Constraining Credibility




Most economists and members of the public – on both the right and the left – believe that economies are constrained by resource scarcity most of the time. In this view, economies are supply-constrained, and that the economic problem is resolved by a mix of more work, more saving and more productivity.

The alternative to a supply-constrained economy is a demand-constrained economy, in which total spending (not total available resources) is the main determinant of the level of production. I believe that economies are demand-constrained most of the time. Further it is not difficult to distinguish demand‑constrained economies from supply‑constrained economies; it’s an exercise in ticking boxes.

(Having said that, economics – even at its most basic – is perceived as difficult and dry; too unrewarding to engage with, in spite of its admitted importance. Public discussion on economic matters is substantially limited by these perceptions; perceptions that stultify our imagination to the point that we have few images of what societal economic success actually looks like. In particular and by default, we presume that production – indeed growth – is a measure of success, and that enjoyment is something frivolous.)

The issue is very important, because solutions to the major economic problems that we face must address the actual constraints that bring about these problems. (Following my radio interview on 2 November, one of the panellists disputed my contention that employment levels are in the main determined by “aggregate demand”.) In a demand-constrained economy, the young and the old compete with each other for employment. In a supply-constrained economy, unemployment is essentially voluntary.)

Economists who I admire – such as Paul Krugman and Richard Koo – believe that modern economies are demand-constrained much of the time. I go further in suggesting most rather than much, and close to all of the time since the mid-1970s; a view dismissed in the past as underconsumptionism. (Krugman writes of “Depression Economics” as distinctly different from neoclassical economics, applicable to demand‑constrained economies. Koo has uncovered the “Balance‑Sheet Recession” which turns out to be not as rare as he initially presumed.) I also take the view that satisfactory resolution of the demand-constraint problem requires more than removing the sources of demand-constraint. (Here we can take our lead from Robert and Edward Skidelsky’s 2012 book How Much is Enough, and through the writings of one interesting writer from over 100 years ago, Simon Patten. Patten’s best-known work is The New Basis of Civilization [1907]; Daniel Fox wrote about Patten’s work in The Discovery of Abundance in 1967.)

(I should add to this list of economists I admire New Zealand’s Paul Dalziel and Caroline Saunders, whose recent book Wellbeing Economics, Future Directions for New Zealand emphasises that consumption – or more correctly ‘wellbeing’ – is the appropriate achievement of economic activity, with production being one means to that end rather than an end in itself. My only disappointment with their book is that it focusses its analysis on the national and sub-national economies. I favour using the closed global economy as a starting point; globally, the otherwise popular option of export-based solutions is a non-starter.)

TDB Recommends

Economists in the classical tradition – conservatives in the American sense – believe that economies workas if they are supply constrained all of the time, and therefore understandings of demand-constrained economies are not required. They refuse to engage in this core discussion, and they dominate the world’s policy think-tanks. Career economists tend to be rewarded best by adhering to the classical tradition.



Identifying a Supply-Constrained Economy

The classic ‘economic problem’ is that of resource scarcity; shortages of land, labour and capital.

In a supply-constrained economy there is a scarcity of labour; employment is constrained by our own inadequacies (which may include both a lack of skills and a lack of aspiration) and our immediate trade‑offs (such as choosing higher education or child-bearing and rearing). The ongoing employment of the old has no impact on the employment and self-employment opportunities of the young.

Essentially, a supply-constrained economy is a full-employment economy. Further, supply-constrained economies teeter on inflation. Wages would be high and inequality would be low.

In a supply-constrained economy there is a scarcity of savings; more demand to incur debt than willingness to forego present consumption. Savers can be and should be rewarded generously, and there cannot be ‘too much’ saving. Debt is substantially confined to business debt, house mortgages and hire‑purchase.Borrowing is undertaken mainly by businesses, though also to fund the building of houses.

In a supply-constrained economy, competition between buyers (as in auctions for Auckland real estate) is more intense than competition between sellers. Thus buyers have more need to advertise their wants than sellers have to advertise their wares. In popular parlance, such an economy is characterised by sellers’ markets.  Further, competition for imports would be stronger than competition for export markets. Importswould be clearly understood as the principal purpose of trade.

