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Tuesday, October 9, 2012
Ramanan — Income = Expenditure
Ramanan sums up the state of the recente debate fron his perspective and adds the dimension of the Dirac delta function.
I'm no mathematical genius like Ramanan but after reading his post it seems like he's splitting hairs with Keen.
It makes no sense to say income before debt injection was $100 for real world transactions in a continuous time formulation. It is actually zero just before a debt injection because all income/expenditure flows are “spikey”.
I think that is being the key quote.
It seems to me they agree but present it differently.
However, I don’t think the Basil Moore quote is particularly helpful. The fact that saving is the record of investment doesn’t mean saving in total can’t be volitional. There’s always inventory to buy somewhere. Nobody is forcing anybody to buy or not to buy what’s on the shelf. So I’m not sure that’s the problem with the SK formulation.
Again, I think it’s a simple matter of attempting to fuse a regression equation with an accounting identity. This is like oil and water.
The basic regression is current expenditure against prior income and intervening debt. That crosses separate accounting periods, within each of which expenditure must equal income. You can regress one against the other, but you can’t write a faux identity as if both pertain to the same accounting period. And whether the accounting is real world discrete or pretend world continuous is irrelevant – the relationship between income and balance sheet accounts and the time ordering of the accounting is well defined in the system of double entry bookkeeping either way.
“It makes no sense to say income before debt injection was $100 for real world transactions in a continuous time formulation. It is actually zero just before a debt injection because all income/expenditure flows are “spikey”. Just after the debt injection it is zero again because nobody spends the instant a loan is given. The debt injection increases assets and liabilities by the amount of the loan if the borrowing is from a bank.”
Right – that’s actually the correct way to apply differential calculus directly to an accounting measurement framework. Dirac is the icing on the cake, but you don’t really need it to make the obvious point here.
its a regression of accounting measures across different accounting time periods
but its written as if its a relationship between accounting measures within the same time period - which contradicts the true relationship between such measures
I think there are inventories will still mean S = I if change in inventories is included in I.
The non-volitional aspect comes in a full model because every model should be thought to sit inside a model with the government and the residual nature of the government balance will make S = I.
Keen includes government later but forgets that with his behaviour where consumers are guzzling consumption, the government will be hitting surpluses.
i.e., he has a black hole in his model is related to the fact that S is not equal to I in his model and surpluses will make make S equal to I.
I don't think there is agreement. All economists basically speak similar language and a cursory look will make one believe they agree.
The point is that his accounting doesn't add up.
The direction he is looking is right but he has to first respect accounting identities instead of claiming that his identities are better because he working in continuous time formulation.
That doesn't take away that he may have a nice econometric model in his head - not yet put on paper.
"Unfortunately the rules of accounting do not allow this!"
However the rules of mathematics do.
There is a point where accounting - which is designed for historic reporting - runs out of power to explain.
Like all things accounting is a useful abstraction, but you have to understand its key features and limitations.
And anybody who has done any system work knows that when you move into the realms of forecasting basic double entry runs out of steam.
"nobody spends when a loan is given".
You do with a credit card. The loan is advanced *after* the decision to purchase has been made - at the point of payment. There is no loan - and therefore no accounting for it in national accounts sense - until the spending happens. AIUI the national accounts accounting policies only deal with loans advanced rather than lines of credit.
This hair splitting all detracts from the actual economic effect which is that somebody with a credit card and confidence in their future *feels* they can spend more and has the demand tool to execute that feeling.
Much as somebody with a 'mortgage offer in principle' and confidence in their future *feels* they can go out and buy a house.
And that activity - which isn't accounted for because it is 'contingent' - is what is giving the production system demand signals. That will tend to lead to more supply in anticipation and the debt allows more transactions to complete.
Essentially the demand system pushes forward with spending and then steps back with saving - which leads to a slightly greater push forward than you would expect from the straight accounting.
The standard understanding is that the economy steps back with saving before pushing forward with spending. That leads to a different impulse reaction.
Keen is trying to move the model on from historic accounting and into the realms of forecast modelling.
I'm still not convinced that mathematical modelling is the best way of getting that across though. It's so obtuse.
"You do with a credit card. The loan is advanced *after* the decision to purchase has been made - at the point of payment. There is no loan - and therefore no accounting for it in national accounts sense - until the spending happens. AIUI the national accounts accounting policies only deal with loans advanced rather than lines of credit."
Yes agree with that.
I should have phrased it differently saying that the statement is not true in all generality.
Anyway when one spends using a credit card, income is created equal to expenditure and Asset-Liabilities are created in pairs.
The bank's assets and liabilities go up and the person shopping has an increase in liabilities and the shop has an increase in assets.
Income is always equal to expenditure no matter which variety of Keynesian or classical economics you espouse - Tobin
Income is always equal to expenditure no matter which variety of mathematics (discrete or continuous) you espouse - me. :)
"You do with a credit card. The loan is advanced *after* the decision to purchase has been made - at the point of payment. "
But nobody said otherwise.
"There is no loan - and therefore no accounting for it in national accounts sense - until the spending happens."
Y_E is still equal to Y_I at every point in time.
The reason dD/dt doesn't appear is that it is cancelled by dA/dt elsewhere.
Someone should go over to Keen's blog (it's working again) and invite him to respond to these criticisms. I would, but for some reason I can't register over there so I can't post any comments.
The problem with saying something like "the source of monetary demand for goods, services and assets is income plus change in debt" is that you are confusing things that are true for the individual with things that are true for the whole economy.
In one of Keen's equations he has expenditure equal to income plus borrowing for every sector--but no lending! This isn't something that I would have thought MMTers would find confusing. The sum of all the net flows between sectors is zero.
So the correct version of Keen's expression is like saying aggregate expenditure equals sum of sector income plus sum of inter-sector borrowing and lending, which is exactly the same as saying aggregate expenditure equals aggregate income.
Another way to solve this problem for Keen would be if he included a simple financial sector in his model. Then, you have agg exp equals sum of sector income plus bank lending--but the banking sector doesn't have any income, it borrows and lends. So the banking system just intermediates loans, borrowing from the other sectors and again, you get AE = Y.
I think Keen went astray as follows: he wanted to model the fact that it is the change in debt that is tightly correlated with expenditure (and hence income), but decided to model it as if it was an accounting identity. It is not. You can increase your debt and save the money, for liquidity purposes or whatever. The correlation of change in debt and spending is tight but not 100%.
so: change in debt ~ spending,
but it is not an identity. Spending = Income is an identity, it is fulfilled at any point of time and space (it is true in any transaction, so Dirac-delta like ;)) You could have a model spending = change in debt, and see what happens, but it is just a model, not an identity.
(the following might be obvious, but you seem to be saying something different. It might be wrong too :-)
my understanding is:
when you get a loan from a bank the bank credits your account, and that credit represents a promise by the bank to give you money on demand. However, in most cases the bank's promise to deliver money is never fulfilled, as the money is never withdrawn. If you take out a $100,000 loan, for example, you usually don’t ask to withdraw the amount in cash, as there's no point.
What normally happens instead is that the credit is simply transferred from one account to another when the borrower spends. And again, the person receiving the credit rarely converts it into money by withdrawing it as cash.
