Savings, investments and a dose of realism

On the Save Our Savers website today is this article by John Phelan. It explains why savings are essential to the economy and why - in his view - central bank and government policies that discourage savings are misguided. And why QE is no substitute for "proper" savings.

I've heard these arguments a lot recently and they always seem to stem from the idea that there is only one sort of "savings", namely retail deposits in banks and building societies. And indeed, the usual definition of "savings" does mean cash, in its various forms, so bank deposits are "savings" whereas pensions are not - they are "investments". I'm not sure people necessarily make such a clear distinction in everyday parlance. But Phelan's argument is an economic one. How does economics define savings?

In economics, "saving" is the residual of income left after consumption. If S = saving, Y = income and C = consumption, S = Y - C. Note that S is the dependent variable: its value depends on the values of Y and C. When these change, so does S. This is fundamental to understanding what the present policies of central banks are intended to achieve.

Keynesian economics also says that all saving should be invested productively in the economy to generate future growth. Indeed, Phelan's entire argument rests on this - after all, if savings aren't invested productively, it is hard to argue that they are essential for future economic growth. If investment is I, therefore, S = I.

Now you can see that we immediately have a problem. If savings = cash, then all investment is cash. Clearly this is wrong. It seems savings has two, quite different, definitions - the common one (savings = cash) and the economic one:

S = Y - C = I

This is really important. Back in the good old days when people were paid in cash, people's idea of saving was to put money in the bank or building society.  And many people in the UK still think like this. As someone put it in a comment on Phelan's post, "if I take my money out of the building society, where do I put it?"  To this day, in the UK, when people talk about saving, they think "bank".

But cross the Pond, and you find people thinking very differently about how to save. There, stock market investments are a way of life. Very ordinary people have stocks & shares, and bank deposits are much less important as savings vehicles. Are we going to argue that because our American cousins invest their residual income in stocks and shares rather than putting it in the bank, that they don't have "savings"? Clearly this is nonsense. The common definition of savings is simply inadequate. People's "life savings" are the sum total of all the residual income they have stashed away over the years, whatever form it is in. To call stashing away cash "saving" and everything else "investing" is economic nonsense. All of it is S.

And ideally, all of it is I, too. The heart of Phelan's argument is that savings are essential if there is to be productive investment. I completely agree. But bank deposits are not the main source of such investment. These days, even in the UK, the main sources of savings for productive investments are funds - pension funds, money funds, wealth funds. And as more people are enrolled in private and corporate pension schemes, those sources will become ever more important. Though in fact bank deposits are really only another sort of fund. The idea that they are in some way "different" from any other sort of investment is fundamentally wrong.

Money in bank deposit accounts has been lent to the bank. It is no more "your money" than any other sort of investment. When you put money in the bank, you exchange cash for a financial asset - a balance on a deposit account. That is no different from buying a bond. In fact you can view bank deposit accounts as bonds: the interest on the account is the coupon, there may or may not be a maturity date (if there isn't it is a "perpetual"), it may or may not be liquid (how easily can you sell it/take your money out). And banks treat deposits in the same way as bonds. As I've explained elsewhere, to banks deposits are simply a source of funding. You have lent your money to the bank just the same as if you have bought its bonds. The bank has no responsibility for "looking after your money" or investing it to generate a good return for you. It will invest your money, yes, but to benefit itself, not you.

So, does S really equal I? Is all saving really productively invested in the economy? Or is there saving that isn't productively invested - and where does it fit in?

No, S does not necessarily equal I. At the moment they are a very long way apart:

(Chart from Paul Krugman via Monetary Realism. Source: FRED. US data, but a similar picture of collapsed private investment and high private saving applies in the UK too - though in the UK it is more corporate saving than domestic).

What happens to saving that isn't invested productively is that it is transformed into financial assets and hoarded. This is what Monetary Realism means when it redefines S = I as S = I + (S-I). Saving is the total of productive investments AND the bit left over. We can argue for hours about what we mean by productive investment and unproductive hoarding of financial assets. The point I am making is that quite a lot of saving simply isn't productively invested in the real economy.

As the chart above shows and Aziz explains, at the present time there is a glut of savings and a shortage of productive ways of using them. The story of the last five years has been a massive failure of corporate and government investment, not because corporates haven't got any money - they have enormous cash balances - but because they can't think of anything useful to do with their money apart from buying back their own stock. And long-term, the need for investment capital seems to be declining as manufacturing becomes more efficient and services more dominant in the economy. But at the same time there has been a huge growth in saving, both domestic and corporate.

This is the real reason why interest rates are so low. Savings that aren't productively invested can't generate a genuine return for their owners. All they can do is extract rents from wage earners and taxpayers to create the illusion of a return. Unless we can find productive uses for all this saving, it simply isn't needed. And when there is a glut of anything, it makes sense to discourage producing it and encourage activities that reduce the glut - in this case, since it appears corporates aren't investing because of a shortage of demand, most obviously consumption (since S = Y - C). Despite what Phelan says, therefore, discouraging saving and encouraging consumption until the economy is growing again makes complete sense from a macroeconomic standpoint.

Unfortunately it doesn't make sense from the point of view of people's needs over their lifetimes. People need to save, particularly to support themselves in retirement and to cover unexpected expenses. This creates a considerable dilemma: from an economic perspective we don't need more saving, but from a personal perspective we do. I am not unsympathetic to this problem, but it seems to me that attempting to persuade those responsible for macroeconomic policy to favour personal needs over economic needs is doomed to fail. The central bank is not responsible for ensuring that people can save. That is the responsibility of the fiscal authorities.

There is a lot that governments could do to help people save in a low-growth, low-investment world, but first they have to get out of the straitjacket they have made for themselves. The primary purpose of government debt is not to finance government - after all, it can create all the money it needs - but to provide safe savings vehicles for citizens. Governments should produce the amount of debt instruments for which there is (domestic) demand, and stop worrying about future debt service. After all, those debt instruments are the current savings of those who will be old in the future. Either those people buy government debt, and are supported in the future from taxes levied on future generations to pay debt service, or they don't, and are supported in the future from taxes levied on future generations to pay old age pensions. Really there is no difference. We have to stop getting so hung up about public debt. Public debt is the savings of the people of the country, and they should have as much of  it as they need.

So where does QE fit in? Does it really create "fake" savings, as Phelan suggests? No. The deposits created by QE are real. They are indistinguishable from any other sort of savings.

In the real economy, deposits are created as a consequence of bank lending. The savings deposited in banks by savers, or paid into their pension funds, were ultimately created as a result of someone else's borrowing - perhaps their employer, in the form of working capital finance enabling him to pay their wages: or perhaps someone who borrowed to buy products from their employer, providing business income from which wages are paid. The loans that originated the funds deposited by our savers can be some distance removed from them, which is why it is hard for people to understand that they only have money because others have debt. But it is important to understand that loans create deposits, not the other way round. 

So normally, in our economy, saving is only possible because others have debt. This is the S = I rule looked at the other way round, of course. As Andy Harless suggests (following Keynes), S is only possible because there is I, where I is some form of debt, physical asset or equity (equity is really only a bonded form of debt, as people enslaved because of indebtedness could tell you). Substituting Monetary Realism's breakdown of I, that means that when I is falling because of lack of productive investment opportunities, either S must falls too (dis-saving or debt increase) or unproductive hoardings of financial assets must increase. It might help to look at the equation again:

S = Y-C = I + (S-I)

When it is doing QE, the Bank of England buys bonds, mainly from investors (though some from banks), in return for newly-created money. These bonds were originally bought with cash, either by individuals or by institutions (funds) on behalf of individuals. In buying the bonds, all the Bank of England does is replace an interest-bearing asset - a bond - with a non-interest-bearing one, i.e. cash. And what do investors do with this cash? They put it in a bank, or they spend it, or they invest it in some way. If the seller of the bond is a bank, it invests the money in some way, or it parks it at the central bank. QE money is real money replacing real assets that have been previously bought with real money. The only difference is that instead of the assets being bought by other savers with money that banks have created through lending, they are bought by the central bank with money created by the central bank. Other savers are therefore forced either to compete for the remaining bonds, or to invest their money in some other way (ideally by buying riskier assets, thus encouraging I to increase) or spend it (reducing S by increasing C). Phelan's suggestion that QE money is somehow disconnected from individuals' savings is simply wrong. It would not be possible to do QE unless individuals (and institutions representing individuals) already had savings in the form of government bonds and other securities that could be bought by the central bank. What QE does is influence how people invest their savings, not create "fake" savings as Phelan suggests. 

