major_Freedom Major_Freedom
    14. March 2012 at 12:19

    ssumner:

    Thus the optimal response to a spending frenzy on housing isn’t tightening our belts, it’s loosening our belts.

    Ah yes, the same old idiotic “spend more money” response. People “should” spend more money. Even if they’re in huge debts, they are obligated to keep this unsustainable thing going by spending more money and not getting out of debt. Brilliant.

    The housing frenzy involved too much investment, and hence too much saving.

    Non sequitur. You are fallaciously presuming that all investment in our inflationary economy is backed by voluntary savings. That’s false. Yes, there was too much investment in housing, but that’s not because there was too much saving. It’s because there was too much credit expansion that boosted the demand for houses without there being a corresponding increase in real voluntary savings. It is precisely because investment in housing exceeded voluntary savings that went into housing, that caused the housing bubble, or what you ignorantly call “irrational exuberance.”

    Yes, saving really, really does equal investment.

    No, it really, really, REALLY does not equal investment. If I printed $100 million in my basement, and then lent it out at next to zero percent interest, to someone who goes on a capital goods buying spree, then sorry, but investment exceeds voluntary savings by exactly $100 million. I did not save that $100 million out of any prior revenues earned in production. No, I simply printed it. In order for investment to equal savings, I had to have earned that $100 million in revenues/sales/wages prior. Because I didn’t, the result is investment exceeding voluntary savings.

    To make up for too much saving, we need to save less and spend more. We should have had a monetary policy that makes that happen, but of course we didn’t.

    And one idiotic assumption leads to another and another and another.

    Your worldview is proof that starting with an irrational foundation invariably leads to making irrational conclusions, this time the silly arbitrary notion that people MUST, not saying how, but they MUST, arbitrarily “spend” more. On what? Who cares, as long as NGDP goes up. Individuals are to be sacrificed to the almighty NGDP aggregate.

  72. Gravatar of Brito Brito
    14. March 2012 at 12:32

    Major_Freedom:

    “Irrational exuberance? This accusation is just the result of denying the artificially low interest rates and massive credit expansion that fueled the housing bubble. ”

    Every empirical study ever basically shows that low interest rates would never, in a million years cause the equilibrium price of housing and housing securities to shoot up to such ridiculously high values that occurred in the last decade. Fundamentals absolutely do not explain the rise in prices. I’ve literally being doing this over the last year with statistics that go back to 1890, interest rates are absolutely not a sufficient explanation. I know that Austrian economists absolutely hate empiricism, reality, being honest and objective and being scientific, but this is just ridiculous, even for extremely idiotic insane maniac Austrians.

  73. Gravatar of Major_Freedom Major_Freedom
    14. March 2012 at 12:42

    Every empirical study ever basically shows that low interest rates would never, in a million years cause the equilibrium price of housing and housing securities to shoot up to such ridiculously high values that occurred in the last decade.

    You mean every empirical study that presumes the model “it cannot happen” is true.

    Empirical data by itself is meaningless without an a priori theory to interpret it. Every single empirical study that presumes the model “it can and does happen” is true, shows the opposite of what you’re claiming.

    Fundamentals absolutely do not explain the rise in prices.

    I know. Central bank controlled interest rates are not market fundamentals.

    I’ve literally being doing this over the last year with statistics that go back to 1890, interest rates are absolutely not a sufficient explanation.

    You will never see empirical inconsistency in what you are claiming if the chosen model presumes the theory true.

    I know that Austrian economists absolutely hate empiricism, reality, being honest and objective and being scientific

    LOL, I know that you don’t understand Austrian economics, that we don’t “hate” empirical data, we just know how to correctly approach it, and as for this “hate reality, honesty, and being objective”, that is just mindless antagonistic nonsense.

    but this is just ridiculous, even for extremely idiotic insane maniac Austrians.

    You need one more pejorative adjective then you’ll convince me.

    PS artificially low interest rates generated from Fed intervention, was a necessary component in the housing bubble, and a sufficient component in the boom and bust.

  74. Gravatar of Martin Martin
    14. March 2012 at 12:45

    Brito,

    Are you familiar with the “treadmill effect” or what others would call “momentum”? It is perfectly possible for values to depart from ‘fundamentals’ for short periods of time, when there is then a push in a particular direction, you can get a self-fulfilling belief that feeds on itself.

    Bank-runs work in a similar fashion, see for example the Diamond-Dybvig model of bank-runs (1983?).

  75. Gravatar of Brito Brito
    14. March 2012 at 12:49

    “You mean every empirical study that presumes the model “it cannot happen” is true.”

    The models assumes no such thing, the models assumes that interest rates, as well as a host of many many other factors, have a role to play in explaining the price of housing. I myself explicitly looked at hundreds of different specifications, none of them show that the house prices were correctly priced according to fundamentals (including interest & mortgage rates etc…), literally none of them.

    “that is just mindless antagonistic nonsense.”

    I know it is, I’m doing it deliberately for reciprocal reasons, because I have never, ever, ever, ever, ever, ever, ever seen a post from people like you that wasn’t extremely heavy in antagonistic rhetoric, filling out all the diagnostic check-boxes for insane crank. Which means I intensely distrust you and your sort.

  76. Gravatar of Brito Brito
    14. March 2012 at 12:55

    Martin

    Yes, statistically speaking house prices depart from fundamentals all the time all over the series, I’m using error correction models here. However once, as you say, this effect becomes self fulfilling, that is by definition bubble behaviour, nothing to do with fundamentals.

  77. Gravatar of Major_Freedom Major_Freedom
    14. March 2012 at 12:55

    Brito:

    The models assumes no such thing

    Yes, they do. Go back and look again.

    the models assumes that interest rates, as well as a host of many many other factors, have a role to play in explaining the price of housing.

    And that “presumed” role is that they cannot do it.

    I myself explicitly looked at hundreds of different specifications, none of them show that the house prices were correctly priced according to fundamentals (including interest & mortgage rates etc…), literally none of them.

    I already said I agree that house prices were not due to market fundamentals. The nominal interest rates that existed were, and still are, a product of Fed intervention.

    I know it is, I’m doing it deliberately for reciprocal reasons, because I have never, ever, ever, ever, ever, ever, ever seen a post from people like you that wasn’t extremely heavy in antagonistic rhetoric, filling out all the diagnostic check-boxes for insane crank. Which means I intensely distrust you and your sort.

    More mindless antagonistic nonsense.

    You keep this up, and I’ll consider you as crazy as Morgan.

    Speaking of cranks, you are a monetary crank. You don’t have the slightest clue what it is, what the implications of it are, nor the effects of central banks manipulating money and interest rates. You’re utterly clueless. I have never, ever x 5 seen an Austrian critic that even understands Austrian economics. I think Bryan Caplan is the only critic who comes even within a light year of it. The rest of you rabble rousers are just ignorant.

  78. Gravatar of Brito Brito
    14. March 2012 at 12:59

    “Yes, they do. Go back and look again.”

    Nice rebuttal, not.

    “And that “presumed” role is that they cannot do it.”

    No it isn’t, Jesus Christ you are clearly utterly clueless if you think this. And I’m not just using models from existing literature, I’m using specifications I empirically derived myself, and I am TELLING you that interest rates in this specification have a statistically significant effect on house prices.

  79. Gravatar of Major_Freedom Major_Freedom
    14. March 2012 at 13:02

    Brito:

    Nice rebuttal, not.

    It was exactly on par with yours.

    No it isn’t

    YES, IT IS.

    Jesus Christ you are clearly utterly clueless if you think this.

    And I’m not just using models from existing literature, I’m using specifications I derived myself, and I am TELLING you that interest rates are presumed to not have the effect on house prices that they actually do.

  80. Gravatar of Major_Freedom Major_Freedom
    14. March 2012 at 13:05

    Brito:

    I bet you a million dollars than in your laughably pedantic empirical work, you didn’t take into account the quantity of credit expansion 2001-2006 did you? No, of course you didn’t. That would have been correct.

  81. Gravatar of D R D R
    14. March 2012 at 13:20

    “No, it really, really, REALLY does not equal investment. If I printed $100 million in my basement, and then lent it out at next to zero percent interest, to someone who goes on a capital goods buying spree, then sorry, but investment exceeds voluntary savings by exactly $100 million. I did not save that $100 million out of any prior revenues earned in production. No, I simply printed it. In order for investment to equal savings, I had to have earned that $100 million in revenues/sales/wages prior. Because I didn’t, the result is investment exceeding voluntary savings.”

    Actually, the $100 million loan is really really REALLY a red herring. To the extent that the $100 million *purchase* raised investment, it also raised income and therefore savings by the same amount.

  82. Gravatar of Brito Brito
    14. March 2012 at 13:24

    Major_Freedom, I looked at measures of ‘credit expansion’ (being careful to not be too endogenous with housing securities, which are a form of credit), as well as broader measures such as m3.

  83. Gravatar of Major_Freedom Major_Freedom
    14. March 2012 at 13:38

    Brito:

    Major_Freedom, I looked at measures of ‘credit expansion’ (being careful to not be too endogenous with housing securities, which are a form of credit), as well as broader measures such as m3.

    And what presumed impact did you have for these in your model?

    D R:

    Actually, the $100 million loan is really really REALLY a red herring. To the extent that the $100 million *purchase* raised investment, it also raised income and therefore savings by the same amount.

    Yeah, AFTER investment already exceeded savings initially, and in the real world with central banking, perpetually exceeding it!

    You’re talking about subsequent respending and saving out of incomes thereafter via the multiplier. That is a red herring. You might as well say stealing money doesn’t result in losses, because as soon as the thief spends the money, others get a gain.

    My argument about the initial investment exceeding voluntary savings, is not a red herring, and is crucial to understanding the destruction that is unleashed by central banks bringing about more investment than what would have otherwise been financed out of voluntary savings only.

  84. Gravatar of Martin Martin
    14. March 2012 at 13:38

    Brito,

    I guess that nets you a million dollars, just beware that MF doesn’t print it up in his basement 😛

  85. Gravatar of Brito Brito
    14. March 2012 at 13:51

    Major Freedom, you don’t have to presume anything. For instance, you can estimate an empirical relationship from before the bubble, and then see how this relationship holds up after the bubble. Now assumptions necessary.

  86. Gravatar of Brito Brito
    14. March 2012 at 13:51

    No*

  87. Gravatar of Brito Brito
    14. March 2012 at 13:56

    During the bubble*. Anyway I’m going to bed.

  88. Gravatar of Major_Freedom Major_Freedom
    14. March 2012 at 14:02

    Brito:

    Major Freedom, you don’t have to presume anything. For instance, you can estimate an empirical relationship from before the bubble, and then see how this relationship holds up after the bubble.

    Brito, that would be presuming the same constant mathematical relationship holds over time. That isn’t the case in the real world market.

    Before the housing bubble, there was a boom in the dotcom/Nasdaq market.

    One of the crucial aspects of inflation is that while credit expansion along with lower interest rates does tend to increase asset/capital goods prices sooner relative to consumer prices, there is no fixed and rigid relationship for, say, housing, over time. It’s not true that credit expansion will always engineer a housing boom. But we can say that the housing boom was caused by credit expansion (among other government policies). Humans aren’t robots. The positivist way you are approaching the economy presumes automaton robots. Humans make choices. That means there are no constancies you will expose by looking at historical data. Historical economic data is past and settled, never to be repeated.

    The next credit expansion bubble is, in my judgment, concentrated not only in the housing sector (since the central bank never let the full corrections occur), but now in the sovereign debt market (since that is where much of the crap was dumped).

    Every time there is a period of credit expansion, it never affects the economy in the same exact way, so by you looking at pre and post housing bubble, you are not able to interpret how credit expansion affects the economy.

    It would be like you looking at the lineups at movie theatres pre and post “The Hobbit” premier, and then concluding that if “The Hobbit” is continually re-released, we should expect to see the same lineups every time.

  89. Gravatar of Greg Ransom Greg Ransom
    14. March 2012 at 14:03

    Keynes tells us directly that the savings = investment idea comes from Mises.

    Hayek showed that Keynes’ account of savings = investment is utterly incoherent and self-contradictory, and utterly fails to understand the economics 101 of Mises and Bohm-Bawerk and Jevon’s who h underlies the whole topic.

    Contemporary economists are on all fours with Keynes in being incompete in this domain of economic science and the logic of choice.

  90. Gravatar of Major_Freedom Major_Freedom
    14. March 2012 at 14:11

    Greg:

    Keynes tells us directly that the savings = investment idea comes from Mises.

    Keynes himself believed that savings = investment and that savings != investment, because he deftly switched the meaning of “saving”, probably without even himself noticing. He wrote:

    “that the excess of income over consumption, which we call saving, cannot differ from the addition to capital equipment which we call investment”

    Then after switching to another meaning of “saving”, this time “unspent money”, he writes about:

    “a chronic tendency throughout human history for the propensity to save to be stronger than the inducement to invest”

  91. Gravatar of Greg Ransom Greg Ransom
    14. March 2012 at 14:13

    Lee, Keynes failed to comprehend how increasing savings by choosing a longer period of production processes promises greater output without sacrificing consumer spending in the present.

    He was simply not educated in this domain and Hayek repeatedly reports — it’s like someone who never learned predicate logic — Keynes was incorrect because he didn’t know it and he didn’t know it because he never learned and he never learned it because he was never taught it.

    I won’t do the history of though piece here showing how Keynes failure to comprehend capital theory 101 was tied directly in Keynes to his paradox of thrift arguments, but you can pick this up on your own if you look at it.

  92. Gravatar of D R D R
    14. March 2012 at 14:14

    “Yeah, AFTER investment already exceeded savings initially, and in the real world with central banking, perpetually exceeding it!”

    Uh… what? I said nothing at all about “subsequent respending” I’m talking only the act of purchasing $100 million in capital goods. I’m NOT talking about any additional spending it might induce.

    Even if your building is such an eyesore that it causes the sun to explode and consume the Earth, thereby reducing all economic activity to zero, your actual investment contributed $100 million to investment and to GDP.

  93. Gravatar of Major_Freedom Major_Freedom
    14. March 2012 at 14:22

    Uh… what? I said nothing at all about “subsequent respending” I’m talking only the act of purchasing $100 million in capital goods. I’m NOT talking about any additional spending it might induce.

    Well I gave you the benefit of the doubt when you said:

    “To the extent that the $100 million *purchase* raised investment, it also raised income and therefore savings by the same amount.”

    That you weren’t silly enough to conflate a growth in nominal incomes with a growth in savings, because that would mean you would be equivocating cash balances and savings.

    Savings the way I treated it in my argument is abstaining from consuming. It is not the mere holding of money. I do not consider someone to be “saving” if they take their paychecks from their employer, cash them at a bank, then go the grocery store to buy groceries. I would not consider that an act of saving just because there was a time period in there where the person held money on their person and were not spending it instantly after receiving it. I would only consider that person to be saving if they took their earnings and abstained from spending that money on consumption, making funds available for investment instead. That would be saving.

