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Saturday, May 18, 2013
Randy Wray — Deriving the Kalecki Profits Equation
Without government providing net financial assets, all the money in an economy is bank money created by bank lending at interest. The only what such a system is stable over time is if all income is spent, including interest income.
There is no room for saving, and any saving will create demand leakage that results in disequilibrium between potential supply and effective demand, hence underperformance.
y, Investment is a function of public spending although the logic is circuitous.…
Assume for simplicity NX=0.
To begin with Investment requires capital…capital comes from…
1. prior saving. 2. borrowing from banks.
Hopefully we agree that prior saving is largely a function of deficit spending, otherwise you wouldn't be an MMT proponent.
The borrowing is the circuitous part but briefly…
Consumer spending pays the debt service of investment borrowing from the revenue generated through sales, so it is consumer borrowing that should be the focus. We know where household savings comes from.
Borrowing leads to spending in anticipation of future income…essentially you are spending income that you haven't earned yet.
Borrowing for consumption leads to one group (investors) accumulating the asset side and another (consumers) accumulating the liability side. Investors accumulate assets as after-tax profit (retained earnings) and distributions.
Those accumulated assets are not in play for the liability holders to obtain to satisfy their debt obligations.
This imbalance can only be alleviated through more public spending…trying to do so with more borrowing by the consumer…borrowing from Peter to pay Paul…leads to a stoppage of flow. Eventually, and it doesn't take long…the increase in debt service will overcome the increase in incomes from the spending, and people will be unable to borrow to fund part of their consumption.
The funds to make the payments have to come from somewhere and deficits are the only remaining source.
Thus, the system is reliant on deficit spending, and the funds for investment come either directly from deficit spending or through anticipation of future deficit spending that will support the debt payment system.
Consumer borrowing intoduces a time lag between spending and eventual income but the piper must be paid.
If there were no public spending there would be little reason for investment. Investment is a function of demand which in turn is a function of income which is a function largely of public investment.
I don't think the rate of investment in a society depends in an essential way on the nature of the monetary system. It's not as though societies didn't have investment, consumption, saving, profit etc. before the dawn of modern chartal money systems.
"we are talking about modern monetary economies..."
Right Tom..
This is another analysis here (Kalecki) that does not take into account the type of monetary system the nations are operating under...
I look at it as for Marx he had no choice as he operated in a period of pure metals... so we can give him a pass for sure...
Kalecki looks like it says died in 1970 so although he wasnt present for the second and final step in metal repudiation by the repeal of Bretton Woods the next year, he was present for FDRs first step in 1933....
So perhaps we can give him a pass as to an extent we were still operating under metals up to his death...
No excuses today though... MANY remain blind as bats to these facts even right now as we speak....
This distinction of what kind of monetary system nations are operating under matters greatly imo and needs to be taken into account in all what is termed "macro economic" analysis...
I dont look like it as though we are trying to explain/analyze solar cycles...
For instance Dan says above, that the rate of investment doesnt depend on the type of monetary system, but I would think that if you looked at the 19th century, you would find investment increasing after the big gold rush in '49 and then Alaska, etc..
So the rate of investment has to depend on the rate at which we happen upon mass measures of metals under that system... I just cant see how it could be different..
Like today under state currency, you have President "We're out of money" Obama and the crazy GOP neo-confederate cohort in current control there thinking likewise so investment is of course in the toilet... there is a dearth of growth in leading $NFA flow from the authority... we can see this...
So I guess you may be correct about Keleckis eqaution here it may "hold" but who cares this is just ex post analysis?
He's adding up what we did last quarter big deal?
Where is the causal/predictive nature of this equation? I dont see it...
Matt, as you say the arrangement of the equation says nothing about causality.
We could rearrange the equation several different ways with each of the components of the right side as the left side with no change.
The equation represents a distribution as a result of a system...not the system itself.
Deficit spending is the major causation behind the other three terms...their levels are a distribution of deficits (or public investment).
As deficits approach zero he levels of the other terms approach zero, although they wouldn't reach zero at zero deficits because people would find some other medium to use for commerce rather than state money.
So the equation always holds but as Tom says the level of public investment is a game-changer.
Everybody's spending is someone else's income, and even over a period in which there is no net government deficit it is possible for investment to increase if there is a shift from private sector consumption to private sector investment. It is even possible for overall spending to increase, without a decline in the stock of savings, if there is a growth the pace of economic activity and transactions, and thus the velocity of money. Government deficits allow overall spending to increase in the context of a net nominal addition to savings and without any change in the velocity of money or prices.
But this is true no matter what sort of monetary system is in question. The sector balances equation contains nothing that presupposes any particular monetary system. None of the terms in the equation presuppose that one of the sectors is also the producer of the medium of exchange. It can be deduced from accounting identities and falls out of the division of the economy into sectors. In the standard case the sectors are government, domestic private sector and foreign sector, and we call the inflow and outflow from the government sector "taxes" and "government spending".
But they could be anything. Even if we divided the economy into seven sectors, it would still be a straightforward accounting consequence that a deficit in any one sector would correspond to an exactly equal surplus from the sum of the other six sectors combined, whatever those sectors are. Net financial assets in the system as a whole have to sum to zero, but the net financial assets of any combination of sectors can sum to a positive number if the net financial assets of the other sectors sum to a negative number.
