Monetary Savings Versus Real Savings

In the National Income and Product Accounts (NIPA), disposable income is defined as the summation of all personal money income minus tax payments to the government. Personal income includes wages and salaries, transfer payments, income from interest and dividends, and rental income. Once we deduct personal monetary outlays from disposable money income, we get the personal savings.

The NIPA framework is based on the Keynesian view that spending by one individual becomes part of the income of another individual. The spending of the purchaser is the income of the seller. From this it follows that spending equals income.

So if people maintain their spending, this keeps overall income going. Hence, why consumer spending is said to be the motor of the economy. Now, an increase in the supply of money affects the total amount of money spent. Consequently, the greater the expansion of the money supply, the more of it will be spent and, therefore, the greater the NIPA’s national income will be.

Saving and Wealth: What Is the Relation?

To maintain their lives and well-being, individuals require access to goods. An increase in various goods permits the increase in individuals’ living standards. What allows an increase in the production of consumer goods is the maintenance and the enhancement of the structure of production. With a better productive structure, greater quantities and qualities of goods can be generated, that is, more real wealth is produced.

The enhancement and the maintenance of the infrastructure becomes possible because of the production, saving, and capital investment, specifically the saving that sustains individuals that are busy expanding and maintaining the infrastructure.

It is the producers of consumer goods that pay various individuals that are engaged in the maintenance and the enhancement of the infrastructure. The producers of consumer goods pay these individuals (i.e., the intermediary producers) out of the savings. When a producer decides to save more and consume less, the decrease allows for the support of individuals engaged in the intermediate stages of production.

What keeps the flow of economic activity going is the fact that the producers—the wealth generators—invest part of their wealth in the expansion and the maintenance of the production structure. It is this that permits the increase in the production of consumer goods more productively and efficiently. This, in turn, makes it possible to increase the consumption of these goods. Out of a greater production of wealth, more can be now consumed. Therefore, the motor of the economy is actually not consumption but rather production and saving.

Since savings enable the production of capital goods, real savings are obviously at the heart of the economic growth that raises living standards. Also, once there has been an adequate increase of savings, individuals may aim at enhancing their well-being by seeking more specific consumer goods like medical treatment and entertainment.

Introducing Money

When a producer of goods sells some of his goods for money to another producer, he has ultimately supplied the other producer with goods. The money received is fully backed by his unconsumed production. Provided that the flow of production is not disrupted whenever he deems it necessary, he can always exchange his money for goods.

Whenever individuals purchase capital goods such as machinery, they transfer money to the individuals who are employed in the making of the machinery, which, in turn, can be exchanged for other goods. With money, the machine-maker can choose to purchase not only consumer goods but also various services. The service provider who receives the money can, in turn, acquire other goods and services.

Without the medium of exchange (i.e., money), exchanges and production are severely limited and a modern capitalist economy cannot emerge. Money enables the goods of one specialist to be exchanged for the goods of another specialist. By means of money, individuals can channel savings to others, which, in turn, permits the widening of the process of real wealth generation.

Problems emerge whenever the central bank embarks on expansionary monetary policies. The increase in the money supply sets in motion an exchange of nothing for something. When such money is exchanged, it amounts to consumption that is not supported by production. When something is exchanged for money and the money is, in turn, exchanged for goods, we have an exchange of something for something. However, when money is generated out of “thin air” by inflation, it sets in motion an exchange of nothing for something.

While the central bank monetary inflation artificially increases monetary savings via the increase in the monetary income of individuals, it weakens real savings. What matters for economic growth is real, not monetary, savings. If it would have been otherwise then world poverty would have been eliminated a long time ago.

What Are Real Savings?

Take an individual, Joe, who produced twelve loaves of bread, out of which he consumes only two loaves. The ten loaves are his savings. Now if he exchanges the ten loaves of bread for $10 his savings in terms of money are $10.

Similarly, Bob produces twenty tomatoes of which he consumes ten tomatoes. The ten tomatoes are his saved tomatoes. Now, he exchanges the saved tomatoes for $5. This means that his savings in terms of money is now $5.

Observe that the total savings of Joe and Bob, in money terms, amounts to $15. While we can establish the overall savings of Joe and Bob in monetary terms, it is impossible to ascertain in real terms. It is not possible to meaningfully add ten loaves of bread to ten tomatoes. Hence, it is not possible to establish the total real savings.

Conclusion

The government-published data on savings is based on the Keynesian view that monetary spending by one individual becomes a part of the monetary earnings of another individual. From this it is derived that, through monetary policies, the Fed can influence the national income and savings. Many assume, therefore, that saving weakens economic growth. While central bank monetary inflation increases the monetary savings of some individuals, all other things being equal, this process weakens real savings. And what matters for economic growth is real savings, not monetary savings.