An economics, investment, trading and policy blog with a focus on Modern Monetary Theory (MMT). We seek the truth, avoid the mainstream and are virulently anti-neoliberalism.
Pages
▼
Pages
▼
Wednesday, July 18, 2012
John T. Harvey — Why You Should Love Government Deficits
The post we've all been waiting for. How's that for a bold title, especially appearing in Forbes.
did you ever notice how fast a game of monopoly ends when 1 person has the most of everything?(usually my wife) http://bobcesca.com/blog-archives/2012/07/obscenity.html
"did you ever notice how fast a game of monopoly ends when 1 person has the most of everything?(usually my wife) http://bobcesca.com/blog-archives/2012/07/obscenity.html"
Another example of wisdom hiding in plain sight.
Most of the things we need to figure out how an economy works we already know, it's just lost in the woods of all of the bullshit we've been taught all of our lives.
Plus we seem to have some innate need to defy gravity rather than make it our friend.
Decent article, but he gets one point wrong. Money is not wealth. T-bonds are not wealth. Printing up a quadrillion t-bills will not necessarily make everyone in the USA wealthy. Money only has utility because it can be used to purchase other goods and services. Making more money does not necessarily make anyone wealthy if the underlying goods and services are worthless. Luckily, in the USA, the goods and services are high quality, but this should be pointed out. Good article otherwise.
Anonymous: Decent article, but he gets one point wrong. Money is not wealth. T-bonds are not wealth. Printing up a quadrillion t-bills will not necessarily make everyone in the USA wealthy. Money only has utility because it can be used to purchase other goods and services. Making more money does not necessarily make anyone wealthy if the underlying goods and services are worthless. Luckily, in the USA, the goods and services are high quality, but this should be pointed out. Good article otherwise.
Difference between financial and non-financial ("real") contribution to net worth on the balance sheet.
Tom: "Difference between financial and non-financial ("real") contribution to net worth on the balance sheet."
Could you expand on that.
I can wrap my mind around sectoral balances and all these "island" scenarios.
I have a harder time seeing how deficit spending actually happens. There's so much noise around Fed actions and "printing money". But am I right to understand that everything with reserves is a separate issue? That deficit spending is simply the govt buying things/services?
I have a harder time seeing how deficit spending actually happens.
The budget is deficit when Congress appropriates more than it taxes, so that Treasury spends more than it takes in in revenue in paying the govt's bills from its account. The Tsy must have reserves in its account at the Fed before it can direct the Fed to create non-govt accounts in payment of invoices and transfers.
The Fed credits the account of the bank at which the target deposit account is held and upon receiving the reserve credit in its reserve account, the bank credits the customer deposit account.
IN this way, the currency that the govt issues through spending enters non-govt as an increase in NFA in case of a deficit.
There's so much noise around Fed actions and "printing money".
"Printing Money" means that the Fed increases the reserves balances in the interbank system through one of its many operations.
But am I right to understand that everything with reserves is a separate issue? That deficit spending is simply the govt buying things/services?
Yes. Reserve balance are for settlement only. The reserve balances that are used to credit non-bank deposit accounts are funds available for spending or saving in the economy. Reserve balances in banks' reserve accounts at the Fed are for settling transaction interbank.
When someone pays with cash, the transaction is settled on the spot. If by check, credit card or electronic payment, settlement after netting takes place in the interbank settlement system using rb.
No mention of U.S. Treasuries when explaining deficit spending?
According to Cullen @ Monetary Realism, (I think) when the U.S. government deficit spends, it sells U.S Treasuries. The selling of Treasuries is essentially an asset swap (a bond for cash), which "puts" cash into Treasury accounts… which the U.S. Gov can then spend into the economy.
Once that money is spent into the economy, deficit spending has occurred… because the non-government sector now has both the money and the bond.
What I'm confused about is when this occurs? Do tax dollars get used up earlier in the (fiscal) year, so that later in the (fiscal) year… U.S. Treasuries have to be sold?
JK, as I said the Tsy has to have rb before it directs the Fed to credit non-govt deposit accounts, This is on account of the rule iaw Tsy is not permitted to run overdrafts. So the Tsy issues tsys. Another rule prohibits the Fed from exchanging rb for tsys with the Tsy. So the Tsy directs the Fed to auction the tsys it has issued and then credit its reserve account with the proceeds.
How this actually occurs is a complicated process of liquidity management that Tsy and Fed coordinate in terms of Tsy need for rb and the Fed's ability to set the overnight ratem which depends on the rb in the system if the Fed is not paying IOR and doesn't choose to set the rate to zero.
Tom, I don't think you have the details right there. JKH has explained this thoroughly in his contingent institutional approach.
The treasury is a currency user. So it must obtain funds through taxation or bond sales. In this regard, the government does not print new "money" or create new deposits. It just recycles old deposits by debiting private sector accounts and then crediting new ones. What the government does is create net new financial assets by running a deficit and adding government bonds to the private sector.
"What the government does is create net new financial assets by running a deficit and adding government bonds to the private sector."
The point is that the govt is the currency issuer and it issues its currency through the internal operations of its agencies, the Tsy and Fed. The fed provides the rb as a result of the auction and the Tsys supplies the tsys. They Tsy disburses the rb back into non-government through spending and transfers, and at the end of the process non-government hold the amount of rb it held before the auction and also the tsys that were auctioned. Hence, non-govt held NFA increases by the amount of the tsys.
Presently, there are political restrictions imposed on direct issuance of currency without tsy issuance. Tsy issuance is still direct issuance because at the end of the day, non-govt net financial assets increase.' That is govt liabilities (tys) increase and non-government net worth increases correspondingly.
In the case of spending, govt financial liabilities increase and real assets also increase, while non-govt real assets decrease and financial assets increase. This is how non-government real resources get transferred to govt for public use.
When the govt is in deficit, net financial assets held by non-govt increase as more non-govt real resources move to public use. The govt liability incurred in this transfer is the "national debt" and corresponding to it is non-govt saving of net financial assets. As the national debt increases as govt liability, non-govt aggregate saving of net financial assets increases as the corresponding accounting entry.
Tom, I think you should read JKH's contingent institutional approach again. He clearly defines how all of this works. The Treasury is a currency user and must obtain funds from the private sector before it spends. It does this by coordinating bond sales with the Fed to debit private sector balances, credit the Treasury's account and issue net financial assets as bonds.
I hate to say it, but the MMT description is not right on the details and never has been right. JKH has always been meticulous about the accounting (I think he's an accountant) and he gets it right here.
They get the deposits from the same place almost all of the deposits in our monetary system come from - private banks. Very little money is actually issued by the government in the grand scheme of things.
Anonymous, do non-government net financial assets increase as a result of govt deficits or remain the same? The liability is on the side of govt and that is "outside" money. This is what counts, not the accounting. It is incorrect to say, btw,saying that the Fed is the issuer of the currency and the Fed is non-standard. The standard is the the govt issues the currency and non-govt uses uses it. What happens behind the veil intra-govt is interesting but it doesn't alter this fundamental relationship of govt to non-govt regarding the govt's currency.
Tom, as I said before, deficit spending results in an increase in the net financial assets of the private sector. That's because the government obtains a deposit from the private sector, issues a bond in exchange and reissues this deposit to someone else in the private sector. The new t-bond is the new financial asset.
I disagree that the accounting does not count. In fact, I think it's all that counts. It's surprising that an MMTer would say otherwise. A monetary system is all about understanding the system of debits and credits as they actually work. Rejecting this in favor of some other idea is incorrect from start to finish.
The Treasury is a currency user and must obtain funds from the private sector before it spends. It does this by coordinating bond sales with the Fed to debit private sector balances, credit the Treasury's account and issue net financial assets as bonds.
I hate to say it, but the MMT description is not right on the details and never has been right.
They're both right. They are describing a different scope of operations. JKH is talking about the specific institutional arrangements within a particular sovereign. MMT is talking about the sovereign as a black box. There's no inherent contradiction between the two.
Tom, again, I don't think you're correct. I will regurgitate what I read from JKH:
"In other words, there is nothing special about the fact that the Fed supplies the reserves that enable tax and bond payments. It does the same thing for all payment activity that may be associated with unintended interest rate pressures."
I would recommend reading his paper again. It details all of this.
Greg,
They're not both right. They can't both be right. They're totally conflicting and contradicting views of the way things actually work.
Again, I would recommend JKH's paper. It very clearly describes all of this and does so by being clear on the accounting and without creating "black box" descriptions, ie, fake descriptions.
Wait a minute here. Now Hickey is saying the accounting does't matter and geerussell is saying MMT "is talking about the sovereign as a black box."
If that's all MMT is then what's the value in it? Some of us recognized a long time ago that MMT was wrong about specific stuff and you have attacked us viciously for saying that. And now you're admitting that it's just a black box description?
I don't believe there's a contradiction and I don't think you really do either if you examine it closely. Here's a example: Why is Greece experiencing a sovereign debt crisis and Japan is not?
A correct analysis of that question can be made from the viewpoint of one nation being a currency user and the other a currency issuer without drilling down to details of their internal arrangements.
On the other hand, if you were sitting down to write actual policy for Japan implement to achieve specific goals you'd need a Japanese JKH to analyze how a detailed policy would transmit to a desired effect within Japan's particular set of arrangements.
Sorry for calling you Greg before. I was reading something else at the same time.
I disagree that they're not contradictory and I dislike the use of the term "currency issuer". I think it is one of MMT's oversimplifications that helps clarify a broad subject matter, but doesn't get the details right. For me personally, I am interested in the details. I am interested in the specific accounting and the reasons why certain things are the exact way they are. That's why I prefer JKH's meticulous approach.
I think JKH would take issue with the idea that his approach is not entirely different. In fact, when he wrote his piece he smacked Fullwiler down hard on this exact point when Fullwiler tried to claim his approach was basically JKH's:
"To migrate a bit of your language, my essay presents institutional contingencies as scenarios which are specific. And while I agree that there is a potential relationship between my TBRC and your general case, the TBRC is very specific and in no way stamped as “general”. TBRC is defined as an institution, one of contingent design with specified operational and accounting structure. It is defined in explicit institutional detail, as one possibility for adjustment to today’s monetary system structure.
So my logical progression is one of iterative institutional specifics.
Yours bears no resemblance to such an approach.
I have portrayed some of the details of monetary operations in that context. That seems like a reasonable thing to do when illustrating a proposed conceptual structure. You have entirely missed the point in your desire to represent the essay as a display of operational detail without further purpose.
I will not have my approach defined by your “scientific method”. Brett Fiebiger has written some things about this notion in comments above that I find eminently sensible. And I will not have my approach defined by MMT’s view of it. It just so happens that my view of how not to describe modern monetary operations intersects with MMT’s method of doing so. But I have no interest in using that as a platform of criticism of MMT per se. I am done with MMT."
Sorry for calling you Greg before. I was reading something else at the same time.
No worries, happens to me all the time in real life. Was kind of spooky to see it here though. Must be the default we're wired for when a name starts with g :)
I won't belabor the point of disagreement because it's smaller than the measure of agreement on the substance of what JKH wrote.
I'll just say that we have different viewpoints on the utility of simplifications.
> I hate to say it, but the MMT description is not right on the details and never has been right.
Yep.
If you can get an MMT guy to stop talking about "NFAs" and rigourously look at what happens at the bond/cash/reserve level, then he starts to see the shakiness of his position.
Once that happens, he will either jump ship to MMR, which at least treats concepts clearly.
Or he jumps deeper into the MMT hole, confusing egalitarian normative and explanatory descriptions, railing against MMR, and attacking other economists.
Neither MMT nor MMR are particularly "modern"... As far as economics goes, they are basically Old Keynesianism + fiat currency. Most of the macro treatment is real-variable targeting, long-term stable Philips curves, etc.
Another way to see this is to say: what is saving? Saving is the flow of unconsumed income. So imagine that consumption is fixed at whatever the level of income is for all time, i.e., that there are no savings. Then, there are no funds to buy government bonds.
I think the MMR guys dropped the Modern. I don't know exactly why, but I noticed it's all changed on their site and Roche has been referring to it as MR in comments on his website. He seems to be coordinating their marketing efforts and JKH seems to be doing the real economics. They're either trying to distance themselves from MMT or something else. Maybe they finally realized MMR is a disease!
I have to say that JKH's paper is really enlightening and I can't say that I've ever seen anything quite like it. It totally changed my view of modern macro.
Another way to see this is to say: what is saving? Saving is the flow of unconsumed income. So imagine that consumption is fixed at whatever the level of income is for all time, i.e., that there are no savings. Then, there are no funds to buy government bonds.
A possible objection to this might be to say, okay then, but the central bank needs to hold some assets against its liabilities. It can’t do this if there are no savings, because there are no assets in the economy for it to acquire. If there is no base money, then no one can buy government bonds, because the government will only accept base money, and therefore your thought experiment is moot.
So say that, at some point in time, there is some saving and that the central bank does some regular-bank intermediation. Now the money supply is positive. But say that we also go back to consuming all income for all t. Then, even though there are positive quantities of base money, no one has any savings other than those represented by the central bank, and no one can buy any government bonds.
As some in here said, the difference IS really a matter of scope. Yes, it's useful and important to understand the exact operational mechanisms of "how it all works" for SOME purposes. But it's not useful and not iimportant to understand the exact operational mechanisms of "how it all works" for OTHER purposes.
For example, if using the sectoral balances approach to understand why Greece is not comparable to the United States, the internal mechanisms (the INTRA-government operations) do not need to be understood. Or said another way, those internal mechanisms are not useful for the analysis.
Do you see? This is what MMT is saying (I think). The necessary level of exactness changes depending on what you are analyzing. MMT is not saying that exactness doesn't matter, rather, the scope of the analysis determines what level of exactness is necessary.
Anonymous, IIRC Scott Fullwiller said that the MMT economists were in general agreement with the way that JKH laid out the intra-govt ops. Scott agreed that from the internal perspective the Fed is currency issuer and Tsy is currency user
But this doesn't alter the fact that the US govt issues currency into non-government through appropriations and taxation that set fiscal policy, and then delegates payment to the Tsy as its payment agency. The Fed, another agency of govt established by law, functions as the govt's bank and runs the settlement system. Other agencies are responsible for handling the actual contracts.
Upon receiving the bills, Tsy directs the Fed as govt's bank to credit the appropriate accounts and gets the reserves to clear through Tsy issuance.
Nothing controversial about this unless one thinks that the Fed is a private corporation, which it is not.
What's the point of studying a monetary theory that doesn't exactly describe any existing monetary system and gets the details wrong? MMT doesn't even accurately describe the USA where it was founded. What good is that?
Another way to see this is to say: what is saving? Saving is the flow of unconsumed income. So imagine that consumption is fixed at whatever the level of income is for all time, i.e., that there are no savings. Then, there are no funds to buy government bonds.
Tom, the point is when MMT says things like: "The funds to pay taxes and buy government securities come from government spending", they're misinterpreting the way the monetary system works.
Most of the funds to pay taxes and buy bonds come from private banks. Not the government. Very little money comes from the government. MMT gets all of this wrong. Its most basic points are all wrong.
And now you say something vague about reserves and the central bank settlement and you get that wrong too. Yet you don't even know why it's wrong and you have no interest in understanding why it's wrong.
Where did the private sector get its "funds" to buy tsys?
From its savings. And where did it get its savings from? From its income."
And where did it get it's income from? From net government spending.
…From its savings…"
A mathematical impossibility. This describes a running total operation across a closed system boundary, with new balances introduced from nothing by the government using keystrokes.
In the beginning there were no "funds" to borrow, or in a relative sense the level of funds was so insignificant as to be neglegible or very nearly zero.
Start at 1913 when the National Debt was $3 Billion. Assume every penny of that was currency (ridiculously conservative). The maximum amount of bonds that could be purchased over any budget cycle IF EVERY DOLLAR IN EXISTENCE WERE BORROWED would be limited to $3 Billion.
Rolling that over 100 times gets you to $300 Billion. How did we get to $16 Trillion?
There is new financial asset creation ==> there is financial wealth in existence after the operation that didn't exist previously.
New financial assets are issued into the economy, where they are recorded on non-government balance sheets.
This can't occur until the government enters them into the non-government system. Causation is clearly on the government side because net financial assets can be introduced without selling bonds to the public.
Increases in financial wealth are not limited to government bonds. $11 Trillion in bonds are held by the public which leaves nearly $5 Trillion in cash in the non-government.
"Marris: If you can get an MMT guy to stop talking about "NFAs" and rigourously look at what happens at the bond/cash/reserve level, then he starts to see the shakiness of his position."
Paul, there's more to the economy than NFAs. MUCH more. But MMT always brings it back to NFAs because that's your only unique or insightful point. Too bad it's a narrow view of things and doesn't tell us even half the story about how things work.
Bank money is only a source of funding for the bank that issued it. Not only that, but in order for banks to acquire funds by issuing money, someone has to save. That's what SFC uses and sources approaches like Godley and Lavoie tell you.
Money is not income. Income is not money. It can certainly be confusing though, because in monetary economies money is the unit of account. So when you look at something like a consistency accounting or social accounting matrix, what you see is bunch of flows denominated in money. But still, the flows are not money.
When a firm sells a bond to the household sector, regardless of the quantity of bank or central bank money in circulation, for the funds to exist, someone somewhere has to save. In order for someone somewhere to save, they must have an income. The source of all funds in the economy is ultimately the income generated by the economy, i.e., economic output.
Tom, The government cannot simply "add" the financial assets. It can borrow funds from the private sector. But in order to do that, the private sector would have to save. But this is exactly my point.
That's true but NFA's are the ultimate settlement balances in the non-government.
Credit expansion has a functional limit, and the balances must be paid back which is the reverse of spending.
Once agents in the economy accumulate wealth (savings) the possibility of repaying those loan balances is undermined - defacto impossible.
So I ask you, where will the USD balances come from necessary to repay those loans?
Basically my claim is it is impossible for capitalist economy to be viable without net creation of NFA's in a sufficient quantity to support both growth and savings desires.
"If bank funds were used to pay most taxes and buy bonds, the balances necessary to repay the loans would disappear.
Where would the funds come from to extinguish the liabilities?"
You've been brainwashed by MMT into thinking that money "disappears" when it's taxed. But that's not what really happens. It gets taxed and then spent by treasury right back into the private sector. All government taxing and spending is a redistribution. The money doesn't "disappear" like MMT pretends.
It makes no logical sense to pay taxes or buy bonds with credit, because you have to repay it with income you haven't earned yet.
In addition you are paying interest.
If you didn't have th eincome to buy th ebond or pay your taxes in the first place what makes you think you will have it in the future, where you will again have to pay taxes.
Further, you have ignored the savings conundrum.
A significant subset of the dollar balances in existence are held by the top 0.1% and a significant subset of the bank liabilities are held by the 99.9%.
What we have here is a dog-bone economy where there are 10 dogs and about 7 bones, but it takes 10 bones to satisfy the loans.
Where will the bones come from, there's only one manufacturer.
You can't borrow money to pay the loan off if you don't have a job or your credit is maxed out.
"It makes no logical sense to pay taxes or buy bonds with credit, because you have to repay it with income you haven't earned yet."
Where do you think most of the money in the economy comes from? It comes from people who have borrowed money from a bank and spent it out into the economy adding to other people's incomes and saving. Remember the "loans create deposits" thing that you guys always shove in other people's faces? Yeah, those deposits came from other people who borrowed. If MMT doesn't understand even this basic fact then I am afraid there is no hope for your theory.
JK "The necessary level of exactness changes depending on what you are analyzing. MMT is not saying that exactness doesn't matter, rather, the scope of the analysis determines what level of exactness is necessary."
The way the MMT economists have put is that they break all this out in papers for professionals who understand the field. However, it blogs they attempt to simplify the presentation down to bare essentials so the rest of us can understand it. If you want the details, go read the papers if you have the chops to do so.
…and subtracting from other people's incomes and saving in an equal amount.
Do you not think that enters into the equation?
Bank money cannot increase savings in the aggregate. Every loan issued cancels to zero on balance sheets.
In the aggregate credit can't increase financial wealth.
When people claim that savings can increase even when the government runs a surplus (true) they are ignoring the fact that offsetting liabilities cancel out most of those savings.
Net savings can't increase. Net savings is the only meaningful metric in a stable economy.
If you have $100,000 in savings and &150,000 in liabilities how much is your savings worth?
Otherwise I would like to borrow $10,000 and trade the loan (and liability) to you for $9000 cash.
You'll make $1000.00 on the deal - obviously the liability doesn't matter.
Have you ever taken out a loan? If I take out a loan to buy a new home tomorrow (let's say for $100) that doesn't reduce my current income by $100. In fact, it increases someone else's income by $100. The loan creates a deposit and I spend the money into someone else's bank account. I didn't lose $100 by taking out the loan. It didn't "subtract" from my income. In fact, the loan might increase my income.
Now, the loan doesn't increase the net worth of the private sector necessarily (it might), but that's a different point. You don't seem to understand even the most basic points about how things work.
"The source of all funds in the economy is ultimately the income generated by the economy, i.e., economic output."
False. Money in a credit based system only comes from the creation of a liability on someones balance sheet - either the governments or the private sectors (the bank). Granted the liability may have been issued to allow someone to buy a real good or service but it was created on a balance sheet - not in the real economy.
JK, I am not the go-to person on this. If Scott is following this, maybe he'll chime in. If not, ask one of the MMT economists. Stephanie is @deficitowl and Scott is @stf18 on Twitter.
Bank's don't issue money they create deposits (which most people treat as "money"). How do they create deposits (a bank LIABILITY), the issue loans. All base money is a government liability (Treasury debt or FED liability). The real economy produces real goods and services. A bank will not accept a car as deposit, however it will issue you a loan to buy the car which will end up as the car manufacturers deposit.
The financial system and the real economy are inter-twined but they are actually separate entities.
Households and firms can net save individually in an closed net-zero system. But in aggregate, financial assets net to zero as a result of DBA. Unless financial assets enter the system from outside, there are no net financial assets since inside financial assets net to zero.
"If I take out a loan to buy a new home tomorrow (let's say for $100) that doesn't reduce my current income by $100."
It does when you pay it back - $100 plus interest.
Funds used to satisfy liabilities subtract directly from spending, both for you and the economy as a whole.
Paying off debt removes dollars from the economy just the same as if you burned it. No one gets the benefit of the income it subtracts from.
There is a common belief among many posters here and on other blogs that liabilities are nothing to worry about.
Dollar liabilities are negative money. They subtract from income over time.
And at the risk of sounding like a broken record, an economy that relies on credit for it's needed spending is doomed to fail, there is no alternative.
There is no escape from The grim "tyranny of the arithmetic".
I'd like to interject from the perspective of a bank (since I work for one)...