So in looking at the unique role of government, and the place where the role of modern monetary sovereign government's role as the apex of their society's monetary systems comes into play, we need to get beyond the sector balances equation. There are a few important facts:
1. The government exists to serve public purpose, not to accumulate wealth for itself, so its deficits are only significant to the extent that the drain the capacity of the government to act, that is, lead to a reduction in the government's stock of real assets.
2. As the fulcrum of the monetary system, the government has an unlimited capacity to expand its balance sheet in nominal, financial terms, and thus its nominal deficits need never result in a reduction in real assets. For the rest of us, that is not the case: If we continue to run deficits and go deeper and deeper into the whole of negative savings, eventually we will hit the point where others decline to extend further credit to us. Since our liabilities are generally backed by collateral, our inability to meet obligations with financial assets will mean that we have to start meeting them with real assets and a reduction of non-financial wealth. In the meantime, our ability to spend will be eliminated.
3. Government investment is an expression of a community's deliberate choices about the production of large and important goods, and these goods do not generally flow from the investment choices of private entrepreneurs.
The limits on the government's ability to promote economic growth and development in these ways come only from the inherent real limits of the economy. At some point at or near full employment, further expansion of the balance sheet will only begin to drive up prices.
Consolidated non-government net financial assets in aggregate can only come from government, i,e, are exogenous to non-government as double entry makes clear. If Consolidated non-government in aggregate wishes to net save in financial assets in aggregate then govt. must provide the $NFA to do so. Otherwise, the net saving of some parties is offset by the net borrowing of other parties and that is unsustainable over time. So there could only be consistent profits in a system in which govt does not contribute net financial assets if all income is spent and nothing is saved, as Say presumed to be the case since producers would not wish to hold money and would immediately spend it. This is basic to why equilibrium doesn't work where there is demand leakage to saving if government doesn't offset it with $NFA.
"plus the third, which is the domestic private sector increasing its claims upon itself (i.e. going into debt to itself)."
That debt nets to zero..
Saving is funded by deficits ultimately, as debt service is paid.
Which is where we started.
Unless you are claiming that private debt can fund the spending cycle in some kind of "virtuous circle" that is self-reinforcing without any input from deficit spending...
...in which case I say no...that can't happen. That would require a system with no saving (accumulation), all funds circulate continuously.
2. As the fulcrum of the monetary system, the government has an unlimited capacity to expand its balance sheet in nominal, financial terms, and thus its nominal deficits need never result in a reduction in real assets. For the rest of us, that is not the case: If we continue to run deficits and go deeper and deeper into the whole of negative savings, eventually we will hit the point where others decline to extend further credit to us. Since our liabilities are generally backed by collateral, our inability to meet obligations with financial assets will mean that we have to start meeting them with real assets and a reduction of non-financial wealth. In the meantime, our ability to spend will be eliminated.
This is the point of contention. Opponents hold that a government that borrows (issues govt securities of non-zero maturity at interest) faces both borrowing costs and credit constraint, since savers will be unwilling to lend to a profligate government when principal and interest obligation rise to a certain unspecified level, which is assumed to be finite. Then, the central bank will have to start purchasing the debt, thereby "monetizing" the debt and debasing the currency. This is the basis of the debt and deficit hawks argument politically, and a lot of the rationale of those predicting imminent hyperinflation due to QE in the US and Japan.
"It is even possible for overall spending to increase, without a decline in the stock of savings, if there is a growth the pace of economic activity and transactions, and thus the velocity of money"
I think this is a source of confusion.
MV=PQ
M and V tend to move in the same direction...together.
This isn't apparent from looking at the equation.
It is unlikely that we would have more spending (velocity) in the face of a smaller money supply.
Said another way, if there was less money to spend why should we expect more spending?
Further, velocity doesn't translate to gains in the level of funds (stocks or accumulated wealth). Velocity can't translate to increased profits (or saving).
If you spend on consumption, this reduces your saving (because you are consuming your income), whilst simultaneously increasing the saving of the person you are buying from. As such there is no net increase in saving.
If you spend on investment, this increases overall saving. You are not consuming your income - you are *investing* it. At the same time your spending simultaneously increases the saving of the person you are buying from. So saving increases overall.
Private investment creates "real saving" in the form of ownership of capital goods added in the period.
Profit share is divided between owner's consumption and owners' saving. If there is financial saving in addition to real saving, that constitutes demand leakage.
Say held that producers would not save financially since they could do better investing profits. Marx observed that this is only the case where the rate of profit on investment opportunities exceeds the risk-weighted return on financial saving.
Paul, in a capitalist economy investment creates ownership of capital goods and inventory, and that increase in ownership is part of owners' saving in their portfolio for the period, i.e. wealth increases over the period due to the add to real saving reflected in increased value of equity.
For instance, most of the increase in net worth over a period for wealthy entrepreneurs is due to increased nominal value of the equity they hold in the firm.
But y, what causes private investment to increase?
And why isnt that happening now?
This is where increased govt expenditure comes in under a system of state currency...
iow leading up to the GFC you had all of that investment increase which was facilitated by increasing govt spending due to GWOT, Homeland Security, Medicare Rx Drugs, "No child left behind", normal increases in the enrollments for Social Security and Medicare and associated COLAs, and the record setting SEVENTEEN increases in the policy interest rate, etc...
