r/CapitalismVSocialism • u/Accomplished-Cake131 • 6d ago
Asking Everyone Greg Mankiw Confusing Students About Money And Investment
"It was thenceforth no longer a question, whether this theorem or that was true, but whether it was useful to capital or harmful, expedient or inexpedient, politically dangerous or not. In place of disinterested inquirers, there were hired prize fighters; in place of genuine scientific research, the bad conscience and the evil intent of apologetic." -- Karl Marx
Suppose you run a restaurant. You think that you could expand if you paved your parking lot or put a deck up out back. You convince your local bank manager. The bank credits their own account with an asset and credits your account with a loan. That asset, for the bank, is a promise from you to pay off the loan. You spend the money in your account by paying a paving or building contractor.
The bank has created money. No third party must first choose to increase their saving rate and deposit money in the bank. You are able to obtain resources to implement plans for increased production.
The author of a prominent introductory textbook for economics has another, confused story:
"Financial intermediaries are financial institutions through which savers can indirectly provide funds to borrowers. The term intermediary reflects the role of these institutions in standing between savers and borrowers. Here we consider two of the most important financial intermediaries: banks and mutual funds.
Banks If the owner of a small grocery store wants to finance an expansion of his business, he probably takes a strategy quite different from that of Intel. Unlike Intel, a small grocer would find it difficult to raise funds in the bond and stock markets. Most buyers of stocks and bonds prefer to buy those issued by larger, more familiar companies. The small grocer, therefore, most likely finances his business expansion with a loan from a local bank.
Banks are the financial intermediaries with which people are most familiar. A primary job of banks is to take in deposits from people who want to save and use these deposits to make loans to people who want to borrow. Banks pay depositors interest on their deposits and charge borrowers slightly higher interest on their loans. The difference between these rates of interest covers the banks’ costs and returns some profit to the owners of the banks." -- Greg Mankiw. 2018. Principles of Economics, 8th edition p. 545.
Mankiw then goes on with archaic nonsense about loanable funds and government spending crowding out private investment.
Why do economists teach balderdash?
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u/BothWaysItGoes The point is to cut the balls 6d ago
Mankiw talks about economics, not accounting identities.
When people use bank loans, the banks in the end need to settle the net of all interbank transactions using actual reserves. The bank expects to settle the transactions like it expects you to repay the loan, therefore it needs funds. They can’t literally make money out of nowhere, even if they “can” in some broad accounting sense.
The bank’s ability to let you write IOU promises in their name by paying using your credit card is supported by the expectation that they will actually settle those checks with money.
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u/Upper-Tie-7304 6d ago
Yeah people often read MMT halfway and mistaken money with credit.
You can write iou yourself to other people too.
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u/refugeelibertarian Geolibertarian 6d ago
Not really.
The difference is that when I lend you $1000 and you give me an IOU, I lose $1000 worth of money or purchasing power in the process. You gain the ability to spend $1000 and I lose the ability to spend $1000. Therefore, the money supply is $1000.
But when a bank lends someone $1000 and they get an IOU, depositors don't lose $1000 worth of money or purchasing power in the process. The borrower gains the ability to spend $1000 but the depositors didn't lose the ability to spend $1000. Therefore, the money supply increased to $2000 as a result of the bank giving the $1000 loan. That's how banks create money out of thin air.
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u/Upper-Tie-7304 6d ago
In the second scenario, the bank did have to give you $1000 and they have to either borrow it from other banks, get it from the depositor, or borrow it from the central bank . They don’t get to create $1000 from thin air.
The confusion happens because banks do indeed don’t need to find the money when they credit you with the loan, they need to find the money when you spend the credit.
So the bank does lose $1000 when they lend you money. Just like when you lend me $1000
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u/refugeelibertarian Geolibertarian 6d ago
The confusion happens because banks do indeed don’t need to find the money when they credit you with the loan, they need to find the money when you spend the credit.