Phelan makes another, all too common, mistake: he states that the purpose of QE is to provide additional funds to banks so that they can lend. But this was never the primary purpose of QE. Both the Bank of England and the Federal Reserve have explained that QE achieves its effects principally through supporting asset prices and encouraging investors (i.e. savers) to rebalance portfolios towards risky assets: the "bank lending channel" is at best weak and at worst non-existent. And QE has indeed raised bond, stock and commodity prices across the board. The downside of this is that yields on investments have fallen, along with associated interest rates including those on bank deposits. Generally speaking, savers who were looking for yield from their investments have suffered from QE: savers who were looking for asset value appreciation have benefited.

It may be that in the future, the economy will have a greater need for saving for investment - though thirty years of interest rate decline is not exactly promising:

UK 10-year gilt yield
Historical Data Chart
(source: Trading Economics)

Or maybe there will be such a decline in saving that demand for what remains forces up interest rates - though successive governments trying to encourage people to save for their futures without providing enough vehicles for them to do so doesn't help matters. If there is a criticism I would make of QE from the point of view of savers, it is the fact that it reduces the stock of safe assets for long-term savings, raising the price and reducing the returns. Savers who don't want risk aren't going to diversify into riskier assets: savers who are saving for retirement aren't going to spend the money instead. They will either pay the higher prices for safe assets or put money in the bank. Either way they will get rubbish returns, since the fact that deposit accounts and gilts are substitutes means the rates will be pretty much the same on both. In other words, they will simply substitute one low-yielding safe asset for another, while moaning about how unfair it is. This strikes me as pretty pointless. But then my regular readers know I am no fan of QE.

In summary, although I agree with Phelan that saving is necessary for investment in a healthy economy, at present we have more savings than we know what to do with. Central banks see the present problem as principally a demand shortfall, which is depressing economic activity and discouraging corporate investment (if companies can't see adequate sales opportunities for the foreseeable future, they won't invest). Their strategy is to discourage saving and encourage consumption. This brings forward demand from the future to the present, which should generate economic activity and encourage companies to start investing again.

This is what lies behind Carney's observation that the best thing for savers is a strong economy. Raising interest rates would reduce household and business consumption, increase corporate finance costs and further discourage already low corporate investment. Keeping interest rates low until the economy is stronger is painful for savers in the short-term, but in the longer-term it will benefit both them and the future generations on whom they will rely for their income.

I suppose everyone will now think I've really got it in for Save Our Savers. Actually I really haven't. But I do wish they would get things right.

Since a couple of people have pointed out that S can only exceed I if either the public sector is in deficit or the external sector is in surplus (or both), I am adding a section on sectoral balances.

The full equation is:

S = Y - C = I + (G - T) + (X - M)

where G = government spending, T = tax revenue, X = exports and M = imports.

Rearranging this equation gives us S - I = (G - T) + (X - M).

Clearly, if S > I then either G  > T (fiscal deficit) or X - M (trade surplus), or both. So S - I, which is the "bit left over" after the private sector has made all the productive investments it desires, is made up of fiscal deficit and/or trade surplus.

If C increases and Y does not, I may decrease (less private sector capital investment). This is what we fear, and if there really are few profitable investment opportunities despite increasing C, this is what we will see. However, if central banks are correct to believe that increasing demand stimulates investment, it seems unlikely that increasing C would result in falling I. The opposite - increasing I - is what we want and is the reason for encouraging C to rise. However, it is also possible that I could remain unchanged and (S-I) could change. In an economy that is over-producing, this outcome is certainly possible. However, the FRED chart shows I rising and (S-I) remaining pretty much unchanged until very recently. The UK's corporate investment picture is not so promising: gross fixed capital formation over the last few years has been dismal.

Save Our Savers' argument is that we need C to FALL, not rise, to increase S, and therefore they want higher interest rates to encourage saving and discourage (leveraged) consumption. This is based on an assumption that increasing S always feeds through into increasing I. I'm afraid the story of the last few years is that it does not.

This sectoral balance stuff is not easy. I got it wrong in the first version of this postscript! Please read JKH's link (Monetary Realism). He explains it much better than I do.

Related links:

Why suppressing savings will lead to another recession - John Phelan, Save Our Savers
Why savers should put up or shut up - Azizonomics
Investment makes saving possible - Andy Harless
JKH on S-I-S-I - Monetary Realism
Paul Krugman does S-I-S-I - Monetary Realism
Lender, beware - Frances Coppola, Pieria
Government debt isn't what you think it is - Coppola Comment
Quantitative Easing Explained - Bank of England (with pdf links for more detail)
Quantitative Easing: Lessons we've learned - St. Louis Federal Reserve
Bank of England boss warns against choking off recovery - Evening Standard (with video)
The investment problem - Coppola Comment


  1. Isn't low demand in the economy because of the debt now encumbering many consumers? Pay day loans are the new safety net. Savers, on the other hand, are not going to suddenly start to spend their savings because of low interest rates. They are more likely to save more because they feel insecure. Pay day loans are not for them!

    Economics doesn't seem understand people. And central banks are populated by people....

    1. Debt is certainly part of it. But low wages and falling real incomes are a big factor too.

      Savers don't necessarily save more because of low interest rates, any more than borrowers necessarily pay off debt faster. It depends on their circumstances. Falling real incomes is a real problem for many people, which prevents them saving more and/or paying off debt faster.

    2. Oh, and most savers are also borrowers of course. Nothing is ever simple!

  2. "Keynesian economics also assumes that all savings are invested productively in the economy to generate future growth"

    An interesting article and I do intend to reply at length. I would, however, just highlight this. Keynesian economics actually argues that more often than not the exact opposite will be the case; that savings can pile up uninvested leading to declines in aggregate demand. That, in fact, was the starting point of his analysis.

    1. I should have said "Keynesian economics says that all savings SHOULD BE invested productively in the economy". I will correct that.

      As you say, Keynes regarded excess saving as a considerable problem. That is really what I have been discussing in this article, though I don't think the "loanable funds" model is right.

    2. The view that "all savings SHOULD BE invested productively in the economy" is far from native to Keynes and his followers though. Smith, Ricardo, and Marshall all said exactly the same long before him. It's really rather a commonplace.

    3. Yeah, but this is a Keynesian post!

  3. Not being a professional economist, it has puzzled me why, with some much deficit spending on the part of government, we do not have greater price inflation. The money supply must be being inflated, but prices have not gone through the roof.

    As an amateur, my only conclusion is that price increases are restrained because people are restrained in their spending. As you said, we have more savings than we know what to do with. Without knowing the correct technical terms for this, it is not just the amount of money that causes price inflation, but how fast it moves and how much it is spent.

    But once price inflation starts, it may go out of control because people will think, I better buy now before prices go up, and then, when the inflated money supply begins to move faster as people spend more, prices may inflate out of control. Then, how does the government put the inflated money supply back in the bottle? How can this be stopped once it starts?