Without these leading actions by govt which resulted in increased $NFA injection, the great increase in "investment" would not have happened imo...
I think "saving" is limited to nominal financial assets by definition.
If saving is defined as income not spent, then once one spends on a real asset it is no longer one's saving. It may be an investment but it isn't saving.
It could become someone else's saving. it likely will because it appears to me that all money creation ultimately becomes someones saving. If that wasn't true then we should have no need for credit or public spending.
Investment is spending, identical to consumption spending except for the accounting distinction. Much of the cost of production is consumed (energy, waste, etc.).
Anyway, for the profit equation that is the topic under discussion all of the terms in the equation are in terms of nominal financial assets. Nothing real.
There is no reason to cross over to real assets as part of the discussion.
The value of real assets is largely dependent upon the flow of nominal financial assets.
The lower the level of dollars flowing in the system the lower the value of real assets is likely to be (in the aggregate).
If you spend on investment, this increases overall saving. You are not consuming your income - you are *investing* it. At the same time your spending simultaneously increases the saving of the person you are buying from. So saving increases overall.
"You" as consumer cannot spend on investment in that "investment" is define in this context as firm spending. Firm spending increases owners' saving as the residual after owners' consumption from profit share.
""You" as consumer cannot spend on investment in that "investment" is define in this context as firm spending. Firm spending increases owners' saving as the residual after owners' consumption from profit share."
Tom, again, saving is defined as income not spent.
Both consumption and investment are spending…
Thus, Investment is not saving (based on the definition).
There may be a relationship between investment and saving, but investment is not saving.
"no it's income not spent on consumption, i.e. income not consumed."
y, look up the definition at wikipedia or the place of your choice.
Anyway, the distinction is irrelevant in math terms…Both drive aggregate demand as an extension of public spending…the distinction is merely a mechanism for tracking investment spending separate from consumption.
The fact that all of the equations we're dealing with in this discussion are in nominal terms which are then conflated interchangeably with real terms is somewhat puzzling.
We are talking about the accounting of nominal dollars here (but we could substitute any currency).
This distinction is being ignored in favor of other less important distinctions.
The wikipedia definition is a bit confused. It says:
"Saving is income not spent, or deferred consumption".
and then:
"the part of a person's income that is spent on mortgage loan repayments is not spent on present consumption and is therefore saving by the above definition"
the implication being that saving is income not spent on present consumption.
Income is comprised of worker income and owners' (capitalists) income. Generally workers are net dissavers and owners are net savers, that is to say, workers consume more in a period than their income in the period by borrowing. Owners are net savers in that they receive more in income (profit share) than they spend.
In addition, owners receive the benefit of "real saving" in their portfolios as increases in the nominal value of the financial interest they hold in real assets (firms), especially where investment increased the underlying value of the asset, whether this increase is realized in the period or not.
While only saving from profit share, i.e., the residual after owners' consumption, is booked under "S," the increased value of their portfolio adds to net worth. This is the "wealth effect" and it is certainly considered as a household's net financial savings after deduction of liabilities against it.
There may be a relationship between investment and saving, but investment is not saving.
S is household money income not consumed, and I is firm money revenue spent on capital goods and inventory. This is what figures into the identities.
In addition, firms don't own themselves. They are owned by other firms or households, and the "other firms" are ultimately owned by households. The increase in the value of the financial interest in firms owned by households shows up as an incremental add to net worth that is not booked as income until realized. But as an add to net worth in the period, it is "saving" that is not included in "S." Most people consider this to be an aspect of "saving" and an important one.
People do spend against this "wealth effect" without realizing the gain. However, until realized the gain is only a paper gain, and spending against it can turn out to be without foundation.
There are only two choices that households have for use of income in y = c + s — consuming and not consuming, and not-consuming is the after consumption income residual defined as saving.
"Saving is income not spent, OR deferred consumption"
y, that means either or both logically, the way I see it. Anyway, as I pointed out a subset of investment spending is strictly consumption. Investment is spending no matter how one defines it.
It seems you're making this much more complicated than it is.
Math is simple…language is hard.
"This is what figures into the identities."
Tom, the identities (I assume you mean the S/B and related identities) are relationships between nominal flows over a period, which are also stocks (incremental) as they accumulate on balance sheets…like a checkbook balance…
…as opposed to strict flows like GDP or Investment or Consumption, which do not add to existing stocks or create new ones and do not accumulate on balance sheets.
The confusion seems to be over what is a flow and or an incremental change to a pair of stocks (transaction), which acts like a flow but is actually a stock moving from one account to another, and a strict flow which is only a measure (rate of change) but not an actual stock or incremental change that accrues on a balance sheet.
S isn't just households; it's the whole private sector.
Right. And it is showing up now due to the historically aberrant increase of retained earnings. Generally speaking retained earnings don't result in demand leakage because they are usually not retained in large amounts for long, but rather used to fund planned investment, pay dividends, fund acquisitions, or buy back shares.
But now corporate savings are a significant portion of private savings and this is contributing to demand leakage.
Here's an explanation by Mosler from 'Soft Currency Economics':
"Investment in new capacity is automatically an increase in savings. Savings rises because workers are paid to produce capital goods they cannot buy and consume. The only other choice left is for individuals to "invest" in capital goods, either directly or through an intermediary. An increase in investment for whatever reason is an increase in savings; a decrease in individual spending, however, does not cause an increase in overall investment. Savings equals investment, but the act of investment must occur to have real savings".