Overall, only a tiny fraction of all the money promised by banks ever needs to be delivered by them, as most of the money promised is never withdrawn. Most spending in the economy just involves credits being transferred from one account to another. Banks also only need a relatively small quantity of money at any given time (in the form of reserves) to settle payments amongst themselves.
As such, for all intents and purposes, bank credit is the same thing as money (for all non-bank sectors excluding the government). So when they make loans by extending credit, banks can be said to “create the money out of thin air”. This 'new money' represents new purchasing power, which adds to overall demand in the economy for goods, services and assets (when the money is spent or used to purchase assets).
In effect, when a bank makes a loan they ‘borrow’ the money from the debtor. That is, the bank issues a liability (IOU), as does the debtor, with the bank's liability representing the debtors asset, and vice versa. The bank's liability is then transferred to another account when the debtor spends. The debtor's spending becomes the other account holder's income.
At each point expenditure = income. But with every net addition to total credit (debt) you get a net increase in total purchasing power. As such expenditure and income after credit is extended will be different to expenditure and income before it is extended. This process of extending credit drives production and consumption, and also drives up asset prices (when borrowed money is used to purchase assets).
Of course over time the debtor has to repay the loan with interest, effectively 'withdrawing' the 'money' created by the loan (the principal) from the economy. But if the amount of outstanding credit grows over time the net effect will be a continuous addition to demand. This process goes into reverse when the amount of credit shrinks, as it did in 2008.
(Of course you also have to include government spending to get a fuller picture).
I think I might have mentioned in the other thread that it's easy to see why Keen might think that, since banks can create money "out of thin air" or because "loans create deposits", expenditure is therefore equal to income plus the free money the banks create.
Well, for one thing, it's wrong to bring identities into this, since by their nature they don't tell you about causality. But here's a couple of things to think about:
Do banks still need to fund their loans, or is that automatically taken care of as a natural consequence of the fact that "loans create deposits"?
Presumably banks have a capital structure that's more complicated than just "deposits", right? Otherwise, they wouldn't have any regulatory capital at all. So what's going on there?
"You could have a model spending = change in debt, and see what happens, but it is just a model, "
I think it would also be interesting to add info from the Treasury's Daily Statement to that, ie look at this expansion in Bank Credit vs Treasury Account withdrawals and receipts....
At some point the system balances being made available to pay the required interest on new/existing system bank credit become insufficient and the whole thing shuts down... it would be perhaps valuable to model that imo...
Agreed. (My understanding of all this is pretty limited, surprise surprise). As I said it would be good to see how Keen responds to these criticisms.
Yes banks have to fund their loans, but the funding is generated largely in a circular fashion through the making of loans, including loans to the government. Banks "leverage" government debt/govt liabilities (inc foreign govt debt?), though not by "lending out" base money, and the extent to which they can do that simply depends on how much debt the non-government sector can bear, before the credit structure becomes too "fragile" and begins to collapse. Bank capital is debt/ liabilities of one sort or another, including government debt/ govt liabilities.
Forget about base money. Just think about what happens, say, when you take out a loan from the bank for some reason. Generally you are going to use that loan to make a payment to someone, perhaps several someones. Then, the money is likely to end up in whatever banks those someones bank with, and your bank is going to have to source some financing other than your deposit, which it no longer holds.
Wondering why there has been a drop-off in spending?
And linked it to the fall in private debt.
I assumed that this was a comment on Keen's expenditure = income plus change in debt equation.
So I linked to a graph that showed that, whatever private debt has done, the level aggregate expenditure hasn't actually fallen.
If you meant consumer spending specifically, you can see a series for real consumption here:
http://research.stlouisfed.org/fred2/graph/?g=bG3
It too has never been higher. Can't seem to locate a nominal series on Fred or elsewhere, but it's not to hard to transform the graph in your head. Again, the conclusion seems clear.
Looks like that lines up with stimulus hitting in latter 2009 and then Social Security COLAs (and probably Medicare reimbursements) went back to non-zero in 2011:
http://www.ssa.gov/oact/cola/colaseries.html
So that helps the withdrawals side of the Treasury Statement... this is what Warren refers to as "muddle thru"... tho the "fiscal cliff" threatens this "muddle" scenario by potentially reducing the rate of Treasury account withdrawals... buckle up!... rsp,
"I assumed that this was a comment on Keen's expenditure = income plus change in debt equation."
No, I've stayed out of that because it seems like much ado about nothing. I'm interested in what conclusions he eventually settles on…he seems headed in the right direction to me but I know you don't see it that way.
GDP is going up because we are deficit spending…that's my view, not because of credit expansion.
We must see things a lot differently because when I look at the Fed graph I posted credit expansion stopped in it's tracks and is nowhere near the previous rate. I doubt that it will ever reach that.
Of course based on ordinary system relationships learned in Thermodynamics 40 years ago It was no surprise the bubble burst. It had to.
The fact others in the discussion don't understand or are unaware of or don't see any importance in these concepts (closed systems, entropy, conservation of matter and energy), all of which our man-made systems must be in harmony with to succeed is a mystery to me but that's the way it is.
The other day you made a comment questioning why I am so critical of mainstream economics when I admit I don't know much about it. (Echoed by JKH and Ramanan also surprisingly) . Mainstraem economics is for the most part applied math, as is heterodox. The mainstream application is trying to solve problems that don't relate in any meaningful way to the real world. The result has been abysmal.
Why would I bother to learn anything about such a flawed system?
Heterodox on the other hand violates none of the laws that I am familiar with, so you can understand why I choose it over mainstream. It is the only choice that makes sense. As Einstein said…insanity is doing the same thing over and over again expecting a different result.
Most of the discussion in this thread and the other longer one is based on criticisms with no attempt to flesh out Keen's argument. You seem baffled by his argument.
Fine, but you have to realize you are making no headway here, because we all tend to have open minds. We don't care what the truth is, we just care about the truth.
We system folks are baffled by your inability to see his point, even if you don't agree with it. Some of you only generate fog, no clarity. You are not a part of the solution.
I would rather be partly right than precisely wrong, as a famous economist once quipped.
Keen is trying to solve a problem in a new way to move economics forward in an effort to help real people.
How it works is kind of like this: If you borrow from a bank to finance investment, you end up with a swish new tangible asset and a debt of equivalent value, so the change in your net worth is zero. The bank has an asset. That's the saving. Of course, it's not really the bank's saving, because that asset is matched by a bank liability. So the saving belongs to whoever holds that.
"I wish Keen would see some value in including fiscal in his models..."
I think he has been moving in that direction. He's been working with the UKMC academics, moving toward some common groud.
That said, I see merit in working on the two seperately. When I solve a problem I break it down into manageable blocks, then look at the interaction.
Fiscal and the credit circuit can be analyzed separately. The effects are additive. Two signals laid on top of each other.
A lot of the misdirected hype at Keen and MMT is that each one ignores the other. They aren't necessarily ignoring, just focusing on their particular system.
From my perspective, credit is not a necessary part of the system, it's an add-on, at least from the point of view of consumption spending. I see the merit in investment borrowing, because the debt is closed out over the investment cycle. Companies aren't spending future income to buy stuff they don't need. The consumer is paying down that debt too.
Why add personal debt to the load we carry?
Credit for consumption is a trap and should be avoided by most at all costs. It effectively reduces one's income and makes it too easy to be irresponsible. Then it collapses, as it must.
