Savings-Investment Nexus: Omissions, Half-Truths and Nuances to the Austrian View from a Post-Keynesian Perspective.

 - By Chinedu Okoye

Summary:

 • The Austrian Business Cycle Theory posits that real savings or deferred consumption are essential for investments and growth. Making savings a non negotiable most important element for determining investment.

 • Post-Keynesians argue that savings alone is not sufficient condition for capital accumulation necessary to stimulate growth, and highlight important factors which can allow investments to occur without an increase in savings.

 • Though monetary expansion can erode real and nominal savings if done excessively, it redirects capital towards high-yield investments through non-bank financial institutions.

 • Small businesses without access to the capital markets and dependent on banks for credit facility to finance working capital are the most hit by a reduction in real savings rate.

 • Increased savings could also reduce aggregate demand and business revenues, change future expectations overtime and weaken investment in the process. This hits a flaw in the Austrian theory that assumes savings automatically translates to investments.

 • The Austrian Business Cycle Theory does not capture the full scope of capital accumulation and is limited in its view of the savings-investment Nexus, and ignores other aspects and factors modelled in Post-Keynesian theories, that affect investment.

 • A balanced view that recognizes real resources constraints of the Austrian ideoloy and the financial complexity of Post-Keynesians (who focused on Institutional reform and inclusive capital access), becomes necessary

ABCT v Keynes:

The Austrian Business Cycle Theory (ABCT) emphasizes the role of savings as a fundamental prerequisite for capital accumulation, investment and sustainable economic growth.

Thus, an economy with abysmal savings cannot sustain economic stability and growth. And all investments are dependent on "savings", without which meaningful growth is impossible to achieve and/or sustain.

This because, in this framework, real savings —reflecring deferred consumption —are what free up resources for the production of capital goods and long-term projects. And all meaningful investments depends on prior savings.

This is in contrast to real-world scenarios, and even though through, is void of nuances to capital formation that go beyond savings. To say that meaningful investments depends on prior savings, is overly simplistic and not appreciative of the complexities of the modern day monetary system.

According to Hayek; "investment is not a simple function of the quantity of money. It is the consequence of real savings out of real outcome."

Whereas, the Keynes's  monetary theory or Quantity theory of money established a link between money supply and investments (output). And explains scenarios where savings (idle balances) doesn't translate to more investments, depending on the expectations of investors/producers in an uncertain world.

Hyman Minksy in his Financial Instability Hypothesis explained further the conditions for which savings are employed amd the limitations of Bank lending. And draws from Keynes's liquidity preference, expectations and uncertainty in giving a succint explanation of the transmissions mechanism.

History hs shown that where liquidity preference is high, a financial crisis can easily transition into a depression—recesssion stuck in a liquidity trap— and so Keynes and Post-Keynesians advocate targeted monetary policy to ameliorate the situation.

However these policies can easily be ill-timed, ill-thought or ill-implemented. This has led to  series of hyper inflationary scenarios that has been critized by the Austrian school, on account that these inflationary policies stifles growth by discouraging or eroding real savings, which in their view is a prerequisite for investment and growth.

For Keynes and Post-Keynesians, expectations, drives investment and all savings don't translate into investments, promoting a need for interventionisr policies to support the (financial) markets.

I explain why the notion is at best half true, and the ABCT nuances missed.

Savings Erosion or Capital Reallocation?

The "erosion" of traditional savings (in cash in savings accounts or bank liability instruments, according to Hayek, is really —in the modern sophisticated financial system—a capital reallocation.

Though excessive expansionary monetary (and fiscal) policy may erode real savings, they raise the opportunity cost of holding money (for both banks and depositors) in idle (bank) balances —due to the money supply increase either from rate cuts, or open market operations.

This then prompts the movement of capital (idle cash) from safe assets —demand and savings deposit, fixed deposit— to more riskier higher yielding assets. [What Minksy's would call a changing ratio of inside to outside assets or an increase in inside assets as a percentage of total assets]

This move is done, through Non-Bank financial institutions and certain arms of the banking sector, involved in alternative investments, directly or indirectly.

