Sunday, July 23, 2017

Peter Cooper — Short & Simple 10 – Spending Independently of Income

It was mentioned (in part 2) that a currency-issuing government issues its currency in the act of spending. An implication of this is that a currency-issuing government does not need income in order to spend. We have also noted (in parts 5 and 9) that a household or business can spend independently of current income. They can do this either by drawing down past savings or through borrowing.
heteconomist
Short & Simple 10 – Spending Independently of Income
Peter Cooper

12 comments:

AXEC / E.K-H said...

Note on Short & Simple 10

Peter Cooper writes in Short & Simple 10: “We have also noted (in parts 5 and 9) that a household or business can spend independently of current income. They can do this either by drawing down past savings or through borrowing.”#1

Peter Cooper wrote in Short & Simple 9: “We understand that, as a rule, total spending must equal total income.”#2

There are two things that Peter Cooper does not understand
(i) National Accounting, which determines the relationship between flows (wage income, consumption expenditures) and balances = differences of flows (saving/dissaving/, loss/profit)
(ii) The relationship between the flows and balances of National Accounting and the changes of the stock of money/credit at the central bank.

This prevents any understanding of how money is created and destroyed in a monetary economy. Accordingly, he claims that money comes into the world by deficit spending of government.

In order that money comes into the world, the government is NOT needed as a deficit spender but only as an institution builder. What is needed is, roughly speaking, a central bank that issues transaction money in parallel with expanding/contracting wage income.#3

Egmont Kakarot-Handtke

#1 Link to source
https://mikenormaneconomics.blogspot.de/2017/07/peter-cooper-short-simple-10-spending.html

#2 Link to source
https://mikenormaneconomics.blogspot.de/2017/07/peter-cooper-short-simple-9-spending.html

#3 For details see ‘Essentials of Constructive Heterodoxy: Money, Credit, Interest’
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2569663

AXEC / E.K-H said...

Summary

For the comprehensive refutation of Peter Cooper’s posts from Short & Simple 7 onward see ‘Macro for dummies’
https://axecorg.blogspot.de/2017/07/macro-for-dummies.html

Egmont Kakarot-Handtke

MRW said...

In order that money comes into the world, the government is NOT needed as a deficit spender but only as an institution builder. What is needed is, roughly speaking, a central bank that issues transaction money in parallel with expanding/contracting wage income.#3

Not in this country.

AXEC / E.K-H said...

How money emerges out of nothing ― the functional account
Comment on Peter Cooper on ‘Short & Simple 10’

“Money is historically an emergent market phenomenon establishing a commodity money, but nearly all contemporary money systems are based on fiat money.”#1

“In MMT, ‘vertical’ money enters circulation through government spending. Taxation and its legal tender power to discharge debt establish the fiat money as currency, giving it value by creating demand for it in the form of a private tax obligation that must be met.”#2

Economists are storytellers, not scientists, and because of this, they explain economic phenomena historically. This is a bit dilettantish, just like physicists trying to derive the phenomena and laws of thermodynamics by recounting the history of major events from the Great Fire of Rome in AD 64 to Great Fire of London in AD 1666. Methodological fact is that the historical approach does NOT work in science. It explains NOTHING.

Therefore, money has to be derived FUNCTIONALLY within an analytical framework that is defined in detail by:
(i) macrofoundations.#3
(ii) National Accounting, which determines the relationship between the nominal flows (wage income, consumption expenditures) and balances = differences of flows (saving/dissaving/, loss/profit).#4
(iii) The relationship between the flows and balances of National Accounting and the changes of the stock of money/credit at the central bank.

Thus stock-flow consistency is secured. The pivot between stocks and flows is the positive or negative balances.

In order to reduce the monetary phenomena to the essentials, it is supposed that all financial transactions are carried out (at first without costs) by the central bank. The stock of money then takes the form of current deposits or current overdrafts. From this follows quantity of money = debit side of the central bank’s balance sheet = current deposits.

In the initial period the conditions of market clearing and budget balancing hold. The central bank provides the transaction medium and creates money out of nothing. Loosely speaking, it finances the business sector’s payroll, whatever it is.

See part 2

AXEC / E.K-H said...

Part 2

By sequencing the initially given period length of one year into months the idealized transaction pattern that is displayed on Wikimedia#5 results. It is assumed that the monthly income Yw/12 is paid out at mid-month. In the first half of the month, the daily spending of Yw/360 increases the current overdrafts of the households. At mid-month, the households change to the positive side and have current deposits of Yw/24 at their disposal. This amount reduces continuously towards the end of the month. This pattern is exactly repeated over the rest of the year. At the end of each sub-period, and therefore also at the end of the year, both the stock of money and the quantity of money is ZERO. Money is present and absent depending on the time frame of observation.

In period 2 the wage rate and the price are doubled. Since no cash balances are carried forward from one period to the next, there results no real balance effect provided the doubling takes place exactly at the beginning of period 2.