    1. You do not have greater price inflation because broad money measures (M4) have been stagnant despite massive increases in narrow money measures (M0). All that new narrow money has piled up in banks and not been lent out at multiples to boost M4 and price inflation.

    2. Although I'm another amateur, I think your view of the causes of inflation are mistaken. Inflation can occur where "too much money chases too few goods". You're only looking at the first part of that equation. Currently more goods can easily be provided at no extra cost, as the economy is running under capacity.

    3. Hamilton,

      A lot of people fear this, because they think of "the money supply" as one homogenous lump of money. But it doesn't actually work like that. QE money expands bank balance sheets, because it increases bank reserves (asset) and bank deposits (liabilities), but there is absolutely no reason why that balance sheet expansion should mean increased bank lending. Banks lend when the risk versus return equation is in their favour. At present they are seeing few opportunities for productive lending (just as corporates are seeing few opportunities for productive investment - it's the same thing really), and they are under regulatory pressure to de-risk their balance sheets and improve capital and liquidity buffers to make them "safer". They don't want to lend. It's as simple as that.

      Would a return to growth cause inflation? Possibly, but it will then be the responsbility of the central bank to use macroeconomic and macroprudential policy to squeeze bank lending and control the price level. I really don't buy the argument that the existence of excess reserves means there will suddenly be a massive demand explosion that will cause runaway inflation.

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  5. Firstly, thanks for a great post sorting this problem out. There is a lot of (dangerous) double talk about *savings* and this post should help to straighten it out.

    Secondly, I remember in the 60s and 70s it was a common idea that USA does well *because* they like to live in the fast lane' and use their credit cards to buy stuff on credit. Makes sense - high velocity of money and low savings makes for a dynamic economy. In UK it was (and is) considered prudent to save more. And in Japan doubly so.

  6. A question. How do we consider cash under the mattress? How can S = I when cash under the mattress is not being invested?

    1. Not much cash under the mattress - but isn't it a CB liability? I am interested from a theory point of view.
      Also gold hidden in garden sheds. Where does that fit in? Savings, investments, assets?

    2. It's savings, uninvested. So in the extended version of the S=I equation, it's part of (S-I).

      Cash is indeed a CB liability. It's not debt though: probably simplest to regard it as shares in UK plc. Cash in your pocket (or under the mattress) is "yours" in a way that money in the bank is not. You haven't lent it to anyone. Same with gold in garden sheds. You haven't put them at risk, apart from theft and (for notes) fire, flood & vermin, but you won't earn a return on them. Over time the value of the cash may diminish: gold is more unpredictable.

    3. The Value of your cash is almost certainly going to diminish. Every central bank in the world has set its objective to create inflation, when was the last time their wasn't inflation and/or rising prices? Gold hasn't suddenly become more valuable (it doesn't do anything) the dollar has just become worth less. Gold and silver are the new "safe" saving banks do you think that after about 6000 years gold will suddenly become worthless?

    4. Central banks are trying desperately not to "create inflation" but to get economies growing, of which higher inflation can be a symptom. But inflation is actually falling in most Western economies. It's higher in the UK because we have a stupid Government that is failing to regulate utility prices and adding price pressures of its own in the form of tax rises, and because the UK's open economy is very sensitive to world commodity prices. But even in the UK, inflation is currently about its long-run average, although slightly above target. In the US and the Eurozone, inflation is below target and falling. We have disinflation, not inflation.

      I've explained elsewhere why low positive inflation is healthy for an economy. Money is not a good long-term store of value for exactly this reason - its value is bound to erode over time in a healthy economy. Long-term savings should be in assets, not money.

    5. "But inflation is actually falling in most Western economies." The inflation has been exported and it will come back home one day. And as a an average person I can only observe how much more expensive food has become since 2008.

    6. There is no reason whatsoever to assume that inflation will "come home one say".

      Essential foodstuffs have indeed become more expensive, because of world commodity prices. But the prices of other consumer goods have fallen. Overall, we do not have high inflation, and have not for a long time. So long, in fact, that most people seem to have forgotten what it is. Do you remember the 1970s?

    7. If you think that the real rate of inflation is the one calculated by the State then you are divorced from reality. The prices of everything that people have to buy in order survive are rising far faster than the official rate. Cheaper TVs do not compensate for rapidly rising fuel, food and housing costs. Some food costs have doubled in the last year or so. Potatoes are twice the price they were. But hey, an iPad costs less than it did! Guess I'll have to eat that then.

      You really are so far removed from how the vast mass of the public live you really should become a politician.

    8. Jim,

      On the contrary, I would absolutely agree that there is much higher inflation in essentials - food, energy, transport, housing.

      What we have is a phenomenon I associate with demand-constrained economies - rising prices in essentials and falling prices in everything else. What is really going on is deflation, not inflation. But because essentials are, well, essential, people prioritise spending on those, so suppliers of essentials have no incentive whatsoever to reduce prices - indeed they may raise them just because they know people will always pay. That I think is what is happening in utilities and transport, due to the abject failure of Government regulators to prevent inflationary price rises in monopoly utility providers. And in the housing sector, high rents are due to supply pressures that the Government is doing absolutely nothing to ease. Rising food prices have been mainly due to world commodity price rises, not domestic producer pressure.

    9. Well then the point is we DO have inflation, the State is just pretending we don't by fiddling the figures. If the cost of real life living is rising faster than people's wages then they are being made poorer. Thats not deflation, its inflation.

      The State is printing money like its going out of fashion, and its creeping out into everything else. I'm a farmer - farmland has doubled in price in the last few years. Why? Because anyone with serious cash (ie tens if not hundreds of millions) is looking to get rid of the paper money and buy something the State can't produce at the touch of a button. Ask James Dyson why he just spent several hundred million buying thousands of acres farmland in East Anglia - if we've got deflation why would he swap cash (an appreciating asset in deflationary times) for land (a depreciating asset in deflationary times)?

    10. Jim,

      Er no. Inflation is not a rise in the price of essential goods. Nor is inflation the ratio of wages to prices. Inflation is a rise in the general price level across all goods and services, not just essential ones. You can't start changing the definition of inflation to suit your world view. Wages not keeping up with price rises in essential goods does not necessarily indicate high inflation: as I said, it may actually imply deflation, and in my view it certainly indicates demand constraint. The problem is low wages as much as high prices.

      Land is an appreciating asset in the UK because it is in short supply. That has nothing to do with whether the general price level is rising or falling.

    11. Oh, and the State is not "printing money" at the moment - at least not in the UK. QE in the UK stopped some time ago, and Funding for Lending does not involve money creation.


      Name me anything thats going down in price, apart from electronic goods, which have always done so, for reasons that are entirely unrelated to our current economic situation. Everything I buy costs more this year than last, by some margin. That goes for goods and services.

      And as for the second part of your statement above, I think the State has done quite enough "changing the definition of inflation to suit your world view" for everyone involved, thanks very much. It has been shown that in the US inflation calculated by the methods of the US government from 30 years ago would currently be running at 10%, not the 2% the US government currently claims. I have no doubt the same statistical sleight of hand is being performed here in the UK. The evidence of millions of peoples wallets backs me up.

  7. So is the current glut of savings in some ways a result of past money creation that was used unproductively, e.g. asset speculation. That is it's past monetary policy that was at fault, current monetary policy has no choice less it wants to liquidate bad investment.

    1. Which it should! The govt are attempting to underpin the status quo by picking winners and losers by propping up the housing market.


      Surely this matters! I am currently saving hard to pay for an absurdly overpriced house. This goes to an older person who paid very little for exactly the same asset. If they also don't save and I have to pay their pension I am a lot worse off.

      Frances' view smacks of Merv's 50,000 ft view where he stated that although housing was absurdly expensive and was creating generational imbalances the system as a whole (the UK) was closed so it was ok. Only an academic would say this.