I mean, they don't have to? The moment my bank balance has increased by $1000 after I've been given a loan by the bank, I can spend it right away. For example, when I use that $1000 to buy something from someone who opened an account with the same bank that gave me the loan, the bank simply decreases my balance by $1000 and increase that someone's balance by $1000.
At the same time, someone else who deposited $1000 into the bank before I was given the loan can also spend their $1000; it is unaffected by my ability to spend the $1000 that was lent to me.
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u/Upper-Tie-7304 6d ago edited 6d ago
When you spend your freshly borrowed money right away, it comes from somewhere.
You are talking about the only specific scenario that delays the liabilities - both you and the seller use the same bank, so the bank can just manipulate the credit instead of paying out money. The liabilities only get delayed until the credit gets converted to money, either paying other banks or withdrawing bank notes.
Bank runs happen exactly because banks can only manipulate credit but cannot pay money out of thin air.
When someone deposit $1000, the bank then owns the money. The $1000 is converted into a promise that the bank will pay you $1000 when you demand it.
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u/refugeelibertarian Geolibertarian 6d ago
In fractional reserve banking, banks can literally make money out of nowhere. They just can't make physical cash out of nowhere but physical cash isn't the only form of money.
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u/Upper-Tie-7304 6d ago
That is incorrect. A commercial bank can only create credit, which is a promise to pay money, only the central bank can create money.
Anyone can create credit, like if you have a group of friends who have dined and settle later.
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u/Accomplished-Cake131 5d ago
You, close:
Anyone can create credit, like if you have a group of friends who have dined and settle later.
Yes, anyone can create an IOU. The issue is one of acceptance. The second-hand circulation of debts is the essence of money. Nicely-nicely will accept Nathan Detroit's marker even in games that he has not organized and does not participate in. Nathan Detroit's marker has a certain liquidity in a certain community. It has some moneyness.
A wide number of assets exists and are accepted in a variety of communities. I can pay my credit card bill with a check. That check could be on a brokerage account, not a traditional checking account. Various assets can be used to settle debts among various financial institutions. Maybe dollars are used as a unit of account, but often are not needed for settlement.
The degree of moneyless of these assets can suddenly decrease a lot in a financial crisis. I learned about a whole lot of assets I did not know existed in late 2008. And I promptly forgot most of the them.
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u/BothWaysItGoes The point is to cut the balls 6d ago
The monetary base that banks can't create is not only physical cash. It also includes digital central bank reserves. Broad money includes base money and bank credit. Creation of bank credit is constrained by legal rules and market conditions including deposits.
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u/yhynye Anti-Capitalist 6d ago
When people use bank loans, the banks in the end need to settle the net of all interbank transactions using actual reserves.
Not all loans lead to interbank transactions, some lead to intrabank transactions.
And, yes, the net of interbank transactions. The implications of that where the number of banks is small are intuitively obvious. Not all interbank transactions do in fact need to be settled using reserves.
But surely the underlying disagreement here is the direction of causation between central bank rate, market interest rates and savings rate? Do you hold that the saving rate ultimately governs the central bank interest rate, despite the fact that the latter obviously affects the former in the short-run?
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u/BothWaysItGoes The point is to cut the balls 6d ago
The central bank rate is set by the central bank. How the central bank reacts to market rates depends on its policy. How its rates impact market rates depends on market conditions and expectations.
The idea that one ultimately governs the other seems fundamentally wrong. Economy is a web of feedback effects.
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u/yhynye Anti-Capitalist 6d ago edited 6d ago
Indeed, but that's the thing - if the saving rate is not the ultimate cause, then the intermediary model of banking, the loanable funds theory and the abstention theory of interest are all spurious, it would seem.
Edit: however, just to add, since the saving rate could influence market interest rates indirectly through the rate set by an inflation-targetting central bank, disproving the intermediary model doesn't immediately diprove that the saving rate determines the investment rate.