The only way to avoid the collapse in my view is to increase taxes on the super-rich, by a huge amount, increasing incomes for the working class so they don't have to go into debt to have the things they need (cars, housing).
The elites can't be trusted, ever, so we must cripple their ability to game the system. If we can't do that we're toast.
Most of the discussion in this thread and the other longer one is based on criticisms with no attempt to flesh out Keen's argument. You seem baffled by his argument.
I don't think I'm baffled by Steve Keen's argument. It seems pretty straightforward. (Incidentally, it seems like the kind of mistake that MMT deals with quite well, via the sector balances.)
Mainstraem economics is for the most part applied math, as is heterodox.
Mainstream econ is applied maths--that's why there are so many applied mathematicians working in the field. Just because econommics is applied maths, doesn't mean that it's empty of content and you can wave all problems away with "closed systems... entropy... obvious really." Statistics is applied mathematics. OR is applied mathematics. Doesn't mean that you're an expert on Bayesian search theory or supply chain management just because you studied engineering at school.
The other day you made a comment questioning why I am so critical of mainstream economics when I admit I don't know much about it.
I'm not sure exactly what comment you're referring to, but I don't understand how you can draw conclusions about what problems economics is trying to solve if you don't know anything about it. I do feel that it's impossible for any one person to study the economy, without knowing anything about how people already study the economy, and exceed their efforts. So it seems like a pointless exercise.
In general, you give the very strong impression of knowing it all already, and so not needing to rely on the work of others. Yet, taken literally, the statements you make are often incorrect (e.g., spending is not down). Perhaps this just reflects that you are not familiar with the standard terminology, and underneath this, you have world saving ideas of stupendous brilliance, shared by all real scientists and engineers and inexplicably absent from economics until now, despite the endless train of scientists and engineers working in the field, for reasons unknown. But unless you can communicate them to people in a common language, that's where they will remain.
We system folks are baffled by your inability to see his point, even if you don't agree with it
Why don't you put it into an easily digested sentence, then?
Here's a link from a recent thread, which Tom posted:
http://en.wikipedia.org/wiki/Liberal_paradox
It's something that has interested philosophers, but it's basically welfare econ, i.e., theoretical micro. So does thermodynamics help you solve the liberal paradox? Did it help you formulate it in advance of being introduced to it?
"Just because econommics is applied maths, doesn't mean that it's empty of content and you can wave all problems away with "closed systems... entropy... obvious really."
Those relationships render moot many of the things that are the premise of mainstream economics. That's why they are so important. If anyone is waving things away I would have to say it is you.
" taken literally, the statements you make are often incorrect (e.g., spending is not down)"
The rate of spending rate has slowed, but the rate of spending is still positive, so spending continues to increase. OK??? The rate of spending has slowed because the rate of increasing debt has slowed.
First you have velocity, then acceleration, then jerk, then jounce.
"I'm not sure exactly what comment you're referring to,"
"In any case, Paul has frequently claimed that he has had no exposure to economic research, so how he could have come to such a conclusion is something of a mystery."
10/7/2012 6:58 PM
"without knowing anything about how people already study the economy"
This has been explained many, many times, by many, many differnt posters here and countless heterodox economists. I know enough to see that those methods have failed miserably. They haven't earned my respect. Compare that with MMT, which is observant of all of the rules of systems.
"In general, you give the very strong impression of knowing it all already,"
I know systems well enough to know that many claims are outright impossible without any further investigation necessary. There is nothing in heterodox (MMT) that I have seen that is mathematically impossible. Why should I engage an argument that is fundamentally impossible?
The fact that I can't convince you of these ideas is of no consequence to me. Hopefully others reading will get something out of it. I am always looking for a coherent argument to push back against mine, it makes me think and maybe re-think my position. Your arguments don't have that effect, because you tend to defend the indefensible.
"Why don't you put it into an easily digested sentence, then?"
Already have, many, many times by many, many posters. You have waved it off because it doesn't mesh with your pre-conceived worldview.
If it violates any of the aforementioned system principles it isn't possible, no furthrr investigation is necessary. It's really that simple.
Instead of you waiting fo me or others to explain these things to you why don't you read a little of the 2nd Law of Thermodynamics and educate yourself. I've at least read some mainstream literature and read many thousands of blogposts by Krugman, Rowe and countless others. I'm not a complete economics illiterate.
If you claim investment can create growth in the aggregate, without any enabling input from the external sectors, especially progressive taxation, then you have no argument. You are dead in the water. You have defeated your own argument. Can you say impossible?
The problem with mainstream economics applied math is that it doesn't really apply to anything meaningful. Again, this point has been made over and over again many times by many different people, not just me.
To put it simply, if you make any argument not in harmony with system principles you are wrong out of the gate. Stop there. Go in a different direction. Or be wrong.
"How it works is kind of like this: If you borrow from a bank to finance investment, you end up with a swish new tangible asset and a debt of equivalent value, so the change in your net worth is zero. The bank has an asset"
Not quite true. I have a debt and an unpaid asset. The bank owns my house, office building, piece of machinery etc until I pay it off. If I cant, they come take the "asset". Doesnt really sound like its mine.
All you really own is the responsibility to maintain it. If you become behind on your note and its a valuable asset......bye bye asset.
"Just think about what happens, say, when you take out a loan from the bank for some reason. Generally you are going to use that loan to make a payment to someone, perhaps several someones. Then, the money is likely to end up in whatever banks those someones bank with, and your bank is going to have to source some financing other than your deposit, which it no longer holds."
I understand that part. So my bank will have to settle whatever payments I make to account holders at other banks with its reserves. It may have to borrow addtional reserves to do that, or sell bonds to get additional reserves, if it doesn't already have enough.
Banks have to get reserves somehow to keep the show on the road, and they can do this in different ways, one of which is attracting depositors by paying interest on deposits. But the way they get the interest to pay those depositors in the first place is by making loans!
I might spend the money I borrow by paying account holders at other banks, but over time I'm going to be paying back the money to the bank I 'borrowed' from, plus interest - probably by getting paid by account holders at other banks.
Banks need to keep the new loans flowing to keep this process going, and loans basically lead the process, not deposits, it seems to me.
Bank A makes a loan at a certain interest rate, for example, creating the deposit as it does so. The borrower then spends the amount, transferring the deposit to an account either at the same bank or at another bank.
Bank A can then try to keep the deposit within the bank, or attract a deposit from another bank by offering to pay interest (at a lower rate than the original loan of course).
In this case the loan leads the process. Over time the quantity of loans and deposits expands in this way, as "loans create deposits", thereby expanding the overall demand for goods, services and assets, and pushing up prices.
I think the key point is that, regardless of whether for an individual bank, the marginal new loan can be created "out of thin air", or for the banking system "loans create deposits," whatever happens, you're going to have borrowers on the asset side of the bank and lenders on its liability side.
That is why if Keen were to include a simple banking sector in his model, he'd get a consistent outcome, because you could have (the change in) loans from the banking system to all sectors, matched with (the change in) bank liabilities held by other sectors (which could be modelled most simply as broad money, but could also be extended into a more complicated arrangement).
"whatever happens, you're going to have borrowers on the asset side of the bank and lenders on its liability side."
yes but the banking system can create those 'lenders' by extending loans ex-nihilo to borrowers. Either that or the government goes further into debt, creating creditors in the process (same thing).