    In your definition, every single earner of money is an instant saver, and those who print money and increase people’s cash balances, are bringing about more savings. That’s nonsense. Savings are brought about when someone earns money and abstains from consuming it, not when someone’s cash balance increases because someone else printed money and gave it to them.

  94. Gravatar of Brito Brito
    14. March 2012 at 14:25

    “Brito, that would be presuming the same constant mathematical relationship holds over time. That isn’t the case in the real world market.”

    Sure, which it was why it is only one of many many different estimation methods used. These are the empirical facts. Without any assumptions whatsoever, variations in interest rates, money supply, population growth, income per capita etc etc… do NOT explain variation in house prices over this period. Fact, end of story. Your theories have not a single shred of empirical support. If credit expansion and interest rates are wholly responsible for the bubble, then variation in these variables would wholly explain variation in house prices over the bubble period, they don’t, your theory fails empirically to comprehensively explain the housing bubble.

  95. Gravatar of Major_Freedom Major_Freedom
    14. March 2012 at 14:27

    D R:

    Even if your building is such an eyesore that it causes the sun to explode and consume the Earth, thereby reducing all economic activity to zero, your actual investment contributed $100 million to investment and to GDP.

    It only “contributed” to devaluing other people’s money, and not bringing about the introduction of a single new capital good, indeed any good.

    Printing $100 million and then investing with it only raises the prices of capital goods from what they otherwise would have been had capital goods been sold into a lower demand (one that is $100 million less).

    I didn’t contribute to real GDP, only nominal GDP, which says nothing about how much real wealth is there that boosts people’s standard of living.

  96. Gravatar of Doc Merlin Doc Merlin
    14. March 2012 at 14:32

    “That’s crazy, I live in a 90 year old home. How many factories last for 90 years? How many trucks? How many jetliners? Homes aren’t just capital goods, they are super capital goods, the most capital-like of all capital goods.”

    “Why does everyone else get this wrong? ”

    Austrians don’t. They have been saying that homes are capital goods for /ages/.

  97. Gravatar of Major_Freedom Major_Freedom
    14. March 2012 at 14:37

    Brito:

    Sure, which it was why it is only one of many many different estimation methods used.

    You mean one of many many constant relationship methods used, haha.

    These are the empirical facts.

    You mean this is the historical data, which I will assume is correct, and I will agree with you 100%. I will agree on the numbers, the events, the data. Where I will differ from you is the interpretation of the historical data, because you are approaching the data from a theory or set of theories that I find to be inherently flawed.

    Without any assumptions whatsoever, variations in interest rates, money supply, population growth, income per capita etc etc… do NOT explain variation in house prices over this period. Fact, end of story.

    That is IMPOSSIBLE. You cannot possibly observe empirical data, and then without any assumptions (theories) “whatsoever”, come up with a conclusion that says something real about the market. You’re fooling yourself.

    What you are ACTUALLY doing when you say “without any assumptions”, is that you are introducing constant assumptions of the form “if interest rates decrease by X%, then house prices should increase by Y%”. You find no such constancy exists, and so you conclude, based on that ASSUMPTION, that interest rates had nothing to do with the housing boom!

    You’re not doing economics. You’re fiddling with numbers using crap theory.

    Your theories have not a single shred of empirical support.

    My theory has 100% empirical consistency. My theory is NOT the FALSE constancy relation theory that you in your model are presuming has to be true before I am right. I am not using those theories!

    If credit expansion and interest rates are wholly responsible for the bubble, then variation in these variables would wholly explain variation in house prices over the bubble period

    NO! You are again fallaciously presuming a constancy relation between the variables. By saying “the variation in these variables would wholly explain variation in house prices”, what you are doing is saying there should be a constant co-variance between interest rates and house prices. That is NOT my theory, that is not what has to be true before I am right, and it is quite literally the OPPOSITE of what I am saying. You could not be more wrong.

  98. Gravatar of Major_Freedom Major_Freedom
    14. March 2012 at 14:38

    Doc Merlin:

    Austrians don’t. They have been saying that homes are capital goods for /ages/.

    That isn’t true, Doc. Austrians don’t hold houses to be either always a capital good or always a consumer good.

  99. Gravatar of Brito Brito
    14. March 2012 at 14:52

    “What you are ACTUALLY doing when you say “without any assumptions”, is that you are introducing constant assumptions of the form “if interest rates decrease by X%, then house prices should increase by Y%”. You find no such constancy exists, and so you conclude, based on that ASSUMPTION, that interest rates had nothing to do with the housing boom!”

    No, I’m not doing that in the slightest. You clearly have absolutely no experience in statistics.

    “what you are doing is saying there should be a constant co-variance between interest rates and house prices. ”

    No, I am not saying that at all. In fact these results are largely heteroskedastic.

  100. Gravatar of Brito Brito
    14. March 2012 at 14:59

    Seriously going to bed now.

  101. Gravatar of dwb dwb
    14. March 2012 at 15:31

    @major

    if low nominal rates themselves were the cause of the housing price runup then we would be having the biggest price runup in history since 30y rates are at their historical lows.

    credit expansion is a function of lending standards, not merely nominal rates.

    many people in the comments section have actually done the statistical heavy lifting, and we are not all as gifted intellectually as you. I realize the complex math is tough to post on a blog, but “every empirical study” says so i am sure its no problem to link to them through google scholar and post a few FRED graphs, since they have all the data.

    otherwise, if “every empirical study” actually did say so it would a) not be a theory and b) would be generally accepted in the housing and banking industry, which it is not.

    in fact, low nominal rates are associated with low, not high demand. prices tend to follow sales (i.e. demand) not rates.

  102. Gravatar of Jim Glass Jim Glass
    14. March 2012 at 16:51

    I own a 135 year old book. Does that mean my book is a “super capital good”? No, it’s still a consumer good.

    If you sell your book for more than its cost to you, you will owe capital gain tax on it. If you are honest enough to report it. The IRS will definitely treat it as a capital asset. (Subject to a special 28% capital gain tax rate, not the normal 15%.) If fact, it will insist!

    If you compile a personal balance sheet, such as to demonstrate your credit rating, and your 135-year old book has a significant value such as a collectible, your accountant will include it on your balance sheet as a capital asset. He will agree with the IRS about the book being a capital asset. Because it is a capital asset.

    If the book has no resale value, because after an ancestor read it 134 years ago it was of no further use or value to anyone, but it is still in your garage which hasn’t been cleaned out in 130 years, then its value has long since been consumed and it is nothing, accounting-wise. Neither the IRS nor your accountant will care.

  103. Gravatar of dtoh dtoh
    14. March 2012 at 17:46

    Scott,
    You said;

    “To make up for too much saving, we need to save less and spend more.”

    I think you meant to say we need to “consume” more.

  104. Gravatar of Phil Phil
    14. March 2012 at 21:31

    At the risk of appearing economically illeterate, why can’t a house be considered both a capital and consumption good? It’s clear that it’s a capital good, by it seems self-evident to me that residents are consuming housing, otherwise they would be indifferent as to whether or not they are living inside it.

  105. Gravatar of Spending isn’t consumption « Economics Info Spending isn’t consumption « Economics Info
    14. March 2012 at 22:03

    […] Source […]

  106. Gravatar of Lorenzo from Oz Lorenzo from Oz
    14. March 2012 at 23:04

    Martin: The value of an asset is the Cash Flow from that asset discounted to infinity. Let’s assume Cash Flow is the same each period, then CF/r = Value of the Asset. Assets can also be stores of value, so your pricing does not quite work. I have actually suggested folk not be permitted to borrow against assets beyond their cash flow value precisely because prices can surge rather beyond that.

    Now let’s assume a perfectly competitive gym membership market. If I prepay my monthly gym fees for infinity, how is this economically different from fractional ownership? It gives you no control apart from use of your membership.

    f your definition of a capital good is that it yields services Beyond one production cycle: that was taken as read. Because, otherwise, it is an intermediate good.

  107. Gravatar of Lorenzo from Oz Lorenzo from Oz
    14. March 2012 at 23:06

    Martin: and before you go there, the gym membership is purchasing the services, the gym is providing them.

  108. Gravatar of Martin Martin
    15. March 2012 at 00:37

    Lorenzo,

    1. Discounted Cash Flow is a pretty standard way of doing valuations. Besides, re-write the equation and you get CF = r * Asset. This is the income from capital in the household budget constraint.

    2. When you lease equipment, ownership can remain with the finance company. Are you telling me that because the lessee has no control rights, the lease itself is not classified as capital on his or her balance sheet?

    3. Regarding the gym membership, leasing a tractor is purchasing the services from the finance company, the tractor however is still capital on the balance sheet of the farm. You need to have a better definition of what is a capital good if you are to exclude gym memberships.

  109. Gravatar of Lorenzo from Oz Lorenzo from Oz
    15. March 2012 at 02:43

    Martin: I believe you are arguing accountancy and I am arguing economics, not the same thing.

    On valuation, I can show you lots of Australian houses whose price exceeds their discounted cash flow. If you suggest to me they are probably over-priced, I would agree with you. But those are still their current prices.

    Of course leasing a whole something gives you rights over it. But you do not lease the gym, you buy rights to use it (along with a whole lot of other people). How you finance such a lease is a separate matter that does not change something from being a capital good.

    There is a difference between purchasing services, and purchasing (or leasing) something that provides services. I have no doubt that a tractor is a capital good, just as a gym is. How can we tell? Because it provides services that are not used up in the process of production. And the gym membership is not providing services (the gym does that), it is purchasing the services (of the gym).

    A capital good is a produced means of production that provides goods and/or services that are not used up in the process of production. Tractors and gyms are capital goods. Gym memberships are not: that is purchasing the services of a capital good. How you finance something does not change this.

    There are assets which are not capital goods, but that is a whole other issue.

  110. Gravatar of Mike Sax Mike Sax
    15. March 2012 at 02:52

    Scott whenever you get going on this whole definition of savings, investment, consumption and savings jag you lose me. I don’t think it’s because I’m especially obtuse.

    To be sure this is nothing new in econoimcs, who can forget the tortured debates between Keynes and Hayek in the early 30s. I’m thinking partiucarly of there correspondence, parsing the defintion of “savings.”

    To this day who knows what Hayek was talking about when he talked about savings to say nothing of “roundabout” production.

    Back to you, I’ll just list a couple things you say that I’m not sure how to take.

    “Spending on new homes isn’t consumption, it’s investment. Period. End of story. Some commenters will insist that new homes are not capital goods. That’s crazy, I live in a 90 year old home. How many factories last for 90 years? How many trucks? How many jetliners? Homes aren’t just capital goods, they are super capital goods, the most capital-like of all capital goods. And no, the fact that they are often owner-occupied, and not rented out, makes no difference. If you insist homes are consumers goods I will regard you as economically illiterate. You’ve been warned.”

    Ok, forewarned is forearmed but I seem to remember spending on housing often referred to as consumption by very good economists. I can’t think of exact for instances at the present but it’s not at all uncommon. How do I know they’re illiterate rather than you? I’m asking not declaring.

    “Krugman’s right that we should not react to the housing bust by spending less. But this is not because the individual family is unrepresentative of the macroeconomy. What’s right for the individual is right for the overall economy.”

    The idea that the federal government that can print endless money-obviously at some level there’s the risk of hyperinflaton but that’s a long threshold-and an individual family with limite funds and who if they try to spend more than is in their bank account, their check bounces sounds entirely wrong. To me “we” and the governement are two wholly differnt entities.

    It’s not “what the government does we should also do” or vice versa but really the opposite. When we-and the private sector more widely-have little to spend that’s when we want th government to spend.

    It’s when we have much to spend that the government need not spend much.

    I do agree with you about the account balance. You;re right that The Day of Reckoning is always around the corner but never arrives. I would add to this also the budget deficit which we are always going to be punished by the bond vigilantes-this day never arrives either.

    However, when you say this:

    “Why does everyone else get this wrong? Perhaps it’s nothing more than confusing the terms ‘spending’ with ‘consumption.’ One can spend on either consumer or investment goods. When you spend on investment goods, it’s called saving.”

    You start to lose me again. First of all if everyone but you says something there is more than one interpretation that everyone is ignorant but you.. LOL

    More to the point you say that you spend on either consumer goods or ivnestment and that if you spend on ivestment goods it’s saving-what then is money that you neither spend on consumption goods or investment goods? What is that?

    That’s what I, and I think many people, even from what I’ve read in the past many Market Monetarists call saving.

    However you reserve the term saving to spending on investment goods. At this point it’s like the fairytale of the man who went crazy when he saw the woman first blow on her hands ot make them warm and then blow on her soup to make it cold, “Aiieee! Hot and cold from one mouth, it;s the Devil!”

    spending on investment goods would seem not to be saving as it’s called “spending on investment goods” not “saving on investment goods”

    The lingiustic twists are a bit unwieldly. To me this is how I understand it and I believe Bill Woolsely said this before-someone did and I think it was him.

    There is savings. There is consumption. There is investment. None of these things are the ssame thing. With you investment and savings mean the same thing so we have an extra redundant word.

    You can either save your money or you can spend you rmoney. The money you spend will be on either consumption or investment goods. That’s my understanding of it. I think many understand it this way.

    I do like your over all point that we should be loosening our belts rather than tightening though I’m not sure we entirely agree on what we mean by “loosening our belts.”

  111. Gravatar of Mike Sax Mike Sax
    15. March 2012 at 03:40

    Then, Scott, when you say this you totally throw your whole post for a loop at least as I understand it:

    “I still think we save too little. But for tax distortion reasons, not because of the housing bubble.”

    Preveiously you seemed to say the total opposite of this when you said:

    “To make up for too much saving, we need to save less and spend more.”

    Totally perplexed how we both have too much saving and we don’t save enough. I’m perplexed.

  112. Gravatar of Mike Sax Mike Sax
    15. March 2012 at 03:41

    So much so that I wrote perplexed twice!

  113. Gravatar of Tom Tom
    15. March 2012 at 03:43

    Scott,
    Renting a home is not investment, it’s consumption.

    A big part of the price of a home is the rental equivalent.

    Another part is the “ownership premium” — the ability to make arbitrary changes.

    A third part is the investment/ speculation. Those who believe home prices are going up, will speculate/invest on the increase, expecting … a return on investment. As long as the ROI of home buying was positive year on year, the part of home prices which was investment/speculation was increasing.

    With the house price collapse, the home “investors” have had their investment wealth wiped out.

    Their rental value has decreased as well, because rents decreased with lower house prices.

    The ownership premium remains 🙂

    House prices are never “end of story”, because so much of so many individual’s wealth, included expected wealth, goes into housing.

    If the banking system loses $10 Trillion, those loses are highly concentrated in the owners & lenders (investors) in the banks. If housing prices decline by $10 Trillion, the individual wealth effects, as well as the massive mal-investment adjusments, hugely change, or freeze, the economy. It’s far more than if a dot.com bubble pops with $10 T in losses (tho I’m pretty sure the dot.com pop was far less of actual investment lost).

    Thus, your #1, as “Spending on new homes isn’t consumption, it’s investment. Period. End of story.” is too simplistic.

