An economics, investment, trading and policy blog with a focus on Modern Monetary Theory (MMT). We seek the truth, avoid the mainstream and are virulently anti-neoliberalism.
I left a comment to the effect that since loans become income for others and so generate federal taxes, the problem is amplified as equity is drained from consumers.
"Engineers should find this argument easy to understand and informative, but tedious to read because the logic is so obvious."
Yes, Steve's model of an economy is conceptually the same "black box" flow model that I was taught as an engineering student. Engineers usually think in terms of flows and rates of change rather than static conditions. It makes perfect sense to me.
The only thing missing from Steve's explanation is a sketch of a black box. :-) Economists like to use tables and charts while engineers prefer to use sketches and flow diagrams.
I try and avoid flow diagrams. Insufficient structure to determine what is going on here.
I'm starting to run up against the limit of what Steve's System Dynamics approach can do as well. Differential Equations are all very well, but they suffer from the essence of the Lucas Critique - policy works on the underlying, not the aggregate.
We need an agent based model system so that we can move up and down the hierarchy as well as side to side across the abstraction layers. I'm pretty sure half of the interesting stuff is in the aggregation processes. We just don't understand them at all.
Neil part of your side to side there is the inter-bank market.. this is where the forex takes place... those agents make adjustments to BS composition based on regulatory rules in response to observed price changes in the product they are financing or holding...
@Matt, Steve's "source" is largely private loans. It's not that Steve is personally opposed to a more active government role -- like his proposed debt jubilee -- he's saying "in our real world, this is what usually happens."
MMT focuses on what government ought to do (but rarely actually does).
China certainly has policy options, just as the US and Europe and Japan have polic options. Should we hold our breath waiting for China to do all the right things? Probably not.
"Yes, Steve's model of an economy is conceptually the same "black box" flow model that I was taught as an engineering student. Engineers usually think in terms of flows and rates of change rather than static conditions. It makes perfect sense to me."
The danger seems to be that engineers usually work with defined systems.
It is VERY dangerous when economic-engineers THINK that they know how an evolving system works. That's mathematically impossible. No system component can mirror all the info broadcast by the system it's merely a part of.
Cultural evolution, business & economics are NOT engineering fields. They all require extreme risks, in the form of rushed decisions based on insufficient data. The only known solution is adequate resiliency. That's why we have social species, and endless forms of teamwork. You don't bet the farm on gambits, nor the Middle Class.
@Roger, engineers work with assumptions, and freshmen engineering students are taught to list their assumptions at the beginning of each exercise. Engineers are well aware that the real world is more complicated than their model and that if their assumptions are wrong then their model will be wrong. Nonetheless simplifying assumptions are always made, otherwise you'd never get anything done.
As my heat transfer prof often said, "if your model is only 20% off, you're doing great !"
Economic modeling is no different except that many economists do not seem to be in the habit of stating their assumptions. I.e., neoclassical economists assume loanable funds. JG proponents assume the unemployed are a fungible commodity. Functional finance assumes that government will respond quickly and intelligently to changes in the economy. And so forth.
Keen's analysis is just BASIC Austrian analysis but which leaves out the essential, ubiquitous and undeniable phenomenon of economic mis-calculation and purchasing power theft invariably induced and facilitated by artificial credit and fiat money creation. We couldn't have the actual source of the problem identified, could we? And, like all "progressives", he calls the resulting government-induced mess "capitalism".
The "cure" for the problem that does not exist is the problem.
Keynes and Post Keynesians expressed similar views.
The problem is that sectoral balances are based on national accounting hence ex post facto and also based on aggregates that are estimates
The functional finance answer is to embedded correction as automatic stabilizers and perhaps also use variable tax rates so that the fiscal stance adjusts itself to changing conditions. The JG is a buffer that expands and contracts with changing conditions to mop up residual unemployment.