In both cases you get an increase in demand as the result of increase in debt. The new debt creates the 'funds' with which it is financed.
Problems arise when some sectors of the economy save all of their income, meaning other sectors have to go further and further into debt to keep growth going and to make previous debt repayment possible.
This is what happens when a country runs a current account deficit - the exporting countries save their income so either the domestic private sector has to take on more debt or the government has to.
Then also "consumption = saving" (with credit). All credit creation creates equal saving. The semantics just is a little weird, because "saving" traditionally means non-consumption.. Net surplus of financial balance.
Not so. With consumption, you the borrower have a dissaving, because you haven't acquired any sort of asset. So the asset of the lender is paired your liability for no new saving overall.
"even if you have "endogenous money," you still have aggregate expenditure equal to aggregate income."
I agree. Keen's argument however (I think) is that expenditure can basicaly come 'out of nowhere', generating additional income. So expenditure can be in excess of the income which preceeded it, whilst still equal to the income generated by it - not just for individuals, but for the economy as a whole. This 'ex-nihilo' expenditure creates income which can 'finance' the expenditure in retrospect. The limit to this process is the private sector (inc banks) ability to maintain debt repayments in the face of increasing total leverage.
Right. Expenditure and income increase discretely, but the identity Y = AE is always satisfied. There can't be an increase in expenditure but no increase in income.
Imagine an economy with one bank. The bank makes a loan of $Z. For that period, say that currently Y = $X. After the bank makes the loan, we still have Y = AE =$X. Then the borrower spends the loan and we have Y = AE = $X + $Z.
But that isn't what Keen's saying, as far as I can see.
My understanding is that Keen's equation basically means:
expenditure = income = (income prior to expenditure) + (change in debt prior to expenditure)
- where 'change in debt' can be positive or negative ('saving'), and the change in debt (if positive) results in expenditure at that point.
(He calls "income prior to expenditure" "current received income")
So if you're calculating income and expenditure at any given point in time, you can say that income and expenditure at that point will be equal to each other, and equal to income prior to that point plus any 'change in debt' (resulting in expenditure, if positive) at that point in time.
Bit of a mouthful.
(I might be wrong).
In Keen's equation "income" is assumed to be "prior income", whilst "expenditure" is assumed to precede the income generated by it (causally) - meaning that "expenditure" can be stated on its own, implicitly equalling the income generated by it.
expenditure = income = (income prior to expenditure) + (change in debt prior to expenditure)
expenditure = income = (income prior to expenditure) + (change in savings + or – prior to expenditure)
System-wise, expenditure in a period comes from 1. present income, 2. past income i.e., savings accumulated from previous saving, and 3. future income or debt, which is dissaving. The debt incurred in a period is a flow of dissaving that adds to the accumulated stock of indebtedness.
At any point in time a household can spend from income received in the period, draw down saving as income from a previous period, or draw forward income from future periods by going into debt which is "negative saving" or "dissaving."
To be representational, an accurate model has to be able to deal with spending present, past, and future income in a single period, because that is what actually happens.
--It seems to me that before borrowed money is spent (or otherwise transferred to someone else), the level of debt hasn't actually changed. ?
The bank has an asset (loan) and a liability (deposit), and the borrower has an asset (deposit) and a liability (loan), all of which cancel each other out.
It's only when the borrower's asset is 'split' from his liability, i.e. when the borrower spends (or otherwise uses the money) and someone else receives his asset, that the borrower can be said to be in debt. At that point the borrower is left with a liability (debt), and someone else has the asset (deposit).
So “change in debt” might just be better as it is. However you still have to specify that the change in debt occurs as a result of expenditure, rather than something else.
So you could say:
expenditure = income = (income prior to expenditure) + change in debt
- where 'change in debt' can be positive or negative ('saving'), and a change in debt (if positive) occurs as the result of expenditure at that point.
The bank has an asset (loan) and a liability (deposit), and the borrower has an asset (deposit) and a liability (loan), all of which cancel each other out.
There is a debt as soon as the papers are signed and the interest clock starts ticking. That's why borrowed funds are used pretty quickly instead of being left in deposit accounts. Generally speaking there is not much time lag between incurring a debt and deploying the funds to use.
But if the borrower keeps the money in their account then they can simply pay each installment, as it falls due, with that money - until it runs out. From that point onwards they can be said to be truly in debt - that is - owing money which they don't have.
I might be playing fast and loose with terminology here...
Coming back to what I said above - I was referring to expenditure and income at a particular point in time, but you could reformulate all of the above to cover expenditure and income over a period of time, or what have you.
Tom, could you email Steve Keen (or ask someone to) and ask him to respond to some of the criticisms put forward by Ramanan, JKH, vimothy, etc? Then we might be able to make some real progress.
Thanks for linking:
ReplyDeleteThe title of the post looks like:
"Ramanan minus Income is equal to Expenditure!" :-)
Can be a good competition to Keen's newly found equation.
[Just let it be like that - else my comment will look silly!]
I'm no mathematical genius like Ramanan but after reading his post it seems like he's splitting hairs with Keen.
ReplyDeleteIt makes no sense to say income before debt injection was $100 for real world transactions in a continuous time formulation. It is actually zero just before a debt injection because all income/expenditure flows are “spikey”.
I think that is being the key quote.
It seems to me they agree but present it differently.
Excellent post
ReplyDeleteThe Tobin quote is bang on, of course.
However, I don’t think the Basil Moore quote is particularly helpful. The fact that saving is the record of investment doesn’t mean saving in total can’t be volitional. There’s always inventory to buy somewhere. Nobody is forcing anybody to buy or not to buy what’s on the shelf. So I’m not sure that’s the problem with the SK formulation.
Again, I think it’s a simple matter of attempting to fuse a regression equation with an accounting identity. This is like oil and water.
The basic regression is current expenditure against prior income and intervening debt. That crosses separate accounting periods, within each of which expenditure must equal income. You can regress one against the other, but you can’t write a faux identity as if both pertain to the same accounting period. And whether the accounting is real world discrete or pretend world continuous is irrelevant – the relationship between income and balance sheet accounts and the time ordering of the accounting is well defined in the system of double entry bookkeeping either way.
“It makes no sense to say income before debt injection was $100 for real world transactions in a continuous time formulation. It is actually zero just before a debt injection because all income/expenditure flows are “spikey”. Just after the debt injection it is zero again because nobody spends the instant a loan is given. The debt injection increases assets and liabilities by the amount of the loan if the borrowing is from a bank.”
Right – that’s actually the correct way to apply differential calculus directly to an accounting measurement framework. Dirac is the icing on the cake, but you don’t really need it to make the obvious point here.
This stuff is so basic.
i.e.
ReplyDeleteits a regression of accounting measures across different accounting time periods
but its written as if its a relationship between accounting measures within the same time period - which contradicts the true relationship between such measures
JKH,
ReplyDeleteI think there are inventories will still mean S = I if change in inventories is included in I.
The non-volitional aspect comes in a full model because every model should be thought to sit inside a model with the government and the residual nature of the government balance will make S = I.
Keen includes government later but forgets that with his behaviour where consumers are guzzling consumption, the government will be hitting surpluses.
i.e., he has a black hole in his model is related to the fact that S is not equal to I in his model and surpluses will make make S equal to I.
senexx,
ReplyDeleteI don't think there is agreement. All economists basically speak similar language and a cursory look will make one believe they agree.