    Your #2 is correct: “we decide to produce say $400 billion less in housing, we might decide to build another $400 billion in non-housing goods, i.e. consumer and non-housing capital goods (private or government.)” … we might.

    But who do YOU know who is increasing production, besides Apple? (see IPhones and Oil by Karl Smith
    http://modeledbehavior.com/2012/03/14/iphones-and-oil/ )

    This is where Kling is more relevantly correct — the entrepreneurs who might want to increase production have less ability to invest, because of their own personal wealth loss in housing, and it’s less clear to them where to invest.

    Unfortunately, it was “clear” to a huge number of investors after the dot.com bubble that the safe place to invest was … AAA rated MBS paper & CDS/CDOs to support more housing.
    Since US house prices always go up (for 20-40 years).

    Your #3 is totally correct; like #4 & #5.
    “But we’ll still want to loosen our belts by saving less. Why does everyone else get this wrong?” — because while it is better for society and workers to spend more, most responsible individual spenders have already suffered a huge unexpected negative lifetime wealth reduction in house price declines. They were both oversaving (investing/speculating) in homes AND overspending on vacations, cars, eToys, clothes, and especially home furnishings — whatever you consider as consumption, the pre-2006 spenders were overconsuming according to their own internal desired lifetime consumption smoothing.

    Expand the supply of money, as you argue, is still the best monetary response. But neglecting or dismissing the micro wealth effects of house price declines weakens your argument.

    Had the “fiscal stimulus” be directed at homeowners, by a 90% tax credit in all house payments (interest and principal), for instance, the wealth effect of the house investors would then go up to support more non-house consumption.

  114. Gravatar of JL JL
    15. March 2012 at 03:51

    Scott,

    Be gentle, not all of your readers are economists.

    The first sentence on Wikipedia/Investment says:
    “Investment has different meanings in finance and economics.”

    There is a reason why, in the personal finance world, housing is said to be consumption.

    During the sub-prime crisis clueless (i.e. actually economically illiterate) buyers were told that their McMansion was an investment.

    They were not informed that their investment could have a negative ROI.

    To get a high ROI on a house it must be cheap to buy, cheap to finance, centrally located (to minimize commuting times) and cheap to maintain.

    As soon as you deviate from these norms you will be making a poor investment, with low or negative ROI’s.

    And in informal speech money that is lost is “consumed”.

    (Obviously, moldy, foreclosed suburban homes will not be occupied for 90 years.)

  115. Gravatar of D R D R
    15. March 2012 at 04:44

    Major says:

    “Printing $100 million and then investing with it only raises the prices of capital goods from what they otherwise would have been”

    Now who is going beyond the actual transaction and relying on secondary effects? You are *assuming* that everyone raises prices on account of the investment. That may be true, but that doesn’t change the fact that S=I.

    Nor does it matter if there is 100% crowding out of other investment. In that case there is no net investment, no net change in income, and no change in savings. It’s still true that S=I.

  116. Gravatar of Martin Martin
    15. March 2012 at 04:55

    Lorenzo,

    “Martin: I believe you are arguing accountancy and I am arguing economics, not the same thing.”

    I sincerely doubt that that is the difference here.

    “On valuation, I can show you lots of Australian houses whose price exceeds their discounted cash flow. If you suggest to me they are probably over-priced, I would agree with you. But those are still their current prices.”

    This can have all sorts of reasons. Houses can exceed their rental equivalent for all sorts of reasons, for example tax policy. You’d have to include that in your model.

    Another reason is that the prices you are referring to are based on comparable houses sold in the past.

    I don’t see what your point is with this though?

    “Of course leasing a whole something gives you rights over it. But you do not lease the gym, you buy rights to use it (along with a whole lot of other people). How you finance such a lease is a separate matter that does not change something from being a capital good.”

    You can also have fractional leases. A lease, like a gym membership gives you rights to use it. A fractional lease, like a gym membership gives you rights to use it with a whole bunch of other people.

    None of these however are relevant when it comes to whether something is a capital good. An investment in housing is therefore not a capital good because it provides housing services.

    “There is a difference between purchasing services, and purchasing (or leasing) something that provides services.”

    This distinction is simply not relevant for the definition of a capital good. Imagine buying a washing machine and going to the laundromat everyday. Prepaying for it in any form, doesn’t make it a capital good.

    “A capital good is a produced means of production that provides goods and/or services that are not used up in the process of production. Tractors and gyms are capital goods. Gym memberships are not: that is purchasing the services of a capital good. How you finance something does not change this.”

    No. A capital good is purely an input in production. How many periods it lasts, who owns it, that it provides services or goods, is all irrelevant.

    When you write down a model the only thing you need to know about a good for it to be a capital good, is that it is part of the K in the production function F(K,L).

  117. Gravatar of D R D R
    15. March 2012 at 05:01

    … part of the problem is confusing an actual transactional history with contrasting counterfactuals.

    If I outbid you, say, then I spend $100 million instead of you. That’s only a question of which one of us is responsible for the transaction, not whether or not the transaction takes place.

    Similarly, in any possible history, S=I at every point in time. It doesn’t matter if in one history S and I are higher in one history than another. The fact is, if you follow production and expenditures in any given period, S=I at every point in time.

  118. Gravatar of Major_Freedom Major_Freedom
    15. March 2012 at 05:26

    Brito:

    “What you are ACTUALLY doing when you say “without any assumptions”, is that you are introducing constant assumptions of the form “if interest rates decrease by X%, then house prices should increase by Y%”. You find no such constancy exists, and so you conclude, based on that ASSUMPTION, that interest rates had nothing to do with the housing boom!”

    No, I’m not doing that in the slightest. You clearly have absolutely no experience in statistics.

    Brito, it IS what you are doing. Telling me that I have no clue about statistics isn’t a proper argument. I did graduate work in statistics. I certainly know what I am talking about.

    “what you are doing is saying there should be a constant co-variance between interest rates and house prices.”

    No, I am not saying that at all. In fact these results are largely heteroskedastic.

    LOL, then you’re just building another constancy assumption on top of the first. Here, you’re presupposing that there is a constancy relation between the value of the independent variable and the variance of the dependent variable!

    In statistics, one cannot help BUT presume constancy relations. Even testing for heteroscedasticity, and claiming to have found a positive heteroscedasticity, is itself an act of presupposing some constancy in relations. You’re still observing particular past economic data, and you’re just testing for the presence of a constancy relation between the value of an independent variable and the variance of the dependent variable.

  119. Gravatar of Major_Freedom Major_Freedom
    15. March 2012 at 05:45

    D R:

    “Printing $100 million and then investing with it only raises the prices of capital goods from what they otherwise would have been”

    Now who is going beyond the actual transaction and relying on secondary effects?

    Haha, no, my argument doesn’t “rely” on that particular phenomena. It is just a result of printing money. My actual argument is that creating new money out of thin air and loaning it out can instantaneously bring about more nominal investment than there is voluntary savings.

    You are *assuming* that everyone raises prices on account of the investment.

    No, I am not assuming everyone RAISES their prices from where they are to some higher value over time. I am saying that prices will be higher than they otherwise would have been. They have to be. Sellers in the aggregate cannot sell supply in the aggregate at prices that logically necessitate more money and spending in existence. For example, if there is only $100 billion in existence, then it is logically impossible for prices (given a particular supply at the time) to be such that aggregate demand has to be $100 trillion.

    You’re taking it for granted that prices are somehow in a supernatural dimension, away from real world transactions that are based on real world demand in money terms, and supply in real goods terms.

    That may be true, but that doesn’t change the fact that S=I.

    Nor does it matter if there is 100% crowding out of other investment. In that case there is no net investment, no net change in income, and no change in savings. It’s still true that S=I.

    Only if you define cash holdings to be savings, which I do not. If you instead define saving to be abstaining from consumption, then should there be so much printing of money from a single source, that it crowds out the investment of everyone else, then the collapsing economy can be connected to a collapse in voluntary saving, i.e. abstaining from consuming and investing instead.

    When you insist that S=I, and defining cash as savings, all you are doing is saying “money spent = money received” or “money held in total = cash “savings” in total” or “the more money that is printed in the aggregate = the more savings people are making in the aggregate.” You’re either not saying anything significant, or you’re saying something positively misleading.

    Saving constitutes a sacrifice of present consumption. Calling the printing of money, and the concomitant increase in cash balances, an increase in “savings”, is to deny the entire foundation of sacrificing present consumption for the sake of increasing future consumption in real terms.

  120. Gravatar of Major_Freedom Major_Freedom
    15. March 2012 at 05:56

    D R:

    … part of the problem is confusing an actual transactional history with contrasting counterfactuals.

    That is exactly it. Unfortunately, that is exactly what you are doing.

    If I outbid you, say, then I spend $100 million instead of you. That’s only a question of which one of us is responsible for the transaction, not whether or not the transaction takes place.

    No, I don’t NOT spend my money just because you’re spending $100 million. You cannot buy up everything in the economy with $100 million. If you spend that $100 million, and you outbid me for particular goods, which I will grant, then I will just spend my money on other goods, where I can outbid you given that you are spending your money elsewhere. It could even be for the same goods from the same sellers, if there are enough of them. If not, then I’ll just buy something else.

    Because I printed $100 million, and then gave it to you, our combined spending will bring about an increased aggregate demand for goods as such, compared to what the aggregate demand would have been. With a higher aggregate demand, prices will go higher than they otherwise would have been. Prices are a FUNCTION of supply and demand, where demand is in money terms. If 1 million widgets of supply are sold into $100 million demand, then the average price of a widget will be $100.

    If I printed an additional $100 million and then give it to you, and given that neither of us brought about the production of any new widgets by virtue of our actions, the 1 million widgets will be sold into $200 million of demand, and the average price of a widget will be $200.

    The counterfactual here is that if I didn’t print that $100 million, then there would have otherwise been a lower demand, and since Price = Demand/Supply, there would have otherwise have been lower prices.

    Similarly, in any possible history, S=I at every point in time. It doesn’t matter if in one history S and I are higher in one history than another. The fact is, if you follow production and expenditures in any given period, S=I at every point in time.

    Only if you define cash holdings as “saving.” I don’t. I define saving to be abstaining from consuming, and investing instead.

  121. Gravatar of D R D R
    15. March 2012 at 06:14

    Major,

    “Haha, no, my argument doesn’t “rely” on that particular phenomena. It is just a result of printing money.”

    That *may* be a result. You might even *argue* that it is an extremely likely result. But there is nothing which requires it to be so. Ever. Even in the very long run.

    “Only if you define cash holdings to be savings, which I do not.”

    What? My point is that cash has nothing at all to do with it.

    “When you insist that S=I, and defining cash as savings..”

    And when you insist that I am creator of the universe…? Yeah, we can all make stuff up. In a closed-economy accounting, private savings is Y-T-C, and public savings is T-G. Cash is nowhere to be found.

    “Saving constitutes a sacrifice of present consumption. Calling the printing of money, and the concomitant increase in cash balances, an increase in “savings”, is to deny the entire foundation of sacrificing present consumption for the sake of increasing future consumption in real terms.”

    Um. Yeah. So?

  122. Gravatar of Mike Sax Mike Sax
    15. March 2012 at 06:48

    Morgan I’m impressed you were able to slip in Wittgenstein for any reason.

  123. Gravatar of D R D R
    15. March 2012 at 07:00

    Major,

    “Only if you define cash holdings as ‘saving.’ I don’t. I define saving to be abstaining from consuming, and investing instead.”

    You really don’t know what you are talking about. You have it exactly backwards. It’s *because* saving is abstaining from consumption (private and government) that S=I. Why? Because income is Y, and consumption is C+G, so the excess income is Y-C-G = I.

    Now, let’s say that production and spending is taking place at a steady rate of Y. Now you decide to abstain from consuming.

    To some extent this is absolutely and unavoidably immediately coincident with an unanticipated increase in inventories. That is, I am building 100 cars an hour and selling the same. When I am suddenly selling only 99, then private consumption falls by 1 car per hour, and inventories rise by an additional 1 car per hour. That is, the rate of investment rises exactly in step with the fall in the rate of consumption. But that doesn’t mean *YOU* are investing instead of consuming. It means that *I* am investing because you are not consuming.

    To the extent this is not the case, it must represent an absolute and unavoidably coincident fall in the rate of production. That is, Scott is giving economics lessons at the rate of 10 per week. When you decide to cancel, he is only giving 9 per week (at least until he manages to fill your slot.) That is, the rate of production falls exactly in step with the fall in consumption. Hence, there is no increase in saving to speak of. It means Scott is *dissaving* because you are not consuming.

    Note that nothing here has anything whatsoever to do with cash.

  124. Gravatar of Mike Sax Mike Sax
    15. March 2012 at 07:25

    Morgan I wrote this just for you

    https://www.themoneyillusion.com/?p=13516&cpage=2#comment-142793

    By the way you still write that blog of yours? If so can I have the link?

  125. Gravatar of Major_Freedom Major_Freedom
    15. March 2012 at 07:39

    D R:

    That *may* be a result. You might even *argue* that it is an extremely likely result. But there is nothing which requires it to be so. Ever. Even in the very long run.

    It is not a hypothetical. It is logical. With a lower demand in money, and given a particular supply, prices MUST be lower. It is a logico-mathematical certainty.

    “Only if you define cash holdings to be savings, which I do not.”

    What? My point is that cash has nothing at all to do with it.

    But then you can’t say that my printing and spending of $100 million increases S. You already made a cash based argument. Are you retracting then?

    “When you insist that S=I, and defining cash as savings..”

    And when you insist that I am creator of the universe…? Yeah, we can all make stuff up. In a closed-economy accounting, private savings is Y-T-C, and public savings is T-G. Cash is nowhere to be found.

    Y-T-C is cash holdings. It is cash income less taxes and consumption. What’s left over is cash holdings.

    T-G is cash holdings. It is the government’s cash revenues less spending. What’s left over is cash holdings.

    “Saving constitutes a sacrifice of present consumption. Calling the printing of money, and the concomitant increase in cash balances, an increase in “savings”, is to deny the entire foundation of sacrificing present consumption for the sake of increasing future consumption in real terms.”

    Um. Yeah. So?

    Yeah so? First, you just contradicted yourself because now you are saying you indeed treat cash holding as saving, whereas before you said “cash holding has nothing to do with it.” Second, denying the foundation of sacrificing present consumption for the sake of increasing future consumption in real terms, is a cognitive error in economic thinking. If you don’t care, then why bother?

    “Only if you define cash holdings as ‘saving.’ I don’t. I define saving to be abstaining from consuming, and investing instead.”

    You really don’t know what you are talking about. You have it exactly backwards. It’s *because* saving is abstaining from consumption (private and government) that S=I. Why? Because income is Y, and consumption is C+G, so the excess income is Y-C-G = I.

    No, you’re still confused. You’re still conflating cash balances with saving. They are not the same thing. You are going from inferring that all investment is savings, which is correct, to the assertion that cash holdings is the same as saving, and so by way of investment equalling savings, that money not consumed by private citizens or by government must be invested.