1) The US treasury as a single government entity is a currency users. It must have reserves in its FED account to spend (with the exception of possible intraday overdraft privileges which are actually for the FED's benefit) 2) Only PRIMARY DEALERS can buy US treasuries. Deposits are NEVER used to purchase a treasury note. Deposits are a liability to the bank and belong to bank customers (yes depositors may swap deposits for treasuries as they add them to portfolios but that is actually a secondary accounting transaction). A bank can only us bank reserves to buy a US treasury unless it is crediting a TT&L account held on its balance sheet, but still needs to use/have reserves when the treasury draws those funds to it FED account (just like any settlement transaction - it requires reserves).
Now down to business... A bank seeks to add profitable income generating assets to its balance sheet. The FED has a target interest rate tied to a money market - historically the Federal Funds Market (the inter-bank overnight lending market). The bank knows that it can indirectly borrow and infinite amount of reserves at that rate. As long as the US treasury is OK with an interest rate that is some profitable level above the FED's target interest rate there is an infinite supply of reserves in the banking system (compliments of the FED's LEGAL obligation to protect the payment system) to buy those US treasuries.
So, unless the banking system finds some reason to believe they can't make money off of buying US treasuries the US Treasury can issue as much debt (and acquire as much reserves) as it wishes - subject to its acceptance of paying a slightly higher interest rate of the current FED target interest rate.
This is exactly what Marriner Ecceles means when he says... "Mr. ECCLES. Well, as I remember the discussion—and I have referred to it in this statement—there was a feeling that this left the door wide open to the Government to borrow directly from the Federal Reserve bank all that was necessary to finance the Government deficit, and that took off any restraint toward getting a balanced budget. Of course, in my opimon, that really had no relationship to budgetary deficits, for the reason that it is the Congress which decides on the deficits or the surpluses, and not the Treasury. If Congress appropriates more money than Congress levies taxes to pay, then, there is naturally a deficit, and the Treasury is obligated to borrow. The fact that they cannot go directly to the Federal Reserve bank to borrow does not mean that they cannot go indirectly to the Federal Reserve bank, for the very reason that there is no limit to the amount that the Federal Reserve System can buy in the market. That is the way the war was financed. Therefore, if the Treasury has to finance a heavy deficit, the Reserve System creates the condition in the money market to enable the borrowing to be done, so that, in effect, the Reserve System indirectly finances the Treasury through the money market, and that is how the interest rates were stabilized as they were during the war, and as they will have to continue to be in the future. So it is an illusion to think that to eliminate or to restrict the direct borrowing privilege reduces the amount of deficit financing. Or that the market controls the interest rate. Neither is true." - page 11.
All that said and done, to me, it seems to be semantics as to whether or not, under normal circumstances, (and even under abnormal circumstances I can't imaging the laws not changing) the US Treasury is fiscally constrained in its spending. The US Treasury always has a ready buyer (FED enabled) of its debt - assuming it is attempting to sell at a rate that is profitably higher than the FED's target interest rate.
Aside from brief blips the total debt owed never falls so the income to pay interest comes from perpetual debt accumulation. So again, you're just making up things to satisfy your failed theory.
Paul, "There is no escape from The grim "tyranny of the arithmetic".:
And, as Michael Hudson would say, the tyranny of compound interest. It not just the loan principal. Without an outside add, an inside system running compound interest is a debt time bomb.
Adam, the problem is in saying things like "spending comes first" or "bond issues are just a reserve drain". What you've just described (accurately mind you - I too am a banker) is not the MMT story. It might be consistent with components of MMT, but it is not the MMT story as told by Warren Mosler and others. Unless the goal posts are shifting as we speak.
An economy does not need public debt to perpetually expand. In fact, many economies run perpetual budget surpluses and get along just fine. They just need a trade surplus as well. It's possible. Look it up.
What's impossible is for private debt to stop growing and still expand the domestic economy. One is necessary, the other is not.
"It might be consistent with components of MMT, but it is not the MMT story as told by Warren Mosler and others."
I really only see it as semantics. Does it matter if the Treasury just runs a continuous overdraft at the FED and later issues bonds to absorb the excess reserves or as we currently work non-transparently have the FED to indirectly insure sufficient reserves to guarantee bond sales.
As Marriner says, the only difference is the price the US Treasury pays in interest which it can always pay by issuing more bonds which have ready and willing buyers ensured by the FED's legal obligation to defend the payment system.
It's like arguing about the solvency of a central bank in its currency of issue. Yes it can happen by technical means of accounting, but is it worth losing sleep over or rationally spending energy arguing over?
I would argue that the details matter enormously here. The Treasury is a currency user and it must find willing buyers of its debt. If, as you noted, the dealers are not willing buyers then the Fed must monetize the debt and this shows that the treasury's money is only good to itself (for whatever reason - perhaps hyperinflation or exchange collapse).
So yes, the details matter and should't just be shrugged off as "semantics". Anyhow, the Open is back on shortly and it's late here. Thanks for entertaining my presence once again. Hopefully some of you are beginning to see where I am coming from.
"So yes, the details matter and should't just be shrugged off as "semantics"."
Yes the details do matter... like the real world we live in. There are nearly 200 sovereign fiat currencies in the real world and they issue debt at about the same rate level as their central banks target interest rate. Except in that "tail" scenario (which I don't think any MMT'er would deny - that's what footnotes and exception are for) why do you insist on quibbling over how many i's were crossed and tee's were dotted. Normal human conversation is NEVER consistently that precise.
For what it's worth this is what Marriner says about your thoughts, "Those who inserted this proviso[preventing direct funding of treasury spending] were motivated by the mistaken theory that it would help to prevent deficit financing. According to the theory, Government borrowing should be subject to the "test of the market." The so-called test could only be applied to marketable securities, and the test would be meaningless unless applied to them in an entirely unregulated market. There could be no such market except at the risk of chaotic conditions in the bond market and incalculable added costs to the Government in managing the public debt."
I don't have any problem with details and I'm certain I've shown that. As for political agenda all I want is for people to more or less understand how the system generally works and to stop buying crap logic presented by so called "very smart people". I don't expect everyone to want or understand the minutia of detail but I'm more than happy to one on one discuss my understandings. What I continuously see from you is consistent nitpicking attacks about details that in the tails may be important but are 99.999999% of the time just nothing more than 50 shades of grey or diversions. Which makes me question your agenda sir.
Adam1" "that's what footnotes and exception are for) why do you insist on quibbling over how many i's were crossed and tee's were dotted. Normal human conversation is NEVER consistently that precise."
This is the point that Scott F. makes. A general description strips a system down to the essentials needed for a basic explanation. The detail can be filled in from there as it becomes necessary. If MMT economists were writing about that level of detail in their blogs who would be reading them? For sure, not me.
I am very pleased they started with a bare bones explanation to get me going. Over time I have filled in a lot of details. There is an opportunity cost involving time and energy. Expenditure on one thing knocks out the next next choice and everything below it. I am at about the level now that I am comfortable with.
I have no intention of working through balance sheets, income statements and flow of funds accounts, NIIP, etc. at this stage of my life. All I need to know is what they are and how they work. That's enough detail.
I have other more pressing priorities for my limited time and energy. I'll let the people who are into it pore over the figures and then try understand the essentials of what they report as conclusions.
The present setup is a facade. The Fed auctions tsys to the PD's who are the sole bidders. They are the market makers for the tsy market and expand and contract their balances sheets as market makers. They know that the Fed has unlimited capacity to exchange rb for the tsys they buy at auction and if their balance sheets become heavier then then like, they know that the Fed will take them onto its balance sheets, which the Fed can always do if it pays IOR. Then the quantity of rb is irrrelevant and the Fed can set the FFR it chooses based on IOR.
Objectors think that by doing this the Fed will create inflationary bias by expanding the monetary base. A correct understanding shows that this is false because the amount of rb is irrelevant. As LLR, the cb will always provide liquidity as required and banks know that they can borrow at the Fed's rate. It's the price that is significant not the quantity of rb.
And as Adam1 points out, if the Tsy sets it interest rate on tsys enough above the Fed's rate, then there will always be buyers anyway because it is essentially "free money." Now that may not hold for every country, but we are talking about present day US here and the foreseeable future. Hyperinflation coming? Really?
You say that banks don’t issue money, but then in the same sentence you say that banks create deposits, which most people treat as money—which seems like a contradiction to me. If you prefer the word “create” to the word issue, that’s okay, but it does seem a bit pedantic.
Either way, as you will know if you are a good MMTer, in order for someone to borrow surplus funds, someone has to have surplus funds to borrow. I think that’s the grim tyranny of arithmetic that Paul is so keen on.
In fact, I’ve just reread your comment and it seems like a bit of a non sequitur. What I’m saying is that, in order for there to be money, someone has to save. In order for there to be saving, someone has to earn. In order for someone to earn, there has to be production and exchange.
"In fact, I’ve just reread your comment and it seems like a bit of a non sequitur. What I’m saying is that, in order for there to be money, someone has to save. In order for there to be saving, someone has to earn. In order for someone to earn, there has to be production and exchange."
Neither production, exchange or savings produce 'dollars' or 'euros' per se.
Mixing apples and oranges again. Come on guys, try harder, you can do better. A 2 years old which hasn't been brainwashed by cognitive biases and social memes can do it better, it's a basic logic operation learned between the age of 2 and 4.
"In order for there to be saving, someone has to earn"
This isn't strictly true. Someone has to have income, which is not necessarily earning. People have money given to them as gifts, transfer payments, etc.
Earning implies labor or effort is involved.
"In order for someone to earn, there has to be production and exchange."
This isn't strictly true either.
re the "tyranny of the arithmetic", that is a reference to the natural decaying processes in a capitalist economy (or any closed system) that require injection of new financial assets into the system other than credit to account for growth, leakages and saving, which is a kind of leakage.
Re your arguments presented in this thread and others supporting the notion that the system is self-funding or the government borrows it's funds from the system, they fail the tyranny of the arithmetic because they have causation backwards and violate system arithmetic.
There is no process within the system that can increase the net cash or net bonds in the system. Such an event is contingent upon a source external to the system.
The government is the only entity that can issue cash or state-backed bonds.
“You say that banks don’t issue money, but then in the same sentence you say that banks create deposits, which most people treat as money—which seems like a contradiction to me. If you prefer the word “create” to the word issue, that’s okay, but it does seem a bit pedantic.”
In the grand scheme of day to day discussions it really is here nor there (I didn’t mean to sound overly picky). That said I do believe I correctly recall a conversation a couple weeks ago regarding the monetary base. The monetary base is the only real money “issued”. Deposits exist in far larger amounts than there is monetary base money issued. Most deposits are nothing more than entries “created” on a bank’s balance sheet. A deposit is really a promise by the bank to make good on some future payment – how that happens is the banks problem (from the depositor’s perspective).
“Either way, as you will know if you are a good MMTer, in order for someone to borrow surplus funds, someone has to have surplus funds to borrow. “
When a bank makes a loan it does NOT lend out surplus funds – it does not lend out other peoples savings. While you and me and the loan shark down a dark alley do lend out prior savings, banks have not lent out surplus funds for a couple hundred years.
A fractional reserve bank operates by making payment promises. If I have a deposit at the bank the bank has in effect promised to clear and settle all payment requests I issue against my account (assuming I’m not trying to overdraw that is). If I write a check to another customer of the same bank the bank just adjusts balance sheet entries tied to my account and my friends account (both liabilities on the bank’s balance sheet). If I write a check to a customer at another institution the bank reduces my deposit account (it’s liability) and settles the payment with the other bank by also reducing the banks reserves (it’s asset) my the amount of the payment settlement. The other bank increases its reserves and its customer’s deposit account.
When you obtain a loan a very similar process occurs. A loan is really nothing more than a promise by the bank to clear and settle a payment on your behalf. Let’s use an example of buying a car. You go to the bank and ask for an auto loan. The bank agrees (assuming it finds you credit worthy) and (for simplicity let’s assume…) issues you a check. You then take that check to an auto dealer who accepts it as payment for a car. The auto dealer now deposits that check at its bank. If it’s the same bank that you obtained the loan from then the bank does nothing more than credits the auto dealer’s bank account. The bank now magically has a new deposit and a new loan on its books. If we rolled the whole banking system up into one entity the process ends right here (if the bank faces a regulatory reserve requirement there are a couple additional steps and I’ll get to those in a minute). Bank creates loan and creates deposit – done. Bank made and kept a promise to its borrower to clear and settle a payment; however it has now created future promises to its depositor who received the loan check as payment.
Going back to our auto dealer and the check… The auto dealer could have deposited that check at another institution. Again the same clearing and settlement process would occur. The issuing bank would have to reduce its reserves by the amount of the loan check (reserves down; loan account up – both asset transactions) while the deposit accepting institution would increase its reserves (asset) and its customers deposit account (liability).
As you can see a bank is really making promises to both its borrowers and its depositors and depending on how the transactions hit its balance sheet it may or may not need reserves to settle the transaction. That said, a bank needs reserves to ensure it can keep its promises to clear and settle payments should those payments require an inter-bank transaction. The cheapest way to obtain those reserves is to attract depositors – not because you need their deposits but because when a bank accepts a deposit from a customer that is coming from somewhere other than its own balance sheet it is also drawing reserves onto its balance sheet as part of this transaction. It’s the cheapest form of obtaining reserves because depositors are typically paid the lowest rates. Alternatively the bank could seek additional reserves by borrowing on the overnight inter-bank lending market; it could issue a longer term bond; or in a pinch it can borrow directly from the central bank’s discount window. Deposits and other means of obtaining reserves is just the cost of running its payment operations which are necessary for it to keep its promises.
If a bank faces a reserve requirement it just means that as loans and deposits are created it must seek out additional reserves at the best price (rate) it can obtain.
Since the scope of discussion is so wide, rational people will disagree. In fact, I would characterise rationality as the ability to disagree. On the other hand, irrational people will shout and stamp their feet and call each other names. So, a general rule of thumb I rely on when reading discussions on the internet is to discount the views of commenters who can’t express their arguments without insulting those who disagree with them.
It’s not an iron-clad law or anything, because I know how easy it is for arguments to overheat. But still, rather than calling people names, why not open your mind to different views a little bit? Not everyone who disagrees with you does so because they are stupid. You might even discover something true and unknown to you.
Anyway, you say that neither production nor exchange produces dollars or euros per se. In fact, I agree with this and it is consistent with the point I am making. In order for there to be an asset of any kind, somebody somewhere must have saved some of their income. And in order for there to be savings of any kind, there has to be assets. That is true of financial assets like money or government bonds, and it’s also true of tangible assets like factories and machinery. Although it’s kind of boring to think these things through or to spend all day staring at accounting identities and matrices, if you do so you’ll end up in the same place.
A basic macroeconomic relationship linking saving and asset accumulation says that for any economic entity, saving plus borrowing equals asset acquisition. This is why intra-sector financial assets net out on aggregation: if we imagine that there is no investment, it’s easy to see that saving will equal borrowing, since on aggregate, the entity is lending to itself. It’s also easy to see that there can’t be any borrowing if there isn’t any saving (if everyone consume all of their income, no one person can consume more).
Where does money come into this? If follows from the above discussion that wealth or saving if it exists has to be allocated to assets. Money is a type of asset. We can see that no savings means no assets means no money. On the other hand, the reverse is not true. All savings are not money (hopefully that’s obvious).
So as long as the economy carries some positive quantity of wealth (i.e., savings exist), this wealth can be held as money. Or government bonds. Or fixed capital. And so on.
@vimothy, “Either way, as you will know if you are a good MMTer, in order for someone to borrow surplus funds, someone has to have surplus funds to borrow. “
When a bank makes a loan it does NOT lend out surplus funds – it does not lend out other peoples savings. While you and me and the loan shark down a dark alley do lend out prior savings, banks have not lent out surplus funds for a couple hundred years.
A fractional reserve bank operates by making payment promises. If I have a deposit at the bank the bank has in effect promised to clear and settle all payment requests I issue against my account (assuming I’m not trying to overdraw that is). If I write a check to another customer of the same bank the bank just adjusts balance sheet entries tied to my account and my friends account (both liabilities on the bank’s balance sheet). If I write a check to a customer at another institution the bank reduces my deposit account (it’s liability) and settles the payment with the other bank by also reducing the banks reserves (it’s asset) my the amount of the payment settlement. The other bank increases its reserves and its customer’s deposit account.
When you obtain a loan a very similar process occurs. A loan is really nothing more than a promise by the bank to clear and settle a payment on your behalf. Let’s use an example of buying a car. You go to the bank and ask for an auto loan. The bank agrees (assuming it finds you credit worthy) and (for simplicity let’s assume…) issues you a check. You then take that check to an auto dealer who accepts it as payment for a car. The auto dealer now deposits that check at its bank. If it’s the same bank that you obtained the loan from then the bank does nothing more than credits the auto dealer’s bank account. The bank now magically has a new deposit and a new loan on its books. If we rolled the whole banking system up into one entity the process ends right here (if the bank faces a regulatory reserve requirement there are a couple additional steps and I’ll get to those in a minute). Bank creates loan and creates deposit – done. Bank made and kept a promise to its borrower to clear and settle a payment; however it has now created future promises to its depositor who received the loan check as payment.
Going back to our auto dealer and the check… The auto dealer could have deposited that check at another institution. Again the same clearing and settlement process would occur. The issuing bank would have to reduce its reserves by the amount of the loan check (reserves down; loan account up – both asset transactions) while the deposit accepting institution would increase its reserves (asset) and its customers deposit account (liability).
As you can see a bank is really making promises to both its borrowers and its depositors and depending on how the transactions hit its balance sheet it may or may not need reserves to settle the transaction. That said, a bank needs reserves to ensure it can keep its promises to clear and settle payments should those payments require an inter-bank transaction. The cheapest way to obtain those reserves is to attract depositors – not because you need their deposits but because when a bank accepts a deposit from a customer that is coming from somewhere other than its own balance sheet it is also drawing reserves onto its balance sheet as part of this transaction. It’s the cheapest form of obtaining reserves because depositors are typically paid the lowest rates. Alternatively the bank could seek additional reserves by borrowing on the overnight inter-bank lending market; it could issue a longer term bond; or in a pinch it can borrow directly from the central bank’s discount window. Deposits and other means of obtaining reserves is just the cost of running its payment operations which are necessary for it to keep its promises.
If a bank faces a reserve requirement it just means that as loans and deposits are created it must seek out additional reserves at the best price (rate) it can obtain.
“What I’m saying is that, in order for there to be money, someone has to save. In order for there to be saving, someone has to earn. In order for someone to earn, there has to be production and exchange.”
Two points… If you read my description above of bank operations you will realize that savings is not needed for lending. While your typical economist says savings leads to investment (performed via borrowing) he actually has the causality backwards because most economists assume bank operations away and therefore do believe banks lend out other people’s money. But once you understand how a bank works you can see that the bank lends out the money which creates an injection of demand into the economy which allows another party to save money (leakage) without reducing demand. It is the lending (ideally via productive investment) that allows for savings to accumulate.
The other point is you need to follow the monetary transactions. You could have worked all day and been paid in bananas or coffee or some other real economic output. However I’m assuming you intend to save monetary assets (i.e. money). If so then it means you were paid in a monetary asset (ie. currency, a deposit, etc…) which means you need to ask yourself where did your employer get that monetary asset from. If you trace the monetary transactions back to their creation you will find out that it was either created by a vertical transaction (the government created it) or by a horizontal transaction (a bank issued a loan creating a deposit).
The issue of what really constitutes money is something that has troubled thinkers for a long time, so it doesn’t seem to be a question that can be settled in a decisive way. It’s common, though, to refer to different types of money. The most significant distinction that is usually made is between base, narrow, or outside money, which is the money issued by the central bank, and broad or inside money, which is the money (or if you prefer, the “money substitute”) issued by banks (and potentially other financial institutions).
I think that in a lot of contexts it can be helpful to retain the word “money” for central bank notes alone, and refer to money in the broader sense in terms of liquid bank liabilities or whatever the particular asset in question might be. In other contexts though, it can make sense to refer to them both as money, since they hold some characteristics in common. One of the problems that economists have is that money has a particular function, and so if something seems to perform like money, it seems hard to argue that it’s not, and from a sufficient distance, all the different classifications of assets into money and not-money seem a bit arbitrary and unsatisfying.
Vimothy: "In fact, I’ve just reread your comment and it seems like a bit of a non sequitur. What I’m saying is that, in order for there to be money, someone has to save. In order for there to be saving, someone has to earn. In order for someone to earn, there has to be production and exchange."
Where do the savings come from? Income. Where does the income come from? Some one ele's savings or income or borrowing. Is all borrowing borrowing savings? This is a circular argument. The currency has to come from somewhere and "currency" implies it comes from the government because currency is "state money."
vimothy: "In order for there to be an asset of any kind, somebody somewhere must have saved some of their income. And in order for there to be savings of any kind, there has to be assets. That is true of financial assets like money or government bonds, and it’s also true of tangible assets like factories and machinery. Although it’s kind of boring to think these things through or to spend all day staring at accounting identities and matrices, if you do so you’ll end up in the same place.
What about Lincoln's greenbacks that financed the Civil War without borrowing? Some were in circulation for over a hundred years.
Governments can and do create currency out of nothing, and the currency is a non-govt asset and a govt liability in terms of accounting. This is an add from outside, and it is called "outside money." Within the system as a whole, government and non-govt, the net is zero, but wrt non-govt only, when there outside added net financial assets are injected into non-government from outside.
These net financial assets could be of zero maturity, like greenbacks, or they could non non-zero maturity, like tsys.
Zero and non-zero govt liabilities are fungible through collateralization, which is, in fact, what happens. It is what modern banking is based on.
If the govt went to direct issuance with no issuance of tsys, banking would change drastically. Which is way Warren allows very short term tsys with yields slightly greater than the interest rate.
vimothy: "The issue of what really constitutes money is something that has troubled thinkers for a long time, so it doesn’t seem to be a question that can be settled in a decisive way."
Of course it can by technical and operational definition. This is what the operational aspect of MMT is all about.
The arguments are over whether the operational description is properly specified.
The problems arise over ambiguities in the meaning of "money" due to differences in use of the term in context. The way to clarify is by showing the specific uses in different contexts.
Yes, it is nuanced because ordinary language is "meaning-rich" and makes a few key terms cover a lot of ground. Rigorous thinkers realize this an attempt to use technical and operational definitions in their fields to avoid misunderstanding and confusion.
Off-topic, but there's an embedded message that is prescient (Daring Fireball):
"Speaking of Microsoft, Gray Knowlton from the Office team has a long piece on the touch-focused aspects of the new Office 2013:
"In this post I’ll walk you through the thinking, engineering process and design framework we used to reimagine these experiences for touch."
They’ve obviously put a ton of thought into this. The question is, do you need to read a 4,000-word explainer to understand how it works?From a user’s perspective, the design process is meaningless, especially for touch interfaces. You see it, you touch it — that’s it. And if that doesn’t work, it’s a failed design."