The point is that his accounting doesn't add up.
The direction he is looking is right but he has to first respect accounting identities instead of claiming that his identities are better because he working in continuous time formulation.
That doesn't take away that he may have a nice econometric model in his head - not yet put on paper.
"Unfortunately the rules of accounting do not allow this!"
ReplyDeleteHowever the rules of mathematics do.
There is a point where accounting - which is designed for historic reporting - runs out of power to explain.
Like all things accounting is a useful abstraction, but you have to understand its key features and limitations.
And anybody who has done any system work knows that when you move into the realms of forecasting basic double entry runs out of steam.
"nobody spends when a loan is given".
You do with a credit card. The loan is advanced *after* the decision to purchase has been made - at the point of payment. There is no loan - and therefore no accounting for it in national accounts sense - until the spending happens. AIUI the national accounts accounting policies only deal with loans advanced rather than lines of credit.
This hair splitting all detracts from the actual economic effect which is that somebody with a credit card and confidence in their future *feels* they can spend more and has the demand tool to execute that feeling.
Much as somebody with a 'mortgage offer in principle' and confidence in their future *feels* they can go out and buy a house.
And that activity - which isn't accounted for because it is 'contingent' - is what is giving the production system demand signals. That will tend to lead to more supply in anticipation and the debt allows more transactions to complete.
Essentially the demand system pushes forward with spending and then steps back with saving - which leads to a slightly greater push forward than you would expect from the straight accounting.
The standard understanding is that the economy steps back with saving before pushing forward with spending. That leads to a different impulse reaction.
Keen is trying to move the model on from historic accounting and into the realms of forecast modelling.
I'm still not convinced that mathematical modelling is the best way of getting that across though. It's so obtuse.
"You do with a credit card. The loan is advanced *after* the decision to purchase has been made - at the point of payment. There is no loan - and therefore no accounting for it in national accounts sense - until the spending happens. AIUI the national accounts accounting policies only deal with loans advanced rather than lines of credit."
ReplyDeleteYes agree with that.
I should have phrased it differently saying that the statement is not true in all generality.
Anyway when one spends using a credit card, income is created equal to expenditure and Asset-Liabilities are created in pairs.
The bank's assets and liabilities go up and the person shopping has an increase in liabilities and the shop has an increase in assets.
Income is always equal to expenditure no matter which variety of Keynesian or classical economics you espouse - Tobin
Income is always equal to expenditure no matter which variety of mathematics (discrete or continuous) you espouse - me. :)
"You do with a credit card. The loan is advanced *after* the decision to purchase has been made - at the point of payment. "
But nobody said otherwise.
"There is no loan - and therefore no accounting for it in national accounts sense - until the spending happens."
Y_E is still equal to Y_I at every point in time.
The reason dD/dt doesn't appear is that it is cancelled by dA/dt elsewhere.
Look, it is Keen who seems to be splitting hairs.
In his presentation Keen says that "in a demand determined economy, expenditure precedes income".
ReplyDeleteI think this is probably key.
It might be simpler if he stuck to something like: 'the source of monetary demand for goods, services and assets is income plus change in debt' ?
Someone should go over to Keen's blog (it's working again) and invite him to respond to these criticisms. I would, but for some reason I can't register over there so I can't post any comments.
ReplyDelete"expenditure precedes income"
ReplyDeleteIncome = Expenditure for a closed economy!
" 'the source of monetary demand for goods, services and assets is income plus change in debt' ?"
You're quite right. (There are some exceptions such as transfers) But it is just an accounting identity.
More importantly, aggregate demand is a phrase reserved from something different.
Can QE said to be creating "aggregate demand"?
Keen's definition is actually Monetarist. Even Krugman figured this out :-)
The problem with saying something like "the source of monetary demand for goods, services and assets is income plus change in debt" is that you are confusing things that are true for the individual with things that are true for the whole economy.
ReplyDeleteIn one of Keen's equations he has expenditure equal to income plus borrowing for every sector--but no lending! This isn't something that I would have thought MMTers would find confusing. The sum of all the net flows between sectors is zero.
So the correct version of Keen's expression is like saying aggregate expenditure equals sum of sector income plus sum of inter-sector borrowing and lending, which is exactly the same as saying aggregate expenditure equals aggregate income.
Another way to solve this problem for Keen would be if he included a simple financial sector in his model. Then, you have agg exp equals sum of sector income plus bank lending--but the banking sector doesn't have any income, it borrows and lends. So the banking system just intermediates loans, borrowing from the other sectors and again, you get AE = Y.
ReplyDelete"Saving = Investment"
ReplyDeleteI don't understand this formula. If a bank creates money out of thin air, and you invest it, you have the investment and debt. Where is the saving?
"Income = Expenditure for a closed economy!"
ReplyDeleteTrue for individual transactions.
True for the economy as a whole.
Misleading wrt individual incomes because in that case spending≠income, if saving occurs.
I think Keen went astray as follows: he wanted to model the fact that it is the change in debt that is tightly correlated with expenditure (and hence income), but decided to model it as if it was an accounting identity. It is not. You can increase your debt and save the money, for liquidity purposes or whatever. The correlation of change in debt and spending is tight but not 100%.
ReplyDeleteso:
change in debt ~ spending,
but it is not an identity.
Spending = Income is an identity, it is fulfilled at any point of time and space (it is true in any transaction, so Dirac-delta like ;)) You could have a model spending = change in debt, and see what happens, but it is just a model, not an identity.
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ReplyDeleteKaj,
ReplyDelete"I don't understand this formula. If a bank creates money out of thin air, and you invest it, you have the investment and debt. Where is the saving?"
Sorry this is one of the most basic economics identity. Do you know what "investment" is?
vimothy,
ReplyDelete(the following might be obvious, but you seem to be saying something different. It might be wrong too :-)
my understanding is:
when you get a loan from a bank the bank credits your account, and that credit represents a promise by the bank to give you money on demand. However, in most cases the bank's promise to deliver money is never fulfilled, as the money is never withdrawn. If you take out a $100,000 loan, for example, you usually don’t ask to withdraw the amount in cash, as there's no point.
What normally happens instead is that the credit is simply transferred from one account to another when the borrower spends. And again, the person receiving the credit rarely converts it into money by withdrawing it as cash.
Overall, only a tiny fraction of all the money promised by banks ever needs to be delivered by them, as most of the money promised is never withdrawn. Most spending in the economy just involves credits being transferred from one account to another. Banks also only need a relatively small quantity of money at any given time (in the form of reserves) to settle payments amongst themselves.
As such, for all intents and purposes, bank credit is the same thing as money (for all non-bank sectors excluding the government). So when they make loans by extending credit, banks can be said to “create the money out of thin air”. This 'new money' represents new purchasing power, which adds to overall demand in the economy for goods, services and assets (when the money is spent or used to purchase assets).
In effect, when a bank makes a loan they ‘borrow’ the money from the debtor. That is, the bank issues a liability (IOU), as does the debtor, with the bank's liability representing the debtors asset, and vice versa. The bank's liability is then transferred to another account when the debtor spends. The debtor's spending becomes the other account holder's income.
