The loanable funds hypothesis in many regards is an approach where the ruling rate of interest in society is – pure and simple – conceived as nothing else than the price of loans / credits set by banks and determined by supply and demand -as Bertil Ohlin put it – “ïn the same way as the price of eggs and strawberries on a village market”.
It is a beautiful fairy tale, but the problem is that banks are not barter institutions that transfer pre-existing loan- able funds from depositors to borrowers. Why? Because, in the real world, there simply are no pre-existing loan- able funds. Banks create new funds – credit money – if someone has got into debt previously! Banks are monetary institutions, not barter vehicles.
In the traditional loanable funds concept – as presented in mainstream macro-economics textbooks – the amount of loans and credit available for financing investment is constrained by how much saving is available.
Saving is the supply of loanable funds, and investment is the demand for loanable funds – assumed to be negatively related to the interest rate. Lowering households’ consumption means increasing savings via a lower interest.
That view has been shown to have very little to do with reality. It’s nothing but an otherworldly neoclassical fantasy. But there are many other problems as well with the standard presentation and formalization of the loanable funds explanation:
As already noticed by James Meade decades ago, the causal story told to explicate the accounting identities used gives the picture of “a dog called saving wagged its tail labelled investment.” In Keynes’s view – and later over and over again confirmed by empirical research – it’s not so much the interest rate at which firms can borrow that causally determines the amount of investment undertaken, but rather their internal funds, profit expectations and capacity utilization.
As is typical of most mainstream macroeconomic formalizations and models, there is pretty little mention of real-world phenomena, like e.g. real money, credit rationing and the existence of multiple interest rates, in the loanable funds explanation. The loanable funds approach essentially reduces modern monetary economies to something akin to barter systems – something that they definitely are not. As emphasized especially by Minsky, to understand and explain how much investment/ loaning/ crediting is going on in an economy, it’s much more important to focus on the working of financial markets than to stare at accounting identities like S = Y – C – G. The problems we meet on modern markets today have more to do with inadequate financial institutions than with the size of loanable-funds- savings.
The loanable funds hypothesis in the ‘New Keynesian’ approach means that the interest rate is endogenised by assuming that Central Banks can (try to) adjust it in response to an eventual output gap. This, of course, is essentially nothing but an assumption of Walras’ law being valid and applicable, and that a fortiori the attainment of equilibrium is secured by the Central Banks’ interest rate adjustments. From a realist Keynes- Minsky point of view, this can’t be considered anything else than a belief resting on nothing but sheer hope (Not to mention that more and more central banks now choose not to followTaylor-like policy rules). The age-old belief that central banks control the money supply has more and more come to be questioned and replaced by an ‘endogenous’ money view, and I think the same will happen to the view that central banks determine “the” rate of interest.
A further problem in the traditional loanable funds theory is that it assumes that saving and investment can be treated as independent entities. This is seriously wrong:According to Keynes: ” The classical theory of the rate of interest [the loanable funds theory] seems to suppose that, if the demand curve for capital shifts or if the curve relating the rate of interest to the amounts saved out of a given income shifts or if both these curves shift, the new rate of interest will be given by the point of intersection of the new positions of the two curves. But this is a nonsense theory. For the assumption that income is constant is inconsistent with the assumption that these two curves can shift independently of one another. If either of them shifts, then, in general, income will change; with the result that the whole schematism based on the assumption of a given income breaks down … In truth, the classical theory has not been alive to the relevance of changes in the level of income or to the possibility of the level of income being actually a function of the rate of the investment. “There are always (at least) two parts in an economic transaction. Savers and investors have different liquidity preferences and face different choices— and their interactions usually only take place intermediated by financial institutions. This, importantly, also means that there is no ‘immediate and direct’ automatic interest mechanism at work in modern monetary economies. What this ultimately boils done to is – iter – that what happens at the microeconomic level – both in and out of equilibrium – is not always compatible with the macroeconomic outcome. The fallacy of composition (‘atomistic fallacy’ of Keynes) has many faces, and loanable funds is one of them.
