What’s Savings Got to Do With it? Not much really.
I want to piggy-back very briefly on Marc’s post from Tuesday (and update yesterday) which suggested that the proposed Tax-Free Savings Account won’t “promote investment” like the government says it will (see page 76 of Budget). The empirical literature I’ve seen certainly supports his argument — most corporate investment is financed from retained earnings, which in turn suggests that consumption, not savings, is the most effective way of stimulating investment for the simple reason that consumption juices corporate profits and provides a powerful signal to corporations that more supply is needed. Put differently, it emboldens their animal spirits, which again, is what investment decisions ultimately come down to.
I think, however, it is important to add that there are also strong theoretical reasons to question the savings generates investment argument. These theoretical points revolve around the nature of money. There is a well developed Post-Keynesian literature that argues — and I think demonstrates — that money is endogenous, a fancy term that means simply that money supply in a modern economy responds to demand.
Banks don’t run around looking for savings when they decide to make a loan. Rather, they create money ex nihilo (out of thin air) and then, if prudence dictates, seek out reserves (high powered money) either from other banks or the Bank of Canada — the textbook money multiplier story has it wrong in other words.
This insight has tremendous implications for the way we think about the whole savings-investment nexus (investment creates savings rather than vice-versa) as well as fiscal (balanced budget rules are worse than pointless at the sovereign level) and monetary policy (control over price of money but nothing else).
For a nice summary of what endogenous money theory implies for fiscal and monetary policy, I strongly recommend Scott Fullwiler’s longish article in the December 2007 issue of the Journal of Economic Issues (the JEI isn’t free but anyone with access to a university library should be able to get a copy).
So, if endogenous money theory is correct and aggregate savings don’t matter from an investment perspective, then what really is at stake with these kinds of tax-exempt savings plans is distributional matters, a point made abundantly clear by the rest of the PEF blogging team.