At each point expenditure = income. But with every net addition to total credit (debt) you get a net increase in total purchasing power. As such expenditure and income after credit is extended will be different to expenditure and income before it is extended. This process of extending credit drives production and consumption, and also drives up asset prices (when borrowed money is used to purchase assets).
Of course over time the debtor has to repay the loan with interest, effectively 'withdrawing' the 'money' created by the loan (the principal) from the economy. But if the amount of outstanding credit grows over time the net effect will be a continuous addition to demand. This process goes into reverse when the amount of credit shrinks, as it did in 2008.
(Of course you also have to include government spending to get a fuller picture).
Y,
ReplyDeleteI think I might have mentioned in the other thread that it's easy to see why Keen might think that, since banks can create money "out of thin air" or because "loans create deposits", expenditure is therefore equal to income plus the free money the banks create.
Well, for one thing, it's wrong to bring identities into this, since by their nature they don't tell you about causality. But here's a couple of things to think about:
Do banks still need to fund their loans, or is that automatically taken care of as a natural consequence of the fact that "loans create deposits"?
Presumably banks have a capital structure that's more complicated than just "deposits", right? Otherwise, they wouldn't have any regulatory capital at all. So what's going on there?
PeterP,
ReplyDelete"You could have a model spending = change in debt, and see what happens, but it is just a model, "
I think it would also be interesting to add info from the Treasury's Daily Statement to that, ie look at this expansion in Bank Credit vs Treasury Account withdrawals and receipts....
At some point the system balances being made available to pay the required interest on new/existing system bank credit become insufficient and the whole thing shuts down... it would be perhaps valuable to model that imo...
rsp,
Agreed. (My understanding of all this is pretty limited, surprise surprise). As I said it would be good to see how Keen responds to these criticisms.
ReplyDeleteYes banks have to fund their loans, but the funding is generated largely in a circular fashion through the making of loans, including loans to the government. Banks "leverage" government debt/govt liabilities (inc foreign govt debt?), though not by "lending out" base money, and the extent to which they can do that simply depends on how much debt the non-government sector can bear, before the credit structure becomes too "fragile" and begins to collapse. Bank capital is debt/ liabilities of one sort or another, including government debt/ govt liabilities.
"So what's going on there?"
Tell me what you think.
Wondering why there has been a drop-off in spending?
ReplyDeleteIt isn't mysterious:
http://news.firedoglake.com/2012/10/10/total-us-debt-at-a-six-year-low/
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ReplyDeleteJust wondering: "lending" is basically the same as "purchasing a financial asset" (i.e. buying someone's debt). Correct?
ReplyDeleteIs Keen possibly redefining lending as "spending" (given that he lumps "purchasing assets" into expenditure)? That would be odd.
Actually, aggregate nominal expenditure in the US has never been higher in its entire history:
ReplyDeletehttp://research.stlouisfed.org/fred2/graph/?g=bFN
Y,
ReplyDeleteForget about base money. Just think about what happens, say, when you take out a loan from the bank for some reason. Generally you are going to use that loan to make a payment to someone, perhaps several someones. Then, the money is likely to end up in whatever banks those someones bank with, and your bank is going to have to source some financing other than your deposit, which it no longer holds.
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ReplyDelete"Actually, aggregate nominal expenditure in the US has never been higher in its entire history:"
ReplyDeleteThe graph is GDP growth. GDP has been growing forever. No news there.
It isn't coming from private debt expansion:
http://research.stlouisfed.org/fred2/series/TCMDO
Paul,
ReplyDeleteNo bottom in sight here yet:
http://research.stlouisfed.org/fred2/series/FODSP
looks like soon all-time lows...
rsp,
The graph shows the level of nominal GDP. It's currently up near the $16 trillion mark, higher than it has ever been.
ReplyDeleteAnd I would add this is in view of the tremendous distributional shift in household incomes towards the top...
ReplyDeleteAnd then you also have $100/bbl petro...
rsp,
Petro being equivalent to a "financial obligation" if you have to drive to work... rsp,
ReplyDelete"The graph shows the level of nominal GDP. It's currently up near the $16 trillion mark, higher than it has ever been."
ReplyDeleteNo one has said otherwise. It is what we would expect, no surprise.
You said that there was a drop in spending:
ReplyDeleteWondering why there has been a drop-off in spending?
And linked it to the fall in private debt.
I assumed that this was a comment on Keen's expenditure = income plus change in debt equation.
So I linked to a graph that showed that, whatever private debt has done, the level aggregate expenditure hasn't actually fallen.
If you meant consumer spending specifically, you can see a series for real consumption here:
http://research.stlouisfed.org/fred2/graph/?g=bG3
It too has never been higher. Can't seem to locate a nominal series on Fred or elsewhere, but it's not to hard to transform the graph in your head. Again, the conclusion seems clear.
vim,
ReplyDeleteLooks like that lines up with stimulus hitting in latter 2009 and then Social Security COLAs (and probably Medicare reimbursements) went back to non-zero in 2011:
http://www.ssa.gov/oact/cola/colaseries.html
So that helps the withdrawals side of the Treasury Statement... this is what Warren refers to as "muddle thru"... tho the "fiscal cliff" threatens this "muddle" scenario by potentially reducing the rate of Treasury account withdrawals... buckle up!... rsp,
vimothy,
ReplyDelete"I assumed that this was a comment on Keen's expenditure = income plus change in debt equation."
No, I've stayed out of that because it seems like much ado about nothing. I'm interested in what conclusions he eventually settles on…he seems headed in the right direction to me but I know you don't see it that way.
GDP is going up because we are deficit spending…that's my view, not because of credit expansion.
We must see things a lot differently because when I look at the Fed graph I posted credit expansion stopped in it's tracks and is nowhere near the previous rate. I doubt that it will ever reach that.
Of course based on ordinary system relationships learned in Thermodynamics 40 years ago It was no surprise the bubble burst. It had to.
The fact others in the discussion don't understand or are unaware of or don't see any importance in these concepts (closed systems, entropy, conservation of matter and energy), all of which our man-made systems must be in harmony with to succeed is a mystery to me but that's the way it is.
The other day you made a comment questioning why I am so critical of mainstream economics when I admit I don't know much about it. (Echoed by JKH and Ramanan also surprisingly)
.
Mainstraem economics is for the most part applied math, as is heterodox. The mainstream application is trying to solve problems that don't relate in any meaningful way to the real world. The result has been abysmal.
Why would I bother to learn anything about such a flawed system?
Heterodox on the other hand violates none of the laws that I am familiar with, so you can understand why I choose it over mainstream. It is the only choice that makes sense. As Einstein said…insanity is doing the same thing over and over again expecting a different result.
Most of the discussion in this thread and the other longer one is based on criticisms with no attempt to flesh out Keen's argument. You seem baffled by his argument.
Fine, but you have to realize you are making no headway here, because we all tend to have open minds. We don't care what the truth is, we just care about the truth.
We system folks are baffled by your inability to see his point, even if you don't agree with it. Some of you only generate fog, no clarity. You are not a part of the solution.
I would rather be partly right than precisely wrong, as a famous economist once quipped.
Keen is trying to solve a problem in a new way to move economics forward in an effort to help real people.
You guys are having none of it.
-Sorry this is one of the most basic economics identity. Do you know what "investment" is?-
ReplyDeleteI guess i should leave this subject to you economists, but in my books "investment" is spending. i.e. buying capital goods.