(Savings and Investment: How the Government Spends and Borrows As Much As It Does Without Causing Hyperinflation).
"The relationship between individual spending decisions and national income is illustrated by assuming the flow of money is through the banking system. The money businesses pay their workers may either be used to buy their output or deposited in a bank. If the money is deposited in a bank, the bank has two basic lending options. The money can be loaned to: 1)someone else who wishes to purchase the output (including the government), or 2) to businesses who paid the individuals in the first place for the purpose of financing the unsold output. If the general demand for goods declines the demand for loans to finance inventories rises. If, on the other hand, individuals spent money at a high rate the demand for purchase loans would rise, inventories would decline and the level of loans to finance business inventories would fall".
The argument that households may offset changes in corporate saving can be illustrated with a simple example. Suppose a corporation decides to increase its saving—that is, to retain earnings rather than distribute them as dividends—sophisticated shareholders should understand that their net worth has increased (through the increase in the market value of equity) and reduce their savings to re-establish their optimal life-cycle consumption.
However, a variety of factors related to constraints on consumer and corporate financial behavior may in practice lead to the imperfect substitutability between personal and corporate saving (Bernheim, 2002). In particular:
• Consumers may have a lower marginal propensity to save out of an increase in wealth rather than out of disposable income (which would increase if retained earnings were distributed as dividends). For example, they may be liquidity constrained, or they may tend to perceive capital gains as transitory.
• Even in the absence of liquidity constraints and myopic behavior, and with individuals successfully piercing the corporate veil, exogenous shocks that redistribute wealth from individuals to corporations may increase aggregate savings if shareholders have a higher propensity to save than do other consumers.
• The value of the firm may not change dollar-to-dollar with retained earnings, reflecting problems in corporate governance and imperfect observability of new investment projects. For example, if managers invest retained earnings in projects yielding below-market returns, then share values will grow by less than the increase in retained earnings (Jensen, 1986).
The opposite would happen if retained earnings were to be invested in high-yielding projects that would have been more difficult or costly to finance through financial markets, due to asymmetry of information
So if corps are saving and you are shareholder, you can cut your own saving in ~ that amount and go on a consumption spree to help the economy.
…and all of the terms on the right side except for Net Exports is ultimately a function of (releiant upon) public spending.
ReplyDeleteQ.E.D.
Paul, what about Investment?
ReplyDeletey,
ReplyDeleteMy hunch is that of you could go back and look at the data, you would find that investment never increases during times where govt spending is flat...
Similar to right now, yoy govt spending is up about 30B at this point and bank credit is up about 300B...
So the ratio looks like it is about 10 to 1...
rsp,
Paul, what about Investment?
ReplyDeleteWithout government providing net financial assets, all the money in an economy is bank money created by bank lending at interest. The only what such a system is stable over time is if all income is spent, including interest income.
There is no room for saving, and any saving will create demand leakage that results in disequilibrium between potential supply and effective demand, hence underperformance.
y, Investment is a function of public spending although the logic is circuitous.…
ReplyDeleteAssume for simplicity NX=0.
To begin with Investment requires capital…capital comes from…
1. prior saving.
2. borrowing from banks.
Hopefully we agree that prior saving is largely a function of deficit spending, otherwise you wouldn't be an MMT proponent.
The borrowing is the circuitous part but briefly…
Consumer spending pays the debt service of investment borrowing from the revenue generated through sales, so it is consumer borrowing that should be the focus. We know where household savings comes from.
Borrowing leads to spending in anticipation of future income…essentially you are spending income that you haven't earned yet.
Borrowing for consumption leads to one group (investors) accumulating the asset side and another (consumers) accumulating the liability side. Investors accumulate assets as after-tax profit (retained earnings) and distributions.
Those accumulated assets are not in play for the liability holders to obtain to satisfy their debt obligations.
This imbalance can only be alleviated through more public spending…trying to do so with more borrowing by the consumer…borrowing from Peter to pay Paul…leads to a stoppage of flow. Eventually, and it doesn't take long…the increase in debt service will overcome the increase in incomes from the spending, and people will be unable to borrow to fund part of their consumption.
The funds to make the payments have to come from somewhere and deficits are the only remaining source.
Thus, the system is reliant on deficit spending, and the funds for investment come either directly from deficit spending or through anticipation of future deficit spending that will support the debt payment system.
Consumer borrowing intoduces a time lag between spending and eventual income but the piper must be paid.
If there were no public spending there would be little reason for investment. Investment is a function of demand which in turn is a function of income which is a function largely of public investment.
Matt, Tom…
ReplyDeleteYour responses are more succinct than mine…glad you are here.
I don't think the rate of investment in a society depends in an essential way on the nature of the monetary system. It's not as though societies didn't have investment, consumption, saving, profit etc. before the dawn of modern chartal money systems.
ReplyDeleteEven simpler
ReplyDeleteNational Survival = public initiative + bookkeeping?
everything else = details?
@ Dan
ReplyDeleteWell, we are talking about modern monetary economies with hefty government input.
"we are talking about modern monetary economies..."
ReplyDeleteRight Tom..
This is another analysis here (Kalecki) that does not take into account the type of monetary system the nations are operating under...
