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On the propensity to consume

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Aristippus Posted: Tue, Oct 9 2012 6:48 AM

The cornerstone of Keynes' General Theory is the so-called 'fundamental psychological law' concerning the propensity to consume:

P. 96: "The fundamental psychological law, upon which we are entitled to
depend with great confidence both a priori from our knowledge of human
nature and from the detailed facts of experience, is that men are disposed,
as a rule and on the average, to increase their consumption as their income
increases, but not by as much as the increase in their income."

P. 97: "But, apart from short-period changes in the level of income, it is also
obvious that a higher absolute level of income will tend, as a rule, to
widen the gap between income and consumption. For the satisfaction of
the immediate primary needs of a man and his family is usually a stronger
motive than the motives towards accumulation, which only acquire
effective sway when a margin of comfort has been attained. These
reasons will lead, as a rule, to a greater proportion of income being saved
as real income increases. But whether or not a greater proportion is
saved, we take it as a fundamental psychological rule of any modern
community that, when its real income is increased, it will not increase its
consumption by an equal absolute amount, so that a greater absolute
amount must be saved, unless a large and unusual change is occurring at
the same time in other factors."
 

Now, Keynes has stated that this is true both a priori and empirically.  Is that so?  Can any such law be deduced praxeologically?  Is there any data to support it empirically?  Hazlitt, in The Failure of the New Economics, provides some statistics to show that there is no such observed relationship.  Does anyone have anything else on this?

Also, any other discussion on praxeological or empirical explanations for the determination of different time preferences is welcome.

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Neodoxy replied on Tue, Oct 9 2012 7:04 PM

No such law can be determined praxeologically, it is strictly unpraxeological, but I would say that Keynes isn't really trying to establish a praxeological concept, insofar as he understands the concept, as indicated by the words "as a rule", and while I would not be at all surprised if it were generally true after income reaches a certain point, however I can testify that in my recent experience where my income has fallen precipitously that I have started saving every f***ing penny. So I think that realistically this will apply itself in "tiers" of income. For myself it depends entirely upon how much my total income is and what becomes realistically available for me to consume at these various levels. At certain levels of income I'd save a high percentage, at others, a low percentage.

As for actual data, I've got nothing.

 

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Malachi replied on Tue, Oct 9 2012 7:24 PM
As people accumulate wealth, their time preference decreases? Is that a way to rephrase in austrian terminology?
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it doesnt make any sense at all.  Why does he use the word 'rule'? is he just avoiding putting any certainty in anything he writes?

 

In other words:

"The fundamental psychological law is that men are [kinda sorta inclined]
 to increase their consumption as their income
increases, but not by [more than they actually make]."

how can he call it a FUNDAMENTAL LAW that is inclined to do something.  Not much of a damn law.

I dont know a single middle income family that doesnt cut spending towards the end of their career to save for retirement (though i acknowledge im sure there are plenty of fiscally irresponsible people at there that do).  This is also during the time where their wages are increasing the most and at their heights of their career (typically). 

How can there be a law in spending behavior that is universal?  its crazy talk.

-people's time preference do change with a change in income, but to suggest there is a law in that is universal is crazy.

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Thanks for the responses.  As I thought, Keynes seems to simply create the supposed 'law' out of nothing.  He relies on the belief that individuals have a certain absolute amount necessarily dedicated to consumption, so that at low income there will be a higher percentage of income going towards this consumption than at higher incomes, even if this total consumption somehow increases with higher income.  But why cannot it not be the opposite case, i.e. that people have a certain absolute amount which they wish to save and that, achieving that, they prefer to consume the rest (resulting in greater total consumption when they have higher incomes)?

Also, I believe that the emphasis on this so-called 'fundamental law' is misplaced, since I have discovered a few reasons why the conclusions of The General Theory do not hold even assuming the veracity of this 'law'.

As people accumulate wealth, their time preference decreases? Is that a way to rephrase in austrian terminology?

I believe that's correct.