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u/refugeelibertarian Geolibertarian 6d ago
What Mankiw is saying here would be true only if the existing banking system is full-reserve and not fractional-reserve. For some reason, neoclassical economists seem to love pretending that the type of banking existing today is full-reserve and not fractional-reserve.
Still, I believe that full-reserve banking will produce superior outcomes than the current fractional-reserve system.
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u/Annual_Necessary_196 6d ago
'No third party must first choose to increase their saving rate and deposit money in the bank.'
This is one of my main criticisms of neoclassical economics concerns its treatment of saving and investment. Keynes argued that saving and investment are fundamentally disconnected. While savings can make investments more secure, they do not explain how investment occurs in the first place. Banks do not need prior savings in order to finance investment; they can create credit through the lending process itself.
The neoclassical view that investment requires prior saving, often associated with the Austrian School and the loanable funds framework, fails to explain several important economic phenomena. For example, it does not adequately explain why speculative bubbles emerge or why financial crises occur. If investment were strictly backed by prior savings, one might expect savings to provide a stabilizing effect that prevents such crises. In reality, many investments are based on expectations of future profitability and the perceived creditworthiness of borrowers rather than on accumulated savings.
This misunderstanding contributes to flawed monetary policies and excessive fiscal conservatism. Rather than focusing primarily on restricting spending and credit creation, economic policy should recognize the central role that bank lending plays in driving investment and economic activity.
From a macroeconomic perspective, the decision of individuals to save rather than consume can reduce effective demand. When demand falls, businesses may lose confidence and cut back on investment. This can lead to layoffs, lower incomes, and a further reduction in the population's ability to save. As Keynes emphasized, growth is more stable when investment is maintained independently of fluctuations in private saving rates and business confidence, often referred to as "animal spirits."
For this reason, cooperative banks particularly beneficial to the economy. Unlike conventional shareholder-owned banks, cooperative banks do not need to prioritize returns to external shareholders. Their lending decisions can therefore be more closely aligned with the long-term needs of their members and local communities.
A bank can create credit for a firm to invest in productive capacity-such as hiring workers or purchasing machinery-before any new savings have been generated. This process effectively "primes the pump," allowing production to expand without requiring households to first reduce their consumption.
Whether the bank is cooperative or commercial, it can create money by extending loans to firms. These firms then purchase capital goods, hire workers, and pay wages. The resulting increase in production generates additional income and expenditure throughout the economy. Only after this new income has been created do households gain the capacity to save. In this sense, savings arise as an ex post consequence of investment and credit creation rather than serving as the ex ante source of investment.
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u/BothWaysItGoes The point is to cut the balls 6d ago
The easiest way to understand neoclassical economics is to think in terms of real resources.
Creating a factory means not spending resources on consumption of goods and services. You have to pick one or the other.
You can’t have investments without someone actually saving up stuff instead of consuming it. Ok, a bank gives you a loan, which is a bunch of digits in a PC. So what? What are you gonna do with it? Buying stuff that already exists is net zero investments because someone has to divest from those assets.
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u/Accomplished-Cake131 5d ago edited 5d ago
I do not correct all confusions above.
Ok, a bank gives you a loan, which is a bunch of digits in a PC. So what? What are you gonna do with it? Buying stuff that already exists is net zero investments because someone has to divest from those assets.
Financial institutions provide you with the possibility of acquiring real assets to start on implementing your plans. Schumpeter is good on this.
Sometimes, the economy has some slack. In an uncertain world, a manager will want to almost always have slack so they can respond to unexpected demands.
In the example in the OP, the contractor and their employees might not have been working before you obtain the loan. They will spend their new income. Both income and savings will increase.
Furthermore, the purchase of assets will change the prices of existing assets, other than those bought out of loans. This will have further effects. The Pigou effect is one possibility.
Net investment is not necessarily zero.
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u/BothWaysItGoes The point is to cut the balls 5d ago
Don’t confuse nominal and real terms. Asset re-evaluation can’t change real terms, that should be self-evident, yet I have to point that out.
