Thursday, October 11, 2012

Matheus responds to Ramanan

Matheus doesn't think that Ramanan has a valid point. If you are following this, read it and let us know what you think.

Quantitative Finance: Foundations and Applications
Income, expenditure, and endogenous money
Matheus Grasselli


jeg3 said...

I came away thinking that they had a strong model of that the change in debt drives a lot in the private sector including bubbles & ponzi schemes. The graphs with there modeled results compared to actual data supported this.

The word war, "a rose by any other name smells as sweet". Not that it is not a bad thing to get everyone on the same page with regard to definitions, assumptions, etc.

JKH said...

vacuous response

and Ramanan knows what endogenous money is

Trixie said...
This comment has been removed by the author.
JKH said...

A vacuous truth is a truth that is devoid of content because it asserts something about all members of a class that is empty or because it says "If A then B" when in fact A is inherently false. More formally, a relatively well-defined usage refers to a conditional statement with a false antecedent. Such statements are considered vacuous because the falsity of the antecedent prevents one from using the conditional to infer the consequent. They are true because a material conditional is defined to be true when the antecedent is false (or the conclusion is true). This notion has relevance in pure mathematics, as well as in any other field which uses classical logic.

Matt Franko said...

"criticisms can be defended in two words: endogenous money!"

this seems somewhat 'monetarist' in nature, perhaps just on the surface... hope he elaborates.


JKH said...


IMO,endogenous money is a machine that creates money as per the correct story that "loans create deposits". There's no question that this constitutes MARGINAL fuel in activating aggregate demand, when combined with the other forces that motivate aggregate demand. That's a very simple point.

But that's not what Ramanan is objecting to, so there's been no response in that sense.

paul said...

"There's no question that this constitutes MARGINAL fuel in activating aggregate demand"

JKH, could you expand on this a little bit? What do you believe is the main "fuel" for aggregate demand and by comparison how do you see debt fitting in?


JKH said...


Ramanan’s point is about stock/flow consistency. The Keen/Grasselli thesis seems to be that continuous time mathematics transforms the basic measurement framework and logic for stock/flow consistency. Ramanan rejects that, as do I.

To your question, I’d answer in two steps.

First, in the same way that money does not spend itself, loans do not borrow themselves.

Borrowing is a volitional act.

Spending is a volitional act.

It is an act that is separate from borrowing.

(This holds whether it is conventional loan borrowing or credit card borrowing. There’s nothing unique about credit card borrowing in this regard. The decision to spend and the decision to borrow as a means of financing spending are still operationally separate. The fact that credit card borrowing is electronically convenient doesn't change this.)

Borrowing can be useful as a means of increasing money available to the spender for spending.

Bank borrowing creates new money for the system as a whole. That is useful in spending.

But spending can use existing money as well.

And much borrowing is non-bank borrowing, which does not create new money for the system as a whole.

Borrowing is captured in a balance sheet and flow of funds framework.

Spending is captured in an income statement framework.

Expenditure and income are always equal in a closed system income statement framework.

(Adjustments made for open systems are not the issue of debate.)

So the overarching point here is that there is a separation of borrowing from spending from the standpoint of stock/flow consistency. And the Keen/Grasselli thesis seems to claim that continuous time mathematics disproves this. That’s the disagreement, I think.

As far as borrowing being a marginal activator of aggregate demand, it’s clear there are other activators - because the annual addition to debt is not equal to GDP. So I think the “main fuel” for aggregate demand is income. Borrowing leverages that income by redistributing its purchasing power, but spending is still separate from borrowing from a stock/flow standpoint. They can’t be commingled in a current period equation (although they can be regressed in a cross-period analysis).

Ignacio said...

JKH but how can income grow (and thus GDP)? It looks like the majority of the grow in income can only happen through credit leveraging (and then, by debt).

Most growth of income in aggregate comes from endogenous growth of credit, even if it comes from exogenous growth of income (via public injections via spending) is leveraged through the financial system.

So yes, the equation is a simplification of what happens in reality, but the correlation exists because the causality exists in reality. Am I missing something?

paul said...

JKH, thanks. Gives me some things to think about in fleshing out my view of the system mechanics.

"So I think the “main fuel” for aggregate demand is income."

Of course I have to agree here - the progressive taxation/spending cycle pushes some $3.5+ Trillion/year through the spending machine.

Household debt increased from $7 T to $13.75 over the period 2000-2008, an average of $844 B/year.