    You aren’t getting S=I “because” saving is abstaining from consumption. You are interjecting the conflation of saving with cash holding.

    There are THREE ways to allocated money income: consumption, investment and cash balances. Saving is NOT adding to cash balances. Saving is abstaining from consumption and investing instead. One can sell one’s investments for cash and raise their cash balances, but that does not mean they are saving more, because they are not reducing their consumption.

    Now, let’s say that production and spending is taking place at a steady rate of Y. Now you decide to abstain from consuming.

    You’re not conflating Y in real terms with Y in nominal spending terms. Production and spending are separate. They can move in different directions. Real production can go up or down, with no change in nominal spending, and vice versa.

    To some extent this is absolutely and unavoidably immediately coincident with an unanticipated increase in inventories. That is, I am building 100 cars an hour and selling the same. When I am suddenly selling only 99, then private consumption falls by 1 car per hour, and inventories rise by an additional 1 car per hour.

    But you did not make an additional investment in that car by virtue of additional saving. You only have an additional car than what you expected to have because the demand for cars was lower than you expected. You did NOT “make an investment” in “one car in inventory” by virtue of someone else NOT paying money for it. You made the investment in that car prior, which was already counted towards past economic statistics.

    Whether or not you sold that 100th car or not, you made an investment in 100 cars in inventory. If 100 cars are sold, or if 99 cars are sold, or if even just 1 car is sold, you are not “making investments” in cars by virtue of consumers buying fewer cars. You already made the investment in the inventory. The question then becomes if you were right about future consumer preferences.

    That is, the rate of investment rises exactly in step with the fall in the rate of consumption. But that doesn’t mean *YOU* are investing instead of consuming. It means that *I* am investing because you are not consuming.

    No, you are not investing MORE simply because I am consuming less. You invested in 100 cars period. That is already past and settled. Nothing that consumers do henceforth will change your investment. You invested in the production of 100 cars, and THEN consumption is what it is. Your investment doesn’t change just because you sold more or fewer cars than you expected to sell.

    Investment and production PRECEDE consumption. Once investment is made, that’s it, it’s crystalized in time. Whether or not you sold the cars later on, does not make a lick of difference to what you invested in. You can’t change the past.

    To the extent this is not the case, it must represent an absolute and unavoidably coincident fall in the rate of production. That is, Scott is giving economics lessons at the rate of 10 per week. When you decide to cancel, he is only giving 9 per week (at least until he manages to fill your slot.) That is, the rate of production falls exactly in step with the fall in consumption.

    TERRIBLE analogy. It’s a terrible analogy because you changed the supply of lessons, whereas in the car example the same supply of 100 cars was considered.

    If the supply of lessons decreases down to 9 per week, on account of people not showing up, then it’s NOT the case that there is an additional investment in “inventory” of lessons. Lessons are a service, and cannot go into inventory.

    Moreover, if Sumner is giving only 9 lessons a week, then what you are ignoring is that he can produce other things. It’s not the case that “production” as such falls on account of consumption falling. For not only does my not consuming his lessons not prevent me from consuming other things thus creating a need to produce elsewhere, but Sumner also has more time on his hands to produce something else with his time. His choice to take advantage of that opportunity will be a function of his abstaining from consumption or not.

    Hence, there is no increase in saving to speak of. It means Scott is *dissaving* because you are not consuming.

    No, he would not be dissaving on account of my not consuming, because he doesn’t spend money by virtue of me not spending money. He has to make that choice himself independently of my choice. My choice only has the effect of reducing his nominal income from where it otherwise would have been. It does not at all take money out of his wallet such that it would constitute “dissaving.”

    Note that nothing here has anything whatsoever to do with cash.

    It has everything to do with cash. Your example is crude, silly, and ignores the substantive aspects of the original argument, making it a red herring.

    You are extremely confused about all sorts of things, and it goes back to your conflating cash balances with saving.

  126. Gravatar of ssumner ssumner
    15. March 2012 at 08:08

    Justin, yes.

    Becky, Good point.

    Martin, Construction of a gym is investment.

    Ritwik, I don’t see any inconsistencies.

    Rebeleconomist, Those rust belt houses are old.

    Morgan, If I meet an honest politician, does that mean he’s not a politician? After all, politician has bad connotations.

    Jon, That’s right.

    UnlearningEcon. You said;

    “This is quite an imperious thing to say. I can only assume (hope) that you’re overstating your case to be controversial.”

    Controversial? Every single econ textbooks says the same thing. So does the US government. Where’s the controversy?

    KRG, That’s right.

    Peter Bias, No capital goods can produce either goods or services. Movie theaters produce services, no one disputes they are capital goods. I suppose a chess game is a service.

    John, You said;

    “People shouldn’t be spending more. They should be spending less on both capital and consumer goods in order to reduce their pathetic amounts of debt.”

    Does that mean they should produce less? Does it mean they should take longer vacations? Does working less help a family get out from under debt?

    Ron, Monetary policy is far more efficient than fiscal policy.

    Brito, Wrong, all the intro textbooks agree that housing is capital. It produces housing services, which is a big part of our GDP.

    Vivian, You said;

    “Is this net investment?”

    I never said it was, I said the construction of new houses is investment.

    Dave Schuler, Wrong, most do not last that long.

    Eric Morey, Saving is the funds that go into investment. So you can’t count both as investment. If you counted the value of the new home, and the $500,000 mortgage on the new home, you’d be double counting. The mortgage is a financial asset like a mutual fund. The investment occurs when the money in mutual funds finances the construction of capital goods.

    Greg Ransom, I meant too much investment in housing, and probably in aggregate (although we can’t be sure.)

    CKE, You asked:

    “A fall in real income resulting from over-investment should force a shift in relative prices as whatever good was overproduced should fall in relative value. Will holding NGDP cloud this shift in relative valuation/prices?”

    No it will help facilitate the change, by keeping the economy near its potential as resources move from one sector to another.

    More to come . . .

  127. Gravatar of Shane Shane
    15. March 2012 at 08:23

    Not sure if you know this particular passage from _The Wealth of Nations_ where Smith addresses this question of what constitutes the capital stock. He sees houses as part of a type of quasi-capital, which consists of things yet to be consumed, reducing the need for future expenditure but not creating any revenue.

    From Book II ch. I

    “The first [division of capital] is that portion which is reserved for immediate consumption, and of which the characteristic is, that it affords no revenue or profit. It consists in the stock of food, clothes, household furniture, etc. which have been purchased by their proper consumers, but which are not yet entirely consumed. The whole stock of mere dwelling-houses, too, subsisting at anyone time in the country, make a part of this first portion. The stock that is laid out in a house, if it is to be the dwelling-house of the proprietor, ceases from that moment to serve in the function of a capital, or to afford any revenue to its owner. A dwelling-house, as such, contributes nothing to the revenue of its inhabitant ; and though it is, no doubt, extremely useful to him, it is as his clothes and household furniture are useful to him, which, however, make a part of his expense, and not of his revenue. If it is to be let to a tenant for rent, as the house itself can produce nothing, the tenant must always pay the rent out of some other revenue, which he derives, either from labour, or stock, or land. Though a house, therefore, may yield a revenue to its proprietor, and thereby serve in the function of a capital to him, it cannot yield any to the public, nor serve in the function of a capital to it, and the revenue of the whole body of the people can never be in the smallest degree increased by it. Clothes and household furniture, in the same manner, sometimes yield a revenue, and thereby serve in the function of a capital to particular persons. In countries where masquerades are common, it is a trade to let out masquerade dresses for a night. Upholsterers frequently let furniture by the month or by the year. Undertakers let the furniture of funerals by the day and by the week. Many people let furnished houses, and get a rent, not only for the use of the house, but for that of the furniture. The revenue, however, which is derived from such things, must always be ultimately drawn from some other source of revenue. Of all parts of the stock, either of an individual or of a society, reserved for immediate consumption, what is laid out in houses is most slowly consumed. A stock of clothes may last several years; a stock of furniture half a century or a century; but a stock of houses, well built and properly taken care of, may last many centuries. Though the period of their total consumption, however, is more distant, they are still as really a stock reserved for immediate consumption as either clothes or household furniture.”

  128. Gravatar of ssumner ssumner
    15. March 2012 at 08:31

    Major, So by your logic a hotel or apartment building are capital goods, but not homes?

    dtoh, Yes, I meant consume.

    Phil, It’s a capital good that produces housing services to be consumed, just a a movie theater produces movie services.

    Mike Sax, You said;

    “Ok, forewarned is forearmed but I seem to remember spending on housing often referred to as consumption by very good economists.”

    If they said that, they are wrong. Please provide quotes so I can mock them.

    These aren’t “my views” they are the standard views of economists, right out of econ101, and also the government statisticians.

    You said;

    “More to the point you say that you spend on either consumer goods or ivnestment and that if you spend on ivestment goods it’s saving-what then is money that you neither spend on consumption goods or investment goods? What is that?”

    You are confusing stocks and flows. I’m not saying all “money” gets spent, I’m saying all income not going into consumption goes into saving (or taxes, if you add government.)

    At the end of this post I said we do save too little, but for reasons of tax distortion. The housing bust, in and of itself, would reduce optimal saving rates.

    Tom, You said,

    “Scott,
    Renting a home is not investment, it’s consumption.”

    I agree, I think you may have misunderstood my argument.

    You have your facts wrong about the housing bust. It occurred well before the recession. As less homes were produces in 2006 and 2007, more of other goods were produced, as it should be. The big drop in GDP occurred well after the big drop in housing construction.

    JL, You said;

    “During the sub-prime crisis clueless (i.e. actually economically illiterate) buyers were told that their McMansion was an investment.
    They were not informed that their investment could have a negative ROI.”

    Nobody but nobody believes that the word ‘investment’ means “will go up in price.” Everyone knows that stock prices can and often do fall. People were quite correct in believing that McMansion was an investment. It was. Just like stocks. The difference between the finance and economic use of the term “investment” has no bearing on this post. Housing was an investment under either definition.

  129. Gravatar of Greg Ransom Greg Ransom
    15. March 2012 at 08:34

    Scott, too much investment in housing means extending the time Perot of production far to long across time. Remember your point about houses being “super capital goods”.

    This does NOT too much spending was taken away from consumption and put into investment.

    It means that too much of investment went into super long investment processes and not into shorter production processe, an unsustainable allocation.

    “Greg Ransom, I meant too much investment in housing, and probably in aggregate (although we can’t be sure.)”

  130. Gravatar of ssumner ssumner
    15. March 2012 at 08:35

    Shane, Adam Smith is wrong, He’s confusing several unrelated issues, such as whether a good produces other goods, and whether it yields revenue. Apartment buildings produce revenue. If one makes them into condos, that doesn’t magically make then non-capital goods.

  131. Gravatar of ssumner ssumner
    15. March 2012 at 08:36

    Greg, That’s a debatable point, no one knows for sure.

  132. Gravatar of ImpartialObserver ImpartialObserver
    15. March 2012 at 08:46

    D R,

    I like your example because it is concrete. What I don’t understand is why it is concluded that production has fallen. When Scott starts teaching 9 rather then 10 classes, what does he do with the remainder of his time, twiddle his thumbs? Presumably he engages in another productive activity that somebody wants. Maybe he produces more blog posts for our consumption. His new activity will be more valuable for society than the last.

    Perhaps this is off-topic, but I see this all over the blogosphere: Lets assume a nice linear model with X and Y but not Z. Now, we can show that in some situation the relation between X and Y leads to things we consider bad – So we propose a solution to manipulate X or Y to our liking. Our solution will work, our model says so! Even though we all know that we’ve excluded Z1, Z2, Z3, Z4, …, because they make our model not so tidy and not so neat.

    Then every ten years or so economists wonder what could have possibly gone wrong.

    I think the reason Austrians get so hot and bothered is because manipulating X and Y usually involves compromising somebody’s freedom through one government action or another, and all with full knowledge that their models are questionable.

  133. Gravatar of Major_Freedom Major_Freedom
    15. March 2012 at 09:10

    ssumner:

    Major, So by your logic a hotel or apartment building are capital goods, but not homes.

    I made myself very clear. I REJECT using the physicality attributes of an object, such as appearance, chemistry, molecular composition, age, weight, or size.

    Again, I utilize a HUMAN-centered purposeful intention standard to distinguish economic goods from non-economized objects, and within the category of economic goods, I still utilize a HUMAN-centered purposeful intention standard to distinguish consumer goods from capital goods.

    Ergo, rhetorically asking me whether a particular object like an apartment building or hotel is a capital good or consumer good, is asking me what I would define a good to be based on the very standard I reject, namely the physicality.

    So to answer your question on a hotel or apartment building, I will first ask you to make clear in your mind the human-centered purpose in which the owner purchased the hotel. Maybe the very word “hotel” gives it away, but to be clear, did the owner buy the hotel for the purposes of opening up a business in selling rooms for nightly rent to the market, so as to earn a profit? Or did he buy the hotel for the purposes of NOT making subsequent sales, and instead purchased the hotel to reside in it, or give it away for free, etc, i.e. for the purposes of direct utility, of consumption?

    If he bought the hotel for the PURPOSES of the former, then that hotel is a capital good. If not, it’s a consumer good. Same thing with the apartment building. If the word “apartment” doesn’t give it away, then we again have to ask the purposes for which the owner bought the apartment building. Is it to make subsequent sales in renting the apartments out, so as to earn a profit? Or is this owner too a rather quirky fellow who bought the apartment building to live in, for direct utility, so as to make it a consumer good instead?

    Empirically though, I would say 99% of all hotel buildings and apartment buildings are capital goods, because very few if any buyers of such buildings do so for direct utility purposes, and they almost always buy them for the purposes of making subsequent sales, making them capital goods.

    Again, the lesson here is not to focus on the physicality of the object itself, but rather the human-centered purpose for which the objects are acquired/produced. Economics is the study of acting man. It is not the study of the chemical properties of various materials like bricks and steel.

    If I asked you whether or not a bag of grain is a consumer good or capital good, and we used YOUR logic, of only concentrating on the physicality of it, then we would be compelled to label the good ignoring the purpose for which it is purchased and used in activity.

    If we label it a capital good on the basis of physicality, then what if the bag of grain was purchased by someone to feed to his pet parrots? That would make it a consumer good, not a capital good. Why? Because we recognized the human-centered standard and identified the purpose for which the bag was purchased. It was purchased for direct utility, and not to make subsequent sales.

    If we label it a consumer good on the basis of physicality, then what if the bag of grain was purchased by a bread making company, for the purposes of using it in the production of bread, for sale at (hopefully) a profit later on? That would make it a capital good wouldn’t it? Why? Because we recognized the human-centered standard and identified the purpose for which the bag was purchased. It was purchased for indirect utility, and to make subsequent sales.

    Center your thinking on human intentions, not chemistry or metallurgy. You’re an economist, not a chemist or physicist.