I look at it as for Marx he had no choice as he operated in a period of pure metals... so we can give him a pass for sure...
Kalecki looks like it says died in 1970 so although he wasnt present for the second and final step in metal repudiation by the repeal of Bretton Woods the next year, he was present for FDRs first step in 1933....
So perhaps we can give him a pass as to an extent we were still operating under metals up to his death...
No excuses today though... MANY remain blind as bats to these facts even right now as we speak....
This distinction of what kind of monetary system nations are operating under matters greatly imo and needs to be taken into account in all what is termed "macro economic" analysis...
rsp,
Matt, it doesn't matter what monetary system you have, Kalecki's equation still holds. It also helps to explain business cycles - see the wiki page.
ReplyDeletepaul
ReplyDelete"Hopefully we agree that prior saving is largely a function of deficit spending"
private saving = private investment + government deficit + net exports
y,
ReplyDeleteI dont look like it as though we are trying to explain/analyze solar cycles...
For instance Dan says above, that the rate of investment doesnt depend on the type of monetary system, but I would think that if you looked at the 19th century, you would find investment increasing after the big gold rush in '49 and then Alaska, etc..
So the rate of investment has to depend on the rate at which we happen upon mass measures of metals under that system... I just cant see how it could be different..
Like today under state currency, you have President "We're out of money" Obama and the crazy GOP neo-confederate cohort in current control there thinking likewise so investment is of course in the toilet... there is a dearth of growth in leading $NFA flow from the authority... we can see this...
So I guess you may be correct about Keleckis eqaution here it may "hold" but who cares this is just ex post analysis?
He's adding up what we did last quarter big deal?
Where is the causal/predictive nature of this equation? I dont see it...
rsp,
Y, are you agreeing or disagreeing?
ReplyDeleteiow I would think the equation should be of the form (under state currency):
ReplyDeleteI = f(G+)
where "G+" is how much $NFA the govt sector injects into the non-govt
Something like that...
rsp,
Matt
ReplyDelete"Where is the causal/predictive nature of this equation? I dont see it..."
read the wikipedia page or these articles by Bill Mitchell:
Investment and profits
http://bilbo.economicoutlook.net/blog/?p=20400
Introducing economic dynamics
http://bilbo.economicoutlook.net/blog/?p=20509
Budget deficits and private profit
http://bilbo.economicoutlook.net/blog/?p=12003
y,
ReplyDeleteIt's all a bit "driving in the rear view mirror" to me...
rsp,
Paul, I partly agree
ReplyDeleteMatt, as you say the arrangement of the equation says nothing about causality.
ReplyDeleteWe could rearrange the equation several different ways with each of the components of the right side as the left side with no change.
The equation represents a distribution as a result of a system...not the system itself.
Deficit spending is the major causation behind the other three terms...their levels are a distribution of deficits (or public investment).
As deficits approach zero he levels of the other terms approach zero, although they wouldn't reach zero at zero deficits because people would find some other medium to use for commerce rather than state money.
So the equation always holds but as Tom says the level of public investment is a game-changer.
y,
ReplyDeleteIt's like we have F=ma (but no one but us knows this)..
Then, somewhere a large truck drives over a bridge and the bridge collapses...
We observe the authorities look at the situation ex post and see the truck weighed 50,000 lbs...
So they say, dont drive a truck weighing 50,000 lbs over that kind of bridge anymore as now we know that is too heavy ...
We are left scratching our heads witnessing this behavior of the authorities ...
rsp,
right Paul now you see this bitcoin-type stuff and Ignacio has reported here about some regional systems popping up in Espana...
ReplyDeletersp,
"Deficit spending is the major causation.."
ReplyDeleteI think it may be just "spending" Paul...
iow "govt spends first and then collects the taxes"...
'deficit spending' being an ex post result...
So it's like: "How can something ex post be ex ante?" type thing...
rsp,
Matt, I agree and I thought that while I was writing...
ReplyDeleteSPENDING is the causation...deficit spending is an ex-post record of the income we were allowed to keep.
Kalecki's equation is an ex-post record of the distribution in a system with two possible inputs...government net spending and net exports.
If we were net exporters we (as a country) would be saving in a foreign currency rather than state money...but we aren't.
"a system with two possible inputs"
ReplyDeleteplus the third, which is the domestic private sector increasing its claims upon itself (i.e. going into debt to itself).
In the equation that's represented by investment and saving out of wages, where negative saving out of wages means workers being net indebted.
Everybody's spending is someone else's income, and even over a period in which there is no net government deficit it is possible for investment to increase if there is a shift from private sector consumption to private sector investment. It is even possible for overall spending to increase, without a decline in the stock of savings, if there is a growth the pace of economic activity and transactions, and thus the velocity of money. Government deficits allow overall spending to increase in the context of a net nominal addition to savings and without any change in the velocity of money or prices.
ReplyDeleteBut this is true no matter what sort of monetary system is in question. The sector balances equation contains nothing that presupposes any particular monetary system. None of the terms in the equation presuppose that one of the sectors is also the producer of the medium of exchange. It can be deduced from accounting identities and falls out of the division of the economy into sectors. In the standard case the sectors are government, domestic private sector and foreign sector, and we call the inflow and outflow from the government sector "taxes" and "government spending".