Vimothy (I'm previous anon), I'm not insulting, I'm stating a fact.
Nothing of what you listed 'units of accounts'. Unit of accounts is what MONEY is.
Not so hard and complicated matter in fact, people over complicates it. There are money-things (financial assets like MBS could acquire the quality of money things at some point and be used to leverage 'real money') and 'money'.
Money = units of accounts to account for economic transactions. Don't overcomplicate it. Money = dollars, euros, etc.
So no, neither productions, transactions or 'saving' does produce money. This terribleness Austrian economics mindset of mixing the nominal monetary system with the real production and economic system is disastrous.
Monetary and financial economy will NEVER correspond with the real production economy. Sa vings of monetary assets will NEVER represent real wealth.
Actually is easy to understand if you check how markets operate and how price action operates. There is a feedback loop (sometimes positive) between prices and flow of monetary assets. That's why we have phenomenons like inflation or deflation.
Off course you need a real economy to have a financial economy, but no real activity produces money per se, sometimes there is a dislocation of the demand and supply of monetary economy and the demand and supply of the real economy. BTW 'saving' in monetary assets doesn't produce new assets per se neither. And saving in 'real' assets DOESN'T produce monetary assets NEITHER.
Saving in 'real' assets in necessary to produce later, you need capital goods to invest and develop new goods. But saving in capital good is not the equivalent of saving in monetary assets. If everyone puts their capital goods at the market there will be a change in the marked-to-market prices and viceversa (this is the sort of feedback I talk about), also there is a time variable in the function of price, as the money created by credit when you for example bought a real good is not the equivalent of today's monetary unit neither the 'real value' of the capital good is the same (it probably is less).
Overall this is why we have 'market economies' and finances, because there isn't a practical way to mix up monetary (nominal) and non-monetary (real) parts of the economy and we need arbitraging to solve this problem.
Why the hell economists, 'asutrians' and everybody tries to mxi them up again when they are clueless I don't know.
Repeat with me: no, financial and monetary part of the system are and never will be a 1:1 representation of the economy.
So the big takedown of MMT is the idea that "wealth" is not created by the government???
So I could tutor the neighbor's daughter in math in exchange for babysitting. And we did it all without deficit spending. What is interesting about that.
This reminds me of JKH's 10 cows. It's not interesting that the farmer creates this new "wealth". It's interesting to think about how the new cows will help him extinguish his tax liability. Or how the cows will pay for more police.
If this is asking for an essence, no. Money is a complex concept in which a single terms covers many uses. "Money" is the label of a set of more specific concepts. There is no clear boundary demarcating the set that can be given as a characteristic defining the set, because there is disagreement over what what falls into the set, i.e, the proper use of the term "money."
"Money" has a lexical definition found in dictionaries. Here is Merriam Webster
Definition of MONEY 1 : something generally accepted as a medium of exchange, a measure of value, or a means of payment: as
a : officially coined or stamped metal currency
b : money of account
c : paper money 2 a : wealth reckoned in terms of money
b : an amount of money
c plural : sums of money : funds 3 : a form or denomination of coin or paper money 4 a : the first, second, and third place winners (as in a horse or dog race) —usually used in the phrases in the money orout of the money
b : prize money 5 a : persons or interests possessing or controlling great wealth
b : a position of wealth money table — for one's money : according to one's preference or opinion — on the money : exactly right or accurate  See money defined for English-language learners » See money defined for kids » Examples of MONEY 1. That painting must be worth a lot of money. 2. He earned some money last summer as a musician. 3. We're trying to save enough money for a new car. 4. The town is raising money for the elementary school. 5. Friends would always ask her for money. 6. It's an interesting idea, but there's no money in it: it'll never sell. 7. He made his money in the insurance business. 8. They decided to put all their money in the stock market. 9. We didn't have much money when I was growing up. 10. Most of the project is being paid for by federal monies. Origin of MONEY Middle English moneye, from Anglo-French moneie, from Latin moneta mint, money — more at mint First Known Use: 14th century
There is the economic definition in terms of function: unit of account, medium of exchange, store of value, and standard of deferred payment.
There is also a theoretical definition in QTM
There are operational definitions such as MO, base money-HPM, narrow money (UK), M1, M2, and M3.
In MMT and MCT, "inside" and "outside" money, "vertical" and "horizontal" money, "endogenous' and "exogenous" money, "credit money," "state money," and money interms of financial assets, e.g., "net financial assets."
There are stipulated and rhetorical definitions, too, such as "hard" and "soft" money.
Thanks for taking the time to write your argument out in such detail. I’ve actually been reading post Keynesians and MMTers (amongst others) for many years now and I feel like I’m pretty familiar with the general thrust of it, but it’s still nice to see it laid out so crisply.
I also agree with what I take to be its core principle, which is that, for the financial system, “loans create deposits.” How can that be, when I’m saying that there can be no money without savings?
What I’m saying is that without positive quantities of wealth or savings, there can be no money stock. I think that you’re saying something different. You’re saying that when the banking system makes a loan, the deposit that ultimately finances the loan is created at the same time. It’s a useful perspective because it’s common to view money as a kind of weird exogenous thing that people already possess and then suddenly one day decide to put in the bank—as opposed to something that is a product of the banking system itself.
It’s not the whole story though. Only in the trivial case when the bank is lending to and borrowing from the same entity can it create money without having to find savers. Otherwise, no one will be willing to hold its liabilities. When you aggregate over the whole economy financial assets equals liabilities and it’s all a wash. But in order for there to be anything to aggregate, there must be activity at the individual level as well. At the individual level, the depositor and lender are not the same.
Since they are not the same, it doesn’t simply wash out. This means the usual rules apply. Depositors need sources of funds and lenders need uses. In other words, what happens when banks lend has to take place in the context of income-expenditure and saving-investment flows.
While your typical economist says savings leads to investment.
Actually, I’ve never heard an economist make that claim. In my experience it’s more that your typical blogger says that your typical economist says saving leads to investment.
It’s not a feature of economic theory at any level, as far as I’m aware. Economists say that in equilibrium, saving equals investment. Saying that saving leads to or causes investment would be like saying that supply causes demand or that 2+%=/. It’s not really a well formed statement.
"…without positive quantities of wealth or savings, there can be no money stock."
Does it not follow from this that without net government spending there cannot be positive quantities of savings (I'm referring to net savings here, applying liabilities)?
There could be savings but no net savings in the aggregate, so how could it be positive?
Using your preferred definition of savings it is only positive if liabilities are ignored. I don't think you can do this and make a cogent argument.
Wealth is another issue, as it is only a number on paper, measured in the unit of account that is some multiple of the real ability of agents to spend (leverage).
Wealth without NFA is simply bubble wealth and unsustainable.
At any rate the money stock is not a function of wealth, it's a function of spending.
It is quite possible for an agent to be wealthy but unable to spend (land-poor comes to mind).
And the money stock cannot affect savings (net savings, the only kind with any mathematical relevance in the system) without net government spending (assuming a balanced CA).
Sorry, bit of a mistake in my comment which I should probably correct:
"Since they are not the same, it doesn’t simply wash out. This means the usual rules apply. Depositors need sources of funds and borrowers need uses."
Tom,
There can be no growth without outside money, and without it over time depreciation will kill an economy.
If we think about a sustainable amount of saving, then an obvious candidate is a level that equates the rate of saving to the rate of depreciation, i.e., the level of saving that keeps the capital stock constant. This is known as the “golden rule” solution to Ramsey’s famous model. It is sustainable indefinitely.
I’m not sure what you mean by the statement, “there can be no growth without outside money”. Can you explain? In what sense is it true?
Aggregate saving and net saving are not the same thing.
So aggregate saving can be positive even if net saving is zero.
The reason for this is that "outside" assets aren't the only type of assets that don't attach to liabilities within the sector and wash out when you aggregate up.
The reason for this is that as well as making loans to one another, we can also invest our savings in the capital stock of the economy. In such cases there are assets that don't net out on aggregation.
Imagine a borrow $1 million from you. I spend it much of it on booze and loose women, and waste the rest. Your asset (a loan to me) equals my liability (a debt to you). So our saving and dissaving cancel each other out.
But say instead that I use that loan to buy a widget making company. Now the situation is that you saved and lent the money to me, but I did not dissave. Instead I invested.
Now I have an asset and I liability, and you have an asset. When we sum these up, the two sides of my balance sheet cancel out, and your savings remain.
Aggregate saving is just the sum of all individual saving over a period. Saving can be positive or negative.
You didn't quite say aggregate saving, but you did ask how saving could be positive without net spending, mentioning that this would only be possible if liabilities were ignored. Whether I was successful or not, that's what I tried to address in my comment.
Whatever you ultimately choose to call it, when we sum up every individual's saving or savings, it is still possible for these values to be positive even if we set NFA to zero.
No only that, but the major component of private savings is not NFA at all, but private capital.
If you think about it, if wealth for the private sector just means the amount of lending its done to the government, then national wealth is zero unless the nation is a net creditor to the rest of the world. But even then, global wealth is always zero.
But this doesn't really make any sense. How could global wealth always be zero? What's going on is that wealth or savings is not the same as NFA.
"I’m not sure what you mean by the statement, “there can be no growth without outside money”. Can you explain? In what sense is it true?"
MOney is like energy. The only way to get more out of the same amount of money is to increase efficiency of use. There are limits to increasing efficiency of use when the system is growing, and population grows geometrically while assets deplete and depreciate.
This is why scientists, engineers, engineers and systems people criticize economists. It is what is wrong with any fixed money supply, like a limited amount of gold. Look at what happened when the world was running on gold. Economic contraction, mercantilism, and wars, until a new supply was discovered and introduced and then a jump in growth.
In your argument above about the flow of saving, investment and income, don't account for where the money comes from. Firms don't produce money. Money is not a commodity except on bullion or a full reserve convertible system (bullion certificate with 100% banking), And, obviously, neither do consumers other than prospectors on a gold standard.
Either some credit creation is required, or else currency in a system with state money. These involve finance or issuance. Modern money is a combination of finance that generates credit money and issuance that generates state money. In this system, the currency is the unit of account.
Your system is on in which there is a constant "energy" flow with no energy source and no energy add.
"While your typical economist says savings leads to investment."
Let me clarify... Most economist incorrectly describe banks as financial intermediaries. They claim that banks take in deposits and then lend them back out. Therefore banks are accepting savings and lending it for investment.
That is NOT how lending works in our modern world.
Lending creates an injection into aggregate demand which simultaneously allows for someone else to remove aggregate demand from the economy as savings without there being an overall decrease in aggregate demand. Mainstream economics has the causality backwards.
"It’s not the whole story though. Only in the trivial case when the bank is lending to and borrowing from the same entity can it create money without having to find savers."
I assume you really mean reserves when you say "savers". That is not true. In modern banking, banks clear and settle payments with reserves. The central bank will supply an infinite amount of them at its target interest rate and if there is still some sort of shortage it will provide them at the discount window.
"Since they are not the same, it doesn’t simply wash out. This means the usual rules apply. Depositors need sources of funds and borrowers need uses."
Agreed, but I think your implying a prior mistake. Factories produce real good and services they do not produce money (unless its a government mint printing press). While workers and businesses are paid in financial assets for their real economic output you need to trace the creation of those financial assets back to where they were create - as state created money or as a bank loan (which resulted in a bank deposit).
vimothy, "Aggregate saving is just the sum of all individual saving over a period. Saving can be positive or negative."
And we continue to talk past each other but I may be beginning to see why…
I will never (nor would anyone using the MMT framework) be using the context of saving that you are using here, because in my mind, it does not say anything about the system as MMT defines it, and so is not relevant to the MMT analysis.
I have been discussing these issues with you under the assumption that you are familiar with the fundamental principles behind the MMT framework.
That does not appear to be the case.
First, the MMT framework is concerned with what goes on on the right side of a balance sheet.
Financial assets, not real assets. Your definition of savings has little meaning in the MMT context so I can see where you would be confused.
When you take a discussion of saving to the left side of a balance sheet you have entered a world outside of the concrete nominal system, and introduced all kinds of unknowns which cannot be evaluated without some supercomputer, and even then an analysis would be suspect because the output would only be as good as the model.
On the left side of a balance sheet value is always an unknown that can have many nominal prices associated with it depending on how it is evaluated, including valuation by opinion.
Things appearing on this side of the balance sheet are called "real assets" or "real wealth" but the only thing real about them is the existence of the physical underlying asset.
The value of an asset on this side of a balance sheet is a function of the composition and distribution of nominal wealth on the right side (of the aggregate balance sheet), but the relationship is "soft" and non-linear.
When discussing the US "system", meaning the closed system of state-backed financial assets that include dollars, dollar liabilities and government bonds issued to the public, it will always be true that the level of the elemental particles, net nominal dollars, can never change one way or the other without some injection or leakage from an external source (sector).
You can prove this to yourself easily with simple arithmetic. A loan doesn't increase one's net worth, nor does it increase the net worth of the system in the aggregate. It enters a balance sheet as a net zero.
vimothy, what is being stated in your S=I model is that goods produced for consumption and goods consumed are equal in a closed economy running at full employment. The value of capital goods produced is accounted for as investment (I). This investment is owned by household as what is "saved" after consumption (S).
If the economy is not performing at FE, then what is not consumed becomes unplanned inventory and is accounted for investment. So saving as ownership by households includes this unplanned inventory in S = I.
This way of looking really treating money as veil, i.e., just as a unit of account for keeping track of real resources, that is, the non-financial. Nothing wrong with that model within its parameters and assumptions.
What Keynes, PKE, MCT, and MMT are saying is that it a very limited model that results in a limited perspective that is not reflective of a modern monetary economy in which money & banking and finance are as importance as production, distribution and consumption of real resources.
Ignoring finance or misunderstanding how it works results in erroneous conclusions about how the economy actually works, as shown by the failure of NCE modeling to predict financial crises that spread to economic crises, such as the present one.
NCE equilibrium models are based on assumptions that make the models founded on them non-representational.
Did you read Matias Vernengo's latest, which I posted today?
This is why we have financial markets and markets in general. 'Markets' are the black boxes which solve the matching between real and nominal. Price fluctuations and dynamics affect the 'quality' of balance sheets at certain point in time.
Talking about stocks of either real assets or financial assets is not very useful if you take in mind a time variable in the function of prices (which modifies the quality of the balance sheet). Stocks are only important at a given point in time!
But the economy is NOT and will NEVER be about stocks alone, but most of the time is flows what matter. When you get different flows going on, how these flows operate exercise a positive feedback loop on prices and valuations of stocks (the 'usefulness' of these assets, either nominal or real).
But you can't produce extra flows out of fixed stocks. This goes against the nature of our universe and financial and production systems are no different.
So both in real or nominal terms you need flows, 'adds' of assets. In the case of real production it means raw materials which we receive from the Earth and Sun (in form of energy and raw materials). The day this stops the economy dies as entropy points out, it will get 'frozen' (along with humanity), you can't run an economy on fixed stocks.
And pretty much the same with nominal economy and financial assets, you need an exogenous supply of it to keep flows going on (either the government or banks), liabilities are an ex-post accounting artefact (although an important one, as it keeps track of relationships) of the creation of an asset. Any monetary system has inefficiencies, wastes and it's own entropic nature, savings are one of these 'wastes' or leakages which require 'exogenous actions' (be more 'adds' or a recirculation of these savings someway).
These systems can't run as a closed system like a perpetual machine without exogenous disruptions on fixated number of assets, there are laws which prevent it.
Excellent explanation, Leverage. We can see money and energy plays a similar role in parallel systems, the real (non-financial) and the nominal (financial). The real system is about the circular flow of production (supply), distribution (market), and consumption (demand). Energy drives the circular flow and money drives the distribution system in a market economy and accounts for the circular flow in nominal terms.
Both the real and nominal systems operate in parallel within the context of a larger system — society. Understanding these systems and how they closely parallel each other is what economics is about, or should be about, as a policy science dealing with the material life support system of a society. The more complex the social order, the more complex the subsystems within it through which it functions. Control over this order is "governance."
Neoliberal as a social model presupposes that "nature knows best." This is a groundless presumption without proof, and it is in essence a denial of a primary evolutionary advantage of humanity.
Your statements about the bank lending process strike me as quite careful, but the inferences you go on to draw about economic theory, less so.
I won’t argue with you about what economists say. But just ask yourself this: where do I get this information from? Is it from careful study of economics, or is from people who only ever complain about it? If it is the latter, then you are a like a judge who listens to the prosecution but not the defence. Only listening to arguments that seem to confirm your hypothesis about some phenomenon seems like a fool proof way to generate plenty of confirmation bias.
Anyway, it’s true that if banks extend a lot of credit, we might expect it to raise aggregate demand. But it’s not true that there is something about saving that necessarily causes it to lower aggregate demand, or that would necessarily cause it to lower aggregate demand in the absence of bank lending.
I assume you really mean reserves when you say "savers".
I’m not sure why you would assume that. I meant savers. We all know that assets must equal liabilities. Unless the bank is lending to and borrowing from the same person, it must find someone to hold its liabilities. We also know that asset acquisition equals borrowing plus saving. This means that the person holding the bank’s liabilities must find a source of funding. That source could be borrowing (we can imagine away the question of whether this would be desirable or feasible), but that simply moves the question one person along. The chain has to end at some point. Wherever it ends, someone will be saving. This has nothing to do with reserves (as far as I can see) and everything to do with consistency. You cannot force people to hold bank deposits. If you assume that they want to, then you’re assuming that people want to save. May argument is that, without saving, there can be no money—so your response does not seem to speak to it directly.
While workers and businesses are paid in financial assets for their real economic output you need to trace the creation of those financial assets back to where they were create - as state created money or as a bank loan.
In practice, this is quite right. However, we’re arguing about principles. My claim is that with no savings there can be no money. Since we do not observe economies in this state, even assuming we agreed on the facts, we cannot simply point to the normal functioning of the economy to settle the matter. Instead, we have to apply basic principles which hold normally to an abnormal hypothetical situation. This is rather abstract, but I don’t see how that can be avoided given the nature of the discussion.
This is why scientists, engineers, engineers and systems people criticize economists.
I’m not an engineer or a physicist, so I won’t comment too much on the appropriateness of your analogy. (It seems that engineers and physicists don’t feel the same way.) Money is not an input to production in the sense that labour or capital is. It doesn’t have a marginal product. If the economy is growing and the money supply is not, then logically, we should expect to see price deflation. But this has nothing to do with the efficiency or inefficiency with which money is being used.
In your argument above about the flow of saving, investment and income, don't account for where the money comes from.
That’s right. But we know where the money comes from. Banks issue it. The point of my argument is that banks cannot issue it without savers who wish to hold some portion of their income in reserve rather than consuming it all. You have argued that the government can create funds by issuing money. I’m saying that you are misunderstanding what the word funds means in this context. Bank money is a use of funds for anyone who isn’t a bank (or a central bank). If bank money is a use of funds, then a source of funds must also be found. That follows from the principle of stock-flow consistency.
I have been discussing these issues with you under the assumption that you are familiar with the fundamental principles behind the MMT framework.
As it happens, I feel that I’m quite familiar with it. You are entitled to draw your own conclusions, of course, but I’ve read their blogs for years, I’ve read a large number of their papers, I’ve read the short books by Wray and Mosler—I’ve even read two textbooks by Wynne Godley.
You’re actually mistaken about how MMT treats saving. The outcome of the whole brouhaha about “net saving” was that the professional MMT contingent uses the same definition that the rest of the economics profession uses. I mean, hello—they’re economists! This is very basic stuff for an economist. The non-professional MMT contingent got a bit confused, because this stuff can be confusing. That’s just the nature of the thing.
Here’s Scott Fullwiler:
In other words, OBVIOUSLY there can be an increase in financial assets without govt deficits if the former "net" to zero in that case, otherwise there would be nothing to "net" in the first place. Similarly, there can OBVIOUSLY be saving without govt deficits or a current account surplus, but not NET saving.
What he’s saying is that everybody knows there can be saving without government or foreign deficits. It’s something that is obvious. Everybody knows this because they share a common education. They understand what the concept of saving means. It means that you take some of the resources that you’ve generated—i.e., your income—and you put them to one side for future use. From that essence, the various identities follow. It’s even implicit in the sector financial balances identity that you like to refer to. If we set the other balances to zero, then we can have (S – I) = 0 IF AND ONLY IF S = I, and therefore, that S = 0 IF AND ONLY IF I = 0.
We don’t need to go over this again though. Just think about my comment above. I borrow the money from you and invest in tangible capital. I have not dissaved and you have saved. You’re proposing that we should simply ignore the fact that I have an asset when we calculate aggregate saving, so that somehow we end up concluding that there has been no aggregate saving. This isn’t something that makes very much sense, and it isn’t something that comes from any MMT work that I’ve ever seen. If you disagree, why not refer me directly to a paper where this is discussed? If it’s not discussed in a paper, can you explain the logic without simply declaring that this is how it’s done in the MMT framework?
Nothing in my argument relies on particular definitions of equilibrium or assumptions about the rate of employment or anything like that. All I’m saying is that, for everyone in the economy, uses of funds equals sources of funds. I don’t think this is theoretical. For e.g., you point to a blog post that quotes post Keynesian economist Gennaro Zezza, who states,
In the economy – and therefore in models representing the economy - everything comes from somewhere and goes somewhere else: there are no black holes.
"The outcome of the whole brouhaha about “net saving” was that the professional MMT contingent uses the same definition that the rest of the economics profession uses. I mean, hello—they’re economists! This is very basic stuff for an economist."
The brouhaha was about confusion that didn't exist for the most part amongst most of us. The only confusion was what point you and others were trying to make.
If yo'r argument is that every economist's definition of saving is the same, I would agree with you and add that this has never been in question.
Saving is income not spent. It's a non-act, a residual. Everyone agrees (or should) with this.
Your example in another thread in which you plugged in a set of numbers to "prove" that saving can be positive when government spending is negative didn't prove anything.
It demonstrated one possible set of numbers that existed out of many that satisied a known relationship, that when applied to the sectoral balances identity fails as a possible outcome that can occur in the real world.
This follows from the fact that the sectoral balances identity is derived from the equations you provided. The S/B equation narrows the universe of possible solutions in your related equation to one unique solution that can occur in the real world.
Thus your original statement was false, and the difference that you are claiming in our understandings of saving is a distiction without a difference.
And in my own appeal to authority since you are so disposed, I will say that I place a great deal more weight on Bill Mitchell's math abilities than yours, but mainly because I understand the underlying system at work that supports his argument.
BTW, where did I make an appeal to authority? Your claim was that saving in the MMT framework was different to saving in the conventional framework. I provided a link to a quote from an MMT economist that shows that this is not so. That’s not an appeal to authority.
"BTW, where did I make an appeal to authority? Your claim was that saving in the MMT framework was different to saving in the conventional framework. I provided a link to a quote from an MMT economist that shows that this is not so. That’s not an appeal to authority."