I'm apparently being thick-headed but a key point Keen makes is that "expenditures = GDP + change in private debt. But I thought GDP = all spending (expenditures). That is, changes in private debt impact GDP but don't add to it So I clearly don't understand. Any insights appreciated.
@Charles, this is what happens when economists try to describe flows with words instead of with sketches and differential equations. :-) Math is precise, words are confusing. :-)
Keen has presented the math in some of his presentations, I believe the key equation is:
Aggregate Demand = Income + net change in private debt.
If you believe in loanable funds then private debt simply moves existing money from one person to another person. Keen is saying that loanable funds is wrong, that private debt creates new money out of thin air and changes aggregate demand.
Some of Keen's youtube presentation will go into more detail if you are interested. Sorry, I don't have a particular link handy.
Steve has been pretty good at answering specific questions if you ask him nice.
Income = expenditure is the same as Y = GDP as a national accounting identity.
It just means that all expenditure is someone else's income as a matter of accounting for transactions and reporting on the income statement.
Wrt to sources and uses, the uses are spending, saving and payment of taxes. As far as sources, there is current income, previous income not yet spent, and drawing future income forward by borrowing.
I'm not sure that Steve always makes this clear when writing about it for popular consumption.
"Mainstream economists will already be screaming at this point, because they believe in a fallacious model of money called “Loanable Funds” in which banks are just intermediaries and lending is a transfer of money between savers and lenders."
What Keen actually means is "a transfer of money between savers and borrowers", as savers are lenders.
Anyway, everything that Keen says is compatible with the idea that lending is a transfer of money between savers and borrowers. This is obvious once you clarify the fact that a bank deposit is a debt of the bank owed to the deposit holder (the depositor).
So when he says:
"When you borrow from a bank ... the bank records a new asset on one side of its ledger (the debt you now owe to the bank) and a new liability (the additional amount of money in your deposit account)."
What he is actually saying is:
"when you borrow from a bank, ... the bank records a new asset on one side of its ledger (the debt you now owe to the bank) and a new liability (the debt the bank now owes to you)."
This is perfectly compatible with the idea that lending is a transfer of money between savers and borrowers. In this case you are both borrower and saver. You are borrowing from the bank (the loan, which is the bank's asset), and simultaneously lending to the bank (the deposit, which is the bank's debt).
"Wrt to sources and uses, the uses are spending, saving and payment of taxes. As far as sources, there is current income, previous income not yet spent, and drawing future income forward by borrowing"
Right, and the money supply increases when banks increase their borrowing because bank debts are a form of money.
Perhaps my previous comment seems to contradict my initial comment about how lending is a transfer of money between savers and borrowers. How can lending be both a transfer of money between savers and borrowers, and at the same time create new money? The answer is that money is not one uniform thing. There are different types of money. Bank loan/deposit creation both transfers base money between savers and borrowers and creates new money in the form of bank debt.
Dan thanks for the input. I will check out your recommendations. As you say - Aggregate Demand = Income plus change in private debt. It the proceeds from the loan get spent - it becomes spending and somebody else's income - so spending = income.
ReplyDeleteI left a comment to the effect that since loans become income for others and so generate federal taxes, the problem is amplified as equity is drained from consumers.
"Engineers should find this argument easy to understand and informative, but tedious to read because the logic is so obvious."
ReplyDeleteYes, Steve's model of an economy is conceptually the same "black box" flow model that I was taught as an engineering student. Engineers usually think in terms of flows and rates of change rather than static conditions. It makes perfect sense to me.
The only thing missing from Steve's explanation is a sketch of a black box. :-) Economists like to use tables and charts while engineers prefer to use sketches and flow diagrams.
I try and avoid flow diagrams. Insufficient structure to determine what is going on here.
ReplyDeleteI'm starting to run up against the limit of what Steve's System Dynamics approach can do as well. Differential Equations are all very well, but they suffer from the essence of the Lucas Critique - policy works on the underlying, not the aggregate.