In the predominant left-version of the supply-constrained economy there are powerful bad guys out there creating opportunity barriers to ordinary folk. The bad guys resist attempts by governments to correct for market failure. They control scarce resources to create monopolies and inequalities. Deal to these guys and the above-mentioned benign characteristics of a supply-constrained economy would prevail.

In the right-version of a supply-constrained economy any observed barriers to participation are mainly self-imposed, and therefore inequality is presumed not to matter.

It is widely accepted that, in a supply-constrained economy, and although the ‘economic problem’ of unlimited wants is by definition insoluble, growth should everywhere and always be powered by our three economic cylinders: increased labour supply, increased saving, and increased productivity.

A variant to the predominant left-version is the Malthusian green view which emphasises the natural resource (‘land’) constraint. This version says we should accept the futility of trying to solve the economic problem by maximising output everywhere and at all times, and be content with less.



Visualising a Demand-Constrained Economy

A demand-constrained economy is usually but not always characterised by ‘cyclical’ unemployment, the kind of unemployment generally associated with recession or below-average economic growth. Very low inflation, under 2%, especially in the world’s largest economies, is another pointer to demand-constraint.

Another key feature of demand-constrained economies is the disproportionate size of the marketingindustry, in its various guises. Intense competition between sellers, under conditions of constrained spending, creates what is popularly known as buyers’ markets; to facilitate sellers, extra resources must be committed to inducing demands which would not otherwise be there. High levels of consumer debtrepresent an important part of this process of creating demand.

Government deficits – at all levels of government – are also symptomatic of a lack of private-sector spending. Governments are by nature debt-averse, yet must incur substantial debt in order to mitigate the problems caused economy-wide by too much unspent private income.

An important part of the way that banks induce spending through the marketing of debt lies in the creation of financial bubbles. These are symptomatic of demand-constrained economies.

Another symptom is vendor-financing, whereby sellers finance the purchasers of their goods. This is particularly prominent in international trade, where countries like Germany, Sweden, Netherlands, Switzerland, Singapore and China accumulate credits in the countries they export to, while showing no indication that they will utilise their credits in (which means purchasing imports) any time soon. In trade, success is understood as exports, not imports.

Another feature of demand-constrained economies is the extent that excessive incomes are generated within the finance sector. The finance sector pushes the excess debt that is necessary to validate the excess saving. In doing so it provides services to those savers who generate demand for financial services.

We can tick the boxes on all these; they have become commonplace features of the twenty-first century global economy.



Global Savings Glut

Demand constrained economies arise because of excess saving. Indeed the world economy throughout this century has been characterised by a savings glut, the root cause of the 2008 global financial crisis. The process of saving is both the non-spending of income and the repayment of debt.

Normal saving – saving to meet the economy’s requirements – is saving by today’s income earners that facilitates: (i) the dissaving of households, in particular the spending of retirement savings and the use of past savings to fund large purchases, and (ii) the normal debt requirements of businesses and house purchasers. An important feature of the 21st century world economy is that the business sector alone has become a substantial net saver; in most years it has saved more than enough to fund both household dissaving and normal business borrowing.

The rest of saving – excess saving, in effect all household saving (given high levels of business saving) – stands to become the unpurchased slice (up to 20%) of the economic cake. The essential role of the financial system is to ensure that this otherwise unpurchased chunk of goods and services is consumed. Capitalism collapses if buyers cannot be found for our glut of saved goods and services. New Zealanders, through high interest monetary policies, have disproportionately taken up the cudgel of induced debt. We have consumed the excess savings of others.

So the unsavoury behaviour of the finance sector as a whole – and the big American investment banks in particular – in the mid-2000s (well-documented in Charles Ferguson’s movie Inside Job) was not the cause of the global financial crisis. The finance sector was doing its very best [though not with any noble intent] to allocate the huge saved portion of global economic production. The 2008 crisis represented the temporary unravelling of the unsustainable balance sheets of global finance. We are now in the middle of a re-ravelling phase. Finance sector excesses are symptomatic of our saving glut problem; not its cause.