My claim wasn't so much that MMT sees saving as a definition of saving is different, only that the metric for measuring saving in the aggregate is different.
MMT focuses on the net increase/decrease of financial assets in the aggregate as the meaningful measure of the non-act of saving.
Your appeal to authority was making the statement that "all economists" have the same definition of saving, which is uncontroversial.
"all economists" is an appeal to authority in my view, as it does not involve logic.
"What it tells us is that, under these conditions S is only zero when I is zero, and I is only zero when S is zero."
True but that doesn't say anything meaningful about net savings.
"even if saving net of investment is zero, saving is not zero unless investment is also zero."
No one is claiming savings is zero if net savings is zero. Net savings can be zero while savings is some positive number.
It just means that savings is at the expense of another. Your saving can only be the result of someone else's spending. It isn't apparent at the micro level but it must be true in the aggregate.
In a closed system it must be true in a nominal sense.
In the equation…
(G - T) + (I - S) + (X - M) = 0
All of the terms excluding I - S are in nominal dollars, so I - S must be in nominal dollars.
Real is never (except for one special case) equal to nominal.
Net savings is nominal. It includes financial assets only.
Define savings net of investment and what that means in a real-world (system) context.
Seems to me savings would be by definition net of investment (and consumption).
Just based on arithmetic, economics view notwithstanding.
vimothy, I don't see economists describing the economy as a system the way other scientists do in their field. Economists recreate models with simple variables that look at a particular aspect of the economy and they draw conclusions about the economy from that. When I see an economist doing that, I put down the paper or book and move on in search of someone who is taking a system approach. That is why I like Godley's SFC modeling.
MMT's general theory is also a systems view from which one can drill in to address different aspects in detail without lossing the big picture.
I maintain that there are parallel systems, real and nominal, and the driver of the real is energy flow and the driver of the nominal is money flow. Without taking this view, the results will be worse than useless because they will be misleading
Nothing in my argument relies on particular definitions of equilibrium or assumptions about the rate of employment or anything like that. All I’m saying is that, for everyone in the economy, uses of funds equals sources of funds. I don’t think this is theoretical. For e.g., you point to a blog post that quotes post Keynesian economist Gennaro Zezza, who states, In the economy – and therefore in models representing the economy - everything comes from somewhere and goes somewhere else: there are no black holes. Which is exactly right, in my view.
Right and agreed. That is not what I am arguing. Where do the funds come from. Don't say "source of funds" because that is not the issue. The unit of account is not only a measure, which is the way it appears in accounting. It is a medium of exchange, and in a monetary economy it comes ultimately from government spending into the economy and lending to the banking system for settlement.
Banks are franchises permitted to generate entries in the unit of account through credit extension, but credit extension by banks and non-banks never alters the amount of net financial assets held by non-govt.
Perhaps you are right about my appeal to authority. You could always verify my claim by spending some time studying economics, but this is costly and possibly not where your interests lie. Still it is hard to see a way round this. Presumably, if we had an argument about engineering, there would be some things that you would draw on as an engineer. Since I’m not an engineer, should you throw out this knowledge, because to do otherwise would be an unfair appeal to authority?
It just means that savings is at the expense of another. Your saving can only be the result of someone else's spending. It isn't apparent at the micro level but it must be true in the aggregate.
No it does not. As well as consumption, expenditure can also take place on investment. Invested income is not consumed. You have claimed that if someone saves, someone else must also dissave, so that on aggregate saving nets out to zero, unless someone from another sector holds the liability.
I think that this is a very common error, but an error it most certainly is. If I borrow from you and buy a factory then I have not dissaved, and you have saved. Thus, all saving does not net out on aggregate. Only when the borrowing leads to consumption does saving net out in the manner you are describing.
But let’s assume that you are correct: if saving always nets out to zero on aggregate, this means that when you sum up saving for the whole economy, its saving is zero, right? But then, what do you think the “S” stands for in your financial balances identity? How is it calculated?
I’m afraid that I don’t know what you mean by a systems view and I don’t know whose research you have been reading. I do know that whatever the differences between Godley & Lavoie and the mainstream approach, looking at the economy as a whole thing is not one of them.
Can you be more concrete? Give me an example from one of Godley’s textbooks and contrast it with an example of a neoclassical model.
"…Funds are generated by productive economic activity…"
This is a fallacy.
Goods and services are generated by productive economic activity.
The level at which goods and services are translated into value is dependent upon a lot of factors, but the most basic factor is the level of dollars available to purchase said goods and services.
It follows that up to the point where the level of spending exceeds production capacity production can be driven by spending.
It matters more to an economy where the money stocks are held than how large they are. It craetes a difference in potential that causes the flow of dollars from a point of lower potential to a point of higher potential.
From consumers to production. If credit is the only source of money driving consumption then growth in production will proceed until the rate of credit expansion can't be maintained and then the system will begin decay, often suddenly.
This is called a bubble.
At this point there is no way to maintain previous levels of spending without the government running deficits, clawing back accumulated wealth from the very rich or reversing flows in the CA.
Increasing production cannot increase spending or the level of the real money stock.
It is spent on the consumption of natural resources and labor. Workers continue the chain of spending by … spending their income on consumption. The same for suppliers of resources used in industry.
Investment is a special class of consumption. In a nominal world it is the same as ordinary consumption.
Anyting left over from income as a residual is considered savings.
Funds are generated by productive economic activity--i.e., by production, income and exchange. "Funds" is not a synonym for "money".
If you are talking about using the unit of account as a measure of the real, no problem.
But that only accounts for half an economy and ignores the financial. This is the Keynesian objection. Just as the non-financial influences the financial, so too, the financial influences the real.
We could use energy units as a unit of account, for example. But the energy has to be sourced. The source of most energy is the sun, stored in various forms like fossil fuels and food stuffs.
Godely and Lavoie suggest what a "Treasury model" looks like. The only place that such models exists are at Treasuries and central banks and at Goldman Sachs.
Econometric models are tiny little things that one person puts together on his desk from limited data. The difference in scale and what they handle is huge.
The Treasury models of economies and IMF's models the global economy are based on how data is actually flowing and what can be expected from that if trends persist, as well as how trends might shift or even could be shifted. Econometric models are based on ergodicity, certainty, and causal relations between limited variables, assuming independent and dependent variable relationships that are supposed relevant to not only to theoretical understanding but also policy making.
“In economic theory or in macroeconomics, investment is the amount purchased per unit time of goods which are not consumed but are to be used for future production (ie. capital). Examples include railroad or factory construction.”
Investment and consumption are not the same thing—that’s why there are two different words to describe them. Investment is expenditure on new capital goods. Consumption is expenditure on consumption goods.
Taking these commonly understood concepts and imposing your own definitions on them strikes me as a bit of a weird exercise. If you wanted to learn maths, would you go about it by redefining terms and making things up as you see fit? That doesn’t seem like it would be very productive.
The reason this matters is that capital is a factor of production and consumption is not. If you consume all of your current income, then the capital stock in the next period will be lower because of depreciation. This means that your income in the next period will also be lower. And therefore that your consumption will be lower as well—even if you consume all of your income again.
In other words, investment increases the future productive capacity of the economy, or prevents it from falling due to the depreciation of capital. It adds to the capital stock. Consumption does not add to the capital stock.
Also, you didn’t answer my question:
If saving always nets out to zero on aggregate, this means that when you sum up saving for the whole economy, its saving is zero, right? But then, what do you think the “S” stands for in your financial balances identity? How is it calculated?
What I’m saying doesn’t really rely on any particular model of or theory about the economy. If you look at any current transactions matrix with banks on it in G&L, you’ll see that money is a source of funds for the issuer and a use of funds for the acquirer, such as households. Since money is a use of funds for households, I don’t see how they can fund their acquisition of money with money.
Regarding models, I’m not sure what you mean by a “treasury model” versus an econometric model. An econometric model can be any size. I can write down a linear econometric model with one dependent variable. One the other hand, one type of econometrics model commonly used by treasury departments and central banks for forecasting is a large scale structural econometric model. This sort of thing is quite crude from the point of view of theory though, and many people have moved onto more dynamic VAR and DSGE approaches.
In the structural models, people do make assumptions about what variables are dependent and what are independent—though certainty is not involved, since these are econometric models—which can be quite hard to justify from a theoretical point of view, and which has contributed to a decline in their popularity amongst academic economists. (Chris Sims won a Nobel Prize last year for work in this area.)
Godley & Lavoie’s models are not unlike traditional structural econometric models. They do not involve data and they are strictly deterministic, perfect foresight economies, but the approach is similar. You can see a very brief example of a structural econometric model at the end of these lecture notes (skip to page 6, section 5.2):
You can see how similar it is to the model in chapter 3 of Godley & Lavoie.
I’m pretty sure that the IMF use a lot of different approaches too. I studied with someone who was a lead economist in their research shop and he taught DSGE models as well as some models without microfoundations. He wasn’t an econometrician, so we didn’t learn much about how they view econometrics. I would have thought that they try to take advantage of whatever tools they can, so I expect they make use of structural econometric models as well as more modern time series methods.
But you didn’t really answer my question. I was asking for some kind of concrete example that showed how a Godley model takes a systems view versus a neoclassical model that does not. When you say “systems view”, what do you actually mean WRT what people are doing? Can you give me an example?
I'm aware of how the definition reads and I look at it as a semantic description to differentiate between two kinds of consumption.
It is logical to conclude that once a dollar is spent on investment it doesn't enter a black hole and disappear. It continues on through the spending chain and is spent over and over again on either consumption or investment until the spending chain is broken by the non-act of saving.
Who knows how many times a dollar is spent as it moves through the economy? A hundred. A Thousand? A million? Some of these transactions will involve investment, some consumption. .
…Consumption does not add to the capital stock…
Consumption continues the chain of spending, and spenders along the chain may spend it on investment, after which it continues along the chain ad infinitum until it is saved. Each time spending occurs on investment it adds to the running total of investment. It also adds to the running total of consumption.
Net savings that remain as the stock of savings that grows over time is a leakage that must be replaced or it will affect both velocity and the level of dollars in the economy. It's a running total.
"If saving always nets out to zero on aggregate, this means that when you sum up saving for the whole economy, its saving is zero, right? But then, what do you think the “S” stands for in your financial balances identity? How is it calculated?"
I don't think I've ever claimed that savings always nets out to zero on aggregate.
"…when you sum up saving for the whole economy, its saving is zero, right?"
No. Saving can still add up to some number. There will be an off-setting number on balance sheets somewhere that represents dis-saving. Someone spent more (fueled by credit) so others could save. This is a short-term dynamic unless offset by deficits.
S and I are both unknown variables in the Sectoral Balances equation. They are place-holders for unknown quantities. The part of the expression that MMT focuses on is the difference which tells us the gain/loss in net financial assets for the system.
In the NIPA tables and FoF tables Savings (and I presume investment) are estimated. Those numbers don't appear to represent the same thing as the terms in the Sectoral Balances and related equations. They are totals of Savings invested (different use of the term investment) in savings vehicles, some of which appear to include real assets.
The numbers for Savings and Investment in the NIPA or FoF tables seldom if ever satify the S/B relationship. I suspect when they do it's coincidence.
Maybe they do in the SFCA accounting system mentioned in the link Tom put up to Naked Keynesianism. I don't know.
Since money is a use of funds for households, I don’t see how they can fund their acquisition of money with money
No? Then you don't understand finance. All money is borrowed money. All money borrowed inside nets to zero. When govt "borrows and spends," it injects financial assets into non-govt, and when govt taxes it withdraws. The net is the govt fiscal balance.
The mainstreams models don't show this and as a result miss a dimension that is determinant. Moreover, not understanding finance properly, mainstream economists are concerned with rising govt debt even when govts are currency sovereigns and they are clueless about the potential effects of private debt.
Just listen to all the jabbering now. They are clueless because they don't understand the system dynamics.
BTW, consumption is consumer spending on consumption goods. Investment is firm spending on capital goods. Households save with they don't spend all their income on consumer goods. The residual is their saving. Firms save with they don't spend all their revenue and don't pass the residual to owners. This is called retained earnings.
So total saving of households and firms from circular flow in a closed system is Revenue minus Spending is equal to Saving over the period.
A great deal of Revenue comes from inside borrowing, since most of the money supply comes from credit extension. In aggregate, this nets to zero.
So in a closed economy with no outside money, there is no actual money. All there is is credit-debt. The backing of the money is the efficiency and effectiveness of the legal system and the collateral that can be recovered in case of default.
That's how a simple monetary economy without government or external trade runs. In the case of blockage of flow, then the system freezes up and breaks down. Savings creates demand leakage so there is always the danger that savings will block the circular flow and disrupt the financial system, resulting in debt-deflationary depression.
vimothy, "But you didn’t really answer my question. I was asking for some kind of concrete example that showed how a Godley model takes a systems view versus a neoclassical model that does not. When you say “systems view”, what do you actually mean WRT what people are doing? Can you give me an example?"
Read any of Godely's analysis (available at levy.org) to see how he uses the model and comes up with different analysis than the mainstream. Godley's approach was famously based on the huge model that he could run his head. No DSGE, representational age agent and other questionable assumptions, no REH, no EMH, no ISLM, etc. needed or wanted.
Godley's models typically assume representative agents and perfect foresight, which is a stronger assumption than rational expectations. (Plenty of modern macro is focused on heterogeneity and modifications to rational expectations.)
I don’t want to read through all of Godley’s papers at the Levy Institute, though. I’d just like to know what you mean when you said that Godley’s models a “systems approach” and that this approach is absent from mainstream research. Can you give me an example of something that is a “systems approach” and something that’s not?
Note, however, that in complex accounting structures the nature of these degrees of freedom may not be obvious at first sight. In particular, the use of a water-tight SFC accounting framework implies that in an economy with n sectors, the financial flows of the nth sector are completely determined by the financial flows of the other n-1 sectors of the economy50. This fact has nothing to do with the neoclassical concepts/assumptions such as Walras's Law, utility maximizing individual agents, market equilibrium and etc. It happens simply because what sectors 1 to n-1 (in the aggregate) pay to sector n is equal to what sector n receives from these sectors and vice-versa. 49 Along, of course, with other theoretical considerations and more
G&L sums up the systems approach in the preface. Emphasis added.
The premises underlying this book are, first, that modern industrial economies have a complex institutional structure comprising production firms, banks, governments and households and, second, that the evolution of economies through time is dependent on the way in which these institutions take decisions and interact with one another. Our aspiration is to introduce a new way in which an understanding can be gained as to how these very complicated systems work as a whole.
Our method is rooted in the fact that every transaction by one sector implies an equivalent transaction by another sector (every purchase implies a sale), while every financial balance (the difference between a sector's income and its outlays) must give rise to an equivalent change in the sum of its balance-sheet (or stock) variables, with every financial asset owned by one sector having a counterpart liability owed by some other. Provided all the sectoral transactions are fully articulated so that 'everything comes from somewhere and everything goes somewhere' such an arrangement of concepts will describe the activities and evolution of the whole economic system, with all financial transactions (including changes in the money supply) fully integrated, at the level of accounting, into the processes which generate factor income, expenditure and production.
As any model which includes the whole range of economic activities described in the national income and flow-of-funds accounts must be extremely complicated, we start off by imagining economies which have unrealistically simplified institutions, and explore how these would work. Then, in stages, we add more and more realistic features until, by the end, the economies we describe bear a fair resemblance to the modern economies we know. In the text we shall employ the narrative method of exposition which Keynes and his followers used, trying to infuse with intuition our conclusions about how particular mechanisms (say the consumption or asset demand functions) work, one at a time, and how they relate to other parts of the economic system. But our underlying method is completely different. Each of our models, before we started to write it up, was set up with its own stock and flow transactions so comprehensively articulated that, however large or small the model, the nth equation was always logically implied by the other n − 1 equations. The way in which the system worked as a whole was then explored via computer simulation, by first solving the model in question for its steady state and then discovering its properties by changing assumptions about exogenous variables and parameters.
vimothy: "Regarding models, I’m not sure what you mean by a “treasury model” versus an econometric model."
A Treasury model, which is explored in G$L can be simplified for understanding as G&L and levels built out. Actual Treasury models are fully built out with all available data. It's based on accounting reports, so no problem adding columns.
Econometric models are simplified by the selection and formulation of assumptions. They involve limited variables. What would happen if econometricians tried to build out their models by making their assumptions more realistic and increasing the variables. How would they deal with causality? Complexity? Why has this not been done?
"May argument is that, without saving, there can be no money—so your response does not seem to speak to it directly."
Assuming we are talking about financial assets then I'd beg to differ. You are logically incorrect and monetarily operational wrong too...
To "save" something first requires you to come into possession of it which means it existed before you could obviously have saved it.
In our modern monetary system of a fiat currency with a central bank charged with ensuring the payment system of the banking system (a description of the US and most banking systems) there most certainly does not need to be "savings" to generate monetary financial assets (money).
Going back to how a bank makes a loan. When a bank makes a loan it generates an asset and a liability (or a need for one at least). You assume that that liability must be someone's savings, but that is not a necessary condition. Yes the bank would prefer that it be a saver making a deposit, but that is not a requirement. To grow its balance sheet the bank needs an offsetting liability. So long as the bank can find credit worthy customer to borrow at a profitable rate above the central banks target interest rate, there is an infinite supply of reserves available from the central bank and a simple phone call to the central bank can convert those reserves into currency which can be dispensed via a bank teller. Bank deposits are not a requirement - in theory you could drain customer deposits from a bank and so long as capital remains and the bank has access to the central bank funding it can continue to lend money. How do you think shadow banking works - entities that make loans without accepting deposits - they source liabilities from the money markets which while receiving money from "savers" are also receiving funding from the central bank via open market operations to defend its target interest rate.
While you may be inclined to discuss what is happening with the stocks and flows within the economy because of all this money create - that is fine (and this is my last post on this comment section, I'm moving on) - but in a nominal sense no money must be pre-saved to create financial assets in our modern monetary system.
TINSTAAFL
ReplyDeleteHNSTTI
ReplyDeletedid you ever notice how fast a game of monopoly ends when 1 person has the most of everything?(usually my wife) http://bobcesca.com/blog-archives/2012/07/obscenity.html
ReplyDelete"did you ever notice how fast a game of monopoly ends when 1 person has the most of everything?(usually my wife) http://bobcesca.com/blog-archives/2012/07/obscenity.html"
ReplyDeleteAnother example of wisdom hiding in plain sight.
Most of the things we need to figure out how an economy works we already know, it's just lost in the woods of all of the bullshit we've been taught all of our lives.
Plus we seem to have some innate need to defy gravity rather than make it our friend.
Great stuff from John Harvey.
ReplyDeleteUses 'closed system' here Paul.
rsp,
Decent article, but he gets one point wrong. Money is not wealth. T-bonds are not wealth. Printing up a quadrillion t-bills will not necessarily make everyone in the USA wealthy. Money only has utility because it can be used to purchase other goods and services. Making more money does not necessarily make anyone wealthy if the underlying goods and services are worthless. Luckily, in the USA, the goods and services are high quality, but this should be pointed out. Good article otherwise.
ReplyDeleteAnonymous: Decent article, but he gets one point wrong. Money is not wealth. T-bonds are not wealth. Printing up a quadrillion t-bills will not necessarily make everyone in the USA wealthy. Money only has utility because it can be used to purchase other goods and services. Making more money does not necessarily make anyone wealthy if the underlying goods and services are worthless. Luckily, in the USA, the goods and services are high quality, but this should be pointed out. Good article otherwise.
ReplyDeleteDifference between financial and non-financial ("real") contribution to net worth on the balance sheet.
Tom: "Difference between financial and non-financial ("real") contribution to net worth on the balance sheet."
ReplyDeleteCould you expand on that.
I can wrap my mind around sectoral balances and all these "island" scenarios.
I have a harder time seeing how deficit spending actually happens. There's so much noise around Fed actions and "printing money". But am I right to understand that everything with reserves is a separate issue? That deficit spending is simply the govt buying things/services?
Y'know, I keep on forgetting this:
ReplyDelete"Even if the federal budget were balanced or in surplus, we’d owe just as much to China."
"Even if the federal budget were balanced or in surplus, we’d owe just as much to China."
ReplyDeleteAlthough this is true it is confusing to the man on the street and the framing is used to create a negative attitude towards "deficits".
What we owe China is goods though not money, and I think most working folks would love to be able to work to provide them.
The conventional belief is that we owe China money. They already have the money.
There, I used the word money. Let the tut tuts ensue. :-)
I have a harder time seeing how deficit spending actually happens.
ReplyDeleteThe budget is deficit when Congress appropriates more than it taxes, so that Treasury spends more than it takes in in revenue in paying the govt's bills from its account. The Tsy must have reserves in its account at the Fed before it can direct the Fed to create non-govt accounts in payment of invoices and transfers.
The Fed credits the account of the bank at which the target deposit account is held and upon receiving the reserve credit in its reserve account, the bank credits the customer deposit account.
IN this way, the currency that the govt issues through spending enters non-govt as an increase in NFA in case of a deficit.
There's so much noise around Fed actions and "printing money".
"Printing Money" means that the Fed increases the reserves balances in the interbank system through one of its many operations.
But am I right to understand that everything with reserves is a separate issue? That deficit spending is simply the govt buying things/services?
Yes. Reserve balance are for settlement only. The reserve balances that are used to credit non-bank deposit accounts are funds available for spending or saving in the economy. Reserve balances in banks' reserve accounts at the Fed are for settling transaction interbank.
When someone pays with cash, the transaction is settled on the spot. If by check, credit card or electronic payment, settlement after netting takes place in the interbank settlement system using rb.
@ Tom Hickey
ReplyDeleteNo mention of U.S. Treasuries when explaining deficit spending?
According to Cullen @ Monetary Realism, (I think) when the U.S. government deficit spends, it sells U.S Treasuries. The selling of Treasuries is essentially an asset swap (a bond for cash), which "puts" cash into Treasury accounts… which the U.S. Gov can then spend into the economy.
Once that money is spent into the economy, deficit spending has occurred… because the non-government sector now has both the money and the bond.
What I'm confused about is when this occurs? Do tax dollars get used up earlier in the (fiscal) year, so that later in the (fiscal) year… U.S. Treasuries have to be sold?
JK, as I said the Tsy has to have rb before it directs the Fed to credit non-govt deposit accounts, This is on account of the rule iaw Tsy is not permitted to run overdrafts. So the Tsy issues tsys. Another rule prohibits the Fed from exchanging rb for tsys with the Tsy. So the Tsy directs the Fed to auction the tsys it has issued and then credit its reserve account with the proceeds.
ReplyDeleteHow this actually occurs is a complicated process of liquidity management that Tsy and Fed coordinate in terms of Tsy need for rb and the Fed's ability to set the overnight ratem which depends on the rb in the system if the Fed is not paying IOR and doesn't choose to set the rate to zero.