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I haven't read The General Theory, but judging from that quote, Keynes doesn't seem to be saying that people have a fixed amount dedicated to consumption and that the percentage of total income devoted to savings necessarily increases with increases in wealth. He seems to be pretty explicit that his main point is about the absolute level:  "But whether or not a greater proportion is saved, we take it as a fundamental psychological rule of any modern community that, when its real income is increased, it will not increase its consumption by an equal absolute amount, so that a greater absolute amount must be saved, unless a large and unusual change is occurring at the same time in other factors."

I take this to mean something like, if I receive a raise of $50, I'm going to increase my consumption by something less than $50.

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Jargon replied on Thu, Oct 11 2012 7:02 PM

So is it impossible that you spend it all?

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Neodoxy replied on Thu, Oct 11 2012 7:09 PM

FOTH,

I don't think anyone here would disagree with that classification of what is being said, but there has been some disagreement raised over whether or not it's necessarily true, although I think everyone here would agree that the MPC being a constant value is foolish.

I would like to throw out there that it is probably true in most situations, but indeed what the actual value is will vary a lot.

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Malachi replied on Thu, Oct 11 2012 7:12 PM
Whats funny to me is that this is supposed to be a "general rule" but it seems like the opposite is more of a general rule, as in somebody who lives paycheck to paycheck is gonna spend his whole paycheck, whether he gets a raise or not. And that has been observed to occur around these parts (Mars).
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He seems to be pretty explicit that his main point is about the absolute level

Did I say something to disagree with that?  I might have said percentage where not necessary (though Keynes does note that he thinks the percentage of savings increases with income 'as a rule'), but the focus was on the gap between saving and consumption.

I take this to mean something like, if I receive a raise of $50, I'm going to increase my consumption by something less than $50.

Is that necessarily the case?

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Is that necessarily the case?

No.

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Now that we have things cleared up, what are the statistics that Hazlitt provides to show that Keynes's claim isn't the case?

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Neodoxy replied on Thu, Oct 11 2012 9:53 PM

FOTH,

What is your new avatar?

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MadMiser replied on Fri, Oct 12 2012 12:39 AM

There's no decrease in 'propensity to consume': as Mises said, all saving is just delayed consumption. If anything, more savings could be considered exhibiting a greater propensity to consume, as if I can either spend $5 on an apple now, or save/invest it, increasing it to $10 in two years time and then spending that $10, obviously (inflation aside) saving it would allow for greater consumption on my part.

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Neodoxy replied on Fri, Oct 12 2012 12:42 AM

Just as with many economic concepts the biggest problem with many of Keynes' ideas is the time frame in which they occur.

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what are the statistics that Hazlitt provides to show that Keynes's claim isn't the case?

Hazlitt, The Failure of the New Economics pp. 112-113 (see also the pages that follow):

'Here is a table, taken from official statistics, showing the
disposable personal income in the United States for the
twelve years 1944 through 1955, inclusive; the amount of
personal savings in the same twelve years, and saving as a
percentage of disposable income:

          Income   Savings  Savings as %
Year (billions) (billions)  of income
1944 $146.8    $36.9           25.2
1945 150.4        28.7           19.1
1946 159.2        12.6           7.9
1947 169.0        4.0             2.4
1948 187.6        10.0          5.3
1949 188.2         7.6           4.0
1950 206.1        12.1          5.9
1951 226.1        17.7         7.8
1952 236.7        18.4         7.8
1953 250.4        19.8         7.9
1954 254.8        18.3         7.2
1955 269.4        17.1         6.3

Now let us see what these figures do to Keynes's alleged
"psychological law." The events of 1955 were in themselves
an emphatic contradiction. Disposable personal income increased
by $14.6 billion, but savings fell by $1.2 billion.
The total percentage of saving to disposable income fell
from 7.2 to 6.3. The same thing happened between 1953
and 1954. Disposable income went up $4.4 billion, savings
down $1.5 billion.'

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That is the same logic as saying someone who has acquired a pizza is more likely to eat a pizza.

Which is quite logical and statistically likely to be true but I do not think that qualifies it as a law.