      The *vast* wealth imbalances created by propping up the housing market are creating two problems:

      1. massive inter-generational wealth transfer, impoverishing the "workers"
      2. increased malinvestment in a non-productive asset which will dig us further into our trench

      The above is achieved with *heavy* state interference at both the production stage (planning) and the pricing stage (subsidies).

    2. I'd also add that we had our inflation during the Labour years. It was in house prices. Now other prices are catching up. It *looked* like we were getting richer during this time but if we thought about house price inflation as we do other price inflation with lagging wages then we would see it for what it is at the time.

      Increased lending against housing is money creation. This is where the glut came from without the wealth creation to back it up, hence it was inflationary. Now we can't clear this glut because the demographic bulk who benefited must be placated by politicians who want to get back in power.

      Mob rule is driving policy. If they crash housing we have a generation without any real savings (other than their house). Hence the next generation is beholden regardless. We either pay them through housing or through taxes. What we can't do is go back in time and make them save in a wealth producing fashion.

    3. Oh forgot. And because the support ratio is only going one way this is just going to get more and more pronounced.

  8. While I agree with the basic insight here, I don't follow the argument. You are corect that savings need to be transformed into real capital assets (investments) in order to generate a return. That is fundamentally the answer to Save our Savers position. While investment is depressed returns on savings will be low.

    You are right too to distinguish between the common use of terms like saving and investment and the meaning economist give those words. The most important difference is one you don't mention. In economics, including the national income equations, saving is a flow. In common discussion savings refers to the stock of capital built up from that flow. Save Our Savers is not just complaining about the interest available on new savings.

    The second difference is that in economics investment means buying real capital assets, eg factories, offices,machinery, software, inventories and working capital. In common discussion we invest in ISAs and pension schemes. This is saving in economics-speak. The investing is done when an entrepreneur puts the savings to use.

    The equation S=I applies to a closed economy. In an open economy the relevant equation is S-I = NX, where NX is net exports(X-M). Again we are talking flows. This is an accounting identity; it always holds. If saving is higher than investment the result is a current account surplus.

    Keynes's insight was that S=I depends on Y.* That is if people try to save more than is invested then the national income will fall. Y = C+I, so if people reduce C to save more then Y falls. See

    One final point, from my simple Keynesian persective low interest rates are not intented to stmulate consumption but to encourage investment. Keynes uses a concept called the "marginal efficiency of capital" which sounds to me very like the IRR. Faced with capital budgeting choices an entrpreneur will decide which investments to make depending on whether the expected return is higher than the alternative of holding interest bearing deposits. (See Keynes 1937 paper in the Quarterly Journal of Economics for a cleaer explanation.)

    Will Hutton makes the argument a bit differently, treating the interest rate as a discount rate in capital budgeting decisions. It has the same result, a lower interest rate makes more investment opportunities profitable.

    *Keynes appears to assume a closed economy, NX=0.

    1. Hi Galludor,

      Yes, SAVING is a flow and SAVINGS is a stock. I've used both in the post, but I was careful to distinguish between them - at least I think I was. If I've confused it anywhere, please do say where and I'll correct.

      The terminology around savings and investments is very confused. I use the term "savings" to mean the sum total of people's unspent income, in whatever form - that includes ISAs, pensions, deposit accounts, stuffed mattresses. Some of that is then lent to businesses for capital investment. At the present time, not much of it is - which is what the chart shows. The rest remains as uninvested savings. You can't simply wipe unspent savings out of the S = I equation, but you don't want to destroy the identity. Hence the expansion of I to show uninvested savings (S-I).

      I could have talked about the external sector. In JHK's link he explains that the S = I + (S-I) applies in a three-sector model, so including the external sector. I've simplified it because I specifically wanted to talk about savings and investments and thought including the external sector would complicate things too much. I didn't include the public sector (G - T) in the equation either. So I'm not assuming a closed economy so much as balanced trade and fiscal budgets - effectively I have assumed X - M = 0 and G - T = 0 to eliminate them. In my link about the role of public debt, though, I do discuss the external sector.

      Ordinarily, I would agree with you that low interest rates are intended to stimulate investment rather than consumption. However, central banks view this as a demand problem, and this is borne out by surveys indicating low business confidence and poor sales inhibiting investment. I think Keynes would agree that if businesses are not investing because of shortage of demand, C needs to increase in order for I to be able to increase.

      Will Hutton's use of interest rates as a discount rate isn't limited to him, by the way. I was a project manager for a long time, and I used interest rates similarly: you have to establish the expected return on a project to know whether it is worth doing, so you always need to factor in your expected cost of capital.

    2. Hi Frances,

      In your third paragraph you shift from stocks to flows and it would be clearer for your readers if this was more explicit.

      I don't get the idea of uninvested savings. If the external sector and the government secter are in balance then S-I = 0. Keynsians usualy distinguish between planned saving which may be higher and actual seaving which must equal investment.

      We can define the terms in the national accouting equation differently. I tend to use C and I to include government consumption and investment (as Keynes did). For simplicity sake the assumption of NX = 0 can help to develop an idea. Some early Keynesians included NX in the definition of I. Whatever definitions you use, there must be an identity.

      I am never comfortable with arguments around "confidence". Cutting investment because consumption is low is kind of what the multiplier is about. Increasing investment will increase income and so increase consumption which will incentivise investment ... I think Keynes argued for government to increase its investment when business investment was low.

    3. Galludor,

      OK, I will revise to make it clearer.

      I am using an expanded version of the S = I identity, remember:

      S = I + (S - I)

      In the expanded version, uninvested savings are (S-I). They are the "bit left over" that corporates don't need for capital investment. They are the "excess savings" that Keynes thought were a drag on the economy.

      I've written a postscript using the full sectoral balance equation and explaining why I eliminated the public and external sectors for the purposes of this post.

      Keynes did indeed argue for government to increase its investment to compensate for low business investment. I have argued for the same thing elsewhere. But THIS post is about private sector saving and investment. I can't cover everything in one post!

  9. I might reply at more length on my blog, but for the moment I have a few points:

    (1) Most investment is about expanding the productive capacity of the economy, when you have chronically weak demand, then not only do corporates not want to invest in expanding future capacity, they already have too much capacity. It follows from this that corporates let physical assets fall into disrepair/restructure them away until the loss of (physical) capacity becomes permanent (hysteresis). As regards the flow, this must result in a period where real interest rates are negative.

    (2) I am pretty sure that most of the world's central banks believe that the Hot Potato Effect is the principle channel, even if they haven't said it. E.g. The BOJ minutes say they have changed the prime monetary instrument from the interest rate to the monetary base. That is, they believe that expanding the money stock will drive activity in aggregate. The issue is that small declines in M2 due to changes in risk preference require enormous changes in base money to offset, but there is no static money multiplier at the ZLB, and obviously banks do not "lend out" reserves in aggregate. Obviously, they can always raise assets to control broad money creation for a given (starting) size of the monetary base. Of course, broad money creation is more or less synonymous with investment - since much investment is funded by loans from banks.

    (3)The decline in interest rates really just reflects the degree to which the world was under-capitalised (physically) in 1950. With Western Europe destroyed by two world wars which produced an epoch changing number of innovations such as radar, effective wireless transmission, mass production, the Haber Process for fertiliser etc, along side huge improvements in basic education in 1900-1950, there was an enormous stock of potential productive improvements, and it literally just took 50 years for this to play out and capital to approach is optimum stock. In the long term, the real rate of return should stabilise around productivity increases, barring "disruptive innovation" which only comes along once a century or so and leads to a massive jump in real interest rates as a bunch of new improvements come along at once.

    (4) Glasner has a nice post/series of posts on the real rate of interest and the Fischer Equation. For those who are interested.

  10. Frances -

    When you write about this stuff, it would be so much easier if you could ditch the word "savings", and use, as applicable, "stock of savings" / "household (net?) financial assets" or "unspent income".