One important tactic to induce spending was the direct hard-sell of debt to people who clearly could not afford it; hence the sub-prime housing loans in the United States, and many of the bad loans made by finance companies in New Zealand.

More significant for us today (as well as 7-10 years ago) is the indirect effect of financial bubble creation. The banks prefer to lend to people with inflated assets as security, rather than lend unsecured. Most of these loans therefore are used to purchase things or promises that already exists: used cars; used houses; shares; bonds. The proceeds of these bank loans therefore go to the sellers of these assets, who may be induced to buy extra goods and services on account of the capital gains realised; or may buy more assets.

More significantly, many people who do not sell their assets that are valued at inflated prices decide to borrow and spend against the security of those ‘assets’. In their eyes they are net savers because their unrealised capital gains exceed the new debts that they take on. This indeed is the classic way that demand-constraints are resolved; through financial bubbles in what are fundamentally demand‑constrained economies.



Auckland’s Property Bubble

This understanding of financial bubbles is very topical in New Zealand at the moment, or at least in Auckland, because the latest house (and land) valuations were issued by the Auckland Council this week. Indeed the Auckland Council’s computer crashed on the day of release, so eager were people to count their new inflated ‘net worth’. The word on the traps is that people were not checking because of concern about their 2015 rates. Rather they wanted to know what their collateral is worth so that they can borrow and spend while believing that their stock of savings continues to rise. The utility of bubbles is that they, like nothing else, induce savers to spend. The economy, on consumer debt steroids, comes to mimic a supply-constrained economy.

It’s the oldest trick in the book of the money cycling profession: make people believe that they are worth more than they really are, so that they will go out and buy what would otherwise be unbought.




The financial collapse of 2008 took place when the ability of the financial sector to substitute for the missing demand was exhausted. The crisis was mercifully brief, because in 2009 the governments of the world took on the borrowing that, despite record-low interest rates, households and businesses were eschewing big-time.

A key feature of most demand-constrained economies is high levels of induced consumer debt; the necessary flipside of the saving glut. When the debt dissolves, when the critical moment arises, many savers get what financiers call a ‘haircut’. We observe the glut of savings by seeing the huge price inflation (bubbles) in so many of the world’s prime asset markets, simultaneous with low inflation in goods and services markets. High house prices are just a symptom of too many ‘investors’ with too much ‘wealth’.

The preponderant view that economies continuously suffer from insufficient savings – the central premise of the supply-constrained view of economies – is simply not credible in the twenty-first century.

Our economies are now for the most part demand-constrained. Induced debt-fuelled consumption – albeit interspersed with financial crashes – facilitates the illusion that our basic problem is our unconstrained desire to spend. Attempts to cure the wrong problem substantially aggravate the actual problem.



  1. So an excess of savings is the cause of the debt crisis. Only an economist could say that with a straight face.

    Also starting the article with that straw-man argument about demand- and supply-constrained positions does not do you credit.

    The main problem is excessive money/credit creation that fuels speculation. When people see a bubble (dot com, property, etc) many borrow against the expectation of realising profits that never eventuate, this exacerbates the problem. Inevitably bubbles burst and then there is a deficient level of money/credit creation as lenders become reticent as they try build up their capital again.

    In summary: excessive credit creation by lenders leads to bubbles that burst, the surviving lenders then become tight-fisted deepening recession.

  2. “Indeed the world economy throughout this century has been characterised by a savings glut, the root cause of the 2008 global financial crisis.”

    I gathered it was is pretty clear at this point the exact opposite is what happened (taking “glut” as meaning “an excess of”). I’ll rewrite the above sentence so that it makes sense:

    “Indeed the world economy throughout this century has been characterised by excessive leverage (i.e. debt), the root cause of the 2008 global financial crisis.”

    I’m just not seeing what you’re driving at here at all:
    Where exactly is this “glut” in savings you speak of relative to debt? (Feel free to find your own charts, this is one I randomly picked from a Google search, but they all look the same).

