Friday, May 25, 2012

Edward Harrison — Why can’t people understand national accounting?

... At the end of any accounting period, then, the sum of the sectoral financial balances must net to zero. The government balance – the private balance – capital account balance = 0. The government balance = the private balance + the capital account balance. See my postEconomics 101 on government budget deficits for the full write-up. I credit British economist Wynne Godley for making this identity relevant to macro economics.

What does all this mean then? Put simply, the financial sector balances framework means that when the government sector runs a deficit, the non-government sector runs a surplus of equivalent size. So, to move any sector balance in an open economy, you need to move the other two balances exactly opposite in equivalent measure. To reduce the government deficit in any period, the private balance and the capital balance must increase by the exact same amount in that period.

Thinking about government deficits this way opens a whole new understanding of what cutting deficits means for the economy. What it should mean to you is that deficits are the effect and not the cause. Budget deficits are the result of the ex-post accounting identity between the sectoral balances and should not be a primary goal of public policy....
...the deficit is the result of an ex-post accounting identity between private savings, and capital account and government balances. It makes zero sense to target the effect (deficits) instead of the cause (excess credit growth and malinvestment). In plain English that means the policy prescriptions are the economic input and the deficit is the output. Focus on the policy and policy goals, not deficits.
Read it at Credit Writedowns
Why can’t people understand national accounting?
by Edward Harrison

Good summary overall.

 However, I disagree that the problem arose from central banks keeping interest rates too low for too long, thereby fueling massive malinvestment that eventually imploded. I think that folks like Bill Black, Michael Hudson, and Randy Wray, all of UMKC, Yves Smith of Naked Capitalism, and Janet Tavakoli of Tavakoli Structured Finance have documented that the problem arose from what Bill Black calls a criminogenic environment in the financial sector, both the mortgage market and the securitization process. It continues in the foreclosure debacle. 

While low rates may have played a role in fomenting the crisis, they were neither the proximate nor the principal cause of it. These crisis can be laid square at the feet of the financial sector, and the next crisis or the further devolution of this one, however one wishes to view it, is already baked in because the behavior hasn't changed, nor have the institutional arrangements.

15 comments:

paul said...

Because, as some of us have noticed, most people don't understand math, especially as it applies to systems.

Unforgiven said...

Tom -

I agree with your summation. The interest rates didn't have so much to do with it as the acceptance of pretty much any loan applicant that wasn't legally dead (man on the street POV here). On second thought, if one pours through the records, there probably were a few that were legally dead.

If the same underwriting standards had been in force with the interest rates at 10%. Hmmm..... perhaps it had to have a certain hang time before it came crashing to earth, by design?

Letsgetitdone said...

I agree with your analysis too, Tom. But I wonder if Ed can admit that:

"a criminogenic environment in the financial sector, both the mortgage market and the securitization process" was the primary factor leading to the crash, since such as environment isn't normally recognized as a macro-economic condition, or as particularly relevant for "right-wing" theorists.

Unforgiven said...

Paul -

It's a question of the system. Blackboxing it, the math isn't wanted or needed in the prevalent system. Just emotions.

Anonymous said...

Stiglitz: Fed's "easy money" policy is not to blame for the crisis http://www.youtube.com/watch?v=YpId56I8ibs

Leverage said...

The low rates thing is a fairy tale made up by austrians.

There is is simply a limit to private debt creation by the private sector, lower rates or higher rates may help how fast and in what conditions you get there.

But the current situation is not caused by lack of productivity or competitiveness, indeed if the "malinvestment" had been less, the thing that would have changed is that we would have even more underutilization of capacity, and that the gap of incomes (or the differential accumulation) between labour and capital would have been getting worse during the last 30 years.

Also the "private" (or the legalized counterfeiting banking cartel) sector has this "hard on" to create inflation and malinvestment constantly in history. I haven't observed rates to matter that much (unless, off course, you go to the extremes of usury) in the process, a 1% or 2% more wouldn't have avoided the process.

Is the capacity to leverage of societies what matters the most in this process. And it's only natural thta it happens because the falling rates of profits feed naturally into overleverage and consumption to keep the machine going on (you have to keep 'pouring money' into the system to feed the desires of savings of the capitalists, to feed the differential accumulation process).

The fairy tales are manufactured to produce a post hoc explanation of the natural shortcoming and failures of a capitalist system.

P.S: Respectfully, I like E.H. a lot but he has his shortcoming because of his background (just like other MMT'ers), IMO.

paul said...