We need an agent based model system so that we can move up and down the hierarchy as well as side to side across the abstraction layers. I'm pretty sure half of the interesting stuff is in the aggregation processes. We just don't understand them at all.
Neil part of your side to side there is the inter-bank market.. this is where the forex takes place... those agents make adjustments to BS composition based on regulatory rules in response to observed price changes in the product they are financing or holding...
ReplyDeletersp,
Seems like Keen is focused on "sink" but not so much on "source"...
ReplyDeleteBiological systems:
https://en.wikipedia.org/wiki/Source%E2%80%93sink_dynamics
or electrical systems:
https://en.wikipedia.org/wiki/Current_sources_and_sinks
@Matt, Steve's "source" is largely private loans. It's not that Steve is personally opposed to a more active government role -- like his proposed debt jubilee -- he's saying "in our real world, this is what usually happens."
ReplyDeleteMMT focuses on what government ought to do (but rarely actually does).
China certainly has policy options, just as the US and Europe and Japan have polic options. Should we hold our breath waiting for China to do all the right things? Probably not.
"Yes, Steve's model of an economy is conceptually the same "black box" flow model that I was taught as an engineering student. Engineers usually think in terms of flows and rates of change rather than static conditions. It makes perfect sense to me."
ReplyDeleteThe danger seems to be that engineers usually work with defined systems.
It is VERY dangerous when economic-engineers THINK that they know how an evolving system works. That's mathematically impossible. No system component can mirror all the info broadcast by the system it's merely a part of.
Cultural evolution, business & economics are NOT engineering fields. They all require extreme risks, in the form of rushed decisions based on insufficient data. The only known solution is adequate resiliency. That's why we have social species, and endless forms of teamwork. You don't bet the farm on gambits, nor the Middle Class.
@Roger, engineers work with assumptions, and freshmen engineering students are taught to list their assumptions at the beginning of each exercise. Engineers are well aware that the real world is more complicated than their model and that if their assumptions are wrong then their model will be wrong. Nonetheless simplifying assumptions are always made, otherwise you'd never get anything done.
ReplyDeleteAs my heat transfer prof often said, "if your model is only 20% off, you're doing great !"
Economic modeling is no different except that many economists do not seem to be in the habit of stating their assumptions. I.e., neoclassical economists assume loanable funds. JG proponents assume the unemployed are a fungible commodity. Functional finance assumes that government will respond quickly and intelligently to changes in the economy. And so forth.
Keen's analysis is just BASIC Austrian analysis but which leaves out the essential, ubiquitous and undeniable phenomenon of economic mis-calculation and purchasing power theft invariably induced and facilitated by artificial credit and fiat money creation. We couldn't have the actual source of the problem identified, could we? And, like all "progressives", he calls the resulting government-induced mess "capitalism".
ReplyDeleteThe "cure" for the problem that does not exist is the problem.
"Economic modeling is no different except that many economists do not seem to be in the habit of stating their assumptions."
ReplyDeleteExactly. Nor their error rates. :(
"50% chance of recession... +/- 50%" :(
or, GDP growth of 3% predicted, +/- 3% Doh!
In engineering there is accountability, In economics not so much. You get to bury your mistakes.
ReplyDeleteDan if we figure this out then China will just copy/hack what we do as usual.... ball is in our court like it always is/has been...
ReplyDeletersp,
ReplyDeleteBut look! There on the horizon... It's the Rational Unicorn!
Lucas critique where does that leave the sectoral balances ?
ReplyDeleteKeynes and Post Keynesians expressed similar views.
ReplyDeleteThe problem is that sectoral balances are based on national accounting hence ex post facto and also based on aggregates that are estimates
The functional finance answer is to embedded correction as automatic stabilizers and perhaps also use variable tax rates so that the fiscal stance adjusts itself to changing conditions. The JG is a buffer that expands and contracts with changing conditions to mop up residual unemployment.
I'm apparently being thick-headed but a key point Keen makes is that "expenditures = GDP + change in private debt. But I thought GDP = all spending (expenditures).