That debt accounts for about 19% of spending in simple terms from external sources.

It would seem to me that spending generated from within the economy moves funds from the 99,9% to the 0,1%, so it does nothing to enhance the ability of consumers (workers and their dependents) to spend in the aggregate.

I don't know the magnitude of debt service over that period but whatever it is it cancels out some of the spending, although that won't show up in GDP numbers. Will have to see if I can find some debt service data.

JKH said...


The debate precipitated by Ramanan’s posts has been about the form of the equation – although I’m not sure Steve and Matheus have entirely understood that’s what it’s about.

That equation in the context of stock/flow consistency is the issue. This aspect of stock/flow consistency should be of central importance to anybody who follows Godley, Lavoie and/or a number of others. This includes MMT as a subset of that interested group.

It could be the case that there’s a fair bit of talking past one another going on - except that not to understand that Ramanan’s posts are about stock/flow consistency is to completely miss the point of them.

My view is that the equation is properly understood as a regression equation over at least two different time periods, rather than in its current form. I would question the completeness of the regression function beyond that, but that is a larger and more detailed question.

Continuous time mathematics does not alter the fact that there is “a before” and “an after” on either side of a differential operation.

So as a regression function, there is definitely an influence of debt on aggregate demand. But the debt, whether captured as a transaction occurring within a discrete time period, or as a discontinuous event in continuous time, has an effect on aggregate demand in a time period subsequent to the discrete timing of the debt issuance. And debt is not a component of aggregate demand – although it can obviously be associated with aggregate demand. Those are different ideas. So the equation should reflect the correct logic in that regard.

Finally, the influence of growth in debt in general on aggregate demand is intuitively reasonable and empirically observable. That’s not the issue. The issue is the form of an equation that conflates a flow of funds and balance sheet item (change in debt) with income statement items (expenditure and income). That is stock/flow inconsistent, and people who are interested in that principle might take note it.

JKH said...

I don’t want to pick on one comment, but here is an example from another blog of exactly the wrong way to think about accounting and stock/flow consistency:

“Try looking forwards through the model rather than backwards. Accounting is a historic reporting system and is designed to look backwards. We accuse the neo-classicals of sticking rigidly to one viewpoint and yet many on the PK side suffer from the same problem!”

This is hopelessly wrong. As a practitioner with decades of experience, I can say that accounting is absolutely essential to forward looking forecasts, simulations, modelling, and risk management of all types in a financial system environment – micro or macro. Risk management systems practice stock/flow consistency through retrospective and prospective accounting congruence as second nature.

It is a terrible lapse of understanding about finance and economics to suggest that accounting is only backward looking.

y said...

"without engaging in a point-by-point reply (which would be a very boring read for anyone not called Grasselli, Keen, or Ramanan"

um, no. That's precisely what everyone wants to see, rather than just "endogenous money!"

Matt Franko said...


Right, as if anyone else other than we nerds would be reading a blog titled: "Quantitative Finance: Foundations and Applications"

LOL! rsp,

Tom Hickey said...

JKH "So I think the “main fuel” for aggregate demand is income."

Not sure what you mean by this. Income is nominal and all money in the closed system comes from borrowing, i.e., either bank credit or govt "borrowing," i.e.,deficit expenditure, and the bulk of it comes from bank credit. How is income different from borrowing? I assume you mean that the entity making the decision to spend, either spends from someone else's borrowing that the spender receives as income or the spender's own borrowing. But macro is concerned with aggregates and the money aggregates are reflected in terms of aggregates of private and public debt.

Ramanan said...

I find the strangest of things people have been saying.

One comment I received was "it is all about expectations". Ha! Like I didn't know!

This "two words: endogenous money" falls in the category. As if I am a Monetarist!

Since when is national accounts inconsistent with endogenous money? :-)

Funny. Steve Keen makes the presentation as if it is a claim of all monetary circuit theorists. Else he wouldn't have called his approach the MCT approach.

I am also sure that Post Keynesian endogenous money theorists disagree with Keen's models. One economists emailed me.

Another comment I got - which is similar to this accounting is a backward looking thing is that models of Godley & Lavoie are backward looking which is completely strange. The models have a strong Keynesian flavour and include things such as expectations. I don't know in which sense they are "backward looking".

It is precisely their approach using which one can circle around Keen's weaknesses.