    When you say "quite a lot of savings simply aren't productively invested in the real economy", are you referring to the stock or flow of savings?

    I'm surprised you didn't show a sector financial balances chart. The amount by which (flow) S > I is equal to (G - T) + (M - X). In other words, your insight seems to be nothing other than an observation that we have large twin deficits at the moment. The reason for this isn't found just by examining the size of the deficits, but by looking at saving propensities (ie the private sector's preference to save rather than spend income).

    Referring to savings "piling up" is the sort of unhelpful metaphor that gets people confused!

    1. I refer you to my answer to Galludor. SAVING is a flow, SAVINGS is a stock. I have used the term correctly throughout as far as I am aware. If I say "savings" I mean the stock, not the flow.

      I deliberately assumed balanced trade and fiscal budgets to elminate them from the equation. This is about the balance of private sector saving versus investment and consumption in the domestic economy. Including the public sector and external sectors would confuse people.

      The large twin deficits are really not the issue I am addressing - which is why I eliminated them. They are a distraction from the fact that DOMESTIC saving is too high relative to investment, and that is not just because saving is high but because investment is low due to flat demand (hence need for C to rise). I know that actually this is impossible, because the fact that S > I implies that one or both of (G - T) and (X - M) is in deficit, but it isn't the problem I want to address.

    2. Brick

      I cannot help thinking in some respects the argument is a little chicken and egg and which comes first. I think I am with you on the diversity of savings. Now unproductive hoarding of financial assets can mean speculation or driving up commodity prices and I think you are right that it is a form of extracting rent from wage earners and tax payers. This must come full circle and effect demand.
      Perhaps unproductive hoarding is actually a drive for yield in a low interest environment. You say corporates can't think of anything useful to do with their money, but raising wages to increase demand might be an option. Reality suggests to me this is not an option because you have to keep your stock price stable and pay dividends to feed the search for yield. May be unproductive hoarding is a direct result of low interest rates which is a result of unproductive hoarding. Perhaps the real starting point is a demand shock caused by an increase in unproductive hoarding in the crisis.
      Putting that aside I think I disagree somewhat about QE. I think QE is more about liquidity of some investments and about putting a price floor under certain types of saving and preventing yields rising too much. It can force more money into unproductive hoarding, and on a indvidual level increase the amount they need to save.
      The way to look at the savings glut might not be to concern yourself with the type of saving but the distribution across income. It may be that the savings glut is actually a glut of too many very rich people and tax policies which tend to increase that. May be the shift from cash savings to investment/debt type savings is the problem.
      Its not just the governments responsibility to provide debt instruments in my view but corporations as well and in a way both would pick up if demand picks up. QE's net effect to encourage unproductive hoarding through the search for yield may be negative now instaed of in its early days of supporting banks to keep lending going. Low interest rates may also encourage unproductive hoarding and I am not convinced that taking them below 2 percent was productive, there just were no good fiscal options put on the table instead.
      In many ways I am agreeing, yet worry that too much creation of government debt will lead to currency fluctuations, significant changes in capital flows such that you end up with asset inflation without wage inflation and another demand shock. Better perhaps to think about changing tax policies to give a demand shock (for the 99%) and a savings shock (for the 1%), to build a framework for printing and destroying money which can act to increase or decrease VAT and be linked to wage inflation and even a revamp of national savings with higher yields for investment in infrastructure. I do buy into the idea that raising interest rates would hurt savers through damping demand for credit, but it may just be that unproductive hoarding has limited the ability to raise interest rates at all.Declining interest rates even before the crisis suggest to me a radical rethink of taxation (particularly capital gains which are not of the inheritance form) and government sponsored and guaranteed debt might be a solution (off the government books apart from the guarantee).

    3. Frances

      On saving vs savings, that makes perfect sense (sorry to have missed this).

      When you say "The large twin deficits are really not the issue I am addressing", I don't follow. If the twin deficits didn't exist, then domestic saving would equal investment! They are inextricably related. They are "chicken and egg", as Anon puts it. And the way to reconcile them is to talk about savings propensitive.

      Phelan's article is effectively saying that with such low (real) rewards to savers, household propensity to save will fall. He is talking nonsense, because:
      (a) households' propensity to save is higher than in the mid-2000s, and is unlikely to fall much further;
      (b) the big structural issue with the UK economy is that corporates' propensity to save is much higher than pre-2001.

      If we want strong structural GDP growth, we need corporates to increase their investment, ie decrease their propensity to spend. Households' propensity to spend isn't that important for investment: if corporates want to borrow to finance their investment, they will get the funds from bank loans which (from "loans create deposits") do not require high household savings first.

      Contrary to SOS, if household saving fell to zero but firms wanted to borrow to finance their investment, then the other sectors (RoW, but more likely the government) would accommodate this by moving into a financial surplus.

      SOS appears to be just a front for rentier interests...

    4. Anders

      Mostly agree, except about the twin deficits being inextricably related to excess saving. It's clearly not the case that all private sector saving either finances private sector investment or is balanced by public and/or external sector deficits. Gold, for example, is not part of either a public or external sector deficit, nor is it productive investment. It's a private sector financial asset which does precisely nothing at all. That's why I've used the expanded form of the sectoral balance equation and set the public and external sectors to zero. The private sector is perfectly capable of creating its own unproductive assets. It doesn't need the public or external sectors to provide them. JKH is illuminating on this - do read his article at Monetary Realism.

      You are right that the problem is that the propensity to save is far too high. So actually we need corporates to decrease their propensity to save, not their propensity to spend. Like households, they are saving too much and neither spending nor investing. Corporates' cash balances are ridiculously high.

      Households' propensity to spend is important because it raises aggregate demand. It makes no difference to corporates' ability to borrow (I'm no supporter of the "loanable funds" model), but it does make a difference to their desire to invest.

      Re SOS, I agree. They are rent-seeking.

  11. ' the present time there is a glut of savings and a shortage of productive ways of using them. ...This is the real reason why interest rates are so low.'
    Excuse me but isn't the Bank of England (acting on behalf of the government) using both QE and it's daily Open Market Operations to manipulate interest rates lower?
    In case you hadn't noticed we have a massive National Debt & huge annual deficit that needs to be financed. Then there is the private sector ( ie. people like you and me) which has close to £1.5 trillion in outstanding, mainly floating rate, debt, largely mortgages, linked to LIBOR/Base Rate. On top of that there are numerous companies with huge debts just clinging onto life by the skin of their teeth. All of these sectors would be in dire straits were it not for record low interest rates courtesy of the Bank of England.
    Governments of all persuasions have deliberately created cheap credit booms over the last thirty years, it's just that the last one from 1997-2007 was the biggest of them all and we are still living with the consequences.

    1. No, Sally.

      1) The Bank of England is independent of government.

      2) The Bank of England's responsibility is macroeconomic and macroprudential policy, not financing a government deficit. It is specifically prevented from financing government spending under the terms of the Lisbon Treaty.

      I agree that private debt is still far too high. I therefore expect that the MPC takes into account the likely effect on the economy of swathes of defaults and bankruptcies when deciding the path of interest rates. And rightly so. Debt deflation is terrible. We narrowly avoided it in 2008. It would be a very, very inept central bank that triggered a debt deflationary spiral by raising interest rates when the economy is still weak. The only central bank that has done so recently is the ECB, which raised rates in 2011. The result was the collapse of Greece.

      Really, we don't want or need higher interest rates at the moment, whatever Save Our Savers may think.

    2. Yes there is really a glut in malinvested credit. It's for this reason interest rate cant be raised.

    3. "The Bank of England is independent of government."


    4. I have to say I find this very academic also. Just because there is no line on the "departmental structure" diagram between the govt and the BoE doesn't mean to say that there is not an understanding. The govt appoint the governor and can get themselves a new one any time they like.

