One genre of claim I hear a lot on Twitter goes something like this: "more pounds spent in the economy means firms have more money so they invest more", or "more stuff consumed means more confidence for investors". I think this confusion comes partly from half-digested media economics, partly from the fact that the individual claims sound very intuitive, and partly from the fact that money is clouding our judgement. Without money, the issue is much clearer.
Imagine there was no money. Instead, a government plans the entire economy. Imagine for a second that it can easily compel people to do what it wants, and that there are no information problems, it can see inside people's minds to understand their preferences exactly.
It faces itself with a number of inputs at its disposal. First it has land—because economy activity has to take place somewhere, and some places can sustain more valuable economic activity, perhaps because there is oil buried there, the climate makes human habitation cheap or pleasant, or because it is near other areas of dense population. Second it has labour—humans are even now the crucial input for making most things through their dexterity, endurance, strength, and most of all brainpower. Third it has capital—in the past we've invested, producing stuff that did not service any of our demands directly, but made us better at serving them in the future, stuff like machinery, buildings, training, skills, and so on.
This economic planner basically arranges these economic inputs to produce two types of outputs:
- Consumption goods. People want medical services, lawyers, restaurants, hotels, aeroplanes, trains, cars, houses, and much much more. You can produce these. We spend 70-75% of our national product on these nowadays.
- Investment goods. If we use all of our inputs to produce consumption goods then we can consume a lot, but the amount we consume doesn't go up over time. In fact, if our capital depreciates over time, then the amount we consume actually falls. So we also use people, land, and capital to invest in new capital. We train new doctors, build new shopping centres and airports and factories, design new drugs and machine tools, invent robots. This stuff gives us no reward now, but it gives us a big reward later.
So it's clear that in this planned economy, any consumption comes at the cost of investment. But this is also true, for the most part, with money brought back in. Except for examples where governments (or firms) make terrible calls or restrictive regulations, most our best land, labour, and capital is tied up in producing consumption and investment goods. If our actions result in lower consumption, then they usually result in higher investment—and vice versa.
Now: this is not true when we're in a recession. At these times, lots of land, labour, and capital is un- or under-employed. At these times, you can increase both consumption and investment.
But in usual times more funds for investment lead to more investment. Slightly higher bids for a given financial security means slightly lower yields, making it slightly cheaper for that firm to borrow. Firms are not continuous, but thresholds in their borrowing costs do make a difference to their investment plans, and each infinitesimal shift is equally likely to bring them over such a psychological threshold on both the extensive (whether to invest) and intensive (how much to invest) margins.
It's true that raw correlations between aggregate borrowing costs and aggregate investment are weak. But that's because borrowing costs are usually low when the macroeconomy is weak, because of poor fiscal or monetary policy, factors we can easily abstract from. Controlling for expected economic conditions (as few papers do) would reveal a tight link.
This is why doing economics without a model—what I call "pub economics"—can be so difficult and misleading. Individually plausible-sounding claims can be false when you integrate them together with all the other relationships that are happening in the economy.