KR,
ReplyDeleteHow it works is kind of like this: If you borrow from a bank to finance investment, you end up with a swish new tangible asset and a debt of equivalent value, so the change in your net worth is zero. The bank has an asset. That's the saving. Of course, it's not really the bank's saving, because that asset is matched by a bank liability. So the saving belongs to whoever holds that.
Paul,
ReplyDeleteI wish Keen would see some value in including fiscal in his models...
rsp,
Matt,
ReplyDelete"I wish Keen would see some value in including fiscal in his models..."
I think he has been moving in that direction. He's been working with the UKMC academics, moving toward some common groud.
That said, I see merit in working on the two seperately. When I solve a problem I break it down into manageable blocks, then look at the interaction.
Fiscal and the credit circuit can be analyzed separately. The effects are additive. Two signals laid on top of each other.
A lot of the misdirected hype at Keen and MMT is that each one ignores the other. They aren't necessarily ignoring, just focusing on their particular system.
From my perspective, credit is not a necessary part of the system, it's an add-on, at least from the point of view of consumption spending. I see the merit in investment borrowing, because the debt is closed out over the investment cycle. Companies aren't spending future income to buy stuff they don't need. The consumer is paying down that debt too.
Why add personal debt to the load we carry?
Credit for consumption is a trap and should be avoided by most at all costs. It effectively reduces one's income and makes it too easy to be irresponsible. Then it collapses, as it must.
The only way to avoid the collapse in my view is to increase taxes on the super-rich, by a huge amount, increasing incomes for the working class so they don't have to go into debt to have the things they need (cars, housing).
The elites can't be trusted, ever, so we must cripple their ability to game the system. If we can't do that we're toast.
Paul,
ReplyDeleteMost of the discussion in this thread and the other longer one is based on criticisms with no attempt to flesh out Keen's argument. You seem baffled by his argument.
I don't think I'm baffled by Steve Keen's argument. It seems pretty straightforward. (Incidentally, it seems like the kind of mistake that MMT deals with quite well, via the sector balances.)
Mainstraem economics is for the most part applied math, as is heterodox.
Mainstream econ is applied maths--that's why there are so many applied mathematicians working in the field. Just because econommics is applied maths, doesn't mean that it's empty of content and you can wave all problems away with "closed systems... entropy... obvious really." Statistics is applied mathematics. OR is applied mathematics. Doesn't mean that you're an expert on Bayesian search theory or supply chain management just because you studied engineering at school.
The other day you made a comment questioning why I am so critical of mainstream economics when I admit I don't know much about it.
I'm not sure exactly what comment you're referring to, but I don't understand how you can draw conclusions about what problems economics is trying to solve if you don't know anything about it. I do feel that it's impossible for any one person to study the economy, without knowing anything about how people already study the economy, and exceed their efforts. So it seems like a pointless exercise.
In general, you give the very strong impression of knowing it all already, and so not needing to rely on the work of others. Yet, taken literally, the statements you make are often incorrect (e.g., spending is not down). Perhaps this just reflects that you are not familiar with the standard terminology, and underneath this, you have world saving ideas of stupendous brilliance, shared by all real scientists and engineers and inexplicably absent from economics until now, despite the endless train of scientists and engineers working in the field, for reasons unknown. But unless you can communicate them to people in a common language, that's where they will remain.
We system folks are baffled by your inability to see his point, even if you don't agree with it
Why don't you put it into an easily digested sentence, then?
Here's a link from a recent thread, which Tom posted:
ReplyDeletehttp://en.wikipedia.org/wiki/Liberal_paradox
It's something that has interested philosophers, but it's basically welfare econ, i.e., theoretical micro. So does thermodynamics help you solve the liberal paradox? Did it help you formulate it in advance of being introduced to it?
"Just because econommics is applied maths, doesn't mean that it's empty of content and you can wave all problems away with "closed systems... entropy... obvious really."
ReplyDeleteThose relationships render moot many of the things that are the premise of mainstream economics. That's why they are so important. If anyone is waving things away I would have to say it is you.
" taken literally, the statements you make are often incorrect (e.g., spending is not down)"
The rate of spending rate has slowed, but the rate of spending is still positive, so spending continues to increase. OK??? The rate of spending has slowed because the rate of increasing debt has slowed.
First you have velocity, then acceleration, then jerk, then jounce.
"I'm not sure exactly what comment you're referring to,"
"In any case, Paul has frequently claimed that he has had no exposure to economic research, so how he could have come to such a conclusion is something of a mystery."
10/7/2012 6:58 PM
"without knowing anything about how people already study the economy"
This has been explained many, many times, by many, many differnt posters here and countless heterodox economists. I know enough to see that those methods have failed miserably. They haven't earned my respect. Compare that with MMT, which is observant of all of the rules of systems.
"In general, you give the very strong impression of knowing it all already,"
I know systems well enough to know that many claims are outright impossible without any further investigation necessary. There is nothing in heterodox (MMT) that I have seen that is mathematically impossible. Why should I engage an argument that is fundamentally impossible?
The fact that I can't convince you of these ideas is of no consequence to me. Hopefully others reading will get something out of it. I am always looking for a coherent argument to push back against mine, it makes me think and maybe re-think my position. Your arguments don't have that effect, because you tend to defend the indefensible.
"Why don't you put it into an easily digested sentence, then?"
Already have, many, many times by many, many posters. You have waved it off because it doesn't mesh with your pre-conceived worldview.
If it violates any of the aforementioned system principles it isn't possible, no furthrr investigation is necessary. It's really that simple.
Instead of you waiting fo me or others to explain these things to you why don't you read a little of the 2nd Law of Thermodynamics and educate yourself. I've at least read some mainstream literature and read many thousands of blogposts by Krugman, Rowe and countless others. I'm not a complete economics illiterate.
If you claim investment can create growth in the aggregate, without any enabling input from the external sectors, especially progressive taxation, then you have no argument. You are dead in the water. You have defeated your own argument. Can you say impossible?
The problem with mainstream economics applied math is that it doesn't really apply to anything meaningful. Again, this point has been made over and over again many times by many different people, not just me.
To put it simply, if you make any argument not in harmony with system principles you are wrong out of the gate. Stop there. Go in a different direction. Or be wrong.
Your choice.
"http://en.wikipedia.org/wiki/Liberal_paradox"
ReplyDeletevimothy,
What does this have to do with system relationships?
"How it works is kind of like this: If you borrow from a bank to finance investment, you end up with a swish new tangible asset and a debt of equivalent value, so the change in your net worth is zero. The bank has an asset"
ReplyDeleteNot quite true. I have a debt and an unpaid asset. The bank owns my house, office building, piece of machinery etc until I pay it off. If I cant, they come take the "asset". Doesnt really sound like its mine.
All you really own is the responsibility to maintain it. If you become behind on your note and its a valuable asset......bye bye asset.
vimothy
ReplyDelete"Just think about what happens, say, when you take out a loan from the bank for some reason. Generally you are going to use that loan to make a payment to someone, perhaps several someones. Then, the money is likely to end up in whatever banks those someones bank with, and your bank is going to have to source some financing other than your deposit, which it no longer holds."
I understand that part. So my bank will have to settle whatever payments I make to account holders at other banks with its reserves. It may have to borrow addtional reserves to do that, or sell bonds to get additional reserves, if it doesn't already have enough.