Contrary to the loanable funds explanation, finance in the world of Keynes and Minsky precedes investment and saving. Highlighting the loanable funds fallacy, Keynes wrote in “The Process of Capital Formation” (1939): “Increased investment will always be accompanied by increased saving, but it can never be preceded by it. Dishoarding and credit expansion provides not an alternative to increased saving, but a necessary preparation for it. It is the parent, not the twin, of increased saving. “
What is ‘forgotten’ in the loanable funds theory, is the insight that finance – in all its different shapes – has its own dimension, and if taken seriously, its effect on an analysis must modify the whole theoretical system and not just be added as an unsystematic appendage. Finance is fundamental to our understanding of modern economies, and acting like the baker’s apprentice who, having forgotten to add yeast to the dough, throws it into the oven afterwards, simply isn’t enough.
All real economic activities nowadays depend upon a functioning financial machinery. But institutional arrangements, states of confidence, fundamental uncertainties, asymmetric expectations, the banking system, financial intermediation, loan granting processes, default risks, liquidity constraints, aggregate debt, cash flow fluctuations, etc., etc. – things playing decisive roles in channelling money/savings/credit – are more or less left in the dark in modern formalizations of the loanable funds theory.
It should be emphasized that the equality between savings and investment … will be valid under all circumstances.
“In particular, it will be independent of the level of the rate of interest which was customarily considered in economic theory to be the factor equilibrating the demand for and supply of new capital. In the present conception investment, once carried out, automatically provides the savings necessary to finance it. Indeed, in our simplified model, profits in a given period are the direct outcome of capitalists’ consumption and investment in that period. If investment increases by a certain amount, savings out of profits are pro tanto higher …
“One important consequence of the above is that the rate of interest can-not be determined by the demand for and supply of new capital because investment ‘finances itself’. ”
So, yes, the ‘secular stagnation’ will be over, as soon as we free ourselves from the loanable funds explanation – and scholastic gibbering about ZLB – and start using good old Keynesian fiscal policies.
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Our current financial system diverts us from our real problems to ask, “Where is the money going to come from?” This should be the least of our worries. As long as we have vast unmet human needs and idle human and nonhuman resources, and resources which can be diverted from wasteful activities such as the military, finance should never be allowed to stand in the way of doing what must be done.
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Lynn Parramore is Senior Research Analyst at the Institute for New Economic Thinking. A cultural theorist who studies the intersection of culture and economics, she is Contributing Editor at AlterNet, where she received the Bill Moyers/Schumann Foundation fellowship in journalism for 2012. She is also a frequent contributor to Reuters, Al Jazeera, Salon, Huffington Post, and other outlets.
Her first book of cultural history, Reading the Sphinx (Palgrave Macmillan) was named a “Notable Scholarly Book for 2008” by the Chronicle of Higher Education.
Dr. Asad Zaman is currently serving as external advisor on the Monetary Policy Committee of the State Bank of Pakistan, and as Director of Uloom-ul-Umran (Islamic alternative to Social Science) on the Al-Nafi online educational platform.
He received his BS Math from MIT in 1974, MS Stat, and Ph.D. Econ from Stanford Univ in 1976 and 1978 respectively. He has taught at Economics Departments of highly ranked international universities like Columbia, U. Penn., Cal. Tech. and Johns Hopkins as well as Bilkent University, Ankara and Lahore University of Managements Sciences.
His econometrics textbook Statistical Foundations of Econometric Techniques is widely used as a reference in graduate econometrics courses, internationally. He is managing editor of International Econometric Reviews and on the editorial board of numerous journals. He has more than 100 publications, with more than a 1600 citations, in top ranked journals like Annals of Statistics, Journal of Econometrics, Econometric Theory, Journal of Labor Economics, etc. He has published widely in Islamic Economics, and is a leading authority in the field.
Ellen Brown is the founder of the Public Banking Institute and the author of a dozen books and hundreds of articles. She developed her research skills as an attorney practicing civil litigation in Los Angeles. In the best-selling Web of Debt (2007, 2012), she turned those skills to an analysis of the Federal Reserve and “the money trust,” showing how this private cartel has usurped the power to create money from the people themselves and how we the people can get it back.