      Sometimes one has no choice but to experience debt deflation. The choice was in 1997. The path is already decided. Only the pace remains to be chosen.

    5. Nope, the pace of debt deflation has also been chosen. Glacial. Hence very low interest rates and unconventional monetary policy.

      I'm not going to discuss the extent of the Bank of England's operational independence. Suffice it to say that the Bank has at times made it very clear that it is not comfortable with the Government's policies, and vice versa.

    6. I clearly don't agree with your point 1. Re your point 2, I really meant that it suits the government, with such huge debts, to keep interest rates low, in order to minimise their funding costs.
      However, regarding your point that the Bank of England is 'specifically prevented from financing government spending under the terms of the Lisbon Treaty', how does the transfer of coupon payments on the B of E's QE portfolio to the Treasury fit in with that?

    7. It does suit the government to keep interest rates low. And that may be a consideration for the MPC - but it is certainly not the only consideration.

      The Bank of England is simply returning to the Government the interest the Government has paid to the Bank of England. It's completely circular and not in any sense "financing government spending".

  12. Thank you for writing this. The topic is usually skewed with the beliefs that saving is good and borrowing is bad, and that investing is buying existing equities. Every dollar saved needs a dollar borrowed, or else the economy merely shrinks by a dollar.

    The drop in private US investment can be directly attributed to the reduction in housing and non-residential construction. That created a private sector savings surplus, which was absorbed by government debt. The increase in government debt was used mostly for transfer payments back to the private sector in order to sustain consumption. It was a circuitous way to keep the economy from shrinking more. No one had a better idea.

    QE lowered the cost of public and private sector borrowing. I always thought that would would increase the rate of investment. But it didn't. I've noticed that in fact lower US interest rates have ALWAYS been correlated with falling private non-financial business investment levels. Check out the data for yourself.

    It appears to me that higher private investment levels are merely driven by higher corporate profits. The higher profits drive higher investment borrowing, which creates higher interest rates. Therefore the change in interest rates is the result and not the cause of investment levels. My cause and effect assumptions have been backwards.

    The really screwy thing that QE has done is create very high profits, to some degree due to low borrowing costs in a period of very low interest rates, while adding little investment. Although our investment levels as a % of GDP are better, they are still at levels historically associated with recessions. QE creates liquidity during a crisis of confidence, and it gives banks the capacity to lend. QE1 solved those problems.

    But QE does little to increase the household consumption needed to increase investment. QE would be much more stimulative if it would buy assets from median households rather than institutional investors, but since their main assets are used cars and household appliances, that isn't practical. Great post, sorry for my long comment.

    1. Kent,

      Thank you. A truly great comment which illuminates many of the issues in this post.

      I'm particularly interested in your insight that the change in interest rates is the result, not the cause, of investment levels. I hadn't thought of it like that, but it makes sense. Lowering interest rates to try to persuade corporates to invest is similar to throwing money at banks to try to persuade them to lend. If they can't see any profitable opportunities, they won't invest (lend) however much you lower interest rates (throw money). The real question is why corporates don't see profitable investment opportunities. I suspect this is inextricably linked with the reasons why banks don't see profitable lending opportunities.

    2. Presumably productive investment requires not just easy funds, but both discernment and opportunity. Debt overhang works against this. Zirp qe does however help prevent debt deflation.

    3. I suspect part of why firms don't see many profitable investment opportunities is that firms often want a large customer base, but with real incomes falling across most of the population, this base isn't growing as they'd like. There is a limit to how much you can sell to the wealthiest percentage, past a certain income for most people it's keeping score rather than to spend.

      The growing inequalities of income are eroding the supply side of the supply and demand equation.

  13. Frances,

    S = Y - C = I + (S - I) + (G - T) + (X - M)

    This seems like double counting.

    In the sectoral balances equation, (S - I) = (G - T) + (X - M)

    JKH says the same thing:

    "(S – I) = (G – T) + (X – M) .... This decomposes (S – I) into its two components – funding for the government budget deficit and a current account surplus."

    So how can S = I + (S - I) + (G - T) + (X - M) ??

    1. Hi Philippe,

      Oops. Yes, you are right, I have fouled up the algebra and double counted S - I. I've corrected it now. I wrote the Postscript in rather a hurry in response to comments and didn't check the derivation of the identity.

      The sectoral balances equation says S = I + (G - T) + (X - M). What JKH has done is rearranged it to give this:

      S - I = (G - T) - (X - M)

      then substituted this back into the equation to give S = I + (S - I), which is how I used it in the main part of the post.

    2. (S - I) = (G - T) + (X - M)

      this arrangement of the sectoral balances equation is also used by MMT. (S - I) is what MMT calls the 'net saving' of the non-government sector.

    3. Yes. Though MR and MMT appear to have had a massive spat about this. I really don't know why.

      I also don't know why I got the algebra wrong. I've used it correctly in a previous post:

    4. "What happens to saving that isn't invested productively is that it is transformed into financial assets and hoarded... Saving is the total of productive investments AND the bit left over".

      I'm not sure it's altogether correct to describe it like that. JKH puts it quite succinctly:


      So it's not so much that people have a pile of savings that then either get invested, lent to government or lent to foreigners, but rather that the investment, government deficit, or trade surplus actually creates the saving, or makes the saving possible.

    5. Philippe,

      I said in the post (in relation to the basic S = I identity) that it is investment that makes saving possible, not the other way round. That is the same point as you have just made.

      Can I remind you that this post responds to an article on the Save Our Savers website, and is therefore couched in those terms. Economically it may be correct to say I drives S, but savers don't see it like that. From their point of view, they are choosing to save from their incomes, and they have choices as to how they invest their savings. Phelan claims that all savings are productively used, however they are invested; and he further claims that low corporate investment is therefore due to lack of savings, and what is needed is more saving, not less. I wrote this post firstly to dispute these claims, and secondly to correct his incorrect statements about the nature of the monetary system and how QE works.

      I feel that what I am trying to say in this post is getting hijacked by people who want to talk about sectoral balances. I added the bit about sectoral balances as an afterthought and I am now regretting it, as it is distracting attention from the point of the post. The relationship between the private, public and external sectors is not the point of this post, and nor is the precedence of investment over saving.

    6. Sorry, I didn't mean to hijack.

    7. No worries. I'm grateful to you for correcting me. :)

    8. I see you made the same point I was making in your text. My mistake.

  14. Another wonderfully lucid piece of writing. It stimulates much thought and at least for me creates more questions than answers; well done!

    Are we absolutely sure productive investment requires savings?

    Savings and collateral are traditionally closely related; large segments of the global population have no way of turning their 'collateral'(gold, crops, social capital etc.) into credit; huge problem as this is where real demand resides.

    Developed world savings should not command much of a return; there is little real demand in the economies. Capital appears to last longer than ever in history so barring huge catastrophes in which massive capital destruction occurs; how do we 'connect' this mountain of savings with real demand?

    Long duration assets such as Equities and Long Bonds should have begun to 'sniff out' the end of global population growth by now; are they?

    Wonderful stuff Mrs. Coppola

  15. This is a good post. My question is -
    see the period in the 2004-2007/8 when savings was substantially above investment? If you take the chart back to 1950, that is the only period where that happens (if I use Flow of Funds data).
    Would you agree that there was something important amiss or out of whack in that period? That Fed policy in particular, by keeping real rates too low, encouraged too much consumption? If not, why not?

    1. You mean investment was higher than saving, surely?? that's what the FRED chart shows at that time. I would say that's the asset bubble that burst in 2007/8 - housing and derived financial assets.