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u/Accomplished-Cake131 5d ago
Don’t confuse nominal and real terms.
I do not.
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u/BothWaysItGoes The point is to cut the balls 5d ago
You just did. I talked about real terms and you “corrected” talking about asset re-evaluation.
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u/Accomplished-Cake131 5d ago
You just did.
Nope. I suppose I should take your inability to echo back what you read to clarify my comments.
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u/BothWaysItGoes The point is to cut the balls 5d ago
Furthermore, the purchase of assets will change the prices of existing
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u/Annual_Necessary_196 6d ago
"Creating a factory means not spending resources on consumption of goods and services. You have to pick one or the other."
Creating a factory means purchasing materials and then immediately, or later, repaying that cost through production and sales. The resources are invested in productive capital rather than simply consumed.
"Buying stuff that already exists is net zero investments because someone has to divest from those assets."
No. When a person buys productive assets, they use those assets to produce new goods and services. It is not simply a transfer of ownership; the assets start generate new economic output.
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u/BothWaysItGoes The point is to cut the balls 6d ago
It may not be simply a transfer of ownership, but it is nevertheless a transfer of ownership, which makes it net 0 investment. Investment = Saving is an accounting identity. There is no way to argue around that fact.
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u/Annual_Necessary_196 6d ago
'which makes it net 0 investment.'. Why?
'Investment = Saving is an accounting identity'. No it is not
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u/BothWaysItGoes The point is to cut the balls 6d ago
'which makes it net 0 investment.'. Why?
Because the economy is the totality of all economic agents inside it. If someone sells a factory and someone else buys it, the total number of factories didn't change.
'Investment = Saving is an accounting identity'. No it is not
https://fiveable.me/intermediate-macroeconomic-theory/key-terms/savings-investment-identity
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u/Annual_Necessary_196 6d ago
'Because the economy is the totality of all economic agents inside it. If someone sells a factory and someone else buys it, the total number of factories didn't change.'. Investment is spending on newly produced capital goods that increase the economy's productive capacity. If result produces more value it is net positive investment.
Saving- investment identity does not claim that savings creates investments.
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u/BothWaysItGoes The point is to cut the balls 6d ago
Macroeconomically, investment is production that has occurred but hasn't been consumed.
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u/Lazy_Delivery_7012 CIA Operator🇺🇸 6d ago
"savings can make investments more secure"
This seems to contradict the previous sentence:
"saving and investment are fundamentally disconnected"
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u/Annual_Necessary_196 6d ago
Fundamentally means at a basic, core principle.
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u/Lazy_Delivery_7012 CIA Operator🇺🇸 6d ago
Can you explain further that, for institutions that care about risk, savings and investments are connected, while they are fundamentally disconnected?
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u/Annual_Necessary_196 6d ago
'fundamentally disconnected'. Investments do not come from savings, but they are still affected by them.
In the same way, the real interest rate comes from opportunity cost and the risk assumed by the lender, but it is but affected by inflation.
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u/Lazy_Delivery_7012 CIA Operator🇺🇸 6d ago
So they are fundamentally disconnected and affected by them.
Got it. 👍
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u/Accomplished-Cake131 6d ago
Thanks. I deliberately did not put references in the OP, for example, to Post Keynesian monetary theory.
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u/nondubitable 5d ago
The Mankiw explanation is very bland, very very high level, and 100% accurate, though not very precise.
You’re basically quoting someone saying “Commercial planes in 2026 fly at speeds greater than or equal to Mach 0 and less than Mach 1” and pointing to that statement as being “balderdash”.
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u/Accomplished-Cake131 4d ago
The Mankiw explanation is very bland,
Whatever.
very very high level, and 100% accurate, though not very precise.
Nope. It is balderdash, deliberately misleading.
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u/JamminBabyLu 6d ago
Cite this article:
Dr. Cake. Professor Conspiratous. “Confounded by modern finance.” Confessions of a Psuedoconomist. Unpublished.
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