Is Keynes' Saving Function Wrong?

Keynes defined 'saving' as being equal to 'investment'. However he did not distinguish in his formula between the savings that were loaned out for investment that increased the productive capacity of the economy (such as being invested in the research and development of solar power, organic food production etc) and the savings that were loaned to financial institutions that were, in turn, loaned out again. This question is increasingly relevant today. After all, in the late 1960s there was a distinct break from traditional banking practice when "instead of waiting for new deposits the banks would go ahead and make new loans, then turn around and borrow huge sums themselves, in effect “buying” their deposit base in the money market to finance the expansion of credit."[1]

"Keynes anticipated that as economies grew and incomes rose, a rising proportion of S/Y would reduce consumption, leading to overproduction if employers did not cut back their own direct investment. This line of thought reflected British marginal utility analysis rather than a financial view of the dynamics that determined the build-up of savings."

Keynes’ savings function: s = S/Y

does not acknowledge that financial institutions tend to save all their income and that a rising proportion of that income is plowed back into new loans rather than invested in tangible capital formation…. "Savings not invested directly in new means of production were invested in more loans and indirectly in stocks, bonds and real estate". ["Nearly all new investment in capital goods and buildings comes from retained business earnings" wrote Dr Hudson.] However, "investment in securities and property already in existence had no positive employment effects. Rather the price of existing assets are pushed up (asset price inflation) and that, in turn, leads to a greater demand for loans from the general public.

At the time Keyne's wrote his General Theory of Employment Interest and Money "there was not much growth in either borrowing or this kind of indirect investment...The tendency was for savings to sit idle, as did much of the labor force."



Since the Second World War a rising proportion of savings find their counterpart more in other peoples’ debts. The net savings rate has fallen, even though debt ratios and gross savings have increased. [2]

Meanwhile the real economy continues to contract. Environmental exploitation is ramped up to service higher levels of debt. The consequent degradation of air, land and water reduces economic opportunities for other peoples and industries. Greater proportions of incomes are diverted from need fulfillment toward more debt servicing.

Money, as we can see, cannot be made with money. "The perception of classical economics that the property and financial system is different has been lost in today’s economic thought." [3]


[1] From: ‘Secrets of the Temple – How the Federal Reserve runs the country’ by William Greider. Pages 109 and 110.
Touchstone Simon & Schuster Building, Rockefeller Center New York. ISBN 0-671-67556-7 pbk. 1987. As quoted in my recent blog entry 'The Beginning of unmanageable liabilities'
'http://econospeak.blogspot.com/2008/10/beginning-of-unmanageable-liabilities.html

[2] Saving, Asset-Price Inflation, and Debt-Induced Deflation by Dr. Michael Hudson
http://www.itulip.com/forums/showthread.php?t=891

[3] Saving, Asset-Price Inflation, and Debt-Induced Deflation by Dr. Michael Hudson
http://www.itulip.com/forums/showthread.php?t=891