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I think the first thing Keynes would probably point out about those statistics is that they completely ignore government spending. If the UK were to privatize healthcare, the resulting decrease in taxation would mean an increase in disposable personal income. However, people would then have to purchase healthcare themselves. If the private healthcare costs more than the government healthcare that it replaces (which the Keynesian would assure you that it would), then consumers would indeed increase their consumption at a higher absolute level than their increase in income.

I haven't been able to find a detailed source for government spending for those years. The best I've found is this graph:

This seems to support my hypothesis that changes in government spending account for the supposed divergences in Keynes "psychological law" (I do find this term a bit strange). During 1944 and 1945, government spending is higher, which corresponds to the high rate of savings. Many people were in the military during these years and had their food, shelter, and healthcare provided for them by the government. They also received a salary, which given that their consumption goods were provided to them directly, they were free to invest a larger portion. The point where government spending reaches its lowest (looks like about 1947) is also when personal savings is lowest. And in or just before 1955 where income increases and savings decrease--which Hazlitt says is an "emphatic contradiction" of Keynes--government spending takes a sharp drop.

I doubt Keynes would be foolish enough to think that government spending has no affect on the propensity to consume. In fact, if it didn't, it would seem to undermine his prescriptive interventionist measures. Keynes is even explicit in the quote that he is talking about the "modern community" and not merely an aggregate of personal incomes. Surely government also takes in income and spends it on consumption.

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Malachi replied on Fri, Oct 12 2012 9:01 PM
I think the first thing Keynes would probably point out about those statistics is that they completely ignore government spending.
perhaps government spending should have been included in the "general rule" elsewise what good is it? If I tell you theres a general rule that martians eat chicken salad on fridays, and then you show me statistics on martian eating habits, and they actually eat porterhouse steak on fridays, would you consider it a cop-out if I replied that they ate the steaks at restaurants and so it doesnt count?
Many people were in the military during these years and had their food, shelter, and healthcare provided for them by the government.
servicemembers pay for their food and shelter. They also oftentimes pay for their healthcare.
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To OP:

Quarterly Credit Card Debt in the United States Since 2010 (in billions):[1]

  • Q2 2012: $799.5
  • Q1 2012: $790.3
  • Q4 2011: $834.4
  • Q3 2011: $799.5
  • Q2 2011: $794.3
  • Q1 2011: $786.0
  • Q4 2010: $833.1
  • Q3 2010: $819.2
  • Q2 2010: $830.5
  • Q1 2010: $843.1

Source:Wikipedia on credit card debt.

How does this fit in with Keynes? I say it refutes him.

 

 

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Neodoxy replied on Sat, Oct 13 2012 2:36 AM

FOTH,

It would appear to be Jacobi... Or such is indicated by my in-depth 3 minute google image investigation.

Dave,

What do you think that the data shows?

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Neo,

The data shows that our little recession has not been because of less spending, with people spending less than their income. Quite the opposite. They live beyond their means to the tune of closee to a trillion bucks.

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@SD: but the debt is decreasing (assuming the figures are cumulative, not incremental), which means at least some persons are paying back their debt, refusing to consume. The bastards are the cause of the recession!

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Groucho replied on Sat, Oct 13 2012 5:30 AM

Aristippus:

The cornerstone of Keynes' General Theory is the so-called 'fundamental psychological law' concerning the propensity to consume:

P. 96: "The fundamental psychological law, upon which we are entitled to
depend with great confidence both a priori from our knowledge of human
nature and from the detailed facts of experience, is that men are disposed,
as a rule and on the average, to increase their consumption as their income
increases, but not by as much as the increase in their income."

....

Keynes seems to assume that the margins between income and consumption either do or will remain fixed, but he has a very non-rigorous way of phrasing it. Regardless, it doesn't seem like a reasonable thing to accept a priori.

 

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Neodoxy replied on Sat, Oct 13 2012 12:38 PM

"The data shows that our little recession has not been because of less spending, with people spending less than their income. Quite the opposite. They live beyond their means to the tune of close to a trillion bucks."

I don't necessarily disagree with your conclusion, but

1. Don't you think that simply looking at credit card debt is a little unsubstantial for the weight of the claim, at least in modern discourse?