  134. Gravatar of Major_Freedom Major_Freedom
    15. March 2012 at 09:28

    ssumner:

    Apartment buildings produce revenue. If one makes them into condos, that doesn’t magically make then non-capital goods.

    Quite right, but it also does not necessarily make them capital goods either. Again, you have to consider the PURPOSE for which the economic goods are bought. If they are bought by the apartment complex owner for the purpose of making subsequent sales, either for renting them out, or selling them outright (condo), then those spaces remain capital goods owned by the complex purchaser. If a unit were sold to a subsequent buyer, who purchased the condo to live in, instead of reselling, then that unit changes, not magically, but intentionally, from a capital good into a consumer good. The same way a computer on a store shelf and owned by the store is a capital good, and as soon as the computer is bought, then it becomes either a consumer good if the buyer is intending to use for direct utility (say a home computer), or it remains a capital good, this time owned by, say a business that uses the computer assisting in a production process, in order to make subsequent sales, which will again be either consumer goods or capital goods, depending on the purpose. And so on.

    Apartment units produce revenues for the owner of the apartment. The owner purchased the apartment for the purposes of making subsequent sales, and not for his direct utility. That is what makes the apartment unit a capital good TO THE OWNER. The owner is the center at which the good is a consumer good or capital good.

    If the units are sold as condos, then before they are sold, they were capital goods to the previous owner (since he purchased or produced them with the intention of making subsequent sales). Once they are sold, then again we have to focus on the intentions of the buyer. If the buyers bought the condos for direct utility, to live in, to not make subsequent sales, then they are consumer goods. If on the other hand the condos are bought by “flippers”, who intend to resell them later on, at a profit, then those condos remain capital goods. This is because the buyers aren’t buying the condos for direct utility (although they may gain utility as a derivative effect), they are buying them for indirect utility, where their goal is to gain direct (consumer) utility from the later sales they hope to bring in.

    You need to stop focusing on the chemical make-up of goods, and start focusing on the human-centered purpose for which the goods are purchased and produced.

    Some more examples to really drive this home:

    A computer is a consumer good if purchased for not making subsequent sales, like in your home, and it is a capital good if purchased for making subsequent sales, like in an office that capitalizes it.

    A pile of wood is a consumer good if purchased for not making subsequent sales, like building a shed in your backyard, and it is a capital good if purchased for making subsequent sales, like building sheds for later sale and earning a profit later on.

    A raw roast beef is a consumer good if it is your refrigerator at home, but it is a capital good if it is in a refrigerator at a restaurant.

    A box of cereal is a consumer good if it is in your cupboard at home, but it is a capital good if it is on the shelf at the grocery store.

    A dog is a consumer good in your home, it is a capital good at the pet store.

    Make sense?

  135. Gravatar of D R D R
    15. March 2012 at 09:51

    “It is not a hypothetical. It is logical. With a lower demand in money, and given a particular supply, prices MUST be lower. It is a logico-mathematical certainty.”

    That’s completely untrue. There is nothing whatsoever requiring any sort of balance between supply and demand in any current production of a single good or in aggregate. If demand falls, holding supply constant, then there is more excess supply/less excess demand. Producers *may* lower prices in response. Or they may not.

    Then again, why are you holding supply constant, anyway?

    “Y-T-C is cash holdings. It is cash income less taxes and consumption. What’s left over is cash holdings.”

    WHAT CASH? What are you talking about? This is complete nonsense.

    “Investment and production PRECEDE consumption. Once investment is made, that’s it, it’s crystalized in time. Whether or not you sold the cars later on, does not make a lick of difference to what you invested in. You can’t change the past.”

    Partly true. If I produce a car, it shows up as inventories until sold. That’s an investment, it is true. But once sold, it counts as both consumption and DISinvestment. The latter as the car is removed from inventory.

    “If the supply of lessons decreases down to 9 per week, on account of people not showing up, then it’s NOT the case that there is an additional investment in “inventory” of lessons. Lessons are a service, and cannot go into inventory.”

    No kidding. That’s the whole point of the second example! If real demand for lessons falls, real production of lessons falls. I’m not “changing the supply of lessons” but I am CHANGING THE QUANTITY SUPPLIED because there can be no excess quantity supplied in services. Until someone else increases their demand for lessons, some lesson provider is stuck with less income.

    “No, he would not be dissaving on account of my not consuming, because he doesn’t spend money by virtue of me not spending money. He has to make that choice himself independently of my choice.”

    No. He has to make a choice if he wants to *maintain* his flow of savings. If he maintains his flow of consumption and his flow of income falls, then his flow of savings falls without his making any choice whatsoever. He may CHOOSE to lower consumption as his income falls, but that’s his CHOICE in response to his falling income. He may CHOOSE to increase his income by re-filling that slot in his schedule, but that’s his CHOICE. Until then, the loss of income comes with it a corresponding fall in saving.

  136. Gravatar of Shane Shane
    15. March 2012 at 10:16

    Actually I think there’s a way in which Smith is making your point, just in the strange language of 18th c. political economy. He seems to call any accumulation of savings a stock (the list he is offering is a list of types of stock, not of capital types as I put in the brackets). He defines capital assets as a subset of this which actually increase production or productivity. So savings in your sense is equal to the increase in stock in his sense–the sum of spending on capital assets and goods for future consumption (including “dwelling houses”).

    Thus, I don’t think he would disagree with your point that spending on housing is still a form of saving. Let’s say I am an extremely conservative investor, and my favorite food is black beans. I could presumably save for retirement by purchasing canned black beans or dried beans with a long shelf life, rather than by putting the money in a savings account or investing in a mutual fund, no? Even if I only plan on consuming those myself, I think both you and Smith would agree that that is a form of saving.

  137. Gravatar of Major_Freedom Major_Freedom
    15. March 2012 at 11:13

    D R:

    “It is not a hypothetical. It is logical. With a lower demand in money, and given a particular supply, prices MUST be lower. It is a logico-mathematical certainty.”

    That’s completely untrue. There is nothing whatsoever requiring any sort of balance between supply and demand in any current production of a single good or in aggregate.

    I never said “balance” between supply and demand was required. By “demand” I wasn’t even referring to the quantity of goods demanded at a given price, but rather to the quantity of dollars offered in exchanges, when then determines (along with supply of goods) the prices.

    By saying there is nothing to inherently equate supply and demand, you are saying there is nothing to inherently equate the quantity of goods offered at specific prices, to the quantity of goods demanded at those same specific prices. There I will agree with you.

    But my argument has nothing to do with quantity demanded. My argument has to do with the demand in money terms. How much money is being offered by buyers in actual exchanges. Here, I hope you can see that the more money that is offered in exchanges, and given a particular supply, the higher prices must be. There is no denying this. This is the logical necessity I was referring to.

    You are holding prices constant in your mind for some reason, stripped away from its dependency on demand (in money terms) and supply, when in reality prices are DETERMINED by the demand (in money terms) and supply.

    If you change either supply or demand (in money terms), then prices MUST change. There is no escaping this. I print an additional $100 million of dollars, and I put that money into exchanges, then given a particular supply, prices MUST be higher than they otherwise would have been. I am not saying we have to observe increasing prices over time, I am saying at that moment in time, prices must otherwise be higher. Like you said before but never followed through on, it’s about the counterfactuals, not temporal changes in prices over time.

    If demand falls, holding supply constant, then there is more excess supply/less excess demand. Producers *may* lower prices in response. Or they may not.

    Only if you define “demand” as “quantity of goods demanded given a particular price.” But I don’t hold prices constant. I make them provisional, determined by demand (in money terms) and by supply (in real goods terms).

    I define demand the way the classicals defined demand. I define demand as the quantity of dollars offered in exchanges, not as the quantity of goods demanded given an arbitrary price.

    Then again, why are you holding supply constant, anyway?

    To isolate the effects of an increase in the quantity of money and volume of spending, which was the issue at hand.

    “Y-T-C is cash holdings. It is cash income less taxes and consumption. What’s left over is cash holdings.”

    WHAT CASH? What are you talking about? This is complete nonsense.

    What cash? THE CASH PEOPLE HAVE ON HAND AFTER THEY PAY THEIR TAXES AND AFTER THEY SPENT MONEY ON CONSUMPTION/INVESTMENT “C + I”!

    What cash? THE CASH THE GOVERNMENT HAS ON HAND AFTER THEY SPEND MONEY “G”!

    “Investment and production PRECEDE consumption. Once investment is made, that’s it, it’s crystalized in time. Whether or not you sold the cars later on, does not make a lick of difference to what you invested in. You can’t change the past.”

    Partly true. If I produce a car, it shows up as inventories until sold. That’s an investment, it is true. But once sold, it counts as both consumption and DISinvestment.

    Right, but if the car is NOT sold, by virtue of the car producer making an error in judging future car sales, then he did NOT make any additional investment merely by virtue of the consumer not buying the car the car producer expected to sell. It’s ONLY a reduction in consumption C. There is NO increase in investment I. There is NO increase in savings S. There is NO increase anywhere. There is simply a reduction in C. The investment I is already past and settled. The prior investment I was already brought about by prior savings S. The car producer had money, and rather than declare a dividend, he saved and invested in producing a car instead. That car is a capital good on the producer’s balance sheet.

    The latter as the car is removed from inventory.

    Sure, but regardless of whether than car is sold, there is no increase or decrease in investment. There is just a physical exchange of car for money, or there is no exchange at all. Selling the car would reduce the producer’s inventory assets, and increase their cash assets. Failing to sell the car does NOT increase the company’s assets. There is no additional investment I, there is no additional savings S.

    The error you are making is the same error Sumner makes. A seller does not increase his investment by virtue of consumers not buying their goods. Yes, there is a physical build up of inventory, but that is not an additional saving or investment, because the saving and investment was already counted prior, in the very production of the goods that went into inventory.

    “If the supply of lessons decreases down to 9 per week, on account of people not showing up, then it’s NOT the case that there is an additional investment in “inventory” of lessons. Lessons are a service, and cannot go into inventory.”

    No kidding. That’s the whole point of the second example!

    That’s exactly what makes it inapplicable as an analogy to the car example!

    If real demand for lessons falls, real production of lessons falls.

    Yes, locally, for individual sellers, production depends on consumption. But in the aggregate, consumption depends on production.

    If consumers purchase fewer lessons from Sumner, then that means they have more money to spend elsewhere, and if investors have foresight, they will anticipate this and make ready consumer goods that the person does want to buy.

    I’m not “changing the supply of lessons” but I am CHANGING THE QUANTITY SUPPLIED because there can be no excess quantity supplied in services. Until someone else increases their demand for lessons, some lesson provider is stuck with less income.

    But lessons are not the only thing people spend their money on. If there is a reduced production of lessons, then Sumner has the opportunity to increase his productivity and supply of something else. Similarly, by reducing the purchase of lessons, the buyers have more money to buy other things.

    It’s not true that production as such falls on the basis of a reduction in purchasing lessons. Only if consumers as a group spend less on consumption, will current production of consumer goods fall. But then that is WANTED! Current production of consumer goods SHOULD fall if consumers as a group spend less on present consumption. It would be a waste to counter-act this by forcing more consumption spending by calling for entities like illegal and legal counterfeiters and thieves to take action. Without any such coercion, a general reduction in consumer spending will make the RELATIVE profitability of capital goods production higher in relation to consumer goods. This will bring about a relative reduction in capital invested in the consumer goods industry, and a relative increase in capital invested in the capital goods industry. This is exactly what the consumers want. They want less consumption in the present, and because they’re not burning their money, they want more future consumption than they otherwise could have gotten had they spent more on consumption in the present.

    In essence, a general increase in cash balances brought about by a reduction in consumer spending, has a similar effect to the situation where people reduce their consumption spending and increase their investment spending. The only difference is that the purchasing power of money will rise in the increase in cash holding situation, which will lead to lower prices all around. Of course with all the governmental interferences in the price system, preventing prices from falling quickly, or even at all in some cases (like labor), then the results will be horrendous, and ignoramuses will blame the market’s alleged tendency to generate “sticky downward prices.”

    “No, he would not be dissaving on account of my not consuming, because he doesn’t spend money by virtue of me not spending money. He has to make that choice himself independently of my choice.”

    No. He has to make a choice if he wants to *maintain* his flow of savings. If he maintains his flow of consumption and his flow of income falls, then his flow of savings falls without his making any choice whatsoever. He may CHOOSE to lower consumption as his income falls, but that’s his CHOICE in response to his falling income. He may CHOOSE to increase his income by re-filling that slot in his schedule, but that’s his CHOICE. Until then, the loss of income comes with it a corresponding fall in saving.

    Utterly false. One does not “maintain his flow of savings.” Savings aren’t a “flow”. Savings are abstentions from consuming, and investing instead. Transactions are a “flow.” You are again conflating cash holding and savings. People who earn money incomes aren’t “increasing their savings flow.” They are increasing their cash balances. They can only increase their savings if they abstain from consuming and invest instead. Someone who earns more and more cash over time, and spends it all on consumption, even if their cash balances are rising over time, they are not saving anything, because they are not abstaining from consumption. No, one cannot call a person a “saver” just because they merely have cash on them. By that logic, no matter how fast someone spends their paycheck, they would be considered “savers”, and “non-savers” would become a practical impossibility.

    If someone consumes more, but earns less, then they are not saving more or less. They might be saving relatively more or less, but that would depend on their investing. If they maintain their investing, and they maintain their consumption, as their income falls, then that could only mean they are holding less cash. If they are still consuming and investing in the same proportion, then they are not saving any more or less, because they are not abstaining more from consuming to invest instead. They are maintaining the same saving and investing, and consumption.

  138. Gravatar of Major_Freedom Major_Freedom
    15. March 2012 at 11:20

    ImpartialObserver:

    I like your example because it is concrete. What I don’t understand is why it is concluded that production has fallen. When Scott starts teaching 9 rather then 10 classes, what does he do with the remainder of his time, twiddle his thumbs? Presumably he engages in another productive activity that somebody wants. Maybe he produces more blog posts for our consumption. His new activity will be more valuable for society than the last.

    Finally! Someone gets it.

  139. Gravatar of Vivian Darkbloom Vivian Darkbloom
    15. March 2012 at 11:55

    “Vivian, You said;

    “Is this net investment?”

    I never said it was, I said the construction of new houses is investment.”

    So, whether the appropriate adjective before investment is “net” or “negative” is irrelevant? If you want to simply leave it as “investment”, I think you are at least implying it is “net”, i.e., positive. How else should I interpret that? What sense is there in only considering one side of the balance sheet—any balance sheet?

  140. Gravatar of J.V. Dubois J.V. Dubois
    15. March 2012 at 11:59

    Scott, you said You are confusing stocks and flows. I’m not saying all “money” gets spent, I’m saying all income not going into consumption goes into saving (or taxes, if you add government.)