Keen has models in which he has only set of variables - such as Y_E or Y_I. In fact he should have had another which is Y_E(e). What Keen does is mess these two into one.

In fact it is Keen and his group which is making the ex-ante ex-post error - by mixing the two set of variables such as mixing Y_E and Y_E(e). These two are different.

The discussion around these issues were muddled - debt injections are not smooth or continuous but income flows taken to be continuous!

And it is because of this that the model will collapse of internal inconsistencies (borrowing words from JKH) because it will lead to impossible future paths.

PeterP in the post said it well. Borrowing can be for liquidity purposes (I said the same in an inarticulate way by saying, what if I borrow and do nothing).

And also that "But credit impulse is not spending, it finances the spending."

What I found interesting about the debate was that people having strangest notions - such as accounting identities being valid only sometimes (and not always) and nonsense like that.

PeterP said...

Yes, I left there a new comment.

I think what they meant to do is to write a model (not an identity):

Income(t+1)= expenditure(t)+change in debt(t)

That is NOT accounting, as accounting is instantaneous (time=t). But it is a perfectly good model for evolution of income(t).

For accounting purposes we see that in EVERY transaction when cash changes hands, one's expenditure is the other's income, identically. Sum all transactions and you get:


Now substitute to above:

Income(t+1)=income(t)+change in debt(t)

that is a model, not an identity, I ignore borrowing to store money for liquidity etc.

Going into continuous time:


units check out as [Y=$/sec] and [Debt=$]

this eqn. is a model, not an identity, so I can tweak it if I want to etc.

OTOH it would be wrong to write:

Income(t)=expenditure(t)+change in debt(t), this violates an IDENTITY that is every transaction however small income=expenditure, so this identity holds for all regions of time and space, however small or big, therefore can be modeled with delta functions ;)

JKH said...


Money is a stock item on the balance sheets of commercial banks.

Expenditure is an (income statement) flow that uses the stock of money to settle corresponding transactions.

Expenditure can use pre-existing money created in earlier accounting periods (by previous borrowing), or new money created in the current account period (by current borrowing).

Most expenditure uses money created in earlier accounting periods. We know this because the increase in bank debt over a year is nowhere near the size of GDP.

Therefore, current borrowing plays a relatively small role in current expenditure in total. Therefore, income not borrowed plays the larger role.

Of course, in aggregate, expenditure equals income. So borrowing is a way of redistributing the purchasing power of income. But non-borrowed versus borrowed income plays the larger role in expenditure for each accounting period, as per above.


I was curious that Lars Syll “announced” the economics Nobel winner 4 days prior to the committee’s actual announcement.


Tom Hickey said...

Thanks, JKH. That's what I thought, but I wasn't clear if it was the correct way to think about it.

I just put up Lars Syll's post as posted. He's Swedish, maybe he knows something? Don't know, but regardless, Romer's view is significant.

My own view is that the current approach to economics doesn't consider "money," energy or the deep and breadth of human needs and resources sufficiently, nor are these key factors integrated into a holistic viewpoint. Therefore the systems that current models represent aren't representational and not useful in policy formulation, for these reasons alone. There are other reasons, too. When all these lacunae are summed, the models become detrimental to policy formulation.

y said...

"current borrowing plays a relatively small role in current expenditure in total. Therefore, income not borrowed plays the larger role"

but of course Keen includes asset purchases, which is a whole other kettle of fish

Ignacio said...

"I think what they meant to do is to write a model (not an identity)"


The confusion comes from mixing language to describe continuous events with discrete language. So the language gets mixed. The model is a continuous function, it can't be an arithmetic equation.

They are not talking in 'accounting' language, or shouldn't, but they are using accounting definitions to describe the continuous variables so all this trouble happens.

But in reality both are right, they have to define strictly what they are talking about, the model is not negated by the discussion because the causality holds. The problem is using the wrong semantics to describe the dynamic. In abstract you can see the model is right.

Ramanan said...

Two new posts appear. The second of the two posted today is the last on this according to the author.

Also commented in the first and the second posts there.

Unsure on what to comment in the latest.

Keen's and Grasseli's assertion has been that recorded income is equal to recorded expenditure by appeal to Lebesgue. Unfortunately that claim is also incorrect - as in it does not follow from his model and in fact even ex post incomes and expenditures are not equal in his "model".

It is strange - it's like having a model with 2 + 3 = 6 and claiming 1 + 2 = 3 in the model.