But they could be anything. Even if we divided the economy into seven sectors, it would still be a straightforward accounting consequence that a deficit in any one sector would correspond to an exactly equal surplus from the sum of the other six sectors combined, whatever those sectors are. Net financial assets in the system as a whole have to sum to zero, but the net financial assets of any combination of sectors can sum to a positive number if the net financial assets of the other sectors sum to a negative number.
So in looking at the unique role of government, and the place where the role of modern monetary sovereign government's role as the apex of their society's monetary systems comes into play, we need to get beyond the sector balances equation. There are a few important facts:
1. The government exists to serve public purpose, not to accumulate wealth for itself, so its deficits are only significant to the extent that the drain the capacity of the government to act, that is, lead to a reduction in the government's stock of real assets.
2. As the fulcrum of the monetary system, the government has an unlimited capacity to expand its balance sheet in nominal, financial terms, and thus its nominal deficits need never result in a reduction in real assets. For the rest of us, that is not the case: If we continue to run deficits and go deeper and deeper into the whole of negative savings, eventually we will hit the point where others decline to extend further credit to us. Since our liabilities are generally backed by collateral, our inability to meet obligations with financial assets will mean that we have to start meeting them with real assets and a reduction of non-financial wealth. In the meantime, our ability to spend will be eliminated.
3. Government investment is an expression of a community's deliberate choices about the production of large and important goods, and these goods do not generally flow from the investment choices of private entrepreneurs.
The limits on the government's ability to promote economic growth and development in these ways come only from the inherent real limits of the economy. At some point at or near full employment, further expansion of the balance sheet will only begin to drive up prices.
Consolidated non-government net financial assets in aggregate can only come from government, i,e, are exogenous to non-government as double entry makes clear. If Consolidated non-government in aggregate wishes to net save in financial assets in aggregate then govt. must provide the $NFA to do so. Otherwise, the net saving of some parties is offset by the net borrowing of other parties and that is unsustainable over time. So there could only be consistent profits in a system in which govt does not contribute net financial assets if all income is spent and nothing is saved, as Say presumed to be the case since producers would not wish to hold money and would immediately spend it. This is basic to why equilibrium doesn't work where there is demand leakage to saving if government doesn't offset it with $NFA.
ReplyDeletewell said Dan.
ReplyDelete"we need to get beyond the sector balances equation..."
ReplyDeleteAmen brother... ;) rsp
"plus the third, which is the domestic private sector increasing its claims upon itself (i.e. going into debt to itself)."
ReplyDeleteThat debt nets to zero..
Saving is funded by deficits ultimately, as debt service is paid.
Which is where we started.
Unless you are claiming that private debt can fund the spending cycle in some kind of "virtuous circle" that is self-reinforcing without any input from deficit spending...
...in which case I say no...that can't happen. That would require a system with no saving (accumulation), all funds circulate continuously.
2. As the fulcrum of the monetary system, the government has an unlimited capacity to expand its balance sheet in nominal, financial terms, and thus its nominal deficits need never result in a reduction in real assets. For the rest of us, that is not the case: If we continue to run deficits and go deeper and deeper into the whole of negative savings, eventually we will hit the point where others decline to extend further credit to us. Since our liabilities are generally backed by collateral, our inability to meet obligations with financial assets will mean that we have to start meeting them with real assets and a reduction of non-financial wealth. In the meantime, our ability to spend will be eliminated.
ReplyDeleteThis is the point of contention. Opponents hold that a government that borrows (issues govt securities of non-zero maturity at interest) faces both borrowing costs and credit constraint, since savers will be unwilling to lend to a profligate government when principal and interest obligation rise to a certain unspecified level, which is assumed to be finite. Then, the central bank will have to start purchasing the debt, thereby "monetizing" the debt and debasing the currency. This is the basis of the debt and deficit hawks argument politically, and a lot of the rationale of those predicting imminent hyperinflation due to QE in the US and Japan.
"It is even possible for overall spending to increase, without a decline in the stock of savings, if there is a growth the pace of economic activity and transactions, and thus the velocity of money"
ReplyDeleteI think this is a source of confusion.
MV=PQ
M and V tend to move in the same direction...together.
This isn't apparent from looking at the equation.
It is unlikely that we would have more spending (velocity) in the face of a smaller money supply.
Said another way, if there was less money to spend why should we expect more spending?
Further, velocity doesn't translate to gains in the level of funds (stocks or accumulated wealth). Velocity can't translate to increased profits (or saving).
There is for sure a certain cohort of humans who save imo ... no getting around it...
ReplyDeleteThese Tom has identified thru Batra's work as 'the acquirers' imo ... they are for sure among us...
rsp,
"That would require a system with no saving"
ReplyDeleteNo, if private investment increases this increases private saving.
private saving = private investment + govt deficit + net exports
What doesn't necessarily increase is private net saving, or net accumulation of financial assets.
"No, if private investment increases this increases private saving"
ReplyDeleteInvestment does not create money, so investment isn't the source of saving...it is an intermediate transaction.
Investment is spending...a flow...saving is an accumulation...a stock.
"investment isn't the source of saving"
ReplyDeleteSaving is income not consumed.
If you spend on consumption, this reduces your saving (because you are consuming your income), whilst simultaneously increasing the saving of the person you are buying from. As such there is no net increase in saving.
