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Spending, Money, and Time, Part 1

December 19, 2011

People take it for granted that they can spend money whenever they want. Indeed, moving spending power from one time to another is a fundamental property of what makes money, money. However, moving spending power through time requires that someone provide goods at the time when the consumer wants to buy the good. If many people want to buy and few people want to sell, prices will increase, lowering the value of money and vice versa. As I have discussed before, fluctuations in the total amount of spending can be quite damaging, so often central banks try to minimize them. Thinking clearly about how spending can move through time allows one to understand government budget crises better.

There are two approaches to thinking about the economy: the real side and the nominal side. The real side consists of production, employment and resource allocation; basically the stuff you can see. The nominal side is the side of money flows: debt, interest rates, cash balances, prices, etc. Sometimes it’s easier to think about a problem one way and sometimes the other. It all depends on the circumstances and you should wind up with the same answer either way.

The impossibility of moving consumption, in aggregate
If people want to reduce consumption now in exchange for increasing it later, they can invest in capital*. For example, instead of building cars, people could build car factories. Fewer cars now, but more cars later. Barring the future invention of time travel, there is no way to increase production now at the expense of future production, beyond reducing capital investments to 0. Every good which you consume has been made in the past, thus, consumption today can never exceed past production. Many goods, such as food, need to be made and consumed in a very short time frame. Consumption of such goods is limited to current productive capacity in those industries.

In many discussions, especially of government spending, imply that we are ruining the lives of our grandchildren by racking up debt today. However, if someone wants to assert that the future generations are made worse off by some policy, they must show how it causes one of the two factors below:

1. Depleting capital – If an action reduces the capital stock, then it will reduce future consumption. Government spending can “crowd out” or reduce current investment by either altering the incentives to invest or using up resources that could have been used to make capital, such as workers and natural resources. You don’t need interest rates or a capital markets model to tell this story, just real resources being consumed.

2. Depleting natural resources – If an action reduces the amount of natural resources available to future generations, it will reduce future consumption. For example, burning oil, cutting down forests or killing endangered species.

Paying down government debt is not a net loss; it is a payment from one group of taxpayers (those who do not hold bonds), to another (those who do hold bonds). The higher taxes required to pay down the debt do cause deadweight losses, however. If the losses grow too large, the government can default on their bonds.

Demographic problems
When you are old, you can’t work, so in order to maintain a decent standard of living in retirement, resources must be transferred from the young to the old. There is no way to escape the fact that fewer young people will have to take care of more old people. Whether the nominal side uses capital sales, government transfers, or some other transfer is irrelevant. When the baby boomers start to retire en masse, the standards of living of the young will go down in order to pay for the resources which will be transferred to the elderly. The opportunity for massive capital and durable goods investment has passed, which was limited anyway, since the elderly tend to consume a disproportionate amount of medical services, which must be produced on the spot and completely customized. There really is no big difference between Social Security and the elderly saving money to pay for themselves. In both cases, there is little real capital investment.

* Capital has other meanings, but I use it to mean real investments which increase future productivity.

Further Reading:
Steve Roth on government debt not having to be paid back.

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4 Comments leave one →
  1. December 19, 2011 9:00 pm

    Nice piece, and thanks for the link!

    I’m on a crusade to get people to say “financial capital” or “real capital.” It’s often unclear, even from real economists, what they mean. Of course that’s partially because many economists don’t really distinguish between the two, as if they were some kind of contiguous or nondifferentiated things.

    Even better, avoid “capital” cause of its ambiguous verbal history and say something like “real productive assets.” I think that says exactly what it means?

    Also to highlight that real assets are not necessarily physical. Knowledge, skills, ideas, and organizational capital are all real capital.

    “consumption today can never exceed past production”

    But it can be less than past production, with inventories either held or trashed… Not symmetrical. So in that sense, isn’t it possible to move consumption in aggregate?

    Thanks again…

  2. December 19, 2011 10:22 pm

    I completely understand being picky about “capital”. I’ve seen many people just talk past one another because they didn’t understand which “capital” the other was using.

    You can consume less than past production, just not more. I was trying to get at, if you want to argue that people are doing something that decreases future production, you should demonstrate a reduction in real productive assets or natural resources and vice versa. People get caught thinking about the nominal side, and get themselves confused.

    • December 20, 2011 10:18 pm

      “I’ve seen many people just talk past one another because they didn’t understand which “capital” the other was using.”

      ‘zactly. Have you noticed how economists are often imprecise and inconsistent in their definitions/uses of terms? Think: “investment.” We know what that means in the NIPAs, but you hear it used sloppily, a lot. Imagine if physicists had multiple meanings for “angular momentum.”

      “if you want to argue that people are doing something that decreases future production, you should demonstrate a reduction in real productive assets or natural resources and vice versa.”

      Hmm. Doesn’t that suggest that “financial capital” is not a factor of production? Anathema!

      Which gets us back to what “capital” means… 😉

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