The transaction pattern looks the SAME if employment L is doubled and productivity R, wage rate W, and price P remain unchanged. So, only the REAL variables employment and output O double, but the transaction pattern is identical with a doubling of the NOMINAL variables wage rate and price.

From the perspective of the central bank, it is a matter of indifference whether the household or the business sector owns current deposits. The pattern of transactions#5 translates into the AVERAGE amount of current deposits. This average stock of transaction money depends on income according to the transaction equation M=kYw.

The variable M is a straightforward period average which results from the AUTONOMOUS transactions between the business and the household sector in the pure consumption economy. The central bank enables the average stock of transaction money to expand or contract with the development of wage income. Analytically (not historically), money emerges from autonomous market transactions. In order that money comes into the world a central bank is needed which issues transaction money in parallel with expanding/contracting wage income.#6 There is NO commodity like gold and no deficit spending government needed.

Both the Quantity Theory of Money and the Chartalist Theory of Money are figments of historical imagination.

Egmont Kakarot-Handtke

#1 Wikipedia Money
https://en.wikipedia.org/wiki/Money

#2 Wikipedia MMT
https://en.wikipedia.org/wiki/Modern_Monetary_Theory

#3 Macrofoundations are given by: (A0) The objectively given and most elementary configuration of the economy consists of the household and the business sector which in turn consists initially of one giant fully integrated firm. (A1) Yw=WL wage income Yw is equal to wage rate W times working hours. L, (A2) O=RL output O is equal to productivity R times working hours L, (A3) C=PX consumption expenditure C is equal to price P times quantity bought/sold X. The nominal variables Yw and C reappear in National Accounting.

#4 See Wikimedia National accounts (a) balanced budget, (b) saving, (c) dissaving
https://commons.wikimedia.org/wiki/File:AXEC94.png
https://commons.wikimedia.org/wiki/File:AXEC96.png
https://commons.wikimedia.org/wiki/File:AXEC95.png

#5 Wikimedia Idealized transaction pattern
https://commons.wikimedia.org/wiki/File:AXEC86.png

#6 For more details see ‘Essentials of Constructive Heterodoxy: Money, Credit, Interest’
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2569663
and ‘Reconstructing the Quantity Theory (I)’
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1895268

peterc said...
This comment has been removed by the author.
peterc said...

Although I don't agree with EKH's argument in general, and don't expect him to agree with mine, his statement here is relevant:

"In order that money comes into the world, the government is NOT needed as a deficit spender ..."

Actually, I didn't say deficit spending was needed, but that government spending comes first. But it was an oversight on my part not to specify that in saying government spending comes first, I am talking about spending in the government's own unit of account within an economy in which government establishes its own currency. (This context was established in part 2 of the series, but needed to be spelled out again in part 10. It was in my head, so to speak, but not on the "page".) I have edited the paragraph in question to that effect.

I don't think I need to claim that "money" must first appear as the creature of government, though it might have arisen that way. It depends, among other things, on what we mean by "money" and "government". But since in the next part of the series I am going to discuss the interpretation of money, in a broad sense, as an IOU, it is clear that money in that sense does not require government. The next three parts concern (i) money as an IOU (part 11); (ii) government's position of strength in getting its own IOU widely accepted (part 12); (iii) commercial bank deposits as banks' IOUs and their place in the hierarchy of a state money system (part 13).

Regarding EKH's arguments concerning national accounting, I don't intend to engage at this stage. I did attempt to engage once before. Irrespective of the status of his argument, I don't consider an elementary series for beginners the place to refashion basic national accounting concepts and conventions. This would need to be done at a higher level of analysis. For this reason, I asked EKH a while back not to post his arguments as comments to the "short & simple" posts. I want to acknowledge that he has kindly respected this request. So thanks, EKH, for that.

AXEC / E.K-H said...

Peter Cooper

One way to explain the actual state of the world is the historico-genetic (K. Mannheim) approach. And this is how the development from barter to fiat money is usually presented. This history is quite interesting, but history is not science. From the history of the practical use of levers among animals and humans, one will never arrive a the Law of the Lever as put down by Archimedes.

Take notice that economics is defined as a science and science is well-defined by material and formal consistency. Your series Short & Simple is inconsistent storytelling.

First of all, the theory of money/debt cannot stand alone but must be embedded in what Keynes called the ‘monetary theory of production’, which in turn must be based on macrofoundations.

Fact is, that your macrofoundations are ill-defined. More specifically, your profit theory is provably false. By consequence, your theory of money is false, too, no matter how many plausible pieces of history it contains.

This is lethal: you cannot show how, in principle, the flows of a simple monetary economy (which are measurable) effect the stock of money (which is also measurable). This cannot be compensated by stories like ‘how government’s position of strength’ had been used ‘in getting its own IOU widely accepted’.