  16. "If you take the chart back to 1950, that is the only period where that happens"

    Investment higher than saving also happened between 1997 - 2002, the dot com boom-bust period. During that period in the US the Fed Funds rate was mainly higher than 5%, going up to 6.5% in 2001. In the UK the Bank of England Bank Rate was between 5% and 7.5% during that period. So there doesn't seem to be any correlation between a low base interest rate and investment > saving.

  17. I suspect that the semantic issues that this post raises explain what is wrong with monetary policy that errs on the inflationary side. The fact that it tends to be the financially unsophisticated who equate "savings" with deposits tells you who loses the most from inflation. It is the relatively poor savers, like the retired without significant occupation pensions and the prudent strivers who set aside enough money to avoid insolvency when they buy a house or get into some trouble who suffer.

    And if you want a dose of realism, Frances, you could try describing any savings which are not productively invested, at least from the point of view of the borrower that is. I struggle to think of any such thing. Why would anyone (except the authorities of course) accept savings that they could not invest productively?

    1. Actually most retired are living on the state pension, which has been protected from inflation for quite some time. So it is not the very poorest who are affected. It is the rather better-off.

      I do wish you wouldn't use emotionally loaded terms like "prudent strivers". It doesn't help your case.

      I take it you didn't appreciate the implications of the FRED chart. Domestic saving very clearly exceeding domestic private sector investment by quite a bit. The difference is the fiscal deficit, of course, as the sectoral balance equation shows (see the Postscript). You may or may not regard the domestic private saving that goes into funding the fiscal deficit as "productive".

    2. I take your point about "prudent strivers"; what I am trying to get across is the idea of people who don't earn much but, because they live frugally, they have a few thousand pounds in savings. The trouble is that, almost by definition, they cannot be described "poor", but to me they are no less deserving of sympathy than people with negative net worth.

      By the way, I find it disingenuous of the BoE to say that the best thing for savers is a strong economy. The market for savings is just that, a market. And if some savers are willing to pay up (in return foregone) because they think that the price of savings contracts that are exposed to the general state of the economy is excessive, I do not think that it should be the business of central banks to confound them. "Sitting in cash, waiting for a crash" is a legitimate saving strategy, and I dare say a stabilising one. If you ask me, a moral hazard culture generated by weak central bankers has been a major cause of the financial crisis.

    3. If it were entirely left to the market to set rates, short rates at least would be negative. The Fed's positive IOER actively props up the Fed Funds rate to keep it from falling below zero, and this supports other short rates too - notably on government debt, both in the US and elsewhere, and on demand deposits (call accounts).

      No-one is stopping savers "sitting in cash" if that's what they want to do. But they aren't going to get a positive return from doing that at the moment.

  18. Savings accounts were of course not unproductive investments, as almost all the money loaned to the bank was reinvested for profit. Only a very small portion of that was ever kept as reserves.

    The difference is that savings accounts were the primary investment vehicle for millions of unsophisticated members of the public. They could always have made direct investments in equities or enterprises, but generally didn't. And they could make a reasonable return anyway. And this is how it was for decades.

    There was no need to lower interest rates to encourage "investments"; this is a canard.

    So why the continued "emergency" low rates? Qui bono?

    The real beneficiaries are the governments that can issue more and more debt without being swamped by the interest payments. This lets the free ride continue. For a while...

    But surely the banks must continue to make money?
    Ah, funnel it to them directly with QE... Problem solved.

    And the 'savers'? Probably, most of them are too stupid and complacent to notice they've been "optimized" out of the profit equation.

    1. I said this in the post:


      Bank deposit accounts (or as you term them, "savings accounts") are not in any sense investment vehicles, however much unsophisticated savers might like to believe that they are. It is time that people woke up to the reality. Banks DO NOT invest your money on your behalf. They invest it on their own behalf and give you as little as they can get away with. We do not have savings banks any more.

      The real beneficiaries of low interest rates are the households and businesses who are interest rate sensitive. The effect on the economy of raising interest rates at the moment would be catastrophic.

    2. These accounts certainly *were* investment vehicles, but for the Average Joe, who had a shop to mind or a field to plow.

      I agree completely that this is no longer the case, but not everyone got the memo. And of course there was no memo.

      If this is not outright theft from the public, it was and is dishonesty on a massive scale. Many, many billions have been diverted away from people who haven't been paying attention, or don't know what to do about it. Fair? Not fair? A tax on stupidity, at least.

      Perhaps "Save our Savers" should be campaigning just to make people aware of this. Might as well withdraw your money and invest in Single Malt. As a side effect, a good old-fashioned bank run would make the buggers eyes water.

      Further to your last point, if business are awash with cash as you say, the only reason they'd be interest rate sensitive is if they'd been induced to borrow by absurdly low rates for financial activities like stock buybacks or acquisitions. This is an indicator that the real economy has been distorted. Housing bubbles are another indicator.

      I believe all of these are ultimately side effects of the need to continue to feed Leviathan.

    3. Deposit accounts in fractional reserve banks have never been investment vehicles for anybody. Savings accounts in NS&I (the old Post Office Savings) and the old Trustee Savings Banks were investment vehicles, but the TSBs died in 1976 and the only private sector "savings bank" that remains now as far as I know is Airdrie Savings Bank. So if people want "investment vehicles", they should be putting money in NS&I or managed funds, not in fractional reserve banks. FR banks are lenders, not fund managers.

      Some businesses are awash with cash, but others are highly leveraged. It is those that I am concerned about.

    4. Oh, and may I remind you of the rules of this site. I accept Anonymous posts only if they are signed. Please identify yourself.

    5. "Bank deposit accounts.....are not in any sense investment vehicles."

      This is where you are fundamentally wrong, Frances. A bank deposit is just a particular form of investment contract. Since the depositor's contract is with the bank, it is reasonable that it is the bank's business what they do with the funding - they of course expect, as specialist investors in, say, loans to local small business, to make more than they pay their depositors. That's just business. I totally agree with "anonymous". It is because of such misconceptions about depositors that British depositors have been persecuted for years, including such rules as the amount of money you can invest in an ISA and what assets you can hold and receive benefits. Result: British people have learned to borrow and punt, especially on housing, and the distortion is crippling our economy.

    6. No Tim, I am not wrong. Deposit accounts are only investments in the sense that any loan to any institution is an "investment". They are not investments on behalf of depositors in the way that pension investments are. The bank has no responsibility whatsoever for "looking after" depositors' money or to generate any sort of decent return for them.

    7. And I mean years! When I was a student living in a terraced house, I lived next door to a widow renting from the same landlord, in her eighties I would guess. I used to occasionally visit her, and like old people do, she would always tell me the same stories. After telling me how difficult it was to manage on the old age pension - "it costs the same to boil a kettle for one as two", she would tell me how she and her railwayman husband had always lived within their means, so that when he was called up in the war, they had no debts to get help with, whereas couples with mortgages got help with theirs. The injustice of her situation left a lasting impression on me.

    8. Please tell me what deposit insurance is if not a government scheme to ensure that depositors don't lose their money when financial institutions go bust? And what about the tax breaks on various forms of saving? Really this idea that savers don't get any help from the state is nonsense.

    9. "Deposit accounts are....are not investments on behalf of depositors in the way that pension investments are." Some people use deposits effectively as their pension (I have probably mentioned my neighbour who used to own a pet shop before?). How does a deposit differ from, say, a defined benefit pension fund? I am lucky enough to have a defined benefit occupational pension. From that point of view, I could not care less if my former employer invests my money in blue chip stocks or the 16.30 at Kempton, as long as they stay solvent.

      "The bank has no responsibility whatsoever for "looking after" depositors' money..." Is the fact that the deposit is a liability of the bank not such a responsibility?

      "...or to generate any sort of decent return for them." They do if the contract specifies some particular return.