2. As Andris pointed out doesn't that appear to be residual debt as much as anything else? It is decreasing over time, and there could be a variety of stuff going on there, I.E half of the population is paying their existing credit card debt, the other half is incurring it ETC.

3. Don't the "real" economist Keynesians these days argue that the problem is arising from a lack of investment spending? I could be wrong, I just know that I've seen that argued before

4. In the end isn't this rather off-topic in the discussion which is going on?

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1. Not sure what you mean. Especially by modern discourse. My thinking is that if you are using a credit card, then you are paying very high interest on a loan, much higher than any use of your money will give you. Why are you doing this? Why are you not dipping into your savings? Only possible answer: You don't have any savings. But according to Keynes, you do, because you are not some peasent in a third world country. Contradiction. QED.

2. It may be decreasing a little bit, [my guess temporarily], but do you think it's ever going to be small or nonexistent? The folks I know for the most part are all in debt. Way beyond their means. And have little to no intentions and/or ability to change that. And even if half the population is paying and half is incurring, Keynes looks at the aggregate, right? And the net is over half a trillion bucks, closer to to a trillion. In short, that debt is not going away anytime soon, and it's an indication that the idea that people are hoarding money in huge quatities, enough to influence the whole economy, is ludicrous.

To flesh out the picture, check out my humble blog: http://smilingdavesblog.wordpress.com/2011/08/24/classic-keynes-and-why-the-credit-card-refutes-him/  The debt picture is much worse than my original post here.

3. Have we changed the subject to investment? Or are we still talking about the propensity to consume? Keynes in his book, Chapter 3 or so, laid it out like this: Company A makes stuff, incurring expenses. They get their money to keep on functioning by getting back all the money they spent, either by people buying thier product, or by people investing in their company. But since the folks who buy and invest, when they are rich, have a propensity to hoard their money to some extent, because you can only eat so many pizzas and only so many pizza shops are good investments, so you have nothing to do with your piles of excess money, you hoard it. [Which the existence of huge amounts of debt disproves, IMHO]. Have the "real' economist Keynesians come up with something new?

4. I think it's right on, topic, as the OP asked for empirical info on the propensity to consume, or its nonexistence. Well, here you have it.

5. Think of it as an elephant in the room. Mr USA is bragging to Mr Keynes about how much money he has salted away, hoarding like there is no tomorrow. His wife, the elephant, pipes in "If you have so much money hoarded away, why are you a trillion dollars in debt at ridiculously high interest?"

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My suspicion is that Keynes would consider income that goes towards paying off or servicing debt to be part of the savings portion. So provided that any portion of an increase in one's income goes towards servicing debt instead of consumption, then Keynes claim would remain correct. Whether one goes in debt beyond one's income isn't really relevant since what the propensity to consume concerns is how one spends one's income.

And remember for every debt, there is a credit. It seems to me that if we hold income constant, then an increasing level of debt could mean that a greater proportion of income is going towards savings--i.e. the creditors are lending a greater portion of their income out and the debtors are devoting a greater portion of their income to debt servicing. Or have I overlooked something?

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My suspicion is that Keynes would consider income that goes towards paying off or servicing debt to be part of the savings portion.

My suspicion is that the butler did it, but where is my proof, or chain of reasoning?

Or have I overlooked something?

Yes. Keynes builds his case on how much money gets back to the producers, claiming that in a rich country it does not all get back, because a large part of it is hoarded. Whether it moves around as debt before it gets back to tthe producers doesn't change anything.

My case is very simple: Who, exactly, is doing the hoarding? Where is the mattress with the huge pile of money under it? The creditors aren't hoarding. The debtors aren't either. So who is?

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Banks are lending less, aren't they? If a smaller percentage of money in the bank is being lent out to people who will spend it, then more money is being hoarded, no?

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Banks are lending less, aren't they?

Is this a new line of reasoning, or an elaboration of your earlier post? I don't see how all the pieces of your argument tie together.