Tom, I don't think you have the details right there. JKH has explained this thoroughly in his contingent institutional approach.
ReplyDeleteThe treasury is a currency user. So it must obtain funds through taxation or bond sales. In this regard, the government does not print new "money" or create new deposits. It just recycles old deposits by debiting private sector accounts and then crediting new ones. What the government does is create net new financial assets by running a deficit and adding government bonds to the private sector.
Paul,
ReplyDeleteYou can use the word 'fruit' also, but we can't let arguments ensue that "apples are fruit .... no oranges are fruit, etccc"
Rsp
"What the government does is create net new financial assets by running a deficit and adding government bonds to the private sector."
ReplyDeleteThe point is that the govt is the currency issuer and it issues its currency through the internal operations of its agencies, the Tsy and Fed. The fed provides the rb as a result of the auction and the Tsys supplies the tsys. They Tsy disburses the rb back into non-government through spending and transfers, and at the end of the process non-government hold the amount of rb it held before the auction and also the tsys that were auctioned. Hence, non-govt held NFA increases by the amount of the tsys.
Presently, there are political restrictions imposed on direct issuance of currency without tsy issuance. Tsy issuance is still direct issuance because at the end of the day, non-govt net financial assets increase.' That is govt liabilities (tys) increase and non-government net worth increases correspondingly.
In the case of spending, govt financial liabilities increase and real assets also increase, while non-govt real assets decrease and financial assets increase. This is how non-government real resources get transferred to govt for public use.
When the govt is in deficit, net financial assets held by non-govt increase as more non-govt real resources move to public use. The govt liability incurred in this transfer is the "national debt" and corresponding to it is non-govt saving of net financial assets. As the national debt increases as govt liability, non-govt aggregate saving of net financial assets increases as the corresponding accounting entry.
Tom, I think you should read JKH's contingent institutional approach again. He clearly defines how all of this works. The Treasury is a currency user and must obtain funds from the private sector before it spends. It does this by coordinating bond sales with the Fed to debit private sector balances, credit the Treasury's account and issue net financial assets as bonds.
ReplyDeleteI hate to say it, but the MMT description is not right on the details and never has been right. JKH has always been meticulous about the accounting (I think he's an accountant) and he gets it right here.
Anon,
ReplyDeleteWhere did the private sector get its "funds" to but tsys?
@ widmerpool,
ReplyDeleteThey get the deposits from the same place almost all of the deposits in our monetary system come from - private banks. Very little money is actually issued by the government in the grand scheme of things.
Anonymous, do non-government net financial assets increase as a result of govt deficits or remain the same? The liability is on the side of govt and that is "outside" money. This is what counts, not the accounting. It is incorrect to say, btw,saying that the Fed is the issuer of the currency and the Fed is non-standard. The standard is the the govt issues the currency and non-govt uses uses it. What happens behind the veil intra-govt is interesting but it doesn't alter this fundamental relationship of govt to non-govt regarding the govt's currency.
ReplyDeleteTom, as I said before, deficit spending results in an increase in the net financial assets of the private sector. That's because the government obtains a deposit from the private sector, issues a bond in exchange and reissues this deposit to someone else in the private sector. The new t-bond is the new financial asset.
ReplyDeleteI disagree that the accounting does not count. In fact, I think it's all that counts. It's surprising that an MMTer would say otherwise. A monetary system is all about understanding the system of debits and credits as they actually work. Rejecting this in favor of some other idea is incorrect from start to finish.
Where did the private sector get its "funds" to but tsys?
ReplyDeleteAnd purchases of tsys can only be settled in reserves, that is, reserve balance or cash currency. And where do rb and cash currency come from? Govt.
The Treasury is a currency user and must obtain funds from the private sector before it spends. It does this by coordinating bond sales with the Fed to debit private sector balances, credit the Treasury's account and issue net financial assets as bonds.
ReplyDeleteI hate to say it, but the MMT description is not right on the details and never has been right.
They're both right. They are describing a different scope of operations. JKH is talking about the specific institutional arrangements within a particular sovereign. MMT is talking about the sovereign as a black box. There's no inherent contradiction between the two.
Tom, again, I don't think you're correct. I will regurgitate what I read from JKH:
ReplyDelete"In other words, there is nothing special about the fact that the Fed supplies the reserves that enable tax and bond payments. It does the same thing for all payment activity that may be associated with unintended interest rate pressures."
I would recommend reading his paper again. It details all of this.
Greg,
They're not both right. They can't both be right. They're totally conflicting and contradicting views of the way things actually work.
Again, I would recommend JKH's paper. It very clearly describes all of this and does so by being clear on the accounting and without creating "black box" descriptions, ie, fake descriptions.
"Major_Freedom said...
ReplyDeleteTINSTAAFL"
Yes there is. When we are at less than full employment, there IS a free lunch. Apparently, however, we'd rather starve!
Wait a minute here. Now Hickey is saying the accounting does't matter and geerussell is saying MMT "is talking about the sovereign as a black box."
ReplyDeleteIf that's all MMT is then what's the value in it? Some of us recognized a long time ago that MMT was wrong about specific stuff and you have attacked us viciously for saying that. And now you're admitting that it's just a black box description?
I don't believe there's a contradiction and I don't think you really do either if you examine it closely. Here's a example: Why is Greece experiencing a sovereign debt crisis and Japan is not?
ReplyDeleteA correct analysis of that question can be made from the viewpoint of one nation being a currency user and the other a currency issuer without drilling down to details of their internal arrangements.
On the other hand, if you were sitting down to write actual policy for Japan implement to achieve specific goals you'd need a Japanese JKH to analyze how a detailed policy would transmit to a desired effect within Japan's particular set of arrangements.
They're both right. It's a difference in scope.
@ geerussell,
ReplyDeleteSorry for calling you Greg before. I was reading something else at the same time.
I disagree that they're not contradictory and I dislike the use of the term "currency issuer". I think it is one of MMT's oversimplifications that helps clarify a broad subject matter, but doesn't get the details right. For me personally, I am interested in the details. I am interested in the specific accounting and the reasons why certain things are the exact way they are. That's why I prefer JKH's meticulous approach.
I think JKH would take issue with the idea that his approach is not entirely different. In fact, when he wrote his piece he smacked Fullwiler down hard on this exact point when Fullwiler tried to claim his approach was basically JKH's:
ReplyDelete"To migrate a bit of your language, my essay presents institutional contingencies as scenarios which are specific. And while I agree that there is a potential relationship between my TBRC and your general case, the TBRC is very specific and in no way stamped as “general”. TBRC is defined as an institution, one of contingent design with specified operational and accounting structure. It is defined in explicit institutional detail, as one possibility for adjustment to today’s monetary system structure.
So my logical progression is one of iterative institutional specifics.
Yours bears no resemblance to such an approach.
I have portrayed some of the details of monetary operations in that context. That seems like a reasonable thing to do when illustrating a proposed conceptual structure. You have entirely missed the point in your desire to represent the essay as a display of operational detail without further purpose.
I will not have my approach defined by your “scientific method”. Brett Fiebiger has written some things about this notion in comments above that I find eminently sensible. And I will not have my approach defined by MMT’s view of it. It just so happens that my view of how not to describe modern monetary operations intersects with MMT’s method of doing so. But I have no interest in using that as a platform of criticism of MMT per se. I am done with MMT."
http://monetaryrealism.com/treasury-and-the-central-bank-a-contingent-institutional-approach/
Sorry for calling you Greg before. I was reading something else at the same time.
ReplyDeleteNo worries, happens to me all the time in real life. Was kind of spooky to see it here though. Must be the default we're wired for when a name starts with g :)
I won't belabor the point of disagreement because it's smaller than the measure of agreement on the substance of what JKH wrote.
I'll just say that we have different viewpoints on the utility of simplifications.
Where did the private sector get its "funds" to buy tsys?
ReplyDeleteFrom its savings. And where did it get its savings from? From its income.
> I hate to say it, but the MMT description is not right on the details and never has been right.
ReplyDeleteYep.
If you can get an MMT guy to stop talking about "NFAs" and rigourously look at what happens at the bond/cash/reserve level, then he starts to see the shakiness of his position.
Once that happens, he will either jump ship to MMR, which at least treats concepts clearly.
Or he jumps deeper into the MMT hole, confusing egalitarian normative and explanatory descriptions, railing against MMR, and attacking other economists.
Neither MMT nor MMR are particularly "modern"... As far as economics goes, they are basically Old Keynesianism + fiat currency. Most of the macro treatment is real-variable targeting, long-term stable Philips curves, etc.
Another way to see this is to say: what is saving? Saving is the flow of unconsumed income. So imagine that consumption is fixed at whatever the level of income is for all time, i.e., that there are no savings. Then, there are no funds to buy government bonds.
ReplyDeleteI think the MMR guys dropped the Modern. I don't know exactly why, but I noticed it's all changed on their site and Roche has been referring to it as MR in comments on his website. He seems to be coordinating their marketing efforts and JKH seems to be doing the real economics. They're either trying to distance themselves from MMT or something else. Maybe they finally realized MMR is a disease!
ReplyDeleteI have to say that JKH's paper is really enlightening and I can't say that I've ever seen anything quite like it. It totally changed my view of modern macro.
JKH's paper
ReplyDeleteLink?
Vimothy, see here. It's very long, but very good.
ReplyDeletehttp://monetaryrealism.com/treasury-and-the-central-bank-a-contingent-institutional-approach/
Whoah! That looks epic, thanks. I wish those guys would put stuff like that up in PDF, though...
ReplyDeleteAnother way to see this is to say: what is saving? Saving is the flow of unconsumed income. So imagine that consumption is fixed at whatever the level of income is for all time, i.e., that there are no savings. Then, there are no funds to buy government bonds.
ReplyDeleteA possible objection to this might be to say, okay then, but the central bank needs to hold some assets against its liabilities. It can’t do this if there are no savings, because there are no assets in the economy for it to acquire. If there is no base money, then no one can buy government bonds, because the government will only accept base money, and therefore your thought experiment is moot.
So say that, at some point in time, there is some saving and that the central bank does some regular-bank intermediation. Now the money supply is positive. But say that we also go back to consuming all income for all t. Then, even though there are positive quantities of base money, no one has any savings other than those represented by the central bank, and no one can buy any government bonds.
Here we got again!
ReplyDeleteAs some in here said, the difference IS really a matter of scope. Yes, it's useful and important to understand the exact operational mechanisms of "how it all works" for SOME purposes. But it's not useful and not iimportant to understand the exact operational mechanisms of "how it all works" for OTHER purposes.
For example, if using the sectoral balances approach to understand why Greece is not comparable to the United States, the internal mechanisms (the INTRA-government operations) do not need to be understood. Or said another way, those internal mechanisms are not useful for the analysis.
Do you see? This is what MMT is saying (I think). The necessary level of exactness changes depending on what you are analyzing. MMT is not saying that exactness doesn't matter, rather, the scope of the analysis determines what level of exactness is necessary.
I'm not sure why this is difficult to understand.
Anonymous, IIRC Scott Fullwiller said that the MMT economists were in general agreement with the way that JKH laid out the intra-govt ops. Scott agreed that from the internal perspective the Fed is currency issuer and Tsy is currency user
ReplyDeleteBut this doesn't alter the fact that the US govt issues currency into non-government through appropriations and taxation that set fiscal policy, and then delegates payment to the Tsy as its payment agency. The Fed, another agency of govt established by law, functions as the govt's bank and runs the settlement system. Other agencies are responsible for handling the actual contracts.
Upon receiving the bills, Tsy directs the Fed as govt's bank to credit the appropriate accounts and gets the reserves to clear through Tsy issuance.
Nothing controversial about this unless one thinks that the Fed is a private corporation, which it is not.
Some people here don't seem to understand English.
ReplyDeleteWhat's the point of studying a monetary theory that doesn't exactly describe any existing monetary system and gets the details wrong? MMT doesn't even accurately describe the USA where it was founded. What good is that?
ReplyDeletevimothy: "From its savings. And where did it get its savings from? From its income."
ReplyDeleteWhere did the income from come. Where did the investment come from. Firm revenue, primary investment and debt. Where did those come from?
The source has to stop either at bank credit or government issuance or both. TINA. Otherwise there is a vicious circle.
So are you claiming that bank credit is the only source of funding a country that issues its own currency like the US, UK, etc.?
Another way to see this is to say: what is saving? Saving is the flow of unconsumed income. So imagine that consumption is fixed at whatever the level of income is for all time, i.e., that there are no savings. Then, there are no funds to buy government bonds.
ReplyDeleteUnless govt adds the financial assets.
Tom, the point is when MMT says things like: "The funds to pay taxes and buy government securities come from government spending", they're misinterpreting the way the monetary system works.
ReplyDeleteMost of the funds to pay taxes and buy bonds come from private banks. Not the government. Very little money comes from the government. MMT gets all of this wrong. Its most basic points are all wrong.
And now you say something vague about reserves and the central bank settlement and you get that wrong too. Yet you don't even know why it's wrong and you have no interest in understanding why it's wrong.
Where did the private sector get its "funds" to buy tsys?
ReplyDeleteFrom its savings. And where did it get its savings from? From its income."
And where did it get it's income from? From net government spending.
…From its savings…"
A mathematical impossibility. This describes a running total operation across a closed system boundary, with new balances introduced from nothing by the government using keystrokes.
In the beginning there were no "funds" to borrow, or in a relative sense the level of funds was so insignificant as to be neglegible or very nearly zero.
Start at 1913 when the National Debt was $3 Billion. Assume every penny of that was currency (ridiculously conservative). The maximum amount of bonds that could be purchased over any budget cycle IF EVERY DOLLAR IN EXISTENCE WERE BORROWED would be limited to $3 Billion.
Rolling that over 100 times gets you to $300 Billion. How did we get to $16 Trillion?
There is new financial asset creation ==> there is financial wealth in existence after the operation that didn't exist previously.
New financial assets are issued into the economy, where they are recorded on non-government balance sheets.
This can't occur until the government enters them into the non-government system. Causation is clearly on the government side because net financial assets can be introduced without selling bonds to the public.
Increases in financial wealth are not limited to government bonds. $11 Trillion in bonds are held by the public which leaves nearly $5 Trillion in cash in the non-government.
Can anyone tell us where that cash came from?
"Marris: If you can get an MMT guy to stop talking about "NFAs" and rigourously look at what happens at the bond/cash/reserve level, then he starts to see the shakiness of his position."
ReplyDeletePaul, there's more to the economy than NFAs. MUCH more. But MMT always brings it back to NFAs because that's your only unique or insightful point. Too bad it's a narrow view of things and doesn't tell us even half the story about how things work.
"Most of the funds to pay taxes and buy bonds come from private banks"
ReplyDeleteAnother mathematical impossibility.
If bank funds were used to pay most taxes and buy bonds, the balances necessary to repay the loans would disappear.
Where would the funds come from to extinguish the liabilities?
Tom,
ReplyDeleteBank money is only a source of funding for the bank that issued it. Not only that, but in order for banks to acquire funds by issuing money, someone has to save. That's what SFC uses and sources approaches like Godley and Lavoie tell you.
Money is not income. Income is not money. It can certainly be confusing though, because in monetary economies money is the unit of account. So when you look at something like a consistency accounting or social accounting matrix, what you see is bunch of flows denominated in money. But still, the flows are not money.
When a firm sells a bond to the household sector, regardless of the quantity of bank or central bank money in circulation, for the funds to exist, someone somewhere has to save. In order for someone somewhere to save, they must have an income. The source of all funds in the economy is ultimately the income generated by the economy, i.e., economic output.
Unless govt adds the financial assets.
ReplyDeleteTom, The government cannot simply "add" the financial assets. It can borrow funds from the private sector. But in order to do that, the private sector would have to save. But this is exactly my point.
The 'private sector ' doesn't buy the bonds it is a DEALER market.
ReplyDeleteSo any 'detailed' analysis that doesnt take THAT into account is WORTHLESS GARBAGE that only a moron would think is valuable.
In 'the REAL WORLD', DEALERS buy USTs not 'the public'.
Rsp
@FDO15
ReplyDeletePaul, there's more to the economy than NFAs."
That's true but NFA's are the ultimate settlement balances in the non-government.
Credit expansion has a functional limit, and the balances must be paid back which is the reverse of spending.
Once agents in the economy accumulate wealth (savings) the possibility of repaying those loan balances is undermined - defacto impossible.
So I ask you, where will the USD balances come from necessary to repay those loans?
Basically my claim is it is impossible for capitalist economy to be viable without net creation of NFA's in a sufficient quantity to support both growth and savings desires.
@vimothy
ReplyDeleteThe government cannot simply "add" the financial assets."
You know that statement is not true. There is a substantial amount of NFA's in the form of dollar balances in the non-government.
No corresponding bonds are held by the public for those balances.
Paul said:
ReplyDelete"If bank funds were used to pay most taxes and buy bonds, the balances necessary to repay the loans would disappear.
Where would the funds come from to extinguish the liabilities?"
You've been brainwashed by MMT into thinking that money "disappears" when it's taxed. But that's not what really happens. It gets taxed and then spent by treasury right back into the private sector. All government taxing and spending is a redistribution. The money doesn't "disappear" like MMT pretends.
@FDO15
ReplyDeleteIt makes no logical sense to pay taxes or buy bonds with credit, because you have to repay it with income you haven't earned yet.
In addition you are paying interest.
If you didn't have th eincome to buy th ebond or pay your taxes in the first place what makes you think you will have it in the future, where you will again have to pay taxes.
Further, you have ignored the savings conundrum.
A significant subset of the dollar balances in existence are held by the top 0.1% and a significant subset of the bank liabilities are held by the 99.9%.
What we have here is a dog-bone economy where there are 10 dogs and about 7 bones, but it takes 10 bones to satisfy the loans.
Where will the bones come from, there's only one manufacturer.
You can't borrow money to pay the loan off if you don't have a job or your credit is maxed out.
Paul said:
ReplyDelete"It makes no logical sense to pay taxes or buy bonds with credit, because you have to repay it with income you haven't earned yet."
Where do you think most of the money in the economy comes from? It comes from people who have borrowed money from a bank and spent it out into the economy adding to other people's incomes and saving. Remember the "loans create deposits" thing that you guys always shove in other people's faces? Yeah, those deposits came from other people who borrowed. If MMT doesn't understand even this basic fact then I am afraid there is no hope for your theory.
JK "The necessary level of exactness changes depending on what you are analyzing. MMT is not saying that exactness doesn't matter, rather, the scope of the analysis determines what level of exactness is necessary."
ReplyDeleteThe way the MMT economists have put is that they break all this out in papers for professionals who understand the field. However, it blogs they attempt to simplify the presentation down to bare essentials so the rest of us can understand it. If you want the details, go read the papers if you have the chops to do so.
@FDO15
ReplyDelete"adding to other people's incomes and saving",
…and subtracting from other people's incomes and saving in an equal amount.
Do you not think that enters into the equation?
Bank money cannot increase savings in the aggregate. Every loan issued cancels to zero on balance sheets.
In the aggregate credit can't increase financial wealth.
When people claim that savings can increase even when the government runs a surplus (true) they are ignoring the fact that offsetting liabilities cancel out most of those savings.
Net savings can't increase. Net savings is the only meaningful metric in a stable economy.
If you have $100,000 in savings and &150,000 in liabilities how much is your savings worth?
Otherwise I would like to borrow $10,000 and trade the loan (and liability) to you for $9000 cash.
You'll make $1000.00 on the deal - obviously the liability doesn't matter.
@Tom and JK
ReplyDeleteIronically semantics doesn't score well when it comes up against the tyranny of the arithmetic.
@paul,
ReplyDeleteHave you ever taken out a loan? If I take out a loan to buy a new home tomorrow (let's say for $100) that doesn't reduce my current income by $100. In fact, it increases someone else's income by $100. The loan creates a deposit and I spend the money into someone else's bank account. I didn't lose $100 by taking out the loan. It didn't "subtract" from my income. In fact, the loan might increase my income.
Now, the loan doesn't increase the net worth of the private sector necessarily (it might), but that's a different point. You don't seem to understand even the most basic points about how things work.
@ vimothy,
ReplyDelete"The source of all funds in the economy is ultimately the income generated by the economy, i.e., economic output."
False. Money in a credit based system only comes from the creation of a liability on someones balance sheet - either the governments or the private sectors (the bank). Granted the liability may have been issued to allow someone to buy a real good or service but it was created on a balance sheet - not in the real economy.
Tom.
ReplyDeleteDo you which MMT paper(s) address the topic at hand here… the operational mechanisms of deficit spending?
Do they have anything comparable to JKH's contingent institutional apporach?
A paper title and author, or a link, would be great. Thanks.
Adam1,
ReplyDeleteBank deposits are use of funds for everyone except banks. If banks are to issue money, somebody somewhere will have to save.
JK, I am not the go-to person on this. If Scott is following this, maybe he'll chime in. If not, ask one of the MMT economists. Stephanie is @deficitowl and Scott is @stf18 on Twitter.
ReplyDeleteProbably the place to start is Scott T. Fullwiler, Modern Central Bank Operations – The General Principles (June 1, 2008) if you are not familiar with it already.
@ vimothy,
ReplyDeleteBank's don't issue money they create deposits (which most people treat as "money"). How do they create deposits (a bank LIABILITY), the issue loans. All base money is a government liability (Treasury debt or FED liability). The real economy produces real goods and services. A bank will not accept a car as deposit, however it will issue you a loan to buy the car which will end up as the car manufacturers deposit.
The financial system and the real economy are inter-twined but they are actually separate entities.
Households and firms can net save individually in an closed net-zero system. But in aggregate, financial assets net to zero as a result of DBA. Unless financial assets enter the system from outside, there are no net financial assets since inside financial assets net to zero.
ReplyDelete@FDO15
ReplyDelete"If I take out a loan to buy a new home tomorrow (let's say for $100) that doesn't reduce my current income by $100."
It does when you pay it back - $100 plus interest.
Funds used to satisfy liabilities subtract directly from spending, both for you and the economy as a whole.
Paying off debt removes dollars from the economy just the same as if you burned it. No one gets the benefit of the income it subtracts from.
There is a common belief among many posters here and on other blogs that liabilities are nothing to worry about.
Dollar liabilities are negative money. They subtract from income over time.
And at the risk of sounding like a broken record, an economy that relies on credit for it's needed spending is doomed to fail, there is no alternative.
There is no escape from The grim "tyranny of the arithmetic".
I'd like to interject from the perspective of a bank (since I work for one)...
ReplyDelete1) The US treasury as a single government entity is a currency users. It must have reserves in its FED account to spend (with the exception of possible intraday overdraft privileges which are actually for the FED's benefit)
2) Only PRIMARY DEALERS can buy US treasuries. Deposits are NEVER used to purchase a treasury note. Deposits are a liability to the bank and belong to bank customers (yes depositors may swap deposits for treasuries as they add them to portfolios but that is actually a secondary accounting transaction). A bank can only us bank reserves to buy a US treasury unless it is crediting a TT&L account held on its balance sheet, but still needs to use/have reserves when the treasury draws those funds to it FED account (just like any settlement transaction - it requires reserves).