    10. Tim,

      How people use deposit accounts has nothing whatsoever to do with their nature. Deposit accounts are unsecured loans to banks. There is no automatic right even to return of the money: in the event of insolvency, all depositors can claim is a share of the assets in accordance with their seniority (they rank pari passu with senior bondholders and below official creditors and secured bondholders). That's why there is a government-mandated deposit insurance scheme. Without it, depositors could lose their entire "investment".

      The difference between retail bank deposits and pension funds is that pension fund investments are ACTIVELY MANAGED, whereas retail deposits are not. Fund managers' job is to manage clients' money so as to give the best returns to those clients. Retail banks have no such responsibility, and they do not actively manage clients' money in the way that fund managers do. They invest deposits in the way that best suits them, not their depositors. I can best sum this up thus: to a pension fund manager, the pension saver is a customer. But to a bank, a depositors is a SUPPLIER, not a customer. Banks' customers are their borrowers, not their depositors.

      Deposit accounts may guarantee a particular rate, but that rate can be varied at the bank's discretion - it is not a guaranteed rate "in perpetuity". If the bank cuts the rate to below the depositor's expectations, the depositor has no recourse whatsoever other than their contractual right to terminate the account. People who plan their expenditure on the basis of expected returns on variable rate savings really need to take into account the fact that the returns can vary!

      I have explained all of this in more detail in this post:

    11. Deposit insurance may be organised and backed by governments (although the Iceland EFTA case brings that into question), but the cost is supposed to be covered by the banks, and therefore effectively by a tax on depositors:

      It was you that raised pensions, Frances. I am just making the case that deposits can be used as a pensions investment in the same way as stocks or bonds. You have some peculiar ideas about what a pension is. For those who do not manage their own pension fund, a pension is just a contract with an provider, and how that provider arranges to cover their outlay is a matter for them and the regulators. Pension fund managers generally aim to meet their liabilities rather than achieve the best returns for their clients, and many do not "actively manage" their fund. Some public sector pension schemes have no assets at all.

      I would be surprised if a bank that offered a fixed rate term deposit could vary the rate at its discretion.

    12. Tim,

      1) Yes, I know deposit insurance is (mostly) paid for by banks. The tax incidence does not fall wholly on depositors - it also falls on borrowers, employees and shareholders.

      2) I said pension FUNDS, not all pensions.

      If you choose to manage your own portfolio of pension investments, that is up to you. Similarly, if you choose to put all your money into bank deposit accounts, management of your money is your responsibility: the bank(s) will not do that for you. But if you pay into a managed fund, you will pay fees for professional management of that fund's investments. Of course pension fund managers aim to meet their liabilities before generating customer returns - if they did not they would risk insolvency. That does not mean that they are not actively managing money and aiming to generate returns.

      Public sector pension schemes are a completely different matter. The majority are unfunded. They are not pension FUNDS.

      3) You know perfectly well that the vast majority of bank deposits are not fixed rate term deposits. They are variable rate call and notice deposits.

  19. We can quibble about the detailed nature of investments for a long time, but the big picture point that I am trying to make here is that your idea that saving in deposits is clearly different from and somehow less worthy than in, say, a pension is dubious at best. Hopefully, the mere fact that our discussion can get so involved is sufficient to cause other readers to question your argument.

    However, for what it is worth, I do agree that the narrow point made by Phelan, that central bank money amounts to "fake savings", is wrong, and left a comment there too.

    Thanks for the discussion.

    1. Tim,

      I never suggested saving in deposits was "less worthy". I said that savers do not understand the nature of bank deposits.

      I'm sorry if you don't like this, but the fact is that bank deposits ARE DIFFERENT from actively-managed funds. They are simply a source of funds for bank lending, no more and no less. I did not invent that situation and I do not necessarily support it. It is simply "how things are".

      I have explained this at some length in the hopes of helping savers understand why banks appear to be offering them a raw deal. I would appreciate it if you would please accept my remarks in the spirit in which they are intended and not attribute to me value judgements such as "less worthy" that I have not made.

  20. This comment has been removed by the author.

  21. Savings are not wealth. Less liquid does not mean more wealthy. Wealth is something that is based on achievements in the past. Money is about future achievements. So if there is no will to achieve more in the future there is no need for more money. That's the long run. Let's give it a try and see what happens. I don't fear the long run.

    There is not the good real world economy and the bad others.:) Money that is not in circulation does not matter, except for the interest.

    Bonds and savings on an account are very much the same. There is a slight difference concerning liquidity which does not count in the just normal case. Cocaine is a term of payment too.

    The problem is then the distribution of terms of payments or things that can be seen that way. In practice what happens is that first the state takes away tremendous amounts of purchasing power limits the choice of individual and justifies feeding the pension funds with argument, they can do bigger investments:) Reality is that it is early enough to start saving 15 years before the pension.

    The Golden Gate bridge was built when they economy was down financed by the people in San Francisco.

    I have found two evils - Keynes and the state. Keynes was maybe not totally wrong in the early days but he turned into a liar when promising that moving away from the gold standard would cause no inflation. The state simply does lie. What is Q.E. about? About liars.

  22. Frances,

    do you agree that the Fed could raise the fed funds rate tomorrow if it wanted to?

    i.e. the current low rate is ultimately a policy choice... the Fed could make the FF rate 20% tomorrow if it so wanted. This would probably crash the economy of course, but that doesn't mean it's not possible.

    1. Yes, of course it could. It is choosing not to.

  23. Don't you think that the reason companies buy their own shares rather than return cash to shareholders is because it benefits board members by inflating the value of their share options?

    1. Dan, buying their own shares IS returning cash to shareholders.

  24. Frances,

    how does one explain the fact that whilst gross and net private saving (in the US) are apparently at all time highs, the personal saving rate is still relatively low compared to the past (say, thirty years ago)

    Personal saving rate:

    Also, do you know where to find data on gross or net private saving as a percentage of GDP? FRED only has data which seems to include 'government saving', i.e.:

    (These inevitably show a downward trend given US current account deficits.)


  25. Everyone is ignoring the very salient fact that its FLS that has decimated interest rates on cash deposits
    They have also ignored the fact that millions of people simply do not have the ability to research stock markets or the investing Frances sees as so critical
    Millions of 70/80/90 year olds need full access to their savings and need an income from them quite simply to pay the most basic bills
    QE and FLS has robbed savers of 500Billion in spending power and they simply dare not or cannot touch the capitol

    Equally many millions have seen the loss of other shares in various companies and quite rightly neither want or need to face any more losses

    Keynsian Economics totally ignores these basic facts just as King, Carney and MPC plus their puppet master Osbourne see plying savers with crocodile tears of "immense sympathy"as the biggest insult of all

    1. Deborah,

      60% of pensioners live on the basic state pension and associated benefits. The majority of pensioners with savings are in the other 40%, who are relatively well-off and many of whom have substantial assets. There may be a minority who are far more dependent on savings, but that is not actually a reason to protect the savings of the majority. Hard cases don't make good law.

      If there are pensioners who are reliant on savings to pay basic bills, that is a failure of fiscal policy. It is the responsibility of government to ensure that pensioners are able to meet basic living expenses. The Bank of England is not responsible for this and it is reprehensible of savers' representatives to attempt to influence the path of interest rates. The correct solution to the problem is to improve state pension provision, not meddle with monetary policy to suit one particular interest group. Therefore savers' representatives should be lobbying government, not the Bank of England.

    2. You can lobby the government till doomsday but they refuse to face the fact that state pensions are inadequate or that having demanded we save for retirement that its now ok for them to fleece us
      The Bank of England does indeed play every bit as major part in the destruction of savings rates just as fiscal policy does
      We have a prime minister who has no clue about the cost of a loaf of bread or indeed that CPI in no way whatever represents the true increase in the most basic costs of living which is all pensioners buy...

  26. Why do central banks believe they will get greater productive investment, having spent their time reducing prospective yields?


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