    But then elsewhere you say that saving equals investment, that really means that all money that is saved need to be invested. Look, this is important. If we have a monetary base and we consider a year as a timeframe where we look on what is produced and consumed, then it is easy to discern investment from consumption. A can of food that was produced and consumed is consumption. A can of food that was stored is considered as investment that will be consumed next year or after that. But then considering that we use money, there have to be some people that ended up with some cash in their wallet during midnight in new years eve, right? So when we make an inventory of what happend last year during first second after midnight, where would you put the cash? It is still part of income from the previous year that was not spent on consumer goods and services. Then it should be savings, right? But then it was also not spent on investment goods then it is not investment. What is it really?

    Greg Ransom: so housing is about people shifting their production too long into future? But then you have to see people as being able to decide this time structure any way they want. But clearly it is not the case. People need to live somewhere. I do not know of any “short term” way of how to live in a house. If they want to live in a house, they have to produce it and house as we know is inherently very durable.

    Also, how do you know that people overinvested in houses? What if during next decade US will live through a huge immigration wave will drive the price of houses that were produced during this housing bubble? Will you argue that people invested too much into short-term production processes during last few years and that they should build houses instead (and that of course it was caused by central bank)?

  141. Gravatar of D R D R
    15. March 2012 at 12:00

    “I like your example because it is concrete. What I don’t understand is why it is concluded that production has fallen. When Scott starts teaching 9 rather then 10 classes, what does he do with the remainder of his time, twiddle his thumbs? Presumably he engages in another productive activity that somebody wants. Maybe he produces more blog posts for our consumption. His new activity will be more valuable for society than the last.”

    Ah. I say production has fallen because I’m talking about the immediate impact of the change. It’s perfectly fine to say someone else shows up for the lesson. In that case there is in the end no change in investment or savings. That is perfectly fine. But at no point does S fail to equal I. Not when Scott drops to 9 lessons, and not when he climbs back to 10.

  142. Gravatar of J.V. Dubois J.V. Dubois
    15. March 2012 at 12:13

    Scott: please ignore my previous question. The money is obviously whatever it was that the cash holder sold in exchange to get those money. If they sold something that got consumed last year, than it was consumption. If it was anything else, it was investment. S=I obviously.

  143. Gravatar of D R D R
    15. March 2012 at 12:20

    “But my argument has nothing to do with quantity demanded. My argument has to do with the demand in money terms. How much money is being offered by buyers in actual exchanges. Here, I hope you can see that the more money that is offered in exchanges, and given a particular supply, the higher prices must be.”

    WRONG.

    If QUANTITY SUPPLIED is held constant, and nominal spending increases, this may draw down inventories.

    “Right, but if the car is NOT sold, by virtue of the car producer making an error in judging future car sales, then he did NOT make any additional investment merely by virtue of the consumer not buying the car the car producer expected to sell. It’s ONLY a reduction in consumption C. There is NO increase in investment I. There is NO increase in savings S. There is NO increase anywhere. There is simply a reduction in C. The investment I is already past and settled. The prior investment I was already brought about by prior savings S. The car producer had money, and rather than declare a dividend, he saved and invested in producing a car instead. That car is a capital good on the producer’s balance sheet.”

    GODDESS ALMIGHTY. The increase in investment comes at time of production, it is true. But you don’t double-count the production of the car first as investment at the time it is produced and then as consumption when sold. AT THE TIME OF SALE you have to remove the car from the producer’s balance sheet. AT THAT TIME the sale adds to C and subtracts from I. So if cars suddenly stop selling, producers find themselves FAILING TO DISINVEST THEMSELVES OF THEIR CARS. That is, producers find themselves investing in more in cars.

    “That’s exactly what makes it inapplicable as an analogy to the car example!”

    It isn’t intended to be an analogy. It’s a different case.

    “If consumers purchase fewer lessons from Sumner, then that means they have more money to spend elsewhere, and if investors have foresight, they will anticipate this and make ready consumer goods that the person does want to buy.”

    Or they may not. So what? Again, you are talking about how agents respond. But S=I no matter how they respond.

    “Only if consumers as a group spend less on consumption, will current production of consumer goods fall. But then that is WANTED! Current production of consumer goods SHOULD fall if consumers as a group spend less on present consumption.”

    I made no judgement about what should or should not happen. I merely point out that S=I.

    “Savings aren’t a ‘flow’. Savings are abstentions from consuming, and investing instead. Transactions are a ‘flow.'”

    The difference between two flows is in fact a flow. Transactions are events.

    “If someone consumes more, but earns less, then they are not saving more or less. They might be saving relatively more or less, but that would depend on their investing.”

    May I suggest a refresher on national accounting? Regardless, an INDIVIDUAL’s investment may not equal their savings. So what? It’s still true that S=I. You did realize that S=I refers to *aggregate* savings and *aggregate* investment, yes?

  144. Gravatar of Major_Freedom Major_Freedom
    15. March 2012 at 12:32

    D R:

    Ah. I say production has fallen because I’m talking about the immediate impact of the change. It’s perfectly fine to say someone else shows up for the lesson. In that case there is in the end no change in investment or savings. That is perfectly fine. But at no point does S fail to equal I. Not when Scott drops to 9 lessons, and not when he climbs back to 10.

    D R, if we’re talking about “immediate” impact, then didn’t production fall on account of Sumner choosing to give one fewer lesson? Consumers might signal to Sumner to reduce the production of lessons, but in principle the immediate reduction occurs when Sumner makes the choice. After all, just like a car maker can save and invest and produce a car that nobody will buy, so too can Sumner give a lesson to an empty room.

    His customers really didn’t force him to reduce his production in general. It was his own choosing that really had the immediate effect.

    You have a very clear consumptionist view of the economy, in that you believe consumption is the primary driver. Locally, you might have a point, but in the aggregate, absolutely not. In the aggregate, ALL consumption depends on saving and investment, on production. In the aggregate, consumers cannot help but consume what has only been first produced for them. In this sense, saving and investment is the primary driver for ECONOMIC growth. Consumption only tells producers WHAT to produce specifically. Consumption qua consumption fully depends on production.

    If Sumner produced one fewer lesson, then if nothing else is different, consumers as such have less to consume. If consumers merely consume fewer lessons because they want more of other things, which you cannot eliminate in your analysis, then production as such doesn’t need to fall. Consumers will be consuming more of other things, like…um…better economic lessons.

  145. Gravatar of D R D R
    15. March 2012 at 12:42

    Major,

    Please understand that Sp=Y-T-C and Sg=T-G can apply to a purely barter economy. Cash is utterly irrelevant.

  146. Gravatar of D R D R
    15. March 2012 at 12:45

    “D R, if we’re talking about ‘immediate’ impact, then didn’t production fall on account of Sumner choosing to give one fewer lesson? Consumers might signal to Sumner to reduce the production of lessons, but in principle the immediate reduction occurs when Sumner makes the choice. After all, just like a car maker can save and invest and produce a car that nobody will buy, so too can Sumner give a lesson to an empty room.”

    Nope. If you produce a car nobody buys, you have still produced a car. If you lecture to an empty room, you have still produced nothing.

  147. Gravatar of Major_Freedom Major_Freedom
    15. March 2012 at 12:49

    D R:

    “But my argument has nothing to do with quantity demanded. My argument has to do with the demand in money terms. How much money is being offered by buyers in actual exchanges. Here, I hope you can see that the more money that is offered in exchanges, and given a particular supply, the higher prices must be.”

    If QUANTITY SUPPLIED is held constant, and nominal spending increases, this may draw down inventories.

    THAT IS A CONTRADICTION. If you say “inventory is drawn down”, then that is an INCREASE in supply. That is not “quantity supplies is held constant.”

    Supply is NOT “the total of goods”. Supply is “the total of goods SOLD.”

    “Right, but if the car is NOT sold, by virtue of the car producer making an error in judging future car sales, then he did NOT make any additional investment merely by virtue of the consumer not buying the car the car producer expected to sell. It’s ONLY a reduction in consumption C. There is NO increase in investment I. There is NO increase in savings S. There is NO increase anywhere. There is simply a reduction in C. The investment I is already past and settled. The prior investment I was already brought about by prior savings S. The car producer had money, and rather than declare a dividend, he saved and invested in producing a car instead. That car is a capital good on the producer’s balance sheet.”

    GODDESS ALMIGHTY. The increase in investment comes at time of production, it is true. But you don’t double-count the production of the car first as investment at the time it is produced and then as consumption when sold.

    GOOD LORD THAT IS MY POINT!

    The same reason why I don’t double count the inventory as an investment by virtue of a future sale, is the same reason I don’t double count the inventory as an investment by virtue of a future LACK of sale!

    YOU are double counting investment when you say “I” increases by virtue of consumers NOT buying it!

    Holy mary mother of pearl.

    AT THE TIME OF SALE you have to remove the car from the producer’s balance sheet. AT THAT TIME the sale adds to C and subtracts from I.

    NO! “I” does NOT decrease! “I” is already past and settled. The car maker saved and invested in the production of a car. Period. End of story. Later on, regardless of whether the car is sold or not, “I” is UNCHANGED. Yes, the car maker probably declares CGS at the point of sale, yes, the car maker subtracts the inventory from his balance sheet. But that is NOT a reduction in investment, it is NOT an increase in investment, it is a TRANSFER of one form of asset for another, inventory for cash. Investment is past and settled.

    So if cars suddenly stop selling, producers find themselves FAILING TO DISINVEST THEMSELVES OF THEIR CARS. That is, producers find themselves investing in more in cars.

    FALSE. They did NOT invest in “more” cars. It’s the same production of cars. Their investment is 100 cars. Period. End of story. LATER ON, when consumers are expected to buy them, they either buy the whole lot, or they buy fewer. No matter what is bought, the investment is already past and settled. No additional investment was made. No reduction in investment was made (although the car maker probably would reduce FUTURE investment in car production going forward).

    “That’s exactly what makes it inapplicable as an analogy to the car example!”

    It isn’t intended to be an analogy. It’s a different case.

    What’s the point of introducing a different case that is not related to inventory?

    “If consumers purchase fewer lessons from Sumner, then that means they have more money to spend elsewhere, and if investors have foresight, they will anticipate this and make ready consumer goods that the person does want to buy.”

    Or they may not. So what? Again, you are talking about how agents respond. But S=I no matter how they respond.

    No, it’s not just how agents respond. They ANTICIPATE future consumer demand and invest accordingly. Their investments are prior, already made. It’s up to the consumers to prove them right or wrong. If they’re right, they earn profits. If they’re wrong, they incur losses.

    And S=I ONLY IF you continue to conflate cash holdings with saving. If you cease conflating the two, then S=I in the past, and in the present, where consumers make their choices, S and I are IRRELEVANT. Neither changes!

    “Only if consumers as a group spend less on consumption, will current production of consumer goods fall. But then that is WANTED! Current production of consumer goods SHOULD fall if consumers as a group spend less on present consumption.”

    I made no judgement about what should or should not happen. I merely point out that S=I.

    Not by virtue of consumers spending more or less. S and I are irrelevant in this decision. S and I occurred prior, and they will occur in the present not because of the consumer’s spending or lack thereof in the technical sense, but rather about the producer’s expectations of future consumer demand.

    “Savings aren’t a ‘flow’. Savings are abstentions from consuming, and investing instead. Transactions are a ‘flow.'”

    The difference between two flows is in fact a flow. Transactions are events.

    Irrelevant. I said savings is not a flow, which is true. Saving is an event, a choice made to abstain from consuming and investing instead.

    “If someone consumes more, but earns less, then they are not saving more or less. They might be saving relatively more or less, but that would depend on their investing.”

    May I suggest a refresher on national accounting?

    I REJECT mainstream national accounting. May I suggest original thinking?

    Regardless, an INDIVIDUAL’s investment may not equal their savings.
    So what? It’s still true that S=I. You did realize that S=I refers to *aggregate* savings and *aggregate* investment, yes?

    You do realize that it is impossible for aggregate cash holdings to go up in the absence of inflation, yes? And yet, savings can increase by virtue of consuming less and investing more, thus creating more capital assets, yes?

  148. Gravatar of D R D R
    15. March 2012 at 12:52

    … I mean, if someone PAYS Scott to lecture to an empty room, then arguably there is some service he his providing. But it isn’t teaching.

    But if you want to view a lecture to an empty room as an unpaid-for service with Scott paying himself, then fine his income did not fall. But his consumption rose by the same amount.

  149. Gravatar of Major_Freedom Major_Freedom
    15. March 2012 at 12:54

    D R:

    Please understand that Sp=Y-T-C and Sg=T-G can apply to a purely barter economy. Cash is utterly irrelevant.

    In a barter economy, what would have been cash holdings in those equations above, would instead become real goods holdings.

    Please understand that the fact the equations “work” for barter economies, doesn’t mean cash is irrelevant in a monetary economy!

    We aren’t living in a barter economy. You cannot possibly abstract away from cash in a monetary economy.

    In a monetary economy, those above equations are in fact measured in money, not real goods.

  150. Gravatar of Major_Freedom Major_Freedom
    15. March 2012 at 12:57

    D R:

    … I mean, if someone PAYS Scott to lecture to an empty room, then arguably there is some service he his providing. But it isn’t teaching.

    You’re just proving my point. If someone is paying him to teach, then that was an investment, it was a saving. That’s already past and settled. Once the time comes for students to arrive, and the expectations are proven wrong, then that doesn’t mean Sumner or whoever paid him, made any more or less investment. Maybe the reduction in students leads them to reducing FUTURE investment and saving in the lessons, but that is a NEW set of decisions.

    But if you want to view a lecture to an empty room as an unpaid-for service with Scott paying himself, then fine his income did not fall. But his consumption rose by the same amount.

    Only because his consumption is financed by his wages that required the saving of someone else prior! He couldn’t have gotten wages from whoever paid him, if that person didn’t abstain from consumption themselves and made available the money to pay his wages.

  151. Gravatar of D R D R
    15. March 2012 at 13:00

    “Supply is NOT ‘the total of goods’. Supply is ‘the total of goods SOLD.'”

    By that logic, demand is the total of goods SOLD and supply is always and by definition equal to demand.

    “I REJECT mainstream national accounting. May I suggest original thinking?”

    Here’s some Major thinking: Private savings is the sum of snakes and snails. Public savings is puppy-dog tails. Investment is a pimple on your ass. Gee. Savings doesn’t equal investment. CONGRATULATIONS.

    Of course S=I only makes sense in the national accounting, because that’s the sense in which we mean savings and investment. If you use a different accounting, you may get a different result. But who cares?

  152. Gravatar of Major_Freedom Major_Freedom
    15. March 2012 at 13:00

    D R:

    “D R, if we’re talking about ‘immediate’ impact, then didn’t production fall on account of Sumner choosing to give one fewer lesson? Consumers might signal to Sumner to reduce the production of lessons, but in principle the immediate reduction occurs when Sumner makes the choice. After all, just like a car maker can save and invest and produce a car that nobody will buy, so too can Sumner give a lesson to an empty room.”

    Nope. If you produce a car nobody buys, you have still produced a car. If you lecture to an empty room, you have still produced nothing.

    *Sigh*, I cannot possibly argue with someone who is so slow.