Banks have to get reserves somehow to keep the show on the road, and they can do this in different ways, one of which is attracting depositors by paying interest on deposits. But the way they get the interest to pay those depositors in the first place is by making loans!
I might spend the money I borrow by paying account holders at other banks, but over time I'm going to be paying back the money to the bank I 'borrowed' from, plus interest - probably by getting paid by account holders at other banks.
Banks need to keep the new loans flowing to keep this process going, and loans basically lead the process, not deposits, it seems to me.
This comment has been removed by the author.
ReplyDeleteBank A makes a loan at a certain interest rate, for example, creating the deposit as it does so. The borrower then spends the amount, transferring the deposit to an account either at the same bank or at another bank.
ReplyDeleteBank A can then try to keep the deposit within the bank, or attract a deposit from another bank by offering to pay interest (at a lower rate than the original loan of course).
In this case the loan leads the process. Over time the quantity of loans and deposits expands in this way, as "loans create deposits", thereby expanding the overall demand for goods, services and assets, and pushing up prices.
Y,
ReplyDeleteI think the key point is that, regardless of whether for an individual bank, the marginal new loan can be created "out of thin air", or for the banking system "loans create deposits," whatever happens, you're going to have borrowers on the asset side of the bank and lenders on its liability side.
That is why if Keen were to include a simple banking sector in his model, he'd get a consistent outcome, because you could have (the change in) loans from the banking system to all sectors, matched with (the change in) bank liabilities held by other sectors (which could be modelled most simply as broad money, but could also be extended into a more complicated arrangement).
"whatever happens, you're going to have borrowers on the asset side of the bank and lenders on its liability side."
ReplyDeleteyes but the banking system can create those 'lenders' by extending loans ex-nihilo to borrowers. Either that or the government goes further into debt, creating creditors in the process (same thing).
In both cases you get an increase in demand as the result of increase in debt. The new debt creates the 'funds' with which it is financed.
Problems arise when some sectors of the economy save all of their income, meaning other sectors have to go further and further into debt to keep growth going and to make previous debt repayment possible.
This is what happens when a country runs a current account deficit - the exporting countries save their income so either the domestic private sector has to take on more debt or the government has to.
What I was trying to show originally was that, even if you have "endogenous money," you still have aggregate expenditure equal to aggregate income.
ReplyDeletevtimothy:
ReplyDeleteThen also "consumption = saving" (with credit). All credit creation creates equal saving. The semantics just is a little weird, because "saving" traditionally means non-consumption.. Net surplus of financial balance.
Not so. With consumption, you the borrower have a dissaving, because you haven't acquired any sort of asset. So the asset of the lender is paired your liability for no new saving overall.
ReplyDeletevimothy,
ReplyDelete(I was simplifying things hugely of course).
"even if you have "endogenous money," you still have aggregate expenditure equal to aggregate income."
I agree. Keen's argument however (I think) is that expenditure can basicaly come 'out of nowhere', generating additional income. So expenditure can be in excess of the income which preceeded it, whilst still equal to the income generated by it - not just for individuals, but for the economy as a whole. This 'ex-nihilo' expenditure creates income which can 'finance' the expenditure in retrospect. The limit to this process is the private sector (inc banks) ability to maintain debt repayments in the face of increasing total leverage.
Right. Expenditure and income increase discretely, but the identity Y = AE is always satisfied. There can't be an increase in expenditure but no increase in income.
ReplyDeleteImagine an economy with one bank. The bank makes a loan of $Z. For that period, say that currently Y = $X. After the bank makes the loan, we still have Y = AE =$X. Then the borrower spends the loan and we have Y = AE = $X + $Z.
But that isn't what Keen's saying, as far as I can see.
My understanding is that Keen's equation basically means:
ReplyDeleteexpenditure = income = (income prior to expenditure) + (change in debt prior to expenditure)
- where 'change in debt' can be positive or negative ('saving'), and the change in debt (if positive) results in expenditure at that point.
(He calls "income prior to expenditure" "current received income")
So if you're calculating income and expenditure at any given point in time, you can say that income and expenditure at that point will be equal to each other, and equal to income prior to that point plus any 'change in debt' (resulting in expenditure, if positive) at that point in time.
Bit of a mouthful.
(I might be wrong).
In Keen's equation "income" is assumed to be "prior income", whilst "expenditure" is assumed to precede the income generated by it (causally) - meaning that "expenditure" can be stated on its own, implicitly equalling the income generated by it.
expenditure = income = (income prior to expenditure) + (change in debt prior to expenditure)
ReplyDeleteexpenditure = income = (income prior to expenditure) + (change in savings + or – prior to expenditure)
System-wise, expenditure in a period comes from 1. present income, 2. past income i.e., savings accumulated from previous saving, and 3. future income or debt, which is dissaving. The debt incurred in a period is a flow of dissaving that adds to the accumulated stock of indebtedness.
At any point in time a household can spend from income received in the period, draw down saving as income from a previous period, or draw forward income from future periods by going into debt which is "negative saving" or "dissaving."
Come to think of it, "change in debt prior to expenditure" might be wrong.
ReplyDelete"expenditure = income = (income prior to expenditure) + (change in debt prior to expenditure)"
is still double counting, I think
I'm trying to think of a better expression
To be representational, an accurate model has to be able to deal with spending present, past, and future income in a single period, because that is what actually happens.
ReplyDeleteI should add to that: Otherwise reality is being fitted to the model rather than the model to reality.
ReplyDeleteOk
ReplyDelete--It seems to me that before borrowed money is spent (or otherwise transferred to someone else), the level of debt hasn't actually changed. ?
The bank has an asset (loan) and a liability (deposit), and the borrower has an asset (deposit) and a liability (loan), all of which cancel each other out.
It's only when the borrower's asset is 'split' from his liability, i.e. when the borrower spends (or otherwise uses the money) and someone else receives his asset, that the borrower can be said to be in debt. At that point the borrower is left with a liability (debt), and someone else has the asset (deposit).
So “change in debt” might just be better as it is. However you still have to specify that the change in debt occurs as a result of expenditure, rather than something else.
So you could say:
expenditure = income = (income prior to expenditure) + change in debt
- where 'change in debt' can be positive or negative ('saving'), and a change in debt (if positive) occurs as the result of expenditure at that point.
Is that circular?
The bank has an asset (loan) and a liability (deposit), and the borrower has an asset (deposit) and a liability (loan), all of which cancel each other out.
ReplyDeleteThere is a debt as soon as the papers are signed and the interest clock starts ticking. That's why borrowed funds are used pretty quickly instead of being left in deposit accounts. Generally speaking there is not much time lag between incurring a debt and deploying the funds to use.
But if the borrower keeps the money in their account then they can simply pay each installment, as it falls due, with that money - until it runs out. From that point onwards they can be said to be truly in debt - that is - owing money which they don't have.
ReplyDeleteI might be playing fast and loose with terminology here...
ReplyDeleteComing back to what I said above - I was referring to expenditure and income at a particular point in time, but you could reformulate all of the above to cover expenditure and income over a period of time, or what have you.
Tom, could you email Steve Keen (or ask someone to) and ask him to respond to some of the criticisms put forward by Ramanan, JKH, vimothy, etc? Then we might be able to make some real progress.
ReplyDelete