Let me summarize my understanding so far. Keynes said that in theory and in practice, the richer the country, the more there are hoarders. I pointed out that not only is nobody hoarding anything, quite the contrary, the country as a whole is living beyond its means,

What is the relevance of the fact that banks are lending less? We are in a prolonged recession, where the events leading up to it, as well as the continuation of it these last few years, show no evidence whatsoever of anyone hoarding anything. The average Joe, as well the US govt, are both living beyond their means and not hoarding anything,

Maybe you are referring to the fact that the Fed is printing more digital money and givng it to banks, which they relend to the Fed., not the private sector, and you consider that "lending less".  But I don't see how what happens to newly printed money is relevant. Keynes was talking about the circulation of the existing money supply, claiming that some of it will be hoarded always.

Maybe you mean that banks are lending less to small businesses, and consider the money unlent to be hoarded by the banks. But the banks themselves owe three dollars for very dollar they have in their vaults. In other words, the net result is still no hoarding whatsoever. 

Once we introduce fractional reserve banking into the picture, where banks lend ten times more than they get in deposits, then there is way more money lent than exists in the bank vaults. Loans would have to be reduced to less than one tenth of what they used to be for any hoarding to be happening by the banks, because only then would there be money somebody got from the producers that doesn't return to them

Put it this way. If I borrow a hundred dollars and spend it all, and then decide not to spend my full paycheck, but put away five dollars, or repay part of my loan with those five dollars, there is no net hoarding, obviously. Even if I borrow a hundred dollars, spend it all, then use my next paycheck to repay the loan in full [which nobody is doing], there is still no hoarding going on.

 

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Let me summarize my understanding so far. Keynes said that in theory and in practice, the richer the country, the more there are hoarders. I pointed out that not only is nobody hoarding anything, quite the contrary, the country as a whole is living beyond its means,

Maybe I don't understand what you mean by hoarding. Keynes doesn't mention hoarding in that quote. He mentions saving. Are you saying that saving is the same thing as hoarding?

My impression of Keynes's theory was that during booms income is overinvested (a form of saving) and during slumps is overhoarded (a different form of saving). This is why I was confused when you brought up hoarding in relation to the propensity to consume.

What is the relevance of the fact that banks are lending less? We are in a prolonged recession, where the events leading up to it, as well as the continuation of it these last few years, show no evidence whatsoever of anyone hoarding anything. The average Joe, as well the US govt, are both living beyond their means and not hoarding anything,

If banks were backed by 100% reserves and those reserves remained constant but the banks lent less money, then would you agree that additional money is being hoarded?

Maybe you are referring to the fact that the Fed is printing more digital money and givng it to banks, which they relend to the Fed., not the private sector, and you consider that "lending less".  But I don't see how what happens to newly printed money is relevant. Keynes was talking about the circulation of the existing money supply, claiming that some of it will be hoarded always.

Could you point me to where he claims that?

Certainly some money always has to be hoarded since businesses and individuals always need a quantity on hand to cover expenses. But I take it this isn't what you think Keynes means.

Maybe you mean that banks are lending less to small businesses, and consider the money unlent to be hoarded by the banks. But the banks themselves owe three dollars for very dollar they have in their vaults. In other words, the net result is still no hoarding whatsoever.

Who do they owe the money to?

Once we introduce fractional reserve banking into the picture, where banks lend ten times more than they get in deposits, then there is way more money lent than exists in the bank vaults. Loans would have to be reduced to less than one tenth of what they used to be for any hoarding to be happening by the banks, because only then would there be money somebody got from the producers that doesn't return to them

You previously indicated that storing money under the mattress was an example of hoarding. If I put $1 million under my mattress while the bank creates $10 million, does that mean the money under my mattress no longer constitutes hoarding?

Put it this way. If I borrow a hundred dollars and spend it all, and then decide not to spend my full paycheck, but put away five dollars, or repay part of my loan with those five dollars, there is no net hoarding, obviously. Even if I borrow a hundred dollars, spend it all, then use my next paycheck to repay the loan in full [which nobody is doing], there is still no hoarding going on.

There could be net savings though, which is what I thought Keynes was talking about.

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I'm sure you'll find the sources easily enough, FOTH.

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