    • Total savings equals total debt. They are one and the same thing, just perceived from the opposite sides of the ledger. Saving equals lending (in essence), and lending equals borrowing (by definition). For every debit there is a credit. A glut of one is a glut of both.

      • To contradict you Keith, Basil Moore (post-Keynesian) writes an interesting paper looking at the relation S=I where he largely goes off at the notion of a pool of savings. I believe he is correct, saying that saving leads to savings is nonsense in aggregate.

        ‘The belief that aggregate saving is the sum of volitional saving decisions by individual economic units is a spectacular macroeconomic illustration of the “fallacy of composition”. This fallacy has been reinforced by the unfortunate use of the colloquial verb “to save”, with its very powerful transitive volitional connotations for an economic term which is simply an intransitive accounting definition: “income not consumed”’ – Moore

        BTW, are you sure that ‘Total savings equals total debt’? If I have my savings in the bank then yes, they owe me that debt and they match, but if I owe the bank a debt, say via a mortgage, that doesn’t seem to be related to a banks prior decision not to consume some income. They certainly didn’t lend me the money out of interest payments (a banks income), in fact they created it when extending me the loan! The point of this pedantry being, if they needed to borrow reserves to settle payments relating to that loan, they would not have had the same incoming in the event of not extending that loan. This doesn’t look like an act of saving at all, why should, total savings equals total debt therefore?

      • The ledger doesn’t account for interest that has to be repaid on the debt.

        This leads to debt accumulating until it becomes unpayable and a haircut has to taken.

      • That would be true if things like “fractional reserve lending”, “deficit spending” that will never be repaid (only perpetually turned over), and “quantitative easing” didn’t exist. None of these represent what could be construed as somehow also representing “savings” with a straight face. Factually, money is LITERALLY created out of thin air on a daily basis, inherently destroying everyone’s purchasing power (including savers and/or wage earners).

        • If banks create money through the “fractional reserve” process, or otherwise, they presumably have the choice of spending it, eg on staff salaries etc, or lending it out to customers. So in this situation Keith’s equation holds, since the latter would be equivalent to saving. With deficit spending the money is not saved so the equation doesn’t apply.

  3. Grasshoppers , their is a difference between what you want and what you need .

    If getting what you want ,still doesn’t give lasting contentment, will more debt bring more contentment or more discontentment ?

    Debt is frequently a tool of enslavement for material clutter we just don’t need .

    Less pop ,urban and consumptive growth = Less deforestation , less species extinction = less environmental damage =less co2 emissions = less global warming .Environmental balance.

    Have fewer possessions, buy less , incur less debt, and feel good because your helping save the planet not destroying it.The application of Zen minimalism on both a personal and global scale really shows how less can be more .

    Classical economics calls no growth ,” Stagnation “, a value laden term which implies a negative state . The preferable term is “equilibrium” which green economists denote as a positive state of balance.

    Endorsing endless destructive economic growth and keeping with the Jones is so 2002 .Take a look in a fresh new direction .

    A Zen based minimalist approach to western materialism has much to offer both in terms of simplicity , personal clarity and ecological sustainability.

    We just don’t need all this stuff !!!!!!

  4. Most economists and members of the public – on both the right and the left – believe that economies are constrained by resource scarcity most of the time.

    That’s because they are but I differ from most economists in that I consider them constrained by sustainability rather than through productivity. Farming in NZ is a good example of going beyond sustainability limits. Digging up fossil fuels and burning them is inherently unsustainable as we will, eventually, run out but we could use those resources sustainably by using them to produce products that were recyclable.

    That said I also believe that we (NZ) can supply all of our requirements for a reasonably high living standard for everyone from those limited available resources. In other words, apart from farming and a couple of other areas, we’re not resource constrained.

  5. I get the feeling that most of the commenters are missing the point here. I also think economic discussions in the mainstream have so little to do with reality that we need to unlearn that nonsense before we try to understand this.

    I heard a quote from Chomsky recently that summed things up quite succinctly. In the US there are huge amounts of savings, a lot of work to be done and lots of people who would like to be in work but the economy is so grotesque that they can’t put it all together and get things happening.

