Saving-induced Capital Restructuring
Suppose that in circumstances of a no-growth economy and a natural rate of
interest of ieq, people become more thrifty. The increased saving is depicted in
Figure 9.8 as a rightward shift in the supply of loanable funds (from S to S′).
With the resulting downward pressure on the interest rate, the loanable funds
market is brought back into equilibrium. The natural rate of interest falls from
ieq to i′eq. The reduced cost of borrowing motivates the business community to
expand investment activities. Increased saving, of course, means reduced consumption.
But the reduced consumption is offset by the increased investment,
allowing the economy to stay on its production possibility frontier. The clockwise
movement along the frontier in the direction of increased investment is
consistent with the hypothesized change in intertemporal preferences.
The corresponding changes in the Hayekian triangle follow straightforwardly.
The currently reduced demand for consumable output (whic
depresses investment) is accompanied by reduced borrowing costs (which
stimulate investment). The effects of these changes in market conditions
were discussed in section 9.4.4 above in terms of ‘derived demand’ and
‘time discount’. The derived-demand effect dominates in the late stages; the
time-discount effect dominates in the early stages. Input prices are bid
down in the late stages (reflecting the low demand for current and near-term
output) and are bid up in the early stages (reflecting the low borrowing
costs). The changes in relative prices draw resources out of the late stages
and into the early stages. Further, stages of production temporally more
remote from final consumption than had existed before will have yields that
are attractive in the light of the low borrowing costs. In the absence of any
further changes in saving preferences or in any other data, the new
intertemporal equilibrium will entail a rate of return in the real sector
(consisting of all the stages) that matches the low rate of interest in the
financial sector. The general pattern of resource reallocation is depicted as a
shallower slope of the triangle’s hypotenuse.
In discussing in more concrete terms the nature of these saving-induced
reallocations, the relevant distinction is not between labour and capital but
rather between resources of both kinds that are (relatively) non-specific and
resources of both kinds that are (relatively) specific. Non-specific capital,
such as building materials that can be used for building either retail outlets or
research facilities, will move out of comparatively late stages and into early
ones in response to relatively small price differentials. Specific capital, such
as mining equipment or amusement park attractions, may enjoy a capital gain
(in the first instance) or suffer a capital loss (in the second). Similarly, nonspecific
labour will migrate in the direction of the early stages in response to
small wage-rate differentials, while workers who are wedded to particular
stages may experience increased – or reduced – wage rates. Note that the
focus on the allocation of resources among the stages of production in response
to changes in relative prices and wages warns against theorizing in
terms of the wage rate.
Once the capital restructuring is complete and the earliest saving-induced
investments work their way through the stages of production, the output of
consumables will increase, eventually exceeding the output that characterized
the initial no-growth economy. If we understand the saving that gave rise to
the capital restructuring not as a permanent reduction in consumption but
rather as an increased demand for future consumption, then we see that the
reallocations are consistent with the preference change that gave rise to them.
Further, we see that the clockwise movement along the production possibilities
frontier, followed by an outward expansion of the frontier itself, traces
out a temporal pattern of consumption that is wholly consistent with the
pattern depicted in Figure 9.2. By forgoing consumption in the near term,
people’s saving behaviour allows the economy to make the transition from a
no-growth economy to an economy experiencing secular growth.
Two qualifications will help to put in perspective this account of the
market’s reaction to an increase in saving. First, the assumption of an initial
no-growth economy was made purely for pedagogical reasons. In this setting
the changes brought about by an increase in saving are isolated from any
other ongoing changes, such as those associated with secular growth. The
demand for inputs falls in some stages and rises in others. Some stages lose
resources; others gain them. In application, however, where there is already
ongoing secular growth, these same relative effects are expressed not in terms
of absolute decreases and increases but rather in terms of increases at a
relatively slow rate and increases at a relative rapid rate. The market is simply
doing the same things it did before the increase in saving – except for its
doing them under conditions of moderated consumption demand marginally
more favourable credit conditions. As suggested earlier, the plausibility of the
market being able to accommodate itself to the increase in saving is about the
same as the plausibility that it could function reasonably well during the
period of secular growth.
Second, and relatedly, the substantial one-time shift in the supply of loanable
funds shown in Figure 9.8 is not intended to suggest that saving behaviour
sometimes changes that dramatically. Like adopting the assumption of nogrowth,
hypothesizing a dramatic change serves a purely pedagogical purpose.
In teaching the basics of supply and demand, professors draw a substantially
shifted curve on the blackboard so that students in the back row can see it.
There is no implication here that actual changes in saving preferences tend to
be dramatic ones or that saving is in some sense unstable. Quite the contrary:
in light of the complexities of the capital structure and the nature of the
market mechanisms that keep it in line with saving preferences, the message
should be that even small and gradual changes in saving preference need to
be accommodated by the appropriate movements of resources among the
stages of production. As in microeconomics, Austrian macroeconomics is
about marginal adjustments to parametric changes.
Because of the explicit temporal element in the capital structure, any interstage
misallocations can be cumulative. The avoidance of such misallocations
requires the interest rate to tell the truth about intertemporal preferences. The
consequences of a falsified interest rate (cumulative intertemporal misallocations
followed by a crisis) are the subject of section 9.10. But it the
following section we consider the Keynesian view of increased saving in the
context of our capital-based macroeconomic framework.