If you spend on investment, this increases overall saving. You are not consuming your income - you are *investing* it. At the same time your spending simultaneously increases the saving of the person you are buying from. So saving increases overall.
Private investment creates "real saving" in the form of ownership of capital goods added in the period.
ReplyDeleteProfit share is divided between owner's consumption and owners' saving. If there is financial saving in addition to real saving, that constitutes demand leakage.
Say held that producers would not save financially since they could do better investing profits. Marx observed that this is only the case where the rate of profit on investment opportunities exceeds the risk-weighted return on financial saving.
Paul, in a capitalist economy investment creates ownership of capital goods and inventory, and that increase in ownership is part of owners' saving in their portfolio for the period, i.e. wealth increases over the period due to the add to real saving reflected in increased value of equity.
ReplyDeleteFor instance, most of the increase in net worth over a period for wealthy entrepreneurs is due to increased nominal value of the equity they hold in the firm.
But y, what causes private investment to increase?
ReplyDeleteAnd why isnt that happening now?
This is where increased govt expenditure comes in under a system of state currency...
iow leading up to the GFC you had all of that investment increase which was facilitated by increasing govt spending due to GWOT, Homeland Security, Medicare Rx Drugs, "No child left behind", normal increases in the enrollments for Social Security and Medicare and associated COLAs, and the record setting SEVENTEEN increases in the policy interest rate, etc...
Without these leading actions by govt which resulted in increased $NFA injection, the great increase in "investment" would not have happened imo...
rsp,
Tom,
ReplyDeleteI think "saving" is limited to nominal financial assets by definition.
If saving is defined as income not spent, then once one spends on a real asset it is no longer one's saving. It may be an investment but it isn't saving.
It could become someone else's saving. it likely will because it appears to me that all money creation ultimately becomes someones saving. If that wasn't true then we should have no need for credit or public spending.
Investment is spending, identical to consumption spending except for the accounting distinction. Much of the cost of production is consumed (energy, waste, etc.).
Anyway, for the profit equation that is the topic under discussion all of the terms in the equation are in terms of nominal financial assets. Nothing real.
There is no reason to cross over to real assets as part of the discussion.
The value of real assets is largely dependent upon the flow of nominal financial assets.
The lower the level of dollars flowing in the system the lower the value of real assets is likely to be (in the aggregate).
If you spend on investment, this increases overall saving. You are not consuming your income - you are *investing* it. At the same time your spending simultaneously increases the saving of the person you are buying from. So saving increases overall.
ReplyDelete"You" as consumer cannot spend on investment in that "investment" is define in this context as firm spending. Firm spending increases owners' saving as the residual after owners' consumption from profit share.
""You" as consumer cannot spend on investment in that "investment" is define in this context as firm spending. Firm spending increases owners' saving as the residual after owners' consumption from profit share."
ReplyDeleteTom, again, saving is defined as income not spent.
Both consumption and investment are spending…
Thus, Investment is not saving (based on the definition).
There may be a relationship between investment and saving, but investment is not saving.
"saving is defined as income not spent"
ReplyDeleteno it's income not spent on consumption, i.e. income not consumed.
"no it's income not spent on consumption, i.e. income not consumed."
ReplyDeletey, look up the definition at wikipedia or the place of your choice.
Anyway, the distinction is irrelevant in math terms…Both drive aggregate demand as an extension of public spending…the distinction is merely a mechanism for tracking investment spending separate from consumption.
The fact that all of the equations we're dealing with in this discussion are in nominal terms which are then conflated interchangeably with real terms is somewhat puzzling.
We are talking about the accounting of nominal dollars here (but we could substitute any currency).
This distinction is being ignored in favor of other less important distinctions.
The wikipedia definition is a bit confused. It says:
ReplyDelete"Saving is income not spent, or deferred consumption".
and then:
"the part of a person's income that is spent on mortgage loan repayments is not spent on present consumption and is therefore saving by the above definition"
the implication being that saving is income not spent on present consumption.
Income is comprised of worker income and owners' (capitalists) income. Generally workers are net dissavers and owners are net savers, that is to say, workers consume more in a period than their income in the period by borrowing. Owners are net savers in that they receive more in income (profit share) than they spend.
ReplyDeleteIn addition, owners receive the benefit of "real saving" in their portfolios as increases in the nominal value of the financial interest they hold in real assets (firms), especially where investment increased the underlying value of the asset, whether this increase is realized in the period or not.
While only saving from profit share, i.e., the residual after owners' consumption, is booked under "S," the increased value of their portfolio adds to net worth. This is the "wealth effect" and it is certainly considered as a household's net financial savings after deduction of liabilities against it.
There may be a relationship between investment and saving, but investment is not saving.
ReplyDeleteS is household money income not consumed, and I is firm money revenue spent on capital goods and inventory. This is what figures into the identities.
In addition, firms don't own themselves. They are owned by other firms or households, and the "other firms" are ultimately owned by households. The increase in the value of the financial interest in firms owned by households shows up as an incremental add to net worth that is not booked as income until realized. But as an add to net worth in the period, it is "saving" that is not included in "S." Most people consider this to be an aspect of "saving" and an important one.
People do spend against this "wealth effect" without realizing the gain. However, until realized the gain is only a paper gain, and spending against it can turn out to be without foundation.
There are only two choices that households have for use of income in y = c + s — consuming and not consuming, and not-consuming is the after consumption income residual defined as saving.
