Monday, December 5, 2016

Jason Smith — Stock-flow consistency is tangential to stock-flow consistent model claims

Critique of Godey & Lavoie and MMT based on an analogy with electrical circuitry.
As I mentioned above, the results of SFC analysis have little to do with the SFC itself, but instead depend on the assumptions about the behavior of the "circuit elements" (firms, households, government) about which SFC analysis tells us almost nothing. 
SFC is an operational description of financial flow — LHS and RHS must balance just as electrical charge in a circuit, that is, sum to zero. No causality implied.

Similarly, the electrical charge in every operable circuit must sum to zero — positive and negative charges much cancel.

But in every circuit the actual components have a use to perform that his not revealed by the circuit diagram but the use to which the circuit is being put.

This corresponds to the theoretical aspect in economics. Accounting identifies are the boundary conditions and reveal nothing about causality. Causation requires theoretical interpretation.

The point of using SFC models, like drawing circuit diagrams in electrical and electronic systems, is to ensure that the boundary conditions are observed on the analogy that Jason Smith provides in terms of conservation in physics.

But to say that SFC is a truism and dismiss it as irrelevant would be applicable only if there were not violations in attempted applications.

Just as conservation laws are the framework for theories about natural sciences, so to is accounting with respect to finance. Economics uses finance as its basis insofar as it uses monetary units —economic units (actual) are converted to financial expressions in a unit of account. Finance underlies economic in in a monetary production economy. For one thing, it is not possible to do mathematical calculations with different real units — add apples and oranges — but it becomes possible by reducing both to price.

This relationship between economics (actual entities like goods and workers) and finance (nominal and real value expressed in price and wages) is where many of the issues in economics arise. to begin with, nominal value is an observable, while real value depends on calculation based on assumptions.

SFC deals with the financial side of economics expressed in nominal units, the operational basis of which which many economist not only do not pay much attention to but also don't seem to understand very well.

For example, at the macro level conventional economics doesn't take history into consideration, e.g., the result of switching from a gold standard to a fiat monetary regime regarding monetary and fiscal policy. This was a chief MMT criticism of the Reinhart & Rogoff study that was used to argue for the fiscal austerity that undermined demand prolonged the Great Recession. Because the monetary units were the same, R&R assumed that conditions were comparable, which they were not, as the MMT economists pointed out.

Under a fixed convertible system, monetary policy takes precedence of the currency issuer will lose control of the value of the currency. This doesn't apply in a fiat regime, greasy increasing fiscal space. This has nothing to do with individual agents or their behavior since it is a policy choice. However, it has a great deal to do with what individual agents can do based on policy choice consequent on that initial policy choice.

Fixed and floating rate monetary system operation under the same SFC principles, however, they different theoretical in terms of causality. In a fixed rate system, the currency issuer is constrained operationally in a way that it is not in a floating rate system. That is to say, different initial policy financial choices impact non-financial behaviors.

For instance, the ideal of macro as a policy science is to reconcile the trifecta of growth, employment and price stability. This is impossible in a fixed rate system where the currency issuer must protect the value of the currency using the interest rate. However, it becomes possible in a floating rate system where that constraint is removed, as MMT analysis shows based on the government balance being the inverse of the nongovernment balance at full employment using functional finance and an ELR (employer of last resort),with the fiscal authority  operating similarly to the monetary authority (central bank) acting as LLR (lender of last resort).

While an electrical circuit diagram may look the same for different devices, the actual devices and components and what they can do will be different in the case of different power sources and inputs. The laws of electricity that apply are the same across devices, similar to the financial conditions applying to SFC, but the uses are varied and must be approached specifically.

Similarly, a monetary production economy is powered economically by energy, work, and natural resources and financially by money. Insufficient funding results in idle resources and deflationary pressure, while funding in excess of production increase results in inflationary pressure building. SFC models are useful in modeling this.

Perhaps most important for the study of economics, physical laws are applicable always and everywhere — they are timeless. But since economics in monetary production economies is based on finance and finance is based on institutional arrangements that are arbitrary rather than fixed, there are no financial laws that natural rather than positive, hence to economic laws that are natural to the degree that finance (nominal values based on a unit of account) that are natural rather than positive either. Economics is not a natural science or even like a natural science. It is social and historical.

Because economics is social an historical, there can be no timeless laws regarding causation that obviate assessment of changing conditions (context). SFC states no more than that the accounting procedures in force in a jurisdiction must be adhered to.

While these may differ among jurisdictions, there is common agreement that accounts must balance in accounting periods, e.g., for financial institutions that generally means daily. While variations may exist over the day, at the end of day accounts are settled and must balance. Bank tellers don't do home until they do.

Information Transfer Economics
Stock-flow consistency is tangential to stock-flow consistent model claims
Jason Smith

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