    You’re proving my point again. The fact that someone didn’t buy the car is not itself a cause for any additional investment on the car maker’s part. That investment is already past and settled. His inventory is one unit higher than he expected it to be, but that doesn’t mean he made an additional investment in inventory. There was already inventory prior to it being sold. There was already saving. There was already investment. That’s done, finished. In the present, whether or not the car is sold will have ZERO impact on investment or saving, because the relevant saving and investment is already past and settled. It can never change. It’s history. In the present, there can only be a reduction of car sale, or a car sale. Whatever happens, there’s no additional or reduced investment or saving.

  153. Gravatar of Major_Freedom Major_Freedom
    15. March 2012 at 13:02

    D R:

    “Supply is NOT ‘the total of goods’. Supply is ‘the total of goods SOLD.'”

    By that logic, demand is the total of goods SOLD and supply is always and by definition equal to demand.

    ONLY if you define “demand” as “quantity of goods desired.”

    Again, I define demand as money spent, not quantity desired.

    “I REJECT mainstream national accounting. May I suggest original thinking?”

    Here’s some Major thinking: Private savings is the sum of snakes and snails. Public savings is puppy-dog tails. Investment is a pimple on your ass. Gee. Savings doesn’t equal investment. CONGRATULATIONS.

    And the penny drops, you’ve emptied your tank.

    Of course S=I only makes sense in the national accounting, because that’s the sense in which we mean savings and investment. If you use a different accounting, you may get a different result. But who cares?

    Who cares? Obvious you should, because it’s leading you astray.

  154. Gravatar of D R D R
    15. March 2012 at 13:11

    “Who cares? Obvious you should, because it’s leading you astray.”

    No. Just because you don’t think they are useful does not mean I am misled. Even if we agreed that the definitions of S and I are useless and have no real-world relevance whatsoever, that doesn’t mean that S does not equal I.

  155. Gravatar of Major_Freedom Major_Freedom
    15. March 2012 at 13:17

    D R:

    “Who cares? Obvious you should, because it’s leading you astray.”

    No. Just because you don’t think they are useful does not mean I am misled.

    Correct, but I’m showing you that you are being mislead because you think it is useful.

    Even if we agreed that the definitions of S and I are useless and have no real-world relevance whatsoever, that doesn’t mean that S does not equal I.

    I never actually denied that S=I. I am just correcting you on your error that a reduction in consumption spending by itself ipso facto implies a change in S or I. It doesn’t.

  156. Gravatar of D R D R
    15. March 2012 at 13:23

    “Correct, but I’m showing you that you are being mislead because you think it is useful.”

    Where do you get that?

    “I never actually denied that S=I. I am just correcting you on your error that a reduction in consumption spending by itself ipso facto implies a change in S or I. It doesn’t.”

    Funny. I actually agree that a reduction in consumption spending by itself does not necessarily imply a change in S or I. I have made exactly this point. So what are we arguing over?

    Oh yeah. You said “No, it really, really, REALLY does not equal investment.”

  157. Gravatar of Major_Freedom Major_Freedom
    15. March 2012 at 13:47

    D R:

    <i.”Correct, but I’m showing you that you are being mislead because you think it is useful.”

    Where do you get that?

    From what you have been saying.

    “I never actually denied that S=I. I am just correcting you on your error that a reduction in consumption spending by itself ipso facto implies a change in S or I. It doesn’t.”

    Funny. I actually agree that a reduction in consumption spending by itself does not necessarily imply a change in S or I.

    Was that before or after our little discussion?

    I have made exactly this point. So what are we arguing over?

    Not sure anymore Mr. Chameleon.

    Oh yeah. You said “No, it really, really, REALLY does not equal investment.”

    That was in the context of inflation of the money supply. Inflation can bring about more nominal investment than there is prior voluntary saving.

  158. Gravatar of Martin Martin
    15. March 2012 at 13:52

    Scott,

    “Martin, Construction of a gym is investment.”

    I never denied that. Defining a house however as a capital good however because it is an investment in housing services (as one commenter did), is akin to arguing that a gym membership is a capital good because it entitles you to gym services.

    It has to be an input in production for it to be a capital good.

    Sure you can argue that capital goods do [X], but it is a different thing all together to claim that because something does [X] it is a capital good.

  159. Gravatar of D R D R
    15. March 2012 at 14:02

    “That was in the context of inflation of the money supply. Inflation can bring about more nominal investment than there is prior voluntary saving.”

    Well, since you don’t agree with Scott regarding what these things mean, you really ought to explain what your unusual terms mean rather than saying Scott is wrong.

    And no, I don’t mean to concern-troll. Debaters really must settle on a language first.

  160. Gravatar of Major_Freedom Major_Freedom
    15. March 2012 at 14:06

    Martin:

    It has to be an input in production for it to be a capital good.

    Bingo. Martin gets it!

    And to cover all the bases, “production” in a division of labor, monetary society means the earning of money, and so making an expenditure for a good that is used for the purpose of making subsequent sales, makes the good a capital good, regardless of its physical appearance. Similarly, buying a good NOT for the purpose of earning money, is not a “productive” expenditure in the monetary order, and is hence a consumer good.

  161. Gravatar of Major_Freedom Major_Freedom
    15. March 2012 at 14:15

    D R:

    “That was in the context of inflation of the money supply. Inflation can bring about more nominal investment than there is prior voluntary saving.”

    Well, since you don’t agree with Scott regarding what these things mean, you really ought to explain what your unusual terms mean rather than saying Scott is wrong.

    I’ve already done that many, many times. You’re not omniscient, are you?

    My terms aren’t “unusual.” They might not be neoclassical synthesis definitions, but then again, neoclassical synthesis economics is to a large degree a disaster.

    And no, I don’t mean to concern-troll. Debaters really must settle on a language first.

    I have gone out of my way to make it absolutely clear how I define my terms. Far more so than I do elsewhere.

    The main reason I don’t define cash holdings as saving, is because it would make “non-savers” in the division of labor impossible. It would be impossible for anyone who earns money to not be a saver, since as soon as they earn money, the definition of saving = cash holding, would make them a saver. But when people typically talk of savers, they are referring to specific people in the division of labor, namely, those who make available funds for investment. This cannot be reconciled unless we either drop the cash holding = saving definition, or we drop the pretension that savers comprise only a portion of the population. We can’t have both.

    Are you prepared to call every single person who participates in the division of labor, and earns money, to all be “savers”? How could anyone not be savers in that world? They can’t. Which means “saver” loses all of the meaning it is intended to convey, and really becomes “money earners.” Well if money earning makes one a saver, then that would mean EVERYTHING purchased is financed by saving, even consumer goods, since consumer goods purchases are also financed out of cash balances.

    But no economist says consumption is financed by saving, because saving is by definition ABSTAINING from consuming.

    Do you see it now? This is why I think it’s wrong to conflate cash holding with saving. It leads to contradiction.

  162. Gravatar of D R D R
    15. March 2012 at 15:52

    “Are you prepared to call every single person who participates in the division of labor, and earns money, to all be ‘savers’? How could anyone not be savers in that world?”

    Uh… by borrowing from others? What do you mean?

    “Well if money earning makes one a saver…”

    I don’t know anyone who thinks this.

    “But no economist says consumption is financed by saving, because saving is by definition ABSTAINING from consuming.”

    RIGHT. We agreed on that long ago, with the understanding that government consumption counts. Which means that S = Y-C-G = I. What else could it be? True, if I have no income, and I consume nothing, I have managed to abstain from consuming $100 trillion, and we have again lost all meaning.

    “Do you see it now? This is why I think it’s wrong to conflate cash holding with saving. It leads to contradiction.”

    I do not so conflate, no matter how many times you attribute that position to me.

  163. Gravatar of Greg Ransom Greg Ransom
    15. March 2012 at 15:55

    Scott, the cool thing about logic is that it ISN’T debatable.

    We face a choice between longer production processes which promise superior output, and shorter production processes that promise inferior output.

    What part of that do you find debatable, Scott?

    If we are choosing superior output taking more time (housing) over inferior output taking less time (toothbrushes) then we ARE choosing MORE over LESS — more investment time input and more promised reward from that larger investment. Time is an input, a costly input. More time = more investment.

    What part of that do you find debatable, Scott?

    If you can’t identify anything that is debatable, then you’re statement that “it’s debatable, no one knows” is has no claim on our attention as a serious and sincere attempt at getting at the truth.

    “Greg, That’s a debatable point, no one knows for sure.”

  164. Gravatar of Jim Glass Jim Glass
    15. March 2012 at 16:19

    “It has to be an input in production for it to be a capital good.”

    Bingo. Martin gets it!

    “Capital goods” is a *subset* of capital assets — one of many such subset items.

    A house is not a capital good but it most definitely is a capital asset, as it has capital value resulting from the economic benefit it produces over a multi-year period.

    The purchase of a capital good that has value resulting from the economic benefit it produces over a multi-year period is an investment.

  165. Gravatar of Jim Glass Jim Glass
    15. March 2012 at 16:31

    the cool thing about logic is that it ISN’T debatable.

    Haven’t spent much time in an academic Philosophy Department, eh? Ah, memories. 🙂

  166. Gravatar of Major_Freedom Major_Freedom
    15. March 2012 at 16:56

    D R:

    “Are you prepared to call every single person who participates in the division of labor, and earns money, to all be ‘savers’? How could anyone not be savers in that world?”

    Uh… by borrowing from others? What do you mean?

    But if they borrow from others, they still have cash balances, so they would still be savers if you define saving as holding cash balances!

    “Well if money earning makes one a saver…”

    I don’t know anyone who thinks this.

    The logic of your position, that cash holding = saving, COMPELS you to think this. Anyone who earns money would have to be classified as savers because they are holding cash balances for whatever positive period of time passes before they spend it.

    “But no economist says consumption is financed by saving, because saving is by definition ABSTAINING from consuming.”

    RIGHT. We agreed on that long ago, with the understanding that government consumption counts. Which means that S = Y-C-G = I. What else could it be?

    It’s incredible how you cannot see that you are holding two contradictory positions at once.

    The equation S=Y-C-G=I is within the sphere of transactions only. Yes, if you take total money in transactions, and subtract consumption spending and government spending, then the only thing left over is investment spending. I am not at all denying this.

    It’s when you said:

    “To the extent that the $100 million *purchase* raised investment, it also raised income and therefore savings by the same amount.”

    It’s the “and therefore saving” part that supposedly follows from “raised income” that you conflated cash balances with saving.

    Saving does not increase just because cash balances go up. Saving only increases when abstaining from consuming takes place, and there is instead investment.

    True, if I have no income, and I consume nothing, I have managed to abstain from consuming $100 trillion, and we have again lost all meaning.

    That’s another reason why it’s a bad idea to equate saving with cash hoarding.

    “Do you see it now? This is why I think it’s wrong to conflate cash holding with saving. It leads to contradiction.”

    I do not so conflate, no matter how many times you attribute that position to me.

    I have conclusively proven that you did.

  167. Gravatar of Jim Glass Jim Glass
    15. March 2012 at 16:59

    Defining a house however as a capital good however because it is an investment in housing services (as one commenter did), is akin to arguing that a gym membership is a capital good because it entitles you to gym services.

    There is no sense in that. A house and a gymnasium are both capital assets (not capital goods) because they produce continuing economic benefits over a multi-year period, which when discounted to present value gives each a current capital value. Purchasing such a capital asset is an investment.

    Purchasing a gymnasium corresponds to purchasing a house — it is an investment in a capital asset.

    Buying a gym membership for a period of time corresponds to renting a house for a period of time — these are consumption expenditures.

    Purchasing a gymnasium and using it yourself corresponds to buying a house and living in it yourself, combining (1) up-front investment in a capital asset with (2) ongoing continuing consumption in the amount of the rental value of the house/market value of the gym membership.

  168. Gravatar of Major_Freedom Major_Freedom
    15. March 2012 at 17:05

    Jim Glass:

    “Capital goods” is a *subset* of capital assets “” one of many such subset items.

    That’s governmental accounting, which is supremely flawed.

    A house is not a capital good but it most definitely is a capital asset, as it has capital value resulting from the economic benefit it produces over a multi-year period.

    Why is “multi-year” significant? Why not multi-month, or multi-week, or multi-day, or multi-hour, or multi-minute, or multi-second periods?

    I enjoy books over multi-years, and I enjoy certain clothes over multi-years, and I enjoy my car over multi-years, and I enjoy my slippers over multi-years, and I enjoy my television over multi-years, and I enjoy my paintings and sculptures over multi-years, and within the multi-month period framework, I enjoy certain other clothes over multi-months, certain video games over multi-months, certain other books over multi-months, and so on. Then there are the enjoyment for goods over multi-weeks, multi-days, multi-hours, and mult-minutes, and multi-seconds.

    Do the fact that my enjoyment lasts for a period of time, make ALL these things “capital assets”? No? Why not? What exactly is it in the nature of time periods that turn a good from a capital asset or capital good, to a consumer good?

    Clearly any time period you give will be completely arbitrary. If you say one year, then I will say why not 364.9 days instead? Clearly if you are relegated to quibbling over arbitrary time periods, something seriously wrong exists in your analysis.

    The purchase of a capital good that has value resulting from the economic benefit it produces over a multi-year period is an investment.

    What about goods that give multi-month, or multi-week, or multi-hour, or multi-minute benefits?

    You’re not being precise at all.

  169. Gravatar of D R D R
    15. March 2012 at 17:10

    “To the extent that the $100 million *purchase* raised investment, it also raised income and therefore savings by the same amount.”

    This has nothing whatsoever to do with cash balances. I don’t care if you spend a penny, or $100 million, or $100 trillion.

  170. Gravatar of Major_Freedom Major_Freedom
    15. March 2012 at 17:32

    D R:

    “To the extent that the $100 million *purchase* raised investment, it also raised income and therefore savings by the same amount.”

    This has nothing whatsoever to do with cash balances. I don’t care if you spend a penny, or $100 million, or $100 trillion.

    It has EVERYTHING to do with cash balances. Raising income by $100 million means someone, or some people, are RECEIVING $100 million. Because you said raised incomes raises saving, you must be saying an increase in cash balances is saving.

  171. Gravatar of D R D R
    15. March 2012 at 18:20

    “It has EVERYTHING to do with cash balances. Raising income by $100 million means someone, or some people, are RECEIVING $100 million. Because you said raised incomes raises saving, you must be saying an increase in cash balances is saving.”

    AND it means someone, or some people are LOSING $100 million. So what?

    In a closed economy, income is generated by production only. When you sell currently-produced goods for money, that’s just an asset swap– trading a good for cash. When you deliver a service for money, that is income for your client for which you are compensated with a cash transfer. (Just as if you are a factory worker you generate income for your employer and are compensated in turn for your labor.)

  172. Gravatar of Major_Freedom Major_Freedom
    15. March 2012 at 18:38

    AND it means someone, or some people are LOSING $100 million. So what?

    So it means that you’re saying increased incomes and hence cash balances is saving, which you also denied, but then re-iterated, and now you’re just ignoring every having said it.

    In a closed economy, income is generated by production only.

    I define that as “real income.”