ReplyDeleteThat is, changes in private debt impact GDP but don't add to it So I clearly don't understand. Any insights appreciated.
@Charles, this is what happens when economists try to describe flows with words instead of with sketches and differential equations. :-) Math is precise, words are confusing. :-)
ReplyDeleteKeen has presented the math in some of his presentations, I believe the key equation is:
Aggregate Demand = Income + net change in private debt.
If you believe in loanable funds then private debt simply moves existing money from one person to another person. Keen is saying that loanable funds is wrong, that private debt creates new money out of thin air and changes aggregate demand.
Some of Keen's youtube presentation will go into more detail if you are interested. Sorry, I don't have a particular link handy.
Steve has been pretty good at answering specific questions if you ask him nice.
Keen seems to have changed his formulation.
ReplyDeleteIn this article, he writes:
" total expenditure and income in our economy is the sum of the turnover of existing money, plus the change in private debt"
Which is different to what he was saying before. In the past he has said things like expenditure = income + the change in debt.
Now he's saying expenditure = income = turnover of existing money + change in debt
Income = expenditure is the same as Y = GDP as a national accounting identity.
ReplyDeleteIt just means that all expenditure is someone else's income as a matter of accounting for transactions and reporting on the income statement.
Wrt to sources and uses, the uses are spending, saving and payment of taxes. As far as sources, there is current income, previous income not yet spent, and drawing future income forward by borrowing.
I'm not sure that Steve always makes this clear when writing about it for popular consumption.
This comment has been removed by the author.
ReplyDeleteKeen writes:
ReplyDelete"Mainstream economists will already be screaming at this point, because they believe in a fallacious model of money called “Loanable Funds” in which banks are just intermediaries and lending is a transfer of money between savers and lenders."
What Keen actually means is "a transfer of money between savers and borrowers", as savers are lenders.
Anyway, everything that Keen says is compatible with the idea that lending is a transfer of money between savers and borrowers. This is obvious once you clarify the fact that a bank deposit is a debt of the bank owed to the deposit holder (the depositor).
So when he says:
"When you borrow from a bank ... the bank records a new asset on one side of its ledger (the debt you now owe to the bank) and a new liability (the additional amount of money in your deposit account)."
What he is actually saying is:
"when you borrow from a bank, ... the bank records a new asset on one side of its ledger (the debt you now owe to the bank) and a new liability (the debt the bank now owes to you)."
This is perfectly compatible with the idea that lending is a transfer of money between savers and borrowers. In this case you are both borrower and saver. You are borrowing from the bank (the loan, which is the bank's asset), and simultaneously lending to the bank (the deposit, which is the bank's debt).
Tom,
ReplyDeleteyou're right, but that's why people said Keen was wrong when he came out with things such as expenditure = income + change in debt.
Now he's changed that to expenditure = income. Full stop.
"Wrt to sources and uses, the uses are spending, saving and payment of taxes. As far as sources, there is current income, previous income not yet spent, and drawing future income forward by borrowing"
ReplyDeleteRight, and the money supply increases when banks increase their borrowing because bank debts are a form of money.
Perhaps my previous comment seems to contradict my initial comment about how lending is a transfer of money between savers and borrowers. How can lending be both a transfer of money between savers and borrowers, and at the same time create new money? The answer is that money is not one uniform thing. There are different types of money. Bank loan/deposit creation both transfers base money between savers and borrowers and creates new money in the form of bank debt.
ReplyDeleteDan thanks for the input. I will check out your recommendations. As you say -
ReplyDeleteAggregate Demand = Income plus change in private debt. It the proceeds from the loan get spent - it becomes spending and somebody else's income - so spending = income.
Bob the Moron:
ReplyDelete"Keen's analysis is just BASIC Austrian analysis"
your comment only serves to demonstrate the fact that you know absolutely nothing about austrian school economics, or any type of economics at all.