In line with the institutional investment surge, individuals with understanding of the financial markets could also be prompted to make this shift as returns on "safe" or "idle balances" reduces relative to other investment vehicles —index, mutual, hedge funds, Venture capitalists and Private equity.

This basically means capital or credit is moving from one part of the financial sector, (assets and liability structures tied or benchmarked to with outside assets) to another segment.

So even if savings rate decreases, it could be offset by an increase in investment rates, depending on the structure and confidence of the non-bank financial system, and expectations of industry.

Individuals would also leverage the availability of credit sources, to smoothen out consumption and invest the extra —credit augmented— cash assets, with the hopes of earning on the spread (i.e., the difference between short-term interest payments and long-term investment returns.

But this shift creates a vacuum in the availability of traditional credit, for economic units dependent on bank credit. For though interest rates are lower, the appeal of alternative sources could cause a credit squeeze in this segment.

Where the capital squeeze is:

The Austrian school theory on savings and investment is therefore restricted to the segment of the market that is dependent on traditional credit/capital sources, for sufficient savings is needed to power investments. 

Thus, tla lack of savings in the Austrian case , is experienced by individuals and business reliant on traditional credit money with little access to the financial markets for sake of expertise, scale and volume. 

The squeeze occurs as a result of a larger portion of institutional investors, and dealers which happen to be significant market movers— choosing high risk - high growth investments.

 

The Crack in the Savings Investment Nexus:

As a result of the above, inaccess to alternative sources of capital becomes a major hinderance of small business development, and not necessarily low savings.

This is not to say savings are unimportant, but if we are to strictly go by the Austrian Savings-Investment model, an increase in savings, builds capital, and encourages investments, and a decrease in savings rate does the opposite.

This hasn't been the case as chart 1 below shows a side-ways capital formation form the past ten years, which should translate to similar moves in investment.

(Chart 1: US Personal Savings Rate 2015-2025)

However, in the same period, as Chart 2 below shows, 'Nonfinancial Corporate Business; Gross Fixed Capital Formation with Equity REITs Residential Structure Transactions' —a proxy for Capital Formation—increasing over the same time period that savings has been somewhat stagnant. 

(Barring the anomaly of COVID stimulus checks and savings from less non-essential expenditures due to the lockdown).

(Chart 2: Nonfinancial Corporate Business; Gross Fixed Capital Formation. 2015-2025)

Demerits of the ABCT:

Thus, the Austrian emphasis on Savings Rate and assertion that investors impossible without sufficient savings is empirically defunct.

Going by the ABCT, investments cannot occur without savings, and a depletion of savings would lead to future declines in investment/real output. 

These assertions ignore; the intricacies of the modern financial system where funds that otherwise would be savings are pooled in various forms, such that investment can increase —as Charts 1 & 2 depict —independent of savings rate. 

The prospects for capital importation in a globalized world is also missed, as savings can be reducing and investment rising from foreign sources —a possible explanation to the Fred Charts above where U.S. Personal Savings rate declined in the past decade, but gross fixed capital formation rose.

The theory also ignores the role of expectations, and the decline in aggregate demand, or assumes real disposable income would be steadily upward trending, with wages clearing at some new equilibrium seamlessly with little or no structural rigidities.

The Paradox of Thrift: is yet another concept not considered in the Austrian Business Cycle Theory, for capital accumulation can be offset by changing expectations from a reduced demand and revenue by extension in the shorterm.

Also not considered are the limits on loanble funds by banks, and the shorterm nature of banking liability could restrain credit and hence investments of small businesses, as institutions can get higher yield in riskier investments.

A Validation of Monetary Intervention:

So, whilst excessive monetary policy does erode (nominal and real) savings, a moderate application —of monetary and financial policy—tailored to the specific needs of the economy, could still be employed to provide support for other industry players exposed to alternative capital sources in the financial markets.

