A frequently repeated claim deployed in critiques of
loanable funds theory is that private bank money creation removes the constraint on
investment being limited by "prior" savings. In a generally good article on loanable funds
here, Servaas Storm spends a lot of time discussing the ex nihilo creation of
private money.
I think this is highly misleading. Whilst not denying that understanding bank
behaviour is important, the savings
constraint issue is simply a result of having a monetary exchange economy and
has nothing to do with where the money comes from.
First some clarification.
It is sometimes suggested that the constraint in question is that saving
must take place before investment. To
the extent this really does refer to the order of events in time, it is clearly
wrong. Saving and investment must always
take place simultaneously, by their very definition, regardless of whether we
are talking about a barter or monetary economy.
What does matter is the relationship between plans and
outcomes, specifically when agents have plans that are inconsistent.[1] In a normal market for some commodity, if planned
demand is different from planned supply, the amount actually traded will be the
lower of the two. Neither buyer or
seller will trade more than they want.
Translated into a loanable funds market, this means that the
amount of actual saving would be the lower of planned saving and planned
investment. Savers cannot end up saving
more than they planned. And this is
indeed what we find in a barter economy, where all saving is in the form of
commodities.
The difference with a monetary economy is that actual saving
is not constrained by planned saving.
This is because actual saving must be equal to actual investment and
actual investment is not constrained by planned saving.
The easiest way to see this is to think about bank lending
and recognise that banks can provide finance to enable new investment without
first needing to check the plans of their depositors. Although this is a useful picture, it can
lead to the mistaken view that it is private bank money creation that removes
the planned saving constraint. This is
not correct. What removes that
constraint is monetary exchange and that holds even with a fixed, exogenous
money supply.
Consider an economy where there is a fixed money supply of
$100, all held by households. Households
also hold $100 in loans to firms, so $200 in total financial assets. Firms would like to borrow more and invest
more, but households do not wish to take on more credit risk.
Now assume that households become less risk averse and wish
to change their portfolio to $50 money and $150 loans. Note the important distinction here between
saving and lending. Households are
planning additional lending, but they are not planning any increase in holding
of financial assets (which we can equate to saving here, as we will assume
households do not undertake investment expenditure). Although we talk about loanable funds, we don't mean what is actually loaned but what is saved. Here, the planned saving is zero.
However, if the $50 of additional loans to firms is spend on
investment then it ends up back in the hands of households again. Household income has risen and they end up still
holding $100 of money, even though they planned to only hold $50. Total financial assets has risen to $250. There has been actual saving of $50,
unconstrained by planned saving of zero, without any new money being created.
The point here is that what facilitates the change in
investment and therefore actual saving, is not a savings decision, but a
portfolio decision. The reason bank
lending matters is because it is a form of portfolio decision and, indeed,
banks play a large part in the overall portfolio decisions. Money creation matters because it changes the
portfolio options for households and may therefore influence their portfolio
decisions. It is not the magic
ingredient that undoes the loanable funds model.
[1] Part
of the reason this whole issue doesn't figure much in more mainstream economics
is that there is a tendency to focus on analysing outcomes that are consistent
with plans, and less attention is given to the question of what happens when
they are not.