Now down to business... A bank seeks to add profitable income generating assets to its balance sheet. The FED has a target interest rate tied to a money market - historically the Federal Funds Market (the inter-bank overnight lending market). The bank knows that it can indirectly borrow and infinite amount of reserves at that rate. As long as the US treasury is OK with an interest rate that is some profitable level above the FED's target interest rate there is an infinite supply of reserves in the banking system (compliments of the FED's LEGAL obligation to protect the payment system) to buy those US treasuries.
So, unless the banking system finds some reason to believe they can't make money off of buying US treasuries the US Treasury can issue as much debt (and acquire as much reserves) as it wishes - subject to its acceptance of paying a slightly higher interest rate of the current FED target interest rate.
This is exactly what Marriner Ecceles means when he says... "Mr. ECCLES. Well, as I remember the discussion—and I have referred to it in this statement—there was a feeling that this left the
door wide open to the Government to borrow directly from the Federal Reserve bank all that was necessary to finance the Government deficit, and that took off any restraint toward getting a balanced budget.
Of course, in my opimon, that really had no relationship to budgetary deficits, for the reason that it is the Congress which decides on the deficits or the surpluses, and not the Treasury. If Congress appropriates
more money than Congress levies taxes to pay, then, there is naturally a deficit, and the Treasury is obligated to borrow. The fact that they cannot go directly to the Federal Reserve bank to borrow
does not mean that they cannot go indirectly to the Federal Reserve bank, for the very reason that there is no limit to the amount that the Federal Reserve System can buy in the market. That is the way the war was financed. Therefore, if the Treasury has to finance a heavy deficit, the Reserve System creates the condition in the money market to enable the borrowing to be done, so that, in effect, the Reserve System indirectly finances the Treasury through the money market, and that is how the interest rates were stabilized as they were during the war, and as they will have to continue to be in the future. So it is an illusion to think that to eliminate or to restrict the direct borrowing privilege reduces the amount of deficit financing. Or that
the market controls the interest rate. Neither is true." - page 11.
http://fraser.stlouisfed.org/docs/historical/house/1947hr_directpurchgov.pdf
All that said and done, to me, it seems to be semantics as to whether or not, under normal circumstances, (and even under abnormal circumstances I can't imaging the laws not changing) the US Treasury is fiscally constrained in its spending. The US Treasury always has a ready buyer (FED enabled) of its debt - assuming it is attempting to sell at a rate that is profitably higher than the FED's target interest rate.
@Paul,
ReplyDeleteAside from brief blips the total debt owed never falls so the income to pay interest comes from perpetual debt accumulation. So again, you're just making up things to satisfy your failed theory.
http://research.stlouisfed.org/fred2/series/TCMDO
Paul, "There is no escape from The grim "tyranny of the arithmetic".:
ReplyDeleteAnd, as Michael Hudson would say, the tyranny of compound interest. It not just the loan principal. Without an outside add, an inside system running compound interest is a debt time bomb.
Adam, the problem is in saying things like "spending comes first" or "bond issues are just a reserve drain". What you've just described (accurately mind you - I too am a banker) is not the MMT story. It might be consistent with components of MMT, but it is not the MMT story as told by Warren Mosler and others. Unless the goal posts are shifting as we speak.
ReplyDelete@FDO15
ReplyDelete"Aside from brief blips the total debt owed never falls…
Aside from brief blips the total deficit spending never falls…
Wonder if there is a correlation?
We have the Eurozone as an example.
A credit-based monetary economy and failure within 10 years of inception. The worst hasn't even happened yet.
Note that the only reason the Eurozone is still standing is because of fiscal transfers via the ECB,which is technically illegal.
Just a coincidence I'm sure.
That was me above. Sorry. It's getting late here.
ReplyDelete@ Paul,
ReplyDeleteAn economy does not need public debt to perpetually expand. In fact, many economies run perpetual budget surpluses and get along just fine. They just need a trade surplus as well. It's possible. Look it up.
What's impossible is for private debt to stop growing and still expand the domestic economy. One is necessary, the other is not.
"It might be consistent with components of MMT, but it is not the MMT story as told by Warren Mosler and others."
ReplyDeleteI really only see it as semantics. Does it matter if the Treasury just runs a continuous overdraft at the FED and later issues bonds to absorb the excess reserves or as we currently work non-transparently have the FED to indirectly insure sufficient reserves to guarantee bond sales.
As Marriner says, the only difference is the price the US Treasury pays in interest which it can always pay by issuing more bonds which have ready and willing buyers ensured by the FED's legal obligation to defend the payment system.
It's like arguing about the solvency of a central bank in its currency of issue. Yes it can happen by technical means of accounting, but is it worth losing sleep over or rationally spending energy arguing over?
I would argue that the details matter enormously here. The Treasury is a currency user and it must find willing buyers of its debt. If, as you noted, the dealers are not willing buyers then the Fed must monetize the debt and this shows that the treasury's money is only good to itself (for whatever reason - perhaps hyperinflation or exchange collapse).
ReplyDeleteSo yes, the details matter and should't just be shrugged off as "semantics". Anyhow, the Open is back on shortly and it's late here. Thanks for entertaining my presence once again. Hopefully some of you are beginning to see where I am coming from.
"So yes, the details matter and should't just be shrugged off as "semantics"."
ReplyDeleteYes the details do matter... like the real world we live in. There are nearly 200 sovereign fiat currencies in the real world and they issue debt at about the same rate level as their central banks target interest rate. Except in that "tail" scenario (which I don't think any MMT'er would deny - that's what footnotes and exception are for) why do you insist on quibbling over how many i's were crossed and tee's were dotted. Normal human conversation is NEVER consistently that precise.
"... it must find willing buyers of its debt."
ReplyDeleteFor what it's worth this is what Marriner says about your thoughts, "Those who inserted this proviso[preventing direct funding of treasury spending] were motivated by the mistaken theory that it would help to prevent deficit financing. According to the theory, Government borrowing should be subject to the "test of the market." The so-called test could only be applied to marketable securities, and the test would be meaningless unless applied to them in an entirely unregulated market. There could be no such market except at the risk of chaotic conditions in the bond market and incalculable added costs to the Government in managing the public debt."
Who needs details when you have a political agenda, a "black box" and don't care for accounting accuracy?
ReplyDeleteI don't have any problem with details and I'm certain I've shown that. As for political agenda all I want is for people to more or less understand how the system generally works and to stop buying crap logic presented by so called "very smart people". I don't expect everyone to want or understand the minutia of detail but I'm more than happy to one on one discuss my understandings. What I continuously see from you is consistent nitpicking attacks about details that in the tails may be important but are 99.999999% of the time just nothing more than 50 shades of grey or diversions. Which makes me question your agenda sir.
ReplyDeleteAdam1" "that's what footnotes and exception are for) why do you insist on quibbling over how many i's were crossed and tee's were dotted. Normal human conversation is NEVER consistently that precise."
ReplyDeleteThis is the point that Scott F. makes. A general description strips a system down to the essentials needed for a basic explanation. The detail can be filled in from there as it becomes necessary. If MMT economists were writing about that level of detail in their blogs who would be reading them? For sure, not me.
I am very pleased they started with a bare bones explanation to get me going. Over time I have filled in a lot of details. There is an opportunity cost involving time and energy. Expenditure on one thing knocks out the next next choice and everything below it. I am at about the level now that I am comfortable with.
I have no intention of working through balance sheets, income statements and flow of funds accounts, NIIP, etc. at this stage of my life. All I need to know is what they are and how they work. That's enough detail.
I have other more pressing priorities for my limited time and energy. I'll let the people who are into it pore over the figures and then try understand the essentials of what they report as conclusions.
There's a saying…
ReplyDelete"it's better to be mostly right than precisely wrong"
It seems apropos to the discussion going on in this thread.
I expect there will be much disagreement over who is mostly right though…
The present setup is a facade. The Fed auctions tsys to the PD's who are the sole bidders. They are the market makers for the tsy market and expand and contract their balances sheets as market makers. They know that the Fed has unlimited capacity to exchange rb for the tsys they buy at auction and if their balance sheets become heavier then then like, they know that the Fed will take them onto its balance sheets, which the Fed can always do if it pays IOR. Then the quantity of rb is irrrelevant and the Fed can set the FFR it chooses based on IOR.
ReplyDeleteObjectors think that by doing this the Fed will create inflationary bias by expanding the monetary base. A correct understanding shows that this is false because the amount of rb is irrelevant. As LLR, the cb will always provide liquidity as required and banks know that they can borrow at the Fed's rate. It's the price that is significant not the quantity of rb.
And as Adam1 points out, if the Tsy sets it interest rate on tsys enough above the Fed's rate, then there will always be buyers anyway because it is essentially "free money." Now that may not hold for every country, but we are talking about present day US here and the foreseeable future. Hyperinflation coming? Really?
Adam1,
ReplyDeleteYou say that banks don’t issue money, but then in the same sentence you say that banks create deposits, which most people treat as money—which seems like a contradiction to me. If you prefer the word “create” to the word issue, that’s okay, but it does seem a bit pedantic.
Either way, as you will know if you are a good MMTer, in order for someone to borrow surplus funds, someone has to have surplus funds to borrow. I think that’s the grim tyranny of arithmetic that Paul is so keen on.
In fact, I’ve just reread your comment and it seems like a bit of a non sequitur. What I’m saying is that, in order for there to be money, someone has to save. In order for there to be saving, someone has to earn. In order for someone to earn, there has to be production and exchange.
ReplyDelete"In fact, I’ve just reread your comment and it seems like a bit of a non sequitur. What I’m saying is that, in order for there to be money, someone has to save. In order for there to be saving, someone has to earn. In order for someone to earn, there has to be production and exchange."
ReplyDeleteNeither production, exchange or savings produce 'dollars' or 'euros' per se.
Mixing apples and oranges again. Come on guys, try harder, you can do better. A 2 years old which hasn't been brainwashed by cognitive biases and social memes can do it better, it's a basic logic operation learned between the age of 2 and 4.
@vimothy
ReplyDelete"In order for there to be saving, someone has to earn"
This isn't strictly true. Someone has to have income, which is not necessarily earning. People have money given to them as gifts, transfer payments, etc.
Earning implies labor or effort is involved.
"In order for someone to earn, there has to be production and exchange."
This isn't strictly true either.
re the "tyranny of the arithmetic", that is a reference to the natural decaying processes in a capitalist economy (or any closed system) that require injection of new financial assets into the system other than credit to account for growth, leakages and saving, which is a kind of leakage.
Re your arguments presented in this thread and others supporting the notion that the system is self-funding or the government borrows it's funds from the system, they fail the tyranny of the arithmetic because they have causation backwards and violate system arithmetic.
There is no process within the system that can increase the net cash or net bonds in the system. Such an event is contingent upon a source external to the system.
The government is the only entity that can issue cash or state-backed bonds.
@ vimothy,
ReplyDelete“You say that banks don’t issue money, but then in the same sentence you say that banks create deposits, which most people treat as money—which seems like a contradiction to me. If you prefer the word “create” to the word issue, that’s okay, but it does seem a bit pedantic.”
In the grand scheme of day to day discussions it really is here nor there (I didn’t mean to sound overly picky). That said I do believe I correctly recall a conversation a couple weeks ago regarding the monetary base. The monetary base is the only real money “issued”. Deposits exist in far larger amounts than there is monetary base money issued. Most deposits are nothing more than entries “created” on a bank’s balance sheet. A deposit is really a promise by the bank to make good on some future payment – how that happens is the banks problem (from the depositor’s perspective).
@ vimothy,
ReplyDelete“Either way, as you will know if you are a good MMTer, in order for someone to borrow surplus funds, someone has to have surplus funds to borrow. “
When a bank makes a loan it does NOT lend out surplus funds – it does not lend out other peoples savings. While you and me and the loan shark down a dark alley do lend out prior savings, banks have not lent out surplus funds for a couple hundred years.
A fractional reserve bank operates by making payment promises. If I have a deposit at the bank the bank has in effect promised to clear and settle all payment requests I issue against my account (assuming I’m not trying to overdraw that is). If I write a check to another customer of the same bank the bank just adjusts balance sheet entries tied to my account and my friends account (both liabilities on the bank’s balance sheet). If I write a check to a customer at another institution the bank reduces my deposit account (it’s liability) and settles the payment with the other bank by also reducing the banks reserves (it’s asset) my the amount of the payment settlement. The other bank increases its reserves and its customer’s deposit account.
When you obtain a loan a very similar process occurs. A loan is really nothing more than a promise by the bank to clear and settle a payment on your behalf. Let’s use an example of buying a car. You go to the bank and ask for an auto loan. The bank agrees (assuming it finds you credit worthy) and (for simplicity let’s assume…) issues you a check. You then take that check to an auto dealer who accepts it as payment for a car. The auto dealer now deposits that check at its bank. If it’s the same bank that you obtained the loan from then the bank does nothing more than credits the auto dealer’s bank account. The bank now magically has a new deposit and a new loan on its books. If we rolled the whole banking system up into one entity the process ends right here (if the bank faces a regulatory reserve requirement there are a couple additional steps and I’ll get to those in a minute). Bank creates loan and creates deposit – done. Bank made and kept a promise to its borrower to clear and settle a payment; however it has now created future promises to its depositor who received the loan check as payment.
Going back to our auto dealer and the check… The auto dealer could have deposited that check at another institution. Again the same clearing and settlement process would occur. The issuing bank would have to reduce its reserves by the amount of the loan check (reserves down; loan account up – both asset transactions) while the deposit accepting institution would increase its reserves (asset) and its customers deposit account (liability).
As you can see a bank is really making promises to both its borrowers and its depositors and depending on how the transactions hit its balance sheet it may or may not need reserves to settle the transaction. That said, a bank needs reserves to ensure it can keep its promises to clear and settle payments should those payments require an inter-bank transaction. The cheapest way to obtain those reserves is to attract depositors – not because you need their deposits but because when a bank accepts a deposit from a customer that is coming from somewhere other than its own balance sheet it is also drawing reserves onto its balance sheet as part of this transaction. It’s the cheapest form of obtaining reserves because depositors are typically paid the lowest rates. Alternatively the bank could seek additional reserves by borrowing on the overnight inter-bank lending market; it could issue a longer term bond; or in a pinch it can borrow directly from the central bank’s discount window. Deposits and other means of obtaining reserves is just the cost of running its payment operations which are necessary for it to keep its promises.
If a bank faces a reserve requirement it just means that as loans and deposits are created it must seek out additional reserves at the best price (rate) it can obtain.
Anonymous,
ReplyDeleteSince the scope of discussion is so wide, rational people will disagree. In fact, I would characterise rationality as the ability to disagree. On the other hand, irrational people will shout and stamp their feet and call each other names. So, a general rule of thumb I rely on when reading discussions on the internet is to discount the views of commenters who can’t express their arguments without insulting those who disagree with them.
It’s not an iron-clad law or anything, because I know how easy it is for arguments to overheat. But still, rather than calling people names, why not open your mind to different views a little bit? Not everyone who disagrees with you does so because they are stupid. You might even discover something true and unknown to you.
Anyway, you say that neither production nor exchange produces dollars or euros per se. In fact, I agree with this and it is consistent with the point I am making. In order for there to be an asset of any kind, somebody somewhere must have saved some of their income. And in order for there to be savings of any kind, there has to be assets. That is true of financial assets like money or government bonds, and it’s also true of tangible assets like factories and machinery. Although it’s kind of boring to think these things through or to spend all day staring at accounting identities and matrices, if you do so you’ll end up in the same place.
A basic macroeconomic relationship linking saving and asset accumulation says that for any economic entity, saving plus borrowing equals asset acquisition. This is why intra-sector financial assets net out on aggregation: if we imagine that there is no investment, it’s easy to see that saving will equal borrowing, since on aggregate, the entity is lending to itself. It’s also easy to see that there can’t be any borrowing if there isn’t any saving (if everyone consume all of their income, no one person can consume more).
Where does money come into this? If follows from the above discussion that wealth or saving if it exists has to be allocated to assets. Money is a type of asset. We can see that no savings means no assets means no money. On the other hand, the reverse is not true. All savings are not money (hopefully that’s obvious).
So as long as the economy carries some positive quantity of wealth (i.e., savings exist), this wealth can be held as money. Or government bonds. Or fixed capital. And so on.
@vimothy,
ReplyDelete“Either way, as you will know if you are a good MMTer, in order for someone to borrow surplus funds, someone has to have surplus funds to borrow. “
When a bank makes a loan it does NOT lend out surplus funds – it does not lend out other peoples savings. While you and me and the loan shark down a dark alley do lend out prior savings, banks have not lent out surplus funds for a couple hundred years.
A fractional reserve bank operates by making payment promises. If I have a deposit at the bank the bank has in effect promised to clear and settle all payment requests I issue against my account (assuming I’m not trying to overdraw that is). If I write a check to another customer of the same bank the bank just adjusts balance sheet entries tied to my account and my friends account (both liabilities on the bank’s balance sheet). If I write a check to a customer at another institution the bank reduces my deposit account (it’s liability) and settles the payment with the other bank by also reducing the banks reserves (it’s asset) my the amount of the payment settlement. The other bank increases its reserves and its customer’s deposit account.
When you obtain a loan a very similar process occurs. A loan is really nothing more than a promise by the bank to clear and settle a payment on your behalf. Let’s use an example of buying a car. You go to the bank and ask for an auto loan. The bank agrees (assuming it finds you credit worthy) and (for simplicity let’s assume…) issues you a check. You then take that check to an auto dealer who accepts it as payment for a car. The auto dealer now deposits that check at its bank. If it’s the same bank that you obtained the loan from then the bank does nothing more than credits the auto dealer’s bank account. The bank now magically has a new deposit and a new loan on its books. If we rolled the whole banking system up into one entity the process ends right here (if the bank faces a regulatory reserve requirement there are a couple additional steps and I’ll get to those in a minute). Bank creates loan and creates deposit – done. Bank made and kept a promise to its borrower to clear and settle a payment; however it has now created future promises to its depositor who received the loan check as payment.
Going back to our auto dealer and the check… The auto dealer could have deposited that check at another institution. Again the same clearing and settlement process would occur. The issuing bank would have to reduce its reserves by the amount of the loan check (reserves down; loan account up – both asset transactions) while the deposit accepting institution would increase its reserves (asset) and its customers deposit account (liability).
As you can see a bank is really making promises to both its borrowers and its depositors and depending on how the transactions hit its balance sheet it may or may not need reserves to settle the transaction. That said, a bank needs reserves to ensure it can keep its promises to clear and settle payments should those payments require an inter-bank transaction. The cheapest way to obtain those reserves is to attract depositors – not because you need their deposits but because when a bank accepts a deposit from a customer that is coming from somewhere other than its own balance sheet it is also drawing reserves onto its balance sheet as part of this transaction. It’s the cheapest form of obtaining reserves because depositors are typically paid the lowest rates. Alternatively the bank could seek additional reserves by borrowing on the overnight inter-bank lending market; it could issue a longer term bond; or in a pinch it can borrow directly from the central bank’s discount window. Deposits and other means of obtaining reserves is just the cost of running its payment operations which are necessary for it to keep its promises.
If a bank faces a reserve requirement it just means that as loans and deposits are created it must seek out additional reserves at the best price (rate) it can obtain.
@ vimothy,
ReplyDelete“What I’m saying is that, in order for there to be money, someone has to save. In order for there to be saving, someone has to earn. In order for someone to earn, there has to be production and exchange.”
Two points… If you read my description above of bank operations you will realize that savings is not needed for lending. While your typical economist says savings leads to investment (performed via borrowing) he actually has the causality backwards because most economists assume bank operations away and therefore do believe banks lend out other people’s money. But once you understand how a bank works you can see that the bank lends out the money which creates an injection of demand into the economy which allows another party to save money (leakage) without reducing demand. It is the lending (ideally via productive investment) that allows for savings to accumulate.
The other point is you need to follow the monetary transactions. You could have worked all day and been paid in bananas or coffee or some other real economic output. However I’m assuming you intend to save monetary assets (i.e. money). If so then it means you were paid in a monetary asset (ie. currency, a deposit, etc…) which means you need to ask yourself where did your employer get that monetary asset from. If you trace the monetary transactions back to their creation you will find out that it was either created by a vertical transaction (the government created it) or by a horizontal transaction (a bank issued a loan creating a deposit).
Adam1,
ReplyDeleteI think you make a valid point.
The issue of what really constitutes money is something that has troubled thinkers for a long time, so it doesn’t seem to be a question that can be settled in a decisive way. It’s common, though, to refer to different types of money. The most significant distinction that is usually made is between base, narrow, or outside money, which is the money issued by the central bank, and broad or inside money, which is the money (or if you prefer, the “money substitute”) issued by banks (and potentially other financial institutions).
I think that in a lot of contexts it can be helpful to retain the word “money” for central bank notes alone, and refer to money in the broader sense in terms of liquid bank liabilities or whatever the particular asset in question might be. In other contexts though, it can make sense to refer to them both as money, since they hold some characteristics in common. One of the problems that economists have is that money has a particular function, and so if something seems to perform like money, it seems hard to argue that it’s not, and from a sufficient distance, all the different classifications of assets into money and not-money seem a bit arbitrary and unsatisfying.
In the non-government there (3) classes of state-backed "money things" exist:
ReplyDelete• dollars
• dollar liabilities
• government-issued bonds held by the public
Not that complicated.
Vimothy: "In fact, I’ve just reread your comment and it seems like a bit of a non sequitur. What I’m saying is that, in order for there to be money, someone has to save. In order for there to be saving, someone has to earn. In order for someone to earn, there has to be production and exchange."
ReplyDeleteWhere do the savings come from? Income. Where does the income come from? Some one ele's savings or income or borrowing. Is all borrowing borrowing savings? This is a circular argument. The currency has to come from somewhere and "currency" implies it comes from the government because currency is "state money."
The other part of the tyranny of arithmetic is depreciation of real assets. Add that to compound interest and go figure.
ReplyDeleteAll saving has to be spent and more private borrowing has to increase just to keep the system at a steady state.
There can be no growth without outside money, And without it over time depreciation will kill an economy.
The accounting is brutal.
vimothy: "In order for there to be an asset of any kind, somebody somewhere must have saved some of their income. And in order for there to be savings of any kind, there has to be assets. That is true of financial assets like money or government bonds, and it’s also true of tangible assets like factories and machinery. Although it’s kind of boring to think these things through or to spend all day staring at accounting identities and matrices, if you do so you’ll end up in the same place.
ReplyDeleteWhat about Lincoln's greenbacks that financed the Civil War without borrowing? Some were in circulation for over a hundred years.