    When you sell currently-produced goods for money, that’s just an asset swap- trading a good for cash.

    Not when the money is created out of nothing. There is no “swap” then. It’s a pure addition to money.

    When you deliver a service for money, that is income for your client for which you are compensated with a cash transfer.

    That’s what I define as income in a monetary economy.

    (Just as if you are a factory worker you generate income for your employer and are compensated in turn for your labor.)

    I say wage earners are receiving an income, a money income. They are offering their labor in exchange. They are helping the employer produce the employer’s goods and services.

  173. Gravatar of Mike Sax Mike Sax
    15. March 2012 at 19:57

    Scott you said:

    “These aren’t “my views” they are the standard views of economists, right out of econ101, and also the government statisticians.”

    You always say this. But if so why does it always generate so much confusion. You said I have to provide quotes of people who diagree, well UnlearningEcon on this page. Actullay there are plenty of comments on this page that argue with it.

    Maybe you can provide a quote of one of these economists or statisticians.

  174. Gravatar of D R D R
    15. March 2012 at 21:52

    “So it means that you’re saying increased incomes and hence cash balances is saving, which you also denied, but then re-iterated, and now you’re just ignoring every having said it.”

    Because I haven’t said it. Stop trying to put words in my mouth. There is NO NEED whatsoever for cash balances.

    “I define that as ‘real income.'”

    Uh, duh! And that’s why cash doesn’t matter! Y, C, I, and G are all real quantities. That’s the standard notation. I’m sorry if by using standard notation I misled you. What did you think they were?

  175. Gravatar of Lorenzo from Oz Lorenzo from Oz
    15. March 2012 at 23:19

    Martin: No. A capital good is purely an input in production. How many periods it lasts, who owns it, that it provides services or goods, is all irrelevant. Electricity is not a capital good. Labour is not a capital good. Water is not a capital good. There are lots of inputs in production which are not capital goods. In business, we call them consumables: because they are consumed in the process of production.

    Also, the long-run/short-run distinction in economics does not make much sense unless capital goods are durable goods.

    (I take the notion that something producing shelter is not producing anything as fairly silly.)

    And we agree the form of financing does not matter: you were the one who brought it up.

  176. Gravatar of Lorenzo from Oz Lorenzo from Oz
    15. March 2012 at 23:21

    Obviously, I do not mean to imply that labour is a consumable. (Though slaves in the Caribbean and Brazil came close to being so, given their low survival rates.)

  177. Gravatar of Martin Martin
    16. March 2012 at 00:32

    Lorenzo,

    “Electricity is not a capital good. Labour is not a capital good. Water is not a capital good. There are lots of inputs in production which are not capital goods. In business, we call them consumables: because they are consumed in the process of production.”

    1. Just because A has characteristic X does not make everything with characteristic X, A.

    2. In the production function F(K,L) where K is capital and L is Labor, water, electricity and such are part of K economy-wide because it takes K to produce these.

    3. #2, in a single firm these are, arguably, also part of K. The accounting period however is simply too long to jot it down as inventory. You do however see it in changes in the firm’s working capital as its cash balance changes.

    4. “Also, the long-run/short-run distinction in economics does not make much sense unless capital goods are durable goods.”

    Everything is non-durable, variable, if you make the period long enough. It depends on what period you use. See above regarding electricity and such.

    5. “And we agree the form of financing does not matter: you were the one who brought it up.”

    I suggest you look at the context of the remarks. The remark you responded to, was a remark by me to another commenter regarding his definition of what a capital good is (investment in services). That definition brought up that it is relevant who finances it. If you look at my remark, you’ll see that I argue that it is irrelevant who finances it or who owns it for something to be a capital good.

  178. Gravatar of ssumner ssumner
    16. March 2012 at 11:48

    MRm, That’s an odd definition.

    Shane, You may be right.

    Vivian, I don’t understand your question.

    JV, You said,

    “But then elsewhere you say that saving equals investment, that really means that all money that is saved needs to be invested. Look, this is important.”

    Look, economists consider them equal by definition. If you don’t like the definition, fine.

    As for the person who suddenly got some money, from where? From someone else? Then the other person dissaved. From Uncle Sam? Then the governemnt dissaved, unless you consider money to be a capital good (most people don’t, but gold would qualify.)

    Oops, I saw the later post too late.

    Martin, Gyms provide gym services and houses provide housing services.

    Greg, I argued your counterfactual forecast of relative outputs was debateable.

    Mike Sax, This blog is aimed at people who have already studied EC101. I don’t have time to rummage through old textbooks, if anyone wants to investigate the official view of economists as to whether houses are capital goods, they are free to do so. I’m confident I will be shown right, just as I was hown right in the long pointless S=I debate, when initally people thought I was saying something controversial.

    I’m done here, I’ll give you guys the last word.

  179. Gravatar of Major_Freedom Major_Freedom
    16. March 2012 at 12:43

    D R:

    “So it means that you’re saying increased incomes and hence cash balances is saving, which you also denied, but then re-iterated, and now you’re just ignoring every having said it.”

    Because I haven’t said it. Stop trying to put words in my mouth. There is NO NEED whatsoever for cash balances.

    You did say it, whether you’re consciously aware of it or not. There is no other way to interpret “raised incomes and hence increased saving” unless you presupposed cash balances to be saving.

    “I define that as ‘real income.'”

    Uh, duh! And that’s why cash doesn’t matter! Y, C, I, and G are all real quantities. That’s the standard notation. I’m sorry if by using standard notation I misled you. What did you think they were?

    No, they are NOT “real quantities.” Y, C, I, and G are ALL measured in terms of quantity of dollars spent. You are conflating money spent on goods produced, with production itself. They are not the same.

    You may believe you’re using the “standard” notion, but you’re really not.

  180. Gravatar of D R D R
    16. March 2012 at 13:46

    “No, they are NOT “real quantities.” Y, C, I, and G are ALL measured in terms of quantity of dollars spent. You are conflating money spent on goods produced, with production itself. They are not the same.”

    Of course it is production and not expenditure. C+I+G is Gross Domestic PRODUCT of a closed economy. That’s why inventory adjustments count. If you produce today 100 trillion hammers and sell only 5, you’ve still produced 100 trillion hammers. If you produce zero hammers and sell 5 you’ve still produced nothing.

    It doesn’t matter how many you sell and how many are stuck in warehouses. If hammers sold for $5 each last year, then your production added $500 trillion to GDP at 2011 prices. If hammers sold for $1 in 1935, then your production added $100 trillion to GDP at 1935 prices. If hammers sell for $25 dollars in 2087, then your production added $5 quadrillion to GDP at 2087 prices.

  181. Gravatar of D R D R
    16. March 2012 at 13:47

    That was supposed to say $2.5 quadrillion, but whatev.

  182. Gravatar of Lorenzo from Oz Lorenzo from Oz
    16. March 2012 at 14:54

    Martin: On (1), yes, I believe that was my point.

    On (2), you seem to believe capital is what it produces; I hold that capital goods produce things. So is the means of production, not the production itself. To me, a power station is a capital good which produces electricity which is used up in the process of production. Sure, you need a capital good to produce electricity and sure electricity is used in production but that no more make electricity capital than it makes what labour produces labour. A haircut is not labour, it is what labour produces. You have to have something come out of the other side of the production function.

    Capital is something you still have when whatever it is comes out of said function (and can use to do it all again: if it breaks or wears out, it stops being capital). That is what makes means of production means of production: they are still there when the production has happened. That is why you repair/maintain buildings and machinery, train (and in other ways manage) labour and look after the land–so it can keep doing that.

    Now, if you want to say there is something then odd about the production function, because it collapses what the means of production use in the process of production into factors of production, that might well be a revealing point. And it is certainly true that any point in time is always at a point in the production process, leaving intermediate goods as part of the assets of a business. But I will stick with a capital good being what is still around after a cycle of the process of production has happened, ready to do it all again.

  183. Gravatar of Jim Glass Jim Glass
    16. March 2012 at 16:32

    A capital good is purely an input in production. How many periods it lasts, who owns it, that it provides services or goods, is all irrelevant.

    Now we’re well into the silly zone. Inputs are called “inputs”. Capital goods are capital assets — hence the “capital” in the name — defined as having a lasting useful life, exceeding one year typically.

    Start with Wikipedia: “In economics, capital, capital goods, or real capital refers to already-produced durable goods used in production of goods or services. The capital goods are not significantly consumed, though they may depreciate in the production process.”

    Then move on to any other reference you want. Is electricity a durable good, “not significantly consumed”? A capital asset? Does it depreciate?

    No, it is an input, immediately fully consumed.

    Capital is an asset of the owner. It is recorded as such on the balance sheet.

    Show us a balance sheet of any of the public corporations of the world upon which a value for “electricity” is recorded among the capital assets.

    This thread can reach 5,000 comments if people insist on creating their own definitions of fish as cats and pigs as birds.

  184. Gravatar of Jim Glass Jim Glass
    16. March 2012 at 16:54

    “Also, the long-run/short-run distinction in economics does not make much sense unless capital goods are durable goods.”

    Everything is non-durable, variable, if you make the period long enough. It depends on what period you use. See above regarding electricity

    Yup, the Egyptian Pyramids are non-durables if you make the accounting period long enough.

    That’s why the accounting boards set the period at one year.

    Talk about the kind of sophistry that gave the Sophists a bad name!

    🙂

  185. Gravatar of dwb dwb
    16. March 2012 at 18:34

    Show us a balance sheet of any of the public corporations of the world upon which a value for “electricity” is recorded among the capital assets.

    sorry i am going to pick on that. power companies like Duke and Exelon have these assets called power plants, the value of which is a function of the expected electricity generation (Q) times the gross margin (market price of electricity minus the fuel andfuel transport cost). Lots of companies have written down assets, because the market price of electricity dropped (the value again expected Q * P).Without getting into the mind numbing details, you write down (impair) an asset when the cashflows do not support the book value, which inherently requires estimated expected generation times the price (minus costs etc.)

    If you dont like that example, many power companies also have derivative positions as hedges: basically swaps (or tolling agreements, or other more complex structures). the value (NPV) of the swap is the (discounted) market price of power less the contracted fixed rate (just like any other swap).The swap basically represents the committment to a future purchase (or sale) of physical electricity at a certain location. The NPV is reported as “derivative in gain” or “derivatives in loss” on the balance sheet and marketed to market.

    http://www.cmegroup.com/trading/energy/electricity/pjm-western-hub-peak-calendar-month-real-time-lmp.html

  186. Gravatar of Martin Martin
    17. March 2012 at 00:23

    Lorenzo,

    1. “Capital is something you still have when whatever it is comes out of said function (and can use to do it all again: if it breaks or wears out, it stops being capital). That is what makes means of production means of production”

    Yes, whether or not something is considered a capital good on a balance sheet is tied to the length of the period of production that we consider to be relevant.

    I haven’t done it before, but I am pretty sure that it is perfectly possible to write down a production function in continuous time with depreciation equal to 1. The flow of K could then just as well represent the use of electricity. There is no difference.

    Do we want to think of electricity as a capital good in everyday life? No. Is it possible? Yes.

    If you disagree with that deprecation = 1 is still a capital good, then let’s say that d < 1, in that case, a physics textbook will tell you that there will always be a tiny bit of it in the wires and therefore it is not fully used in one arbitrary short period.

    Again then, do we want to put that on the balance sheet in every day life? No. Is it possible? Yes.

    Jim,

    2. "Start with Wikipedia: “In economics, capital, capital goods, or real capital refers to already-produced durable goods used in production of goods or services. The capital goods are not significantly consumed, though they may depreciate in the production process.”"

    Go down further that page and you'll see that a capital good is an input in the production function. It's the K in F(K,L).

    Now the above you quote, has the following words in it "durable, significantly and production process", these are all arbitrary and contingent on the purpose and organization of the (actor controlling the) firm. These will tell you when you go into a firm, based on the purpose of the firm what is what.

    However, just because something is not classified as K in one firm for one reason or another, does not mean that it therefore can never be classified as K. This is the mistake you seem to be making when you state this:

    "That’s why the accounting boards set the period at one year."

    If you look at a good, that is not Labor, but is an input in production, then you know to either disregard it as insignificant for your purpose, or that you have to classify it as a capital good.

    If you have a system in aggregate represented by F(K,L) however it is either Labor or K and the intermediate goods (usually) cancel out, because it is as if the entire economy is a single firm.

    In the end whether or not a particular good is a capital good, depends on your purpose. To say that something is or is not, will get you in the same trouble as when you have to come up with objective criteria to decide whether a diamond is more valuable than water.

    On another note, you'll see that: "Homes and personal autos are not capital but are instead durable goods because they are not used in a production effort."

  187. Gravatar of Greg Ransom Greg Ransom
    17. March 2012 at 08:41

    “Greg, I argued your counterfactual forecast of relative outputs was debateable.”

    There’s no forecast.

    Show me where there is a forecast.

    It’s stipulated that houses are longer term productive goods than tooth brushes.

    It’s a matter of logic — just like any other logic of choice situation — that individuals have a choice between waiting for the superior output from longer production processes and not waiting so long for inferior output from shorter production processes.

    What part of this do you contest?

  188. Gravatar of Major_Freedom Major_Freedom
    17. March 2012 at 13:37

    D R:

    “No, they are NOT “real quantities.” Y, C, I, and G are ALL measured in terms of quantity of dollars spent. You are conflating money spent on goods produced, with production itself. They are not the same.”

    Of course it is production and not expenditure. C+I+G is Gross Domestic PRODUCT of a closed economy. That’s why inventory adjustments count. If you produce today 100 trillion hammers and sell only 5, you’ve still produced 100 trillion hammers. If you produce zero hammers and sell 5 you’ve still produced nothing.

    No D R, it’s MONEY based, not “PRODUCT” based. Inventory adjustments are made according to their expected MONEY sale value. Just because the WORDS are “gross domestic product”, it doesn’t mean it is adding up product. No, it is adding up all the money expenditures, and adjusting for expected money expenditures for inventory.

    It doesn’t matter how many you sell and how many are stuck in warehouses. If hammers sold for $5 each last year, then your production added $500 trillion to GDP at 2011 prices.

    This is exactly why GDP and NGDP don’t tell us anything about how many real goods are being produced! You’re proving my point.

    If hammers sold for $1 in 1935, then your production added $100 trillion to GDP at 1935 prices. If hammers sell for $25 dollars in 2087, then your production added $5 quadrillion to GDP at 2087 prices.

    And yet there is no reference to how many hammers were produced and sold, which is the REAL production.

  189. Gravatar of D R D R
    17. March 2012 at 14:17

    Major,

    You simply don’t know what you are writing about.

    Cheers!

  190. Gravatar of Major_Freedom Major_Freedom
    19. March 2012 at 13:09

    D R:

    You’re simply wrong!

    Hey this is fun.

  191. Gravatar of Lorenzo from Oz Lorenzo from Oz
    16. April 2012 at 18:15

    Martin: Our discussion ended up provoking me into thinking a bit more about production functions and how they can be misleading.

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