Dean Baker is senior economist at the Center for Economic and Policy Research in Washington, DC. He is frequently cited in economics reporting in major media outlets, including the New York Times, Washington Post, CNN, CNBC, and National Public Radio. He writes a weekly column for the Guardian Unlimited (UK), the Huffington Post, TruthOut, and his blog, Beat the Press, features commentary on economic reporting. His analyses have appeared in many major publications, including the Atlantic Monthly, the Washington Post, the London Financial Times, and the New York Daily News. He received his Ph.D in economics from the University of Michigan.
David Shearman is Emeritus Professor of Medicine at Adelaide University and previously held senior positions at Edinburgh and Yale Universities.
He is author of many books relating to climate change, its science, consequences and democratic and other solutions; he served on the IPCC for two terms on health and scientific sections. He has been President of the Conservation Council of South Australia and with the late Professor Tony McMichael he founded Doctors for the Environment Australia in 2001 and was the Hon Secretary 2001- 2018.
He is author and co-author of several hundred scientific and medical papers and writes frequently for the media. He was awarded an AM for service to medicine and to climate change.
Dr Mark Diesendorf is currently Honorary Associate Professor in the School of Humanities & Languages, Faculty of Arts, Design and Architecture, UNSW Sydney. He researches in the interdisciplinary fields of renewable energy, energy policy, ecological economics, and practical processes by which government, business and other organisations can achieve ecologically sustainable and socially just development.
Mark was originally trained as a physicist and applied mathematician. Previously, at various times, he was a Principal Research Scientist in CSIRO, Professor of Environmental Science and Founding Director of the Institute for Sustainable Futures at University of Technology Sydney, and Education Program Leader of the Australian Cooperative Research Centre for Low Carbon Living. His most recent book is Sustainable Energy Solutions for Climate Change (UNSW Press and Routledge-Earthscan).
Ha-Joon Chang is a South Korean institutional economist, specialising in development economics. He earned his undergraduate degree from Seoul National University, and an M.Phil and Ph.D from the University of Cambridge. He is well known for his work in institutionalist political economy, which is a study of economics that situates the economy in context with sociopolitical factors.
Currently he is a reader in the Political Economy of Development at the University of Cambridge. Chang is the author of several widely discussed policy books, most notably Kicking Away the Ladder: Development Strategy in Historical Perspective (2002).
Dr Geoff Davies is a scientist, commentator and the author most recently of Desperately Seeking the Fair Go (July 2017).
He is a retired Senior Fellow in geophysics at the Australian National University and has authored 100 scientific papers and two scientific books.
In 2005 he was awarded the inaugural Augustus Love medal for geodynamics by the European Geosciences Union, and he has been honoured as a Fellow of the American Geophysical Union.
Associate Professor Steven Hail is an Adjunct Associate Professor at Torrens University, having previously been a lecturer in economics in the School of Economics at the University of Adelaide for nearly 20 years, and is a research scholar at the Global Institute for Sustainable Prosperity. He regularly contributes to economic debates via magazine articles, radio interviews and podcasts.
During the 1990s, Steven trained bankers, including central bankers, and other finance professionals, in London, across the UK and internationally. More recently, he has lectured in all four universities in South Australia, usually in finance or macroeconomics. He is a teaching specialist, an advocate for teaching modern monetary theory to all economics students, and an activist in spreading an awareness of modern monetary theory to the broader public.
J.D. ALT is an architect and author in Annapolis, Maryland. He became interested in understanding—and explaining—Modern Monetary Theory in 2011 while researching a strategy for implementing affordable housing on a national scale. His novel, The Architect Who Couldn’t Sing, won the 2012 eLit Gold Award for architecture. He is a frequent contributor to New Economic Perspectives.
Michael Hudson is president of the Institute for the Study of Long-term Economic Trends (ISLET) in New York and London. Among his books on the politics of international finance are Super-Imperialism: The Economic Strategy of American Empire, and Global Fracture: The New International Economic Order, The Bubble and Beyond, and Finance Capital and its Discontents.