Governments can and do create currency out of nothing, and the currency is a non-govt asset and a govt liability in terms of accounting. This is an add from outside, and it is called "outside money." Within the system as a whole, government and non-govt, the net is zero, but wrt non-govt only, when there outside added net financial assets are injected into non-government from outside.
These net financial assets could be of zero maturity, like greenbacks, or they could non non-zero maturity, like tsys.
Zero and non-zero govt liabilities are fungible through collateralization, which is, in fact, what happens. It is what modern banking is based on.
If the govt went to direct issuance with no issuance of tsys, banking would change drastically. Which is way Warren allows very short term tsys with yields slightly greater than the interest rate.
vimothy: "The issue of what really constitutes money is something that has troubled thinkers for a long time, so it doesn’t seem to be a question that can be settled in a decisive way."
ReplyDeleteOf course it can by technical and operational definition. This is what the operational aspect of MMT is all about.
The arguments are over whether the operational description is properly specified.
The problems arise over ambiguities in the meaning of "money" due to differences in use of the term in context. The way to clarify is by showing the specific uses in different contexts.
Yes, it is nuanced because ordinary language is "meaning-rich" and makes a few key terms cover a lot of ground. Rigorous thinkers realize this an attempt to use technical and operational definitions in their fields to avoid misunderstanding and confusion.
Off-topic, but there's an embedded message that is prescient (Daring Fireball):
ReplyDelete"Speaking of Microsoft, Gray Knowlton from the Office team has a long piece on the touch-focused aspects of the new Office 2013:
"In this post I’ll walk you through the thinking, engineering process and design framework we used to reimagine these experiences for touch."
They’ve obviously put a ton of thought into this. The question is, do you need to read a 4,000-word explainer to understand how it works?From a user’s perspective, the design process is meaningless, especially for touch interfaces. You see it, you touch it — that’s it. And if that doesn’t work, it’s a failed design."
Tom,
ReplyDeleteCan you define money, then?
Vimothy (I'm previous anon), I'm not insulting, I'm stating a fact.
ReplyDeleteNothing of what you listed 'units of accounts'. Unit of accounts is what MONEY is.
Not so hard and complicated matter in fact, people over complicates it. There are money-things (financial assets like MBS could acquire the quality of money things at some point and be used to leverage 'real money') and 'money'.
Money = units of accounts to account for economic transactions. Don't overcomplicate it. Money = dollars, euros, etc.
So no, neither productions, transactions or 'saving' does produce money. This terribleness Austrian economics mindset of mixing the nominal monetary system with the real production and economic system is disastrous.
Monetary and financial economy will NEVER correspond with the real production economy. Sa vings of monetary assets will NEVER represent real wealth.
Actually is easy to understand if you check how markets operate and how price action operates. There is a feedback loop (sometimes positive) between prices and flow of monetary assets. That's why we have phenomenons like inflation or deflation.
Off course you need a real economy to have a financial economy, but no real activity produces money per se, sometimes there is a dislocation of the demand and supply of monetary economy and the demand and supply of the real economy. BTW 'saving' in monetary assets doesn't produce new assets per se neither. And saving in 'real' assets DOESN'T produce monetary assets NEITHER.
Saving in 'real' assets in necessary to produce later, you need capital goods to invest and develop new goods. But saving in capital good is not the equivalent of saving in monetary assets. If everyone puts their capital goods at the market there will be a change in the marked-to-market prices and viceversa (this is the sort of feedback I talk about), also there is a time variable in the function of price, as the money created by credit when you for example bought a real good is not the equivalent of today's monetary unit neither the 'real value' of the capital good is the same (it probably is less).
Overall this is why we have 'market economies' and finances, because there isn't a practical way to mix up monetary (nominal) and non-monetary (real) parts of the economy and we need arbitraging to solve this problem.
Why the hell economists, 'asutrians' and everybody tries to mxi them up again when they are clueless I don't know.
Repeat with me: no, financial and monetary part of the system are and never will be a 1:1 representation of the economy.
So the big takedown of MMT is the idea that "wealth" is not created by the government???
ReplyDeleteSo I could tutor the neighbor's daughter in math in exchange for babysitting. And we did it all without deficit spending. What is interesting about that.
This reminds me of JKH's 10 cows. It's not interesting that the farmer creates this new "wealth". It's interesting to think about how the new cows will help him extinguish his tax liability. Or how the cows will pay for more police.
Maybe there's a deeper debate I am missing.
Can you define money, then?
ReplyDeleteIf this is asking for an essence, no. Money is a complex concept in which a single terms covers many uses. "Money" is the label of a set of more specific concepts. There is no clear boundary demarcating the set that can be given as a characteristic defining the set, because there is disagreement over what what falls into the set, i.e, the proper use of the term "money."
"Money" has a lexical definition found in dictionaries. Here is Merriam Webster
Definition of MONEY
1
: something generally accepted as a medium of exchange, a measure of value, or a means of payment: as
a : officially coined or stamped metal currency
b : money of account
c : paper money
2
a : wealth reckoned in terms of money
b : an amount of money
c plural : sums of money : funds
3
: a form or denomination of coin or paper money
4
a : the first, second, and third place winners (as in a horse or dog race) —usually used in the phrases in the money orout of the money
b : prize money
5
a : persons or interests possessing or controlling great wealth
b : a position of wealth
money table
— for one's money
: according to one's preference or opinion
— on the money
: exactly right or accurate
 See money defined for English-language learners »
See money defined for kids »
Examples of MONEY
1. That painting must be worth a lot of money.
2. He earned some money last summer as a musician.
3. We're trying to save enough money for a new car.
4. The town is raising money for the elementary school.
5. Friends would always ask her for money.
6. It's an interesting idea, but there's no money in it: it'll never sell.
7. He made his money in the insurance business.
8. They decided to put all their money in the stock market.
9. We didn't have much money when I was growing up.
10. Most of the project is being paid for by federal monies.
Origin of MONEY
Middle English moneye, from Anglo-French moneie, from Latin moneta mint, money — more at mint
First Known Use: 14th century
There is the economic definition in terms of function: unit of account, medium of exchange, store of value, and standard of deferred payment.
There is also a theoretical definition in QTM
There are operational definitions such as MO, base money-HPM, narrow money (UK), M1, M2, and M3.
In MMT and MCT, "inside" and "outside" money, "vertical" and "horizontal" money, "endogenous' and "exogenous" money, "credit money," "state money," and money interms of financial assets, e.g., "net financial assets."
There are stipulated and rhetorical definitions, too, such as "hard" and "soft" money.
@adam1
ReplyDeleteif you haven't already, you should consider writing an essay on banking operations. your style and clarity seems ideal for mass-consumption.
I'd read it.
Adam1,
ReplyDeleteThanks for taking the time to write your argument out in such detail. I’ve actually been reading post Keynesians and MMTers (amongst others) for many years now and I feel like I’m pretty familiar with the general thrust of it, but it’s still nice to see it laid out so crisply.
I also agree with what I take to be its core principle, which is that, for the financial system, “loans create deposits.” How can that be, when I’m saying that there can be no money without savings?
What I’m saying is that without positive quantities of wealth or savings, there can be no money stock. I think that you’re saying something different. You’re saying that when the banking system makes a loan, the deposit that ultimately finances the loan is created at the same time. It’s a useful perspective because it’s common to view money as a kind of weird exogenous thing that people already possess and then suddenly one day decide to put in the bank—as opposed to something that is a product of the banking system itself.
It’s not the whole story though. Only in the trivial case when the bank is lending to and borrowing from the same entity can it create money without having to find savers. Otherwise, no one will be willing to hold its liabilities. When you aggregate over the whole economy financial assets equals liabilities and it’s all a wash. But in order for there to be anything to aggregate, there must be activity at the individual level as well. At the individual level, the depositor and lender are not the same.
Since they are not the same, it doesn’t simply wash out. This means the usual rules apply. Depositors need sources of funds and lenders need uses. In other words, what happens when banks lend has to take place in the context of income-expenditure and saving-investment flows.
Adam1,
ReplyDeleteWhile your typical economist says savings leads to investment.
Actually, I’ve never heard an economist make that claim. In my experience it’s more that your typical blogger says that your typical economist says saving leads to investment.
It’s not a feature of economic theory at any level, as far as I’m aware. Economists say that in equilibrium, saving equals investment. Saying that saving leads to or causes investment would be like saying that supply causes demand or that 2+%=/. It’s not really a well formed statement.
@vimothy
ReplyDelete"…without positive quantities of wealth or savings, there can be no money stock."
Does it not follow from this that without net government spending there cannot be positive quantities of savings (I'm referring to net savings here, applying liabilities)?
There could be savings but no net savings in the aggregate, so how could it be positive?
Using your preferred definition of savings it is only positive if liabilities are ignored. I don't think you can do this and make a cogent argument.
Wealth is another issue, as it is only a number on paper, measured in the unit of account that is some multiple of the real ability of agents to spend (leverage).
Wealth without NFA is simply bubble wealth and unsustainable.
At any rate the money stock is not a function of wealth, it's a function of spending.
It is quite possible for an agent to be wealthy but unable to spend (land-poor comes to mind).
And the money stock cannot affect savings (net savings, the only kind with any mathematical relevance in the system) without net government spending (assuming a balanced CA).
Sorry, bit of a mistake in my comment which I should probably correct:
ReplyDelete"Since they are not the same, it doesn’t simply wash out. This means the usual rules apply. Depositors need sources of funds and borrowers need uses."
Tom,
There can be no growth without outside money, and without it over time depreciation will kill an economy.
If we think about a sustainable amount of saving, then an obvious candidate is a level that equates the rate of saving to the rate of depreciation, i.e., the level of saving that keeps the capital stock constant. This is known as the “golden rule” solution to Ramsey’s famous model. It is sustainable indefinitely.
I’m not sure what you mean by the statement, “there can be no growth without outside money”. Can you explain? In what sense is it true?
Paul,
ReplyDeleteAggregate saving and net saving are not the same thing.
So aggregate saving can be positive even if net saving is zero.
The reason for this is that "outside" assets aren't the only type of assets that don't attach to liabilities within the sector and wash out when you aggregate up.
The reason for this is that as well as making loans to one another, we can also invest our savings in the capital stock of the economy. In such cases there are assets that don't net out on aggregation.
Imagine a borrow $1 million from you. I spend it much of it on booze and loose women, and waste the rest. Your asset (a loan to me) equals my liability (a debt to you). So our saving and dissaving cancel each other out.
But say instead that I use that loan to buy a widget making company. Now the situation is that you saved and lent the money to me, but I did not dissave. Instead I invested.
Now I have an asset and I liability, and you have an asset. When we sum these up, the two sides of my balance sheet cancel out, and your savings remain.
Aggregate saving and net saving are not the same thing. "
ReplyDeleteHow do you define "aggregate saving"?
btw I didn't use the term aggregate saving. I wrote "net savings in the aggregate".
Your other comment(s) require some thought, will address later.
Paul,
ReplyDeleteAggregate saving is just the sum of all individual saving over a period. Saving can be positive or negative.
You didn't quite say aggregate saving, but you did ask how saving could be positive without net spending, mentioning that this would only be possible if liabilities were ignored. Whether I was successful or not, that's what I tried to address in my comment.
Whatever you ultimately choose to call it, when we sum up every individual's saving or savings, it is still possible for these values to be positive even if we set NFA to zero.
No only that, but the major component of private savings is not NFA at all, but private capital.
If you think about it, if wealth for the private sector just means the amount of lending its done to the government, then national wealth is zero unless the nation is a net creditor to the rest of the world. But even then, global wealth is always zero.
But this doesn't really make any sense. How could global wealth always be zero? What's going on is that wealth or savings is not the same as NFA.
"I’m not sure what you mean by the statement, “there can be no growth without outside money”. Can you explain? In what sense is it true?"
ReplyDeleteMOney is like energy. The only way to get more out of the same amount of money is to increase efficiency of use. There are limits to increasing efficiency of use when the system is growing, and population grows geometrically while assets deplete and depreciate.
This is why scientists, engineers, engineers and systems people criticize economists. It is what is wrong with any fixed money supply, like a limited amount of gold. Look at what happened when the world was running on gold. Economic contraction, mercantilism, and wars, until a new supply was discovered and introduced and then a jump in growth.
In your argument above about the flow of saving, investment and income, don't account for where the money comes from. Firms don't produce money. Money is not a commodity except on bullion or a full reserve convertible system (bullion certificate with 100% banking), And, obviously, neither do consumers other than prospectors on a gold standard.
Either some credit creation is required, or else currency in a system with state money. These involve finance or issuance. Modern money is a combination of finance that generates credit money and issuance that generates state money. In this system, the currency is the unit of account.
Your system is on in which there is a constant "energy" flow with no energy source and no energy add.
@ vimothy,
ReplyDelete"While your typical economist says savings leads to investment."
Let me clarify... Most economist incorrectly describe banks as financial intermediaries. They claim that banks take in deposits and then lend them back out. Therefore banks are accepting savings and lending it for investment.
That is NOT how lending works in our modern world.
Lending creates an injection into aggregate demand which simultaneously allows for someone else to remove aggregate demand from the economy as savings without there being an overall decrease in aggregate demand. Mainstream economics has the causality backwards.
"It’s not the whole story though. Only in the trivial case when the bank is lending to and borrowing from the same entity can it create money without having to find savers."
I assume you really mean reserves when you say "savers". That is not true. In modern banking, banks clear and settle payments with reserves. The central bank will supply an infinite amount of them at its target interest rate and if there is still some sort of shortage it will provide them at the discount window.
"Since they are not the same, it doesn’t simply wash out. This means the usual rules apply. Depositors need sources of funds and borrowers need uses."
Agreed, but I think your implying a prior mistake. Factories produce real good and services they do not produce money (unless its a government mint printing press). While workers and businesses are paid in financial assets for their real economic output you need to trace the creation of those financial assets back to where they were create - as state created money or as a bank loan (which resulted in a bank deposit).
vimothy,
ReplyDelete"Aggregate saving is just the sum of all individual saving over a period. Saving can be positive or negative."
And we continue to talk past each other but I may be beginning to see why…
I will never (nor would anyone using the MMT framework) be using the context of saving that you are using here, because in my mind, it does not say anything about the system as MMT defines it, and so is not relevant to the MMT analysis.
I have been discussing these issues with you under the assumption that you are familiar with the fundamental principles behind the MMT framework.
That does not appear to be the case.
First, the MMT framework is concerned with what goes on on the right side of a balance sheet.
Financial assets, not real assets. Your definition of savings has little meaning in the MMT context so I can see where you would be confused.
When you take a discussion of saving to the left side of a balance sheet you have entered a world outside of the concrete nominal system, and introduced all kinds of unknowns which cannot be evaluated without some supercomputer, and even then an analysis would be suspect because the output would only be as good as the model.
On the left side of a balance sheet value is always an unknown that can have many nominal prices associated with it depending on how it is evaluated, including valuation by opinion.
Things appearing on this side of the balance sheet are called "real assets" or "real wealth" but the only thing real about them is the existence of the physical underlying asset.
The value of an asset on this side of a balance sheet is a function of the composition and distribution of nominal wealth on the right side (of the aggregate balance sheet), but the relationship is "soft" and non-linear.
When discussing the US "system", meaning the closed system of state-backed financial assets that include dollars, dollar liabilities and government bonds issued to the public, it will always be true that the level of the elemental particles, net nominal dollars, can never change one way or the other without some injection or leakage from an external source (sector).
You can prove this to yourself easily with simple arithmetic. A loan doesn't increase one's net worth, nor does it increase the net worth of the system in the aggregate. It enters a balance sheet as a net zero.
vimothy, what is being stated in your S=I model is that goods produced for consumption and goods consumed are equal in a closed economy running at full employment. The value of capital goods produced is accounted for as investment (I). This investment is owned by household as what is "saved" after consumption (S).
ReplyDeleteIf the economy is not performing at FE, then what is not consumed becomes unplanned inventory and is accounted for investment. So saving as ownership by households includes this unplanned inventory in S = I.
This way of looking really treating money as veil, i.e., just as a unit of account for keeping track of real resources, that is, the non-financial. Nothing wrong with that model within its parameters and assumptions.
What Keynes, PKE, MCT, and MMT are saying is that it a very limited model that results in a limited perspective that is not reflective of a modern monetary economy in which money & banking and finance are as importance as production, distribution and consumption of real resources.
Ignoring finance or misunderstanding how it works results in erroneous conclusions about how the economy actually works, as shown by the failure of NCE modeling to predict financial crises that spread to economic crises, such as the present one.
NCE equilibrium models are based on assumptions that make the models founded on them non-representational.
Did you read Matias Vernengo's latest, which I posted today?
As I said before: mixing apples and oranges.
ReplyDeleteThis is why we have financial markets and markets in general. 'Markets' are the black boxes which solve the matching between real and nominal. Price fluctuations and dynamics affect the 'quality' of balance sheets at certain point in time.
Talking about stocks of either real assets or financial assets is not very useful if you take in mind a time variable in the function of prices (which modifies the quality of the balance sheet). Stocks are only important at a given point in time!
But the economy is NOT and will NEVER be about stocks alone, but most of the time is flows what matter. When you get different flows going on, how these flows operate exercise a positive feedback loop on prices and valuations of stocks (the 'usefulness' of these assets, either nominal or real).
But you can't produce extra flows out of fixed stocks. This goes against the nature of our universe and financial and production systems are no different.
So both in real or nominal terms you need flows, 'adds' of assets. In the case of real production it means raw materials which we receive from the Earth and Sun (in form of energy and raw materials). The day this stops the economy dies as entropy points out, it will get 'frozen' (along with humanity), you can't run an economy on fixed stocks.
And pretty much the same with nominal economy and financial assets, you need an exogenous supply of it to keep flows going on (either the government or banks), liabilities are an ex-post accounting artefact (although an important one, as it keeps track of relationships) of the creation of an asset. Any monetary system has inefficiencies, wastes and it's own entropic nature, savings are one of these 'wastes' or leakages which require 'exogenous actions' (be more 'adds' or a recirculation of these savings someway).
These systems can't run as a closed system like a perpetual machine without exogenous disruptions on fixated number of assets, there are laws which prevent it.
Lev: Excellent overview
ReplyDeleteExcellent explanation, Leverage. We can see money and energy plays a similar role in parallel systems, the real (non-financial) and the nominal (financial). The real system is about the circular flow of production (supply), distribution (market), and consumption (demand). Energy drives the circular flow and money drives the distribution system in a market economy and accounts for the circular flow in nominal terms.
ReplyDeleteBoth the real and nominal systems operate in parallel within the context of a larger system — society. Understanding these systems and how they closely parallel each other is what economics is about, or should be about, as a policy science dealing with the material life support system of a society. The more complex the social order, the more complex the subsystems within it through which it functions. Control over this order is "governance."
Neoliberal as a social model presupposes that "nature knows best." This is a groundless presumption without proof, and it is in essence a denial of a primary evolutionary advantage of humanity.
Adam1,
ReplyDeleteYour statements about the bank lending process strike me as quite careful, but the inferences you go on to draw about economic theory, less so.
I won’t argue with you about what economists say. But just ask yourself this: where do I get this information from? Is it from careful study of economics, or is from people who only ever complain about it? If it is the latter, then you are a like a judge who listens to the prosecution but not the defence. Only listening to arguments that seem to confirm your hypothesis about some phenomenon seems like a fool proof way to generate plenty of confirmation bias.
Anyway, it’s true that if banks extend a lot of credit, we might expect it to raise aggregate demand. But it’s not true that there is something about saving that necessarily causes it to lower aggregate demand, or that would necessarily cause it to lower aggregate demand in the absence of bank lending.
I assume you really mean reserves when you say "savers".
I’m not sure why you would assume that. I meant savers. We all know that assets must equal liabilities. Unless the bank is lending to and borrowing from the same person, it must find someone to hold its liabilities. We also know that asset acquisition equals borrowing plus saving. This means that the person holding the bank’s liabilities must find a source of funding. That source could be borrowing (we can imagine away the question of whether this would be desirable or feasible), but that simply moves the question one person along. The chain has to end at some point. Wherever it ends, someone will be saving. This has nothing to do with reserves (as far as I can see) and everything to do with consistency. You cannot force people to hold bank deposits. If you assume that they want to, then you’re assuming that people want to save. May argument is that, without saving, there can be no money—so your response does not seem to speak to it directly.
While workers and businesses are paid in financial assets for their real economic output you need to trace the creation of those financial assets back to where they were create - as state created money or as a bank loan.
In practice, this is quite right. However, we’re arguing about principles. My claim is that with no savings there can be no money. Since we do not observe economies in this state, even assuming we agreed on the facts, we cannot simply point to the normal functioning of the economy to settle the matter. Instead, we have to apply basic principles which hold normally to an abnormal hypothetical situation. This is rather abstract, but I don’t see how that can be avoided given the nature of the discussion.
Tom,
ReplyDeleteThis is why scientists, engineers, engineers and systems people criticize economists.
I’m not an engineer or a physicist, so I won’t comment too much on the appropriateness of your analogy. (It seems that engineers and physicists don’t feel the same way.) Money is not an input to production in the sense that labour or capital is. It doesn’t have a marginal product. If the economy is growing and the money supply is not, then logically, we should expect to see price deflation. But this has nothing to do with the efficiency or inefficiency with which money is being used.
In your argument above about the flow of saving, investment and income, don't account for where the money comes from.
That’s right. But we know where the money comes from. Banks issue it. The point of my argument is that banks cannot issue it without savers who wish to hold some portion of their income in reserve rather than consuming it all. You have argued that the government can create funds by issuing money. I’m saying that you are misunderstanding what the word funds means in this context. Bank money is a use of funds for anyone who isn’t a bank (or a central bank). If bank money is a use of funds, then a source of funds must also be found. That follows from the principle of stock-flow consistency.
Paul,
ReplyDeleteI have been discussing these issues with you under the assumption that you are familiar with the fundamental principles behind the MMT framework.
As it happens, I feel that I’m quite familiar with it. You are entitled to draw your own conclusions, of course, but I’ve read their blogs for years, I’ve read a large number of their papers, I’ve read the short books by Wray and Mosler—I’ve even read two textbooks by Wynne Godley.
You’re actually mistaken about how MMT treats saving. The outcome of the whole brouhaha about “net saving” was that the professional MMT contingent uses the same definition that the rest of the economics profession uses. I mean, hello—they’re economists! This is very basic stuff for an economist. The non-professional MMT contingent got a bit confused, because this stuff can be confusing. That’s just the nature of the thing.
Here’s Scott Fullwiler:
In other words, OBVIOUSLY there can be an increase in financial assets without govt deficits if the former "net" to zero in that case, otherwise there would be nothing to "net" in the first place. Similarly, there can OBVIOUSLY be saving without govt deficits or a current account surplus, but not NET saving.