But small businesses seem to be lacking in that regard as explained above. Hence, a policy or instrument that can incorporate them into the capital markets is essential for growth of these businesses. Short-term financing can't fund a long term life changing project.

The critique of the eroded savings should be geared towards stabilizing the risks involved in saving and investing cash holdings of economic agents. Financial instruments are to some degree exposed to; liquidity, insolvency, inflation, and Interest rate risks, and all these are excercebated by excessive or early monetary policy.

Solving this would do more to build capital than savings would.

Why Savings isn't as significant as Austrians make it seem:

The nature of instruments in which most idle balances take place, places a limitation on the amount of credit available. Savings, demand, fixed and time deposits could be liquidated on demand so bankd need to keep sufficient amounts of their deposit liabilities (or cash assets from savers) liquid.

Also, even though savings rate where to increase to desired levels, the effect on industry could be offset by falling revenues. As an economy can't save more without spending less if income doesn't grow significantly—hence the reason why the above section states that ABCT logic assumes steady rising real disposable income with little to no structural rigidities.

This is not to dismiss the importance of savings, but to point out it's limitations and highlight the significance of alternative financial assets (to financial institutions), and liabilities (to borrowers), in stimulating growth in addition to —or in the absence of excess savings.

A Balance of Reality: Reconciling Plausible Logic from Both Schools

On the recognition of the limitations of the Austrian savings-investment model, and the dangers of excessive investment-boosting monetary intervention, a reconciliation— or an attempt at that— is made between the logical(but obvious) tenets of the Austrian school, and the more empirically backed Keynes/Post-Keynesian theories.

One must reconcile —for a complete insight and analysis into the savings-investment dynamic— the Austrian focus on real resource constraints and sustainable growth with the Post-Keynesian insight into financial complexity, uncertainty, the role of expectations, interventionism, and institutional arrangements.

The Austrian critique rightly warns against over-reliance on artificial credit expansion, which can distort investment signals and lead to unsustainable booms.

Whilst this has truth, it overlooks or discards the Post-Keynesian perspective, by underestimating the transformative role of expectations, liquidity, and modern credit —or capital market—mechanisms in mobilizing capital beyond the bounds of current savings.

In the modern financial system, a moderate and timed credit expansion or liquidity supply could, cushiot, or overturn a slump or slowdown.

Still, the Post-Keynesian position, while more attuned to financial realities and institutional evolution, risks placing too much faith in the timing and efficacy of interventionist policies, which may either overshoot or underperform, especially in fragile economic contexts.

Though this is addressed in Minksy's financial Instability Hypothesis where he sates that "Central banks cannot abort an impending crisis", as it is naturally a result of a build up of events leading to a change in expectations following a strain in the financial system. So, Central bank interventionism advocated by Post-Keynesian and Keynes, whilst a necessary feature, isn't a blanket or full proof instrument.

A Synthetic Middle ground:

Savings are a constraint—but not the only one. In an era where capital markets and financial institutions dynamically reallocate resources, investment can precede idle or near cash balances, particularly when sentiments are positive and supported by a credible macroeconomic framework and forward-looking monetary policy.

The assertion that there can be no investment without savings is flawed by the logic of aggregate demand, where increased savings, lead to a decline in sales from an associated drop in consumption. This fall in aggregate demand is recorded in sales books of businesses, and if sustained, can lead to changing expectations about future income which builds from demand.

So savings can increase without investment —and/or output—increasing. And any attempt to analyse investment must take into account the other segments of the financial markets and the effect of an abrupt increase in savings rate where income stays stagnant.

To ensure investments are sustainable, they must be anchored by real productivity, not speculative fervor.

Therefore, the future of growth depends not solely on boosting aggregate savings or expanding credit, but on building institutional bridges—between small businesses and capital markets, between idle balances and productive projects, and between monetary policy and sectoral realities.

Only through such an integrated approach can policy effectively balance stability and dynamism, prudence and innovation in the capital formation process.