Take notice that MMT has been thoroughly refuted. Here are all proofs and arguments for your convenience collected:

See part 2

AXEC / E.K-H said...

Somehow Part 2 vanished. For the full text see here
https://axecorg.blogspot.de/2017/07/how-money-emerges-out-of-nothing.html

jrbarch said...

I am enjoying reading peterc’s ‘Short & Simple’ series.

Am also thoroughly enjoying a 26 video lecture series on neuroanatomy (Suzanna Stensaas, PhD, Uni of Utah). The techniques used are brain dissection (axial, coronal, sagittal) combined with animated graphics to explain anatomy and functions. I guess that is science. It would be incredibly interesting to see the electrical brain maps of users of this site, to see who uses which part of the brain, and combinations; concrete thinkers, and abstract thinkers and feelers. What we see and understand of each other, in one way, is limited by brain horizon.

It’s a pity the economy could not be similarly excised from the societal head, (or is it the digestive system - ?) placed on a dish and dissected. It really makes me question the idea that economics is an objective science, because of the conceptual overlay. When I look at this little mass of spongy grey and white matter, floating in csf , I wonder how it could even have come up with rubbing two sticks together or striking flint; let alone the whole human story, the whole drama of everything -2 minute snapshot here
or
here

Economics is just a part of that drama and just as you cannot isolate any part of the brain from another part because of the internal connections, you cannot isolate economics or politics or religion or hope from one another – they are a part of the human drama. It is the whole human being that is the challenge. Kindness holds the key.

Bob, I miss you ...!

Calgacus said...

EKH:And this is how the development from barter to fiat money is usually presented.

And what about the development from flying saucers to the invention of the wheel?
Or the development of an Argument that proves one is the Pope, into a Bar of Mottled Soap.

The point is that there was, is no such development.

The point is that this history is backwards. It. did. not. happen. that. way.
All historical evidence, all logic, all intellectual disciplines with the exception of economics say that the story you have been hoodwinked into believing is wrong and makes no sense.

Fiat = credit money is the ancient thing. Barter, commodity money, metal standards, even coinage etc is recent.

Again, I don't think you understand MMT enough to criticize it reasonably. The things you want to talk about can't be considered until one grasps the MMT definitions, understandings of the terms used therein. The problem is that you are unconsciously using incoherent mainstream "definitions".

Its like trying to prove "all groups of odd order are solvable" without knowing what "group" or "solvable" mean.

AXEC / E.K-H said...

Peter Cooper

Money has taken various historical forms (token, coin, note, deposit, etc.) and the banking system in each country is the outcome of a murky historical process. Therefore, the first thing to do is to ABSTRACT from the historical detail and to define a clear-cut analytical frame of reference. This frame has been called by Keynes the ‘monetary theory of production’.

(i) The pure consumption economy consists of the business and the household sector. The household sector provides the labor input to the business sector which consists initially of one firm. The product of the firm is sold to the household sector. Example: the wage income per period (e.g. year) is 100 [thousand/million/billion, euro/dollar/yen]. So, in a period of defined length, the households put in their work and the firm owes in total 100 monetary units to the household sector.

(ii) The firm issues IOUs and these are used in turn by the households to buy the output. For simplicity, the wage income of 100 monetary units is fully spent on the consumption good. Starting from zero at the beginning of each period IOUs are created by the firm and vanish completely until the end of the period. Clearly, IOUs are debt and they are used exclusively for the transactions between the business and the household sector.

(iii) IOUs work fine with one firm but not with many firms. If the business sector consists of many firms the need for a GENERAL IOU arises. This general IOU is produced by the central bank and is called money. The central bank gives the firm money in the form of current deposits and the firm owes overdrafts to the central bank. The firm pays the workers by transferring the deposits instead of IOUs. The workers spend their income and the deposits return to the business sector which reduces the overdrafts. At the end of the period, all deposits and overdrafts are again ZERO. So money is created out of nothing and vanishes into nothing until the end of each period. This process can continue in principle for all eternity no matter how big or small the economy is. There is NO such thing as a fixed quantity of money.

(iv) Only deposits are money but, clearly, deposits are always exactly equal to overdrafts. Hence, money is the central bank’s half of what is essentially a credit relationship. Both sides of the central bank’s balance sheet are equal at any point in time by logical necessity. So, there is no such thing as debt-free money. But note that deposit/overdraft money as TRANSACTION medium is entirely different from CREDIT for houses and cars or for financing real investment of the business sector or for financing public deficits. Not keeping these things properly apart is a recipe for messing up the theory of money.

The fact that money is debt does NOT mean that it should be spent into existence by government deficits. The proper way of creating money is to finance an expanding wage bill. To bring money into the world by financing government deficits is a program for increasing the profit of the business sector. So, either MMTers in their scientific incompetence do not understand how the economy works or MMT is a pseudo-scientific veil for a free-lunch program for the one-percenters.

Egmont Kakarot-Handtke