Suppose that in circumstances of a no-growth economy and a natural rate of
interest of ieq, people become more thrifty. The increased saving is depicted in
Figure 9.8 as a rightward shift in the supply of loanable funds (from S to S′).
With the resulting downward pressure on the interest rate, the loanable funds
market is brought back into equilibrium. The natural rate of interest falls from
ieq to i′eq. The reduced cost of borrowing motivates the business community to
expand investment activities. Increased saving, of course, means reduced consumption.
But the reduced consumption is offset by the increased investment,
allowing the economy to stay on its production possibility frontier. The clockwise
movement along the frontier in the direction of increased investment is
consistent with the hypothesized change in intertemporal preferences.
The corresponding changes in the Hayekian triangle follow straightforwardly.
The currently reduced demand for consumable output (whic
depresses investment) is accompanied by reduced borrowing costs (which
stimulate investment). The effects of these changes in market conditions
were discussed in section 9.4.4 above in terms of ‘derived demand’ and
‘time discount’. The derived-demand effect dominates in the late stages; the
time-discount effect dominates in the early stages. Input prices are bid
down in the late stages (reflecting the low demand for current and near-term
output) and are bid up in the early stages (reflecting the low borrowing
costs). The changes in relative prices draw resources out of the late stages
and into the early stages. Further, stages of production temporally more
remote from final consumption than had existed before will have yields that
are attractive in the light of the low borrowing costs. In the absence of any
further changes in saving preferences or in any other data, the new
intertemporal equilibrium will entail a rate of return in the real sector
(consisting of all the stages) that matches the low rate of interest in the
financial sector. The general pattern of resource reallocation is depicted as a
shallower slope of the triangle’s hypotenuse.
In discussing in more concrete terms the nature of these saving-induced
reallocations, the relevant distinction is not between labour and capital but
rather between resources of both kinds that are (relatively) non-specific and
resources of both kinds that are (relatively) specific. Non-specific capital,
such as building materials that can be used for building either retail outlets or
research facilities, will move out of comparatively late stages and into early
ones in response to relatively small price differentials. Specific capital, such
as mining equipment or amusement park attractions, may enjoy a capital gain
(in the first instance) or suffer a capital loss (in the second). Similarly, nonspecific
labour will migrate in the direction of the early stages in response to
small wage-rate differentials, while workers who are wedded to particular
stages may experience increased – or reduced – wage rates. Note that the
focus on the allocation of resources among the stages of production in response
to changes in relative prices and wages warns against theorizing in
terms of the wage rate.
Once the capital restructuring is complete and the earliest saving-induced
investments work their way through the stages of production, the output of
consumables will increase, eventually exceeding the output that characterized
the initial no-growth economy. If we understand the saving that gave rise to
the capital restructuring not as a permanent reduction in consumption but
rather as an increased demand for future consumption, then we see that the
reallocations are consistent with the preference change that gave rise to them.
Further, we see that the clockwise movement along the production possibilities
frontier, followed by an outward expansion of the frontier itself, traces
out a temporal pattern of consumption that is wholly consistent with the
pattern depicted in Figure 9.2. By forgoing consumption in the near term,
people’s saving behaviour allows the economy to make the transition from a
no-growth economy to an economy experiencing secular growth.
Two qualifications will help to put in perspective this account of the
market’s reaction to an increase in saving. First, the assumption of an initial
no-growth economy was made purely for pedagogical reasons. In this setting
the changes brought about by an increase in saving are isolated from any
other ongoing changes, such as those associated with secular growth. The
demand for inputs falls in some stages and rises in others. Some stages lose
resources; others gain them. In application, however, where there is already
ongoing secular growth, these same relative effects are expressed not in terms
of absolute decreases and increases but rather in terms of increases at a
relatively slow rate and increases at a relative rapid rate. The market is simply
doing the same things it did before the increase in saving – except for its
doing them under conditions of moderated consumption demand marginally
more favourable credit conditions. As suggested earlier, the plausibility of the
market being able to accommodate itself to the increase in saving is about the
same as the plausibility that it could function reasonably well during the
period of secular growth.
Second, and relatedly, the substantial one-time shift in the supply of loanable
funds shown in Figure 9.8 is not intended to suggest that saving behaviour
sometimes changes that dramatically. Like adopting the assumption of nogrowth,
hypothesizing a dramatic change serves a purely pedagogical purpose.
In teaching the basics of supply and demand, professors draw a substantially
shifted curve on the blackboard so that students in the back row can see it.
There is no implication here that actual changes in saving preferences tend to
be dramatic ones or that saving is in some sense unstable. Quite the contrary:
in light of the complexities of the capital structure and the nature of the
market mechanisms that keep it in line with saving preferences, the message
should be that even small and gradual changes in saving preference need to
be accommodated by the appropriate movements of resources among the
stages of production. As in microeconomics, Austrian macroeconomics is
about marginal adjustments to parametric changes.
Because of the explicit temporal element in the capital structure, any interstage
misallocations can be cumulative. The avoidance of such misallocations
requires the interest rate to tell the truth about intertemporal preferences. The
consequences of a falsified interest rate (cumulative intertemporal misallocations
followed by a crisis) are the subject of section 9.10. But it the
following section we consider the Keynesian view of increased saving in the
context of our capital-based macroeconomic framework.
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