What he’s saying is that everybody knows there can be saving without government or foreign deficits. It’s something that is obvious. Everybody knows this because they share a common education. They understand what the concept of saving means. It means that you take some of the resources that you’ve generated—i.e., your income—and you put them to one side for future use. From that essence, the various identities follow. It’s even implicit in the sector financial balances identity that you like to refer to. If we set the other balances to zero, then we can have (S – I) = 0 IF AND ONLY IF S = I, and therefore, that S = 0 IF AND ONLY IF I = 0.
We don’t need to go over this again though. Just think about my comment above. I borrow the money from you and invest in tangible capital. I have not dissaved and you have saved. You’re proposing that we should simply ignore the fact that I have an asset when we calculate aggregate saving, so that somehow we end up concluding that there has been no aggregate saving. This isn’t something that makes very much sense, and it isn’t something that comes from any MMT work that I’ve ever seen. If you disagree, why not refer me directly to a paper where this is discussed? If it’s not discussed in a paper, can you explain the logic without simply declaring that this is how it’s done in the MMT framework?
Tom,
ReplyDeleteNothing in my argument relies on particular definitions of equilibrium or assumptions about the rate of employment or anything like that. All I’m saying is that, for everyone in the economy, uses of funds equals sources of funds. I don’t think this is theoretical. For e.g., you point to a blog post that quotes post Keynesian economist Gennaro Zezza, who states,
In the economy – and therefore in models representing the economy - everything comes from somewhere and goes somewhere else: there are no black holes.
Which is exactly right, in my view.
vimothy
ReplyDelete"The outcome of the whole brouhaha about “net saving” was that the professional MMT contingent uses the same definition that the rest of the economics profession uses. I mean, hello—they’re economists! This is very basic stuff for an economist."
The brouhaha was about confusion that didn't exist for the most part amongst most of us. The only confusion was what point you and others were trying to make.
If yo'r argument is that every economist's definition of saving is the same, I would agree with you and add that this has never been in question.
Saving is income not spent. It's a non-act, a residual. Everyone agrees (or should) with this.
Your example in another thread in which you plugged in a set of numbers to "prove" that saving can be positive when government spending is negative didn't prove anything.
It demonstrated one possible set of numbers that existed out of many that satisied a known relationship, that when applied to the sectoral balances identity fails as a possible outcome that can occur in the real world.
This follows from the fact that the sectoral balances identity is derived from the equations you provided. The S/B equation narrows the universe of possible solutions in your related equation to one unique solution that can occur in the real world.
Thus your original statement was false, and the difference that you are claiming in our understandings of saving is a distiction without a difference.
And in my own appeal to authority since you are so disposed, I will say that I place a great deal more weight on Bill Mitchell's math abilities than yours, but mainly because I understand the underlying system at work that supports his argument.
I don't see how there can be any argument with the following very simple bit of algebraic manipulation:
ReplyDeleteLet X = M and G = T
Then,
(S - I) = 0
IFF
S = I
Therefore,
S = 0
IFF
I = 0
If you can find fault in it, then I'm all ears (or even eyes).
BTW, where did I make an appeal to authority? Your claim was that saving in the MMT framework was different to saving in the conventional framework. I provided a link to a quote from an MMT economist that shows that this is not so. That’s not an appeal to authority.
ReplyDeleteNot in the fallacious sense, anyway.
ReplyDeletevimothy
ReplyDeleteYour example doesn't tell us much of anything.
"…S = 0 IFF I = 0…"
Is not true.
It's true for any S = I.
What it tells us is that, under these conditions S is only zero when I is zero, and I is only zero when S is zero.
ReplyDelete(S - I) = 0
IFF
S = I
In other words, even if saving net of investment is zero, saving is not zero unless investment is also zero.
vimothy
ReplyDelete"BTW, where did I make an appeal to authority? Your claim was that saving in the MMT framework was different to saving in the conventional framework. I provided a link to a quote from an MMT economist that shows that this is not so. That’s not an appeal to authority."
My claim wasn't so much that MMT sees saving as a definition of saving is different, only that the metric for measuring saving in the aggregate is different.
MMT focuses on the net increase/decrease of financial assets in the aggregate as the meaningful measure of the non-act of saving.
Your appeal to authority was making the statement that "all economists" have the same definition of saving, which is uncontroversial.
"all economists" is an appeal to authority in my view, as it does not involve logic.
The English language is complicated.
"What it tells us is that, under these conditions S is only zero when I is zero, and I is only zero when S is zero."
ReplyDeleteTrue but that doesn't say anything meaningful about net savings.
"even if saving net of investment is zero, saving is not zero unless investment is also zero."
No one is claiming savings is zero if net savings is zero. Net savings can be zero while savings is some positive number.
It just means that savings is at the expense of another. Your saving can only be the result of someone else's spending. It isn't apparent at the micro level but it must be true in the aggregate.
In a closed system it must be true in a nominal sense.
In the equation…
(G - T) + (I - S) + (X - M) = 0
All of the terms excluding I - S are in nominal dollars, so I - S must be in nominal dollars.
Real is never (except for one special case) equal to nominal.
Net savings is nominal. It includes financial assets only.
Define savings net of investment and what that means in a real-world (system) context.
Seems to me savings would be by definition net of investment (and consumption).
Just based on arithmetic, economics view notwithstanding.
vimothy, I don't see economists describing the economy as a system the way other scientists do in their field. Economists recreate models with simple variables that look at a particular aspect of the economy and they draw conclusions about the economy from that. When I see an economist doing that, I put down the paper or book and move on in search of someone who is taking a system approach. That is why I like Godley's SFC modeling.
ReplyDeleteMMT's general theory is also a systems view from which one can drill in to address different aspects in detail without lossing the big picture.
I maintain that there are parallel systems, real and nominal, and the driver of the real is energy flow and the driver of the nominal is money flow. Without taking this view, the results will be worse than useless because they will be misleading
Nothing in my argument relies on particular definitions of equilibrium or assumptions about the rate of employment or anything like that. All I’m saying is that, for everyone in the economy, uses of funds equals sources of funds. I don’t think this is theoretical. For e.g., you point to a blog post that quotes post Keynesian economist Gennaro Zezza, who states, In the economy – and therefore in models representing the economy - everything comes from somewhere and goes somewhere else: there are no black holes. Which is exactly right, in my view.
ReplyDeleteRight and agreed. That is not what I am arguing. Where do the funds come from. Don't say "source of funds" because that is not the issue. The unit of account is not only a measure, which is the way it appears in accounting. It is a medium of exchange, and in a monetary economy it comes ultimately from government spending into the economy and lending to the banking system for settlement.
Banks are franchises permitted to generate entries in the unit of account through credit extension, but credit extension by banks and non-banks never alters the amount of net financial assets held by non-govt.
Tom,
ReplyDeleteFunds are generated by productive economic activity--i.e., by production, income and exchange. "Funds" is not a synonym for "money".
Paul,
ReplyDeletePerhaps you are right about my appeal to authority. You could always verify my claim by spending some time studying economics, but this is costly and possibly not where your interests lie. Still it is hard to see a way round this. Presumably, if we had an argument about engineering, there would be some things that you would draw on as an engineer. Since I’m not an engineer, should you throw out this knowledge, because to do otherwise would be an unfair appeal to authority?
It just means that savings is at the expense of another. Your saving can only be the result of someone else's spending. It isn't apparent at the micro level but it must be true in the aggregate.
No it does not. As well as consumption, expenditure can also take place on investment. Invested income is not consumed. You have claimed that if someone saves, someone else must also dissave, so that on aggregate saving nets out to zero, unless someone from another sector holds the liability.
I think that this is a very common error, but an error it most certainly is. If I borrow from you and buy a factory then I have not dissaved, and you have saved. Thus, all saving does not net out on aggregate. Only when the borrowing leads to consumption does saving net out in the manner you are describing.
But let’s assume that you are correct: if saving always nets out to zero on aggregate, this means that when you sum up saving for the whole economy, its saving is zero, right? But then, what do you think the “S” stands for in your financial balances identity? How is it calculated?
Tom,
ReplyDeleteI’m afraid that I don’t know what you mean by a systems view and I don’t know whose research you have been reading. I do know that whatever the differences between Godley & Lavoie and the mainstream approach, looking at the economy as a whole thing is not one of them.
Can you be more concrete? Give me an example from one of Godley’s textbooks and contrast it with an example of a neoclassical model.
"…Funds are generated by productive economic activity…"
ReplyDeleteThis is a fallacy.
Goods and services are generated by productive economic activity.
The level at which goods and services are translated into value is dependent upon a lot of factors, but the most basic factor is the level of dollars available to purchase said goods and services.
It follows that up to the point where the level of spending exceeds production capacity production can be driven by spending.
It matters more to an economy where the money stocks are held than how large they are. It craetes a difference in potential that causes the flow of dollars from a point of lower potential to a point of higher potential.
From consumers to production. If credit is the only source of money driving consumption then growth in production will proceed until the rate of credit expansion can't be maintained and then the system will begin decay, often suddenly.
This is called a bubble.
At this point there is no way to maintain previous levels of spending without the government running deficits, clawing back accumulated wealth from the very rich or reversing flows in the CA.
Increasing production cannot increase spending or the level of the real money stock.
vimothy,
ReplyDelete"Invested income is not consumed…"
Yes it is.
It is spent on the consumption of natural resources and labor. Workers continue the chain of spending by … spending their income on consumption. The same for suppliers of resources used in industry.
Investment is a special class of consumption. In a nominal world it is the same as ordinary consumption.
Anyting left over from income as a residual is considered savings.
Funds are generated by productive economic activity--i.e., by production, income and exchange. "Funds" is not a synonym for "money".
ReplyDeleteIf you are talking about using the unit of account as a measure of the real, no problem.
But that only accounts for half an economy and ignores the financial. This is the Keynesian objection. Just as the non-financial influences the financial, so too, the financial influences the real.
We could use energy units as a unit of account, for example. But the energy has to be sourced. The source of most energy is the sun, stored in various forms like fossil fuels and food stuffs.
Godely and Lavoie suggest what a "Treasury model" looks like. The only place that such models exists are at Treasuries and central banks and at Goldman Sachs.
ReplyDeleteEconometric models are tiny little things that one person puts together on his desk from limited data. The difference in scale and what they handle is huge.
The Treasury models of economies and IMF's models the global economy are based on how data is actually flowing and what can be expected from that if trends persist, as well as how trends might shift or even could be shifted. Econometric models are based on ergodicity, certainty, and causal relations between limited variables, assuming independent and dependent variable relationships that are supposed relevant to not only to theoretical understanding but also policy making.
Paul,
ReplyDeleteHere’s what Wikipedia says:
“In economic theory or in macroeconomics, investment is the amount purchased per unit time of goods which are not consumed but are to be used for future production (ie. capital). Examples include railroad or factory construction.”
Investment and consumption are not the same thing—that’s why there are two different words to describe them. Investment is expenditure on new capital goods. Consumption is expenditure on consumption goods.
Taking these commonly understood concepts and imposing your own definitions on them strikes me as a bit of a weird exercise. If you wanted to learn maths, would you go about it by redefining terms and making things up as you see fit? That doesn’t seem like it would be very productive.
The reason this matters is that capital is a factor of production and consumption is not. If you consume all of your current income, then the capital stock in the next period will be lower because of depreciation. This means that your income in the next period will also be lower. And therefore that your consumption will be lower as well—even if you consume all of your income again.
In other words, investment increases the future productive capacity of the economy, or prevents it from falling due to the depreciation of capital. It adds to the capital stock. Consumption does not add to the capital stock.
Also, you didn’t answer my question:
If saving always nets out to zero on aggregate, this means that when you sum up saving for the whole economy, its saving is zero, right? But then, what do you think the “S” stands for in your financial balances identity? How is it calculated?
Tom,
ReplyDeleteWhat I’m saying doesn’t really rely on any particular model of or theory about the economy. If you look at any current transactions matrix with banks on it in G&L, you’ll see that money is a source of funds for the issuer and a use of funds for the acquirer, such as households. Since money is a use of funds for households, I don’t see how they can fund their acquisition of money with money.
Regarding models, I’m not sure what you mean by a “treasury model” versus an econometric model. An econometric model can be any size. I can write down a linear econometric model with one dependent variable. One the other hand, one type of econometrics model commonly used by treasury departments and central banks for forecasting is a large scale structural econometric model. This sort of thing is quite crude from the point of view of theory though, and many people have moved onto more dynamic VAR and DSGE approaches.
In the structural models, people do make assumptions about what variables are dependent and what are independent—though certainty is not involved, since these are econometric models—which can be quite hard to justify from a theoretical point of view, and which has contributed to a decline in their popularity amongst academic economists. (Chris Sims won a Nobel Prize last year for work in this area.)
Godley & Lavoie’s models are not unlike traditional structural econometric models. They do not involve data and they are strictly deterministic, perfect foresight economies, but the approach is similar. You can see a very brief example of a structural econometric model at the end of these lecture notes (skip to page 6, section 5.2):
http://homepage.univie.ac.at/robert.kunst/prognos5.pdf
You can see how similar it is to the model in chapter 3 of Godley & Lavoie.
I’m pretty sure that the IMF use a lot of different approaches too. I studied with someone who was a lead economist in their research shop and he taught DSGE models as well as some models without microfoundations. He wasn’t an econometrician, so we didn’t learn much about how they view econometrics. I would have thought that they try to take advantage of whatever tools they can, so I expect they make use of structural econometric models as well as more modern time series methods.
But you didn’t really answer my question. I was asking for some kind of concrete example that showed how a Godley model takes a systems view versus a neoclassical model that does not. When you say “systems view”, what do you actually mean WRT what people are doing? Can you give me an example?
vimothy,
ReplyDelete"…goods which are not consumed…"
I'm aware of how the definition reads and I look at it as a semantic description to differentiate between two kinds of consumption.
It is logical to conclude that once a dollar is spent on investment it doesn't enter a black hole and disappear. It continues on through the spending chain and is spent over and over again on either consumption or investment until the spending chain is broken by the non-act of saving.
Who knows how many times a dollar is spent as it moves through the economy? A hundred. A Thousand? A million? Some of these transactions will involve investment, some consumption.
.
…Consumption does not add to the capital stock…
Consumption continues the chain of spending, and spenders along the chain may spend it on investment, after which it continues along the chain ad infinitum until it is saved. Each time spending occurs on investment it adds to the running total of investment. It also adds to the running total of consumption.
Net savings that remain as the stock of savings that grows over time is a leakage that must be replaced or it will affect both velocity and the level of dollars in the economy. It's a running total.
"If saving always nets out to zero on aggregate, this means that when you sum up saving for the whole economy, its saving is zero, right? But then, what do you think the “S” stands for in your financial balances identity? How is it calculated?"
I don't think I've ever claimed that savings always nets out to zero on aggregate.
"…when you sum up saving for the whole economy, its saving is zero, right?"
No. Saving can still add up to some number. There will be an off-setting number on balance sheets somewhere that represents dis-saving. Someone spent more (fueled by credit) so others could save. This is a short-term dynamic unless offset by deficits.
S and I are both unknown variables in the Sectoral Balances equation. They are place-holders for unknown quantities. The part of the expression that MMT focuses on is the difference which tells us the gain/loss in net financial assets for the system.
In the NIPA tables and FoF tables Savings (and I presume investment) are estimated. Those numbers don't appear to represent the same thing as the terms in the Sectoral Balances and related equations. They are totals of Savings invested (different use of the term investment) in savings vehicles, some of which appear to include real assets.
The numbers for Savings and Investment in the NIPA or FoF tables seldom if ever satify the S/B relationship. I suspect when they do it's coincidence.
Maybe they do in the SFCA accounting system mentioned in the link Tom put up to Naked Keynesianism. I don't know.
Since money is a use of funds for households, I don’t see how they can fund their acquisition of money with money
ReplyDeleteNo? Then you don't understand finance. All money is borrowed money. All money borrowed inside nets to zero. When govt "borrows and spends," it injects financial assets into non-govt, and when govt taxes it withdraws. The net is the govt fiscal balance.
The mainstreams models don't show this and as a result miss a dimension that is determinant. Moreover, not understanding finance properly, mainstream economists are concerned with rising govt debt even when govts are currency sovereigns and they are clueless about the potential effects of private debt.
Just listen to all the jabbering now. They are clueless because they don't understand the system dynamics.
BTW, consumption is consumer spending on consumption goods. Investment is firm spending on capital goods. Households save with they don't spend all their income on consumer goods. The residual is their saving. Firms save with they don't spend all their revenue and don't pass the residual to owners. This is called retained earnings.
So total saving of households and firms from circular flow in a closed system is Revenue minus Spending is equal to Saving over the period.
A great deal of Revenue comes from inside borrowing, since most of the money supply comes from credit extension. In aggregate, this nets to zero.
So in a closed economy with no outside money, there is no actual money. All there is is credit-debt. The backing of the money is the efficiency and effectiveness of the legal system and the collateral that can be recovered in case of default.
That's how a simple monetary economy without government or external trade runs. In the case of blockage of flow, then the system freezes up and breaks down. Savings creates demand leakage so there is always the danger that savings will block the circular flow and disrupt the financial system, resulting in debt-deflationary depression.
Where do the models show this?
vimothy, "But you didn’t really answer my question. I was asking for some kind of concrete example that showed how a Godley model takes a systems view versus a neoclassical model that does not. When you say “systems view”, what do you actually mean WRT what people are doing? Can you give me an example?"
ReplyDeleteRead any of Godely's analysis (available at levy.org) to see how he uses the model and comes up with different analysis than the mainstream. Godley's approach was famously based on the huge model that he could run his head. No DSGE, representational age agent and other questionable assumptions, no REH, no EMH, no ISLM, etc. needed or wanted.
Godley's models typically assume representative agents and perfect foresight, which is a stronger assumption than rational expectations. (Plenty of modern macro is focused on heterogeneity and modifications to rational expectations.)
ReplyDeleteI don’t want to read through all of Godley’s papers at the Levy Institute, though. I’d just like to know what you mean when you said that Godley’s models a “systems approach” and that this approach is absent from mainstream research. Can you give me an example of something that is a “systems approach” and something that’s not?
I think you are looking for something that is beyond my ability to provide. Try this paper.
ReplyDeleteNotes on the Stock-Flow Consistent Approach to Macroeconomic Modeling
Note, however, that in complex accounting structures the nature of these degrees of freedom may not be obvious at first sight. In particular, the use of a water-tight SFC accounting framework implies that in an economy with n sectors, the financial flows of the nth sector are completely determined by the financial flows of the other n-1 sectors of the economy50. This fact has nothing to do with the neoclassical concepts/assumptions such as Walras's Law, utility maximizing individual agents, market equilibrium and etc. It happens simply because what sectors 1 to n-1 (in the aggregate) pay to sector n is equal to what sector n receives from these sectors and vice-versa. 49 Along, of course, with other theoretical considerations and more
G&L sums up the systems approach in the preface. Emphasis added.
ReplyDeleteThe premises underlying this book are, first, that modern industrial economies have a complex institutional structure comprising production firms, banks, governments and households and, second, that the evolution of economies through time is dependent on the way in which these institutions take decisions and interact with one another. Our aspiration is to introduce a new way in which an understanding can be gained as to how these very complicated systems work as a whole.
Our method is rooted in the fact that every transaction by one sector implies an equivalent transaction by another sector (every purchase implies a sale), while every financial balance (the difference between a sector's income and its outlays) must give rise to an equivalent change in the sum of its balance-sheet (or stock) variables, with every financial asset owned by one sector having a counterpart liability owed by some other. Provided all the sectoral transactions are fully articulated so that 'everything comes from somewhere and everything goes somewhere' such an arrangement of concepts will describe the activities and evolution of the whole economic system, with all financial transactions (including changes in the money supply) fully integrated, at the level of accounting, into the processes which generate factor income, expenditure and production.
As any model which includes the whole range of economic activities described in the national income and flow-of-funds accounts must be extremely complicated, we start off by imagining economies which have unrealistically simplified institutions, and explore how these would work. Then, in stages, we add more and more realistic features until, by the end, the economies we describe bear a fair resemblance to the modern economies we know. In the text we shall employ the narrative method of exposition which Keynes and his followers used, trying to infuse with intuition our conclusions about how particular mechanisms (say the consumption or asset demand functions) work, one at a time, and how they relate to other parts of the economic system. But our underlying method is completely different. Each of our models, before we started to write it up, was set up with its own stock and flow transactions so comprehensively articulated that, however large or small the model, the nth equation was always logically implied by the other n − 1 equations. The way in which the system worked as a whole was then explored via computer simulation, by first solving the model in question for its steady state and then discovering its properties by changing assumptions about exogenous variables and parameters.
vimothy: "Regarding models, I’m not sure what you mean by a “treasury model” versus an econometric model."
ReplyDeleteA Treasury model, which is explored in G$L can be simplified for understanding as G&L and levels built out. Actual Treasury models are fully built out with all available data. It's based on accounting reports, so no problem adding columns.
Econometric models are simplified by the selection and formulation of assumptions. They involve limited variables. What would happen if econometricians tried to build out their models by making their assumptions more realistic and increasing the variables. How would they deal with causality? Complexity? Why has this not been done?
vimothy
ReplyDeleteI recommend reading this as it is along the lines of the things we have been discussing - from today's billy blog…
http://bilbo.economicoutlook.net/blog/?p=20343
@vimothy,
ReplyDelete"May argument is that, without saving, there can be no money—so your response does not seem to speak to it directly."
Assuming we are talking about financial assets then I'd beg to differ. You are logically incorrect and monetarily operational wrong too...
To "save" something first requires you to come into possession of it which means it existed before you could obviously have saved it.
In our modern monetary system of a fiat currency with a central bank charged with ensuring the payment system of the banking system (a description of the US and most banking systems) there most certainly does not need to be "savings" to generate monetary financial assets (money).
Going back to how a bank makes a loan. When a bank makes a loan it generates an asset and a liability (or a need for one at least). You assume that that liability must be someone's savings, but that is not a necessary condition. Yes the bank would prefer that it be a saver making a deposit, but that is not a requirement. To grow its balance sheet the bank needs an offsetting liability. So long as the bank can find credit worthy customer to borrow at a profitable rate above the central banks target interest rate, there is an infinite supply of reserves available from the central bank and a simple phone call to the central bank can convert those reserves into currency which can be dispensed via a bank teller. Bank deposits are not a requirement - in theory you could drain customer deposits from a bank and so long as capital remains and the bank has access to the central bank funding it can continue to lend money. How do you think shadow banking works - entities that make loans without accepting deposits - they source liabilities from the money markets which while receiving money from "savers" are also receiving funding from the central bank via open market operations to defend its target interest rate.
While you may be inclined to discuss what is happening with the stocks and flows within the economy because of all this money create - that is fine (and this is my last post on this comment section, I'm moving on) - but in a nominal sense no money must be pre-saved to create financial assets in our modern monetary system.