He formerly taught international economics at the New School for Social Research, Graduate Faculty (1969-72), and has traced the development of international trade and financial theory in Trade, Development and Foreign Debt (Pluto Press, 1993).
Lars Jörgen Pålsson Syll is a Swedish economist who is a Professor of Social Studies and Associate professor of Economic History at Malmö University College. Lars Syll has been a prominent contributor to the economic debate in Sweden over the global financial crisis that began in 2008.
Associate Professor Philip Lawn is currently a research officer with the Southgate Institute for Health, Society and Equity at Flinders University, a visiting lecturer in economics in the School of Economics at the University of Adelaide, a research scholar at the Global Institute for Sustainable Development and a senior research fellow with the Centre of Full Employment and Equity (University of Newcastle).
Phil has for many years been one of Australia’s leading ecological economists, working to build a bridge between modern monetary theory and ecological economics. He has written a series of articles and books on the principles, indicators, and policy aspects of sustainable development – most notably Resolving the Climate Change Crisis: The Ecological Economics of Climate Change (2016).
Associate Professor Lawn is a pioneer of the Genuine Progress Indicator (GPI), a superior indicator of social well-being to Gross Domestic Product, and in 2017 produced a report for the Government of South Australia, estimating the Genuine Progress Indicator for the state, and comparing South Australia with the rest of the country, across the range of environmental, social and economic indicators which are included in the GPI. He is currently developing a set of consistent GPI accounts for most countries in the world, to serve as a guide to policy makers internationally.
Adair Turner (Lord Turner of Ecchinswel) chairs the Energy Transitions Commission, a global coalition of major power and industrial companies, investors, environmental NGOs and experts working out achievable pathways to limit global warming to well below 2˚C by 2040 while stimulating economic development and social progress.
He was chairman of the Institute for New Economic Thinking until January 2019, where he remains a Senior Fellow. He is Chairman of Chubb Europe and on the Advisory Board of Envision Energy, a Shanghai-based group focussed on renewable energy, batteries and digital systems.
He has been closely involved with the Institute for New Economic Thinking (INET)
L. Randall Wray, Ph.D. is Professor of Economics at the University of Missouri-Kansas City, Research Director with the Center for Full Employment and Price Stability and Senior Research Scholar at The Levy Economics Institute. His research expertise is in: financial instability, macroeconomics, and full employment policy.
Frank Stilwell is Professor Emeritus in Political Economy at the University of Sydney. He is the coordinating editor of the Journal of Australian Political Economy. He has written and edited 20 books on political economic topics, most recently ‘The Political Economy of Inequality’ (Polity Press 2019).
Dr. David F. Ruccio is Professor Emeritus at the University of Notre Dame, where he was a professor of economics from 1982 to 2019. He was also a member of the Higgins Labor Studies Program and the Joan B. Kroc Institute for International Peace Studies. He won the Kaneb Teaching Award, the Rev. Edmund P. Joyce, C.S.C. Award for Excellence in Undergraduate Teaching, and an American Association of University Professors Academic Freedom Award.
Dr. Ruccio received his undergraduate degree from Bowdoin College in 1976 (during which he spent a year at the Universidad Nacional del Centro in Huancayo, Peru) and completed his Ph.D. in Economics at the University of Massachusetts Amherst in 1984 (with a dissertation on mathematical models and optimal planning theory). He served as Area Studies Coordinator and the Director of Latin American Studies at the University of Notre Dame from 1984 to 1991, and was a fellow of the Helen Kellogg Institute for International Studies from 1982 to 1999.
Dr Patricia Ranald is an honorary research associate at the University of Sydney and is the convener of the Australian Fair Trade and Investment Network.
Dr Ranald holds a Master’s Degree in Political Science from the University of Adelaide and a Master of Public Policy degree from the Graduate School of Business at the University of Sydney. Her Doctoral thesis in International Relations at the University of NSW was a comparative study of the World Trade Organisation and regional trade agreements, and won the UNSW Humanities Research Centre Award for best doctoral thesis of 2000.
Dr. Ted Trainer is a Conjoint Lecturer in the School of Social Sciences, University of New South Wales.
He has taught and written about sustainability and justice issues for many years.