    Of course that’s the US. A lot of those savings are derived from places like New Zealand so it doesn’t necessarily apply to us but Maybe this is why they used to have Jubilees.

  6. Aaron, I dont see that ” commenters are missing the point here”. The fact that so many commenters agree with each other and disagree with Keith Rankin, suggests that they ‘understand this’ rather better than Keith Rankin does. Indeed ‘we need to unlearn that nonsense” and should understand that economics deliberately misuse words so that they are unintelligible to the lay man, so “savings equal debt”; “credit equals debit” etc. How is the lay man to make sense out of this?
    As Korakys points out loans dont equal debts because of the interest that needs to be paid together with the debt, but for which there is no provision made in the economy. The loan can be repaid by debt instalments (and can be seen as equal) but the interest never is, so the two sides of the ledger do not really balance except by some shonky accountancy.
    Your comment about Jubilees is interesting but I think needs to be explained for most readers.

    • ” …. loans dont equal debts because of the interest that needs to be paid together with the debt, but for which there is no provision made in the economy.”.

      Interest is paid from the bank customer’s revenue. The money to pay the interest is always available because the bank recycles that interest by spending it (eg on staff salaries etc) or by further lending.

      • Your “explanation” of how interest is ‘repaid’ by being recycled through the economy sounds plausible but bears no resemblance to the facts. Essentially you are rehashing the long discredited idea that banks are merely intermediaries who just borrow money from ‘somewhere else’ . The money already exists in the economy , as does the interest to repay it. It is a belief in a steady state economy where new money is never needed in the long run – the money just churns around endlessly. Reality is nothing like this.
        This view of the economy was totally destroyed by the Bank of England’s recent assertion that all loans come into existence by the creation of new money and that all private bank money (98% of all money in existence) is debt. So we are expected to pay off the 98% of debt plus interest from the 2% of debt -free real money created by the Reserve Bank. No amount of juggling with economic theory can make that possible.. You cant pay such debt; you cant even pay the interest on that debt,, which must rise inexorably.
        Your explanation is completely unable to account for the numerous graphs showing that total debt is rising exponentially every year, or those graphs put out by the Reserve Bank showing that the % of household disposable income required to pay debt is rising remorselessly despite present low interest rates. What happens when the remaining disposable income is insufficient to pay for rent and food? Isn’t this the point we are reaching now?

        • “The money already exists in the economy , as does the interest to repay it.”

          You misrepresent me. I think I said that the interest is paid from the customer’s income. There is sufficient money in circulation to cover that income because the banks create it and pump it into the economy through their spending and lending.

    • The point (I think) was to explain some conventional economics so that people are equipped to argue with the Neoliberal point of view. Most of the comments are accurate in what they say but are not the issue Keith was trying to write about.

      It’s good to understand how interest works etc etc, but it’s also good to know that the neo liberal orthodoxy doesn’t even make sense within the confines of text-book economics and can easily be ridiculed from a purely mainstream angle.

      The jubilees that I’m aware of are the biblical type where every 50 years debts are forgiven and slaves are allowed to return to their homeland. I have read (but can’t give references) that scholars have recently concluded that jubilees were definitely observed in biblical times and that the Roman empire resulted when they stopped having them.

      Other scholars have noted the similarities between the current western empire and the later stages of the ancient Roman one.

      There are better experts out there than me though.

  7. IN Wake up kiwi an articles states that bank deposits ,savings etc will be reclassified as paper investments in corporate banks,this means that your money will be the same as other investments if the investment goes down you lose your money without agreeing in the first place to invest instead of the intention to just deposit.

    Maybe others could google the site and give opinions ,just google Wake Up Kiwi,an amazing amount of info that would benefit from discussion if the info is true.

    • Wow, that would be an improvement if true. Currently, as I understand it, investors get first dibs and only after every other class of investor/backer is paid out by the liquidators do depositors get a chance at getting their money back.

      • Banks don’t invest. Business proprietors, homeowners etc invest, though of they may borrow from a bank or other moneylender to do so.

        • Ever heard of an investment bank?

          But what I meant by investors was the people who have invested in the bank itself ie; bank shareholders.

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