ReplyDeleteS isn't just households; it's the whole private sector.
ReplyDelete"Saving is income not spent, OR deferred consumption"
ReplyDeletey, that means either or both logically, the way I see it. Anyway, as I pointed out a subset of investment spending is strictly consumption. Investment is spending no matter how one defines it.
It seems you're making this much more complicated than it is.
Math is simple…language is hard.
"This is what figures into the identities."
Tom, the identities (I assume you mean the S/B and related identities) are relationships between nominal flows over a period, which are also stocks (incremental) as they accumulate on balance sheets…like a checkbook balance…
…as opposed to strict flows like GDP or Investment or Consumption, which do not add to existing stocks or create new ones and do not accumulate on balance sheets.
The confusion seems to be over what is a flow and or an incremental change to a pair of stocks (transaction), which acts like a flow but is actually a stock moving from one account to another, and a strict flow which is only a measure (rate of change) but not an actual stock or incremental change that accrues on a balance sheet.
S isn't just households; it's the whole private sector.
ReplyDeleteRight. And it is showing up now due to the historically aberrant increase of retained earnings. Generally speaking retained earnings don't result in demand leakage because they are usually not retained in large amounts for long, but rather used to fund planned investment, pay dividends, fund acquisitions, or buy back shares.
But now corporate savings are a significant portion of private savings and this is contributing to demand leakage.
Paul,
ReplyDeletethis link explains my point:
http://www.beezernotes.com/wordpress/?p=4401
Y,
ReplyDelete"G" doesn't include transfer payments....
Iow, how do we look at this if we acknowledge that under a state currency system, govt makes transfer payments?
Iow, govt transfer payments DIRECTLY fund savings.... Where is that equation?
We can always add up numbers in some way ex post, who cares?
Is this valuable?
We can always talk about dead economists who operated in times where we were running completely different monetary systems, again, who cares?
We need equations that describe what is really going on....
Rsp
What is the economics profession's obsession with dead members of their academe? (it's weird-o-rama imo...)
ReplyDeleteName some units of measure after the people AND MOVE ON... oh they dont have such things it's already taken it's called 'a dollar'....
Complete disgrace...
Here's an explanation by Mosler from 'Soft Currency Economics':
ReplyDelete"Investment in new capacity is automatically an increase in savings. Savings rises because workers are paid to produce capital goods they cannot buy and consume. The only other choice left is for individuals to "invest" in capital goods, either directly or through an intermediary. An increase in investment for whatever reason is an increase in savings; a decrease in individual spending, however, does not cause an increase in overall investment. Savings equals investment, but the act of investment must occur to have real savings".
(Savings and Investment: How the Government Spends and Borrows As Much As It Does Without Causing Hyperinflation).
http://www.epicoalition.org/docs/soft0004.htm
cont.
ReplyDelete"The relationship between individual spending decisions and national income is illustrated by assuming the flow of money is through the banking system. The money businesses pay their workers may either be used to buy their output or deposited in a bank. If the money is deposited in a bank, the bank has two basic lending options. The money can be loaned to: 1)someone else who wishes to purchase the output (including the government), or 2) to businesses who paid the individuals in the first place for the purpose of financing the unsold output. If the general demand for goods declines the demand for loans to finance inventories rises. If, on the other hand, individuals spent money at a high rate the demand for purchase loans would rise, inventories would decline and the level of loans to finance business inventories would fall".
y,
ReplyDeleteGovt SPENDS FIRST, then collects the taxes....
It's the "SPENDS FIRST" we should be focusing on...
Here from Warren: "if individuals spent money at a high rate the demand for purchase loans would rise,"
Why isnt this happening now?
rsp,
Matt, I agree.
ReplyDeleteWhy isnt this happening now?
ReplyDeleteFrom the IMF, Awash with Cash, p.137-138:
The argument that households may offset changes in corporate saving can be illustrated with a simple example. Suppose a corporation decides to increase its saving—that is, to retain earnings rather than distribute them as dividends—sophisticated shareholders should understand that their net worth has increased (through the increase in the market value of equity) and reduce their savings to re-establish their optimal life-cycle consumption.
However, a variety of factors related to constraints on consumer and corporate financial behavior may in practice lead to the imperfect substitutability between personal and corporate saving (Bernheim, 2002). In particular:
• Consumers may have a lower marginal propensity to save out of an increase in wealth rather than out of disposable income (which would increase if retained earnings were distributed as dividends). For example, they may be liquidity constrained, or they may tend to perceive capital gains as transitory.
• Even in the absence of liquidity constraints and myopic behavior, and with individuals successfully piercing the corporate veil, exogenous shocks that redistribute wealth from individuals to corporations may increase aggregate savings if shareholders have a higher propensity to save than do other consumers.
• The value of the firm may not change dollar-to-dollar with retained earnings, reflecting problems in corporate governance and imperfect observability of new investment projects. For example, if managers invest retained earnings in projects yielding below-market returns, then share values will grow by less than the increase in retained earnings (Jensen, 1986).
The opposite would happen if retained earnings were to be invested in high-yielding projects that would have been more difficult or costly to finance through financial markets, due to asymmetry of information
So if corps are saving and you are shareholder, you can cut your own saving in ~ that amount and go on a consumption spree to help the economy.