He is also developing Pigface Point, an alternative lifestyle educational site near Sydney, and a website for use by critical global educators, which can be viewed at: http://thesimplerway.info/
Warwick Smith is an honorary fellow at the University of Melbourne’s School of Social and Political Sciences, a Research Fellow at progressive think tank Per Capita. He is also Co-founder and Economist at the Castlemaine Institute. His current academic research includes the role of expert opinion in macroeconomic forecasting and the accumulation of disadvantage over the life course. Warwick’s research interests are very broad, including evidence in public policy making, taxation economics, gender economics, ageing populations, the economics of climate change, and the history and philosophy of economics.
Dr Cameron Murray is an economist with a passion for improving society. He specialises in property markets, resource and environmental economics, and corruption. His research on grey corruption in Australia has been transformed into a book called Game of Mates: How favours bleed the nation. The book explains how the Game of grey corruption is played, how much it costs us, and what we can do about it.
Cameron also teaches at the University of Queensland, blogs at fresheconomicthinking.com, tweets at @DrCameronMurray and his Facebook page is Fresh Economic Thinking.
Christopher Sheil, BA (Hons), PhD, is a social historian whose principal interest is in the history of labour. He is also an Adjunct Professor in social policy at Boston University (Sydney Academic Centre), and a former member of the Senior Executive Service in the NSW Cabinet Office. He has been a senior policy official under six governments (four Labor and two Liberal-National), has served on over 60 national and state government social and economic policy committees (including a dozen cabinet committees), and is the author or editor of well over 200 academic and government publications.
Robert Reich is an American economist, professor, author, lawyer, and political commentator. He served in the administrations of Presidents Gerald Ford and Jimmy Carter, as well as serving as the United States Secretary of Labor from 1993 to 1997 under President Bill Clinton. He was a member of President Barack Obama’s economic transition advisory board.
He has been the Chancellor’s Professor of Public Policy at the Goldman School of Public Policy at UC Berkeley since January 2006. Robert formerly served as a professor at Harvard University’s John F. Kennedy School of Government and professor of social and economic policy at the Heller School for Social Policy and Management of Brandeis University.
Professor Steve Keen is a Distinguished Research Fellow at UCL, the author of The New Economics: A Manifesto (2021) Debunking Economics (2011) and Can We Avoid Another Financial Crisis? (2017), and one of the few economists to anticipate the Global Financial Crisis of 2008, for which he received the Revere Award from the Real World Economics Review. His main research interests are developing the complex systems approach to macroeconomics, and the economics of climate change. He has over 100 refereed publications on financial instability, money creation, logical and mathematical flaws in conventional and Marxian economic theory, the role of energy in production, and many other topics. He is ranked in 19th in Academic Influence’s list of influential economists.
He designed the Open Source system dynamics program Minsky (https://sourceforge.net/projects/minsky/), which is the first program to allow monetary economic models to be designed visually.
He has previously been Professor of Economics at Kingston University London and the University of Western Sydney, Australia.
He is active on Twitter as @ProfSteveKeen, and is crowdfunding his non-mainstream research into economics via Patreon at https://www.patreon.com/ProfSteveKeen.
When: Thursday 28 January 2021, 6:00pm start Where: The Braggs lecture theatre (or online on Zoom if necessary)
Speakers: Professor Barbara Pocock, Mark Butler MP and Rebekha Sharkie MP
Dr John Hermann is one of the co-founders of ERA, and is currently ERA Secretary and Editor of the ERA Review. His formal training is in Applied Mathematics and Physics, and he was employed as a scientist for many years, within the UK and Australia.
In 1990 his attention was first drawn to the parlous state of neoclassical economics, and out of interest since that time he has been engaged in a long journey of learning and discovery within the broad field of heterodox economics.
Bernard Thomson has had a long standing interest in economics and financial systems. He led the establishment of the Australian association for Rethinking Economics and manages a number of not for profit websites (including this one).
Bernard has a BSc Hons degree in Economics (Philosophy) from the London school of Economics and a post graduate diploma in Disputes Resolution. His career experience is in business management, organisational and leadership development in the not for profit sector.