"Blackboxing it, the math isn't wanted or needed in the prevalent system. Just emotions."

"There is is simply a limit to private debt creation by the private sector…"

"…the current situation is not caused by lack of productivity or competitiveness…"

"The fairy tales are manufactured to produce a post hoc explanation of the natural shortcoming and failures of a capitalist system."

Quoted for truth.

How do we get the message across?

Bob Roddis said...

People do understand “national accounting” and “sector balances”. Your analysis makes no sense and people understand that.

Suppose that the Feds sell a bond to the ChiComs for $1.5 trillion and pass out the proceeds to Obama supporters to buy whiskey, weed and lap dances. The money is now spent. When the Feds come after me and mine to repay the ChiComs (or steal my purchasing power through fiat funny dilution), how can that conceivably be a positive for the "non-governmental sector"? Also, I understand that your solution to the situation would be for the treasury to simply create the fiat funny-money out of thin air using keystrokes to be used to buy the whiskey, weed and lap dances more directly.

Seriously, people do understand MMT.

paul said...

"…Suppose that the Feds sell a bond to the ChiComs for $1.5 trillion and pass out the proceeds to Obama supporters…"

Are you claiming that the US acquires dollars from ChiCom when we sell them bonds?

Tom Hickey said...

"Seriously, people do understand MMT."

Right. Those people are largely Austrians, who see any expansion of "money" as leading to inflation, which is, of course, daft.

A growing economy needs an increasing money flow and growing money stock to support growth and saving respectively.

As long as the net injection meets this without overshoot, sparking inflation, or undershoot, resulting in deflation, the outcome is price stability.

Just do the math.

paul said...

According to Austrians if we printed $10 Trillion and sent it to the moon it would cause inflation.

Tom Hickey said...

paul: "Are you claiming that the US acquires dollars from ChiCom when we sell them bonds?

It has nothing to do with China. Who saves in USD is irrelevant to money creation. It makes no substantial difference who holds financial claims against a country's goods and assets, which is what currency is as a financial asses, i.e., it can be exchanged for real goods and assets at will as long as there is a willing sellers.

Of course, govts do limit external transfers for "national security" reasons, so the external sector may be limited in a way that the domestic is not.

Under the current system the Treasury issues currency through tsy issuance, which is required for the Fed to credit the Treasury account from which expenditure takes place, and deficit expenditure injects NFA into non-government, both domestic and external sectors.

Due to the institutional arrangements, the precise amount injected is "saved" in tsys as non-govt net financial assets. The flow of that injection through the economy provides the offset so that the saving doesn't result in demand leakage and too litte demand for economy to perform at potential.

paul said...

Tom, have you seen this?

http://thinkprogress.org/climate/2012/05/26/490694/must-see-tedx-video-if-you-want-them-to-remember-tell-a-story/?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+climateprogress%2FlCrX+%28Climate+Progress%29&utm_content=Google+Reader&mobile=nc

STF said...

"Suppose that the Feds sell a bond to the ChiComs for $1.5 trillion and pass out the proceeds to Obama supporters to buy whiskey, weed and lap dances."

The bond sale has nothing to do with it acquiring the proceeds.

"When the Feds come after me and mine to repay the ChiComs (or steal my purchasing power through fiat funny dilution),"

They don't need to do that. Fiscal sustainability is about the interaction of the debt RATIO (not the debt itself) and the interest on the national debt. This isn't MMT, this is every school of thought (save Austrians, perhaps) and is standard in every macro textbook.

"how can that conceivably be a positive for the "non-governmental sector"?"

Straw man. It's an increase in the private sector's net financial assets, but that doesn't mean it's a "positive factor," as that depends on the combination of the opportunity cost of the govt's spending and the capacity utilization of the economy at the time. It could be a very negative factor.

"Also, I understand that your solution to the situation would be for the treasury to simply create the fiat funny-money out of thin air using keystrokes to be used to buy the whiskey, weed and lap dances more directly."

No. What we say is that they necessarily already do it that way whether they are selling bonds or not. Big difference.

"Seriously, people do understand MMT."

You clearly do not.

Matt Franko said...

Bob,

"the Feds sell a bond to the ChiComs for $1.5 trillion"

For the Feds to be able to sell the Chinese the bonds that LOGICALLY means the Chinese have to have already been "paid".

"To do a reserve drain, you first have to have done a reserve add"

This little baby girl knows this:

http://mikenormaneconomics.blogspot.com/2012/04/to-be-able-to-do-drain-you-first-have.html

Do you?

resp,