Friday, July 28, 2017

Peter Cooper — Self-Imposed Constraints as an Obfuscating Factor

From inception of a monetary economy with a government-issued currency, it is clear that government spending must come before tax payments or purchases of government debt. The order of requirements is basically: (i) government defines its monetary unit of account; (ii) government imposes taxes and other obligations that can only finally be settled in that currency; (iii) government spends (or lends) its currency into existence; (iv) non-government can now obtain the currency and, among other things, pay its taxes and purchase government debt. It is clear that government spending must logically come before tax payments or purchases of government debt because non-government must be able to get hold of the currency before it can do these things….
"Tax and spend is really "spend and tax" at the operationally level. The "tax and spend" illusion arises from optics that are created by failure of operational understanding.

It's the same with credit creation through bank lending. Loans create deposits. Deposits don't create loans and are not necessary for lending.

The government and banks create the unit of account simply be crediting accounts. But only the government can create entries in the payments system that is used for final settlement and settlement of obligations to the government, which are only redeemable using liabilities issued by government.

23 comments:

Matt Franko said...

"Tax and spend is really "spend and tax" at the operationally level."

Not under Modified Accrual accounting... you have to be able to accrue the taxes receivable which you can't under Modified Accrual....

Matt Franko said...

You can keep saying this until you are blue in the face getting nowhere for 20+ years... until you change the basis of Accounting you will keep getting nowhere...

Neil Wilson said...

That's complete rubbish Matt.

Accounting is an historic convention. You tot up *after* the date. What policies you apply have no effect on what has already happened. It's just a way of presenting things that are long gone.

Operational is in the now. It has nothing to do with accounting and everything to do with the power to say 'no'.

AXEC / E.K-H said...

Money and time
Comment on Peter Cooper on ‘Self-Imposed Constraints as an Obfuscating Factor’

Peter Cooper describes how money comes into the world: “From inception of a monetary economy with a government-issued currency, it is clear that government spending must come before tax payments …. The order of requirements is basically: (i) government defines its monetary unit of account; (ii) government imposes taxes and other obligations that can only finally be settled in that currency; (iii) government spends its currency into existence; (iv) non-government can now obtain the currency and, among other things, pay its taxes and purchase government debt.”

From this follows for the time sequence of spending and taxation: “Since the destruction of something cannot logically occur prior to its creation, clearly government spending (which creates government money) logically precedes tax payments (which destroy government money).”

This suggests that money comes into the world through deficits. This is true in principle but from this does not follow a rationale for ever expanding government debt.

To see this one has to start with the basics, i.e. with the time pattern of transactions and the emergence of deficits. The pure consumption economy is for a start clearly defined by three macro axioms (Yw=WL, O=RL, C=PX), two conditions (X=O, C=Yw) and two definitions (Qm≡C-Yw, Sm≡Yw-C).#1

What is needed for a start is two things (i) a central bank which creates money on its balance sheet in the form of deposits, and (ii), a legal system which declares the central bank’s deposits as legal tender.

Deposit money is needed by the business sector to pay the workers who receive the wage income Yw per period. The need is only temporary because the business sector gets the money back if the workers fully spend their income, i.e. if C=Yw.

Overdrafts are needed by the household sector for consumption expenditures if the households want to spend before they get their income. This time sequence is no problem for the central bank because the temporary overdrafts vanish with wage payments.

The two transaction sequences for the case of a balanced budget C=Yw are combined in Figure 1 which shows the deposits/overdrafts of the household sector at the central bank over the course of one period.

https://commons.wikimedia.org/wiki/File:AXEC98.png

The household sector’s deposits/overdrafts are zero at the beginning and end of the period. The business sector’s transaction pattern is the exact mirror image. Money = deposits is continually created and destroyed during the period under consideration.

As a matter of principle, the time sequence ― spending before income or income before spending ― is NOT an issue at all. The central bank can handle EVERY transaction pattern. What matters is whether the budget is balanced at the end of the period or not, i.e. whether C=Yw.

So we have two cases. First case, the household sector’s spending C is greater than wage income Yw. The transaction pattern in the case of continuous dissaving is shown in Figure 2.
https://commons.wikimedia.org/wiki/File:AXEC99.png

The household sector ends up with overdrafts. As a mirror image, the business sector ends up with deposits. The household sector’s debt increases through dissaving. It holds -Sm=Qm.

The transaction pattern in the case of saving, i.e. C is less than wage income Yw, is shown in Figure 3.
https://commons.wikimedia.org/wiki/File:AXEC100.png

In both cases, the quantity of money = deposits at the central bank increases. In the first case the additional money is in the hands of the business sector (= profit), in the second case the additional money is in the hands of the household sector (= saving).

See part 2

AXEC / E.K-H said...

Part 2

Now, exactly the SAME holds when government is included. Whether government spending comes before taxes or vice versa is a matter of INDIFFERENCE. It is merely a technical issue and the central bank can handle it without difficulties.

The all important question is whether the government ends up with a deficit or a surplus. If government spending G is greater than taxes T then government debt increases and this has NOTHING to do with whether spending comes before taxes or whether taxes come before spending.

Peter Cooper confounds the question of the time sequence of transactions with the question of government deficits/surpluses. The deficit ceiling of the US government refers to the accumulated debt and NOT to short term overdrafts which are only a minor cash management problem as long as G=T.

Egmont Kakarot-Handtke

#1 For the detailed verbal description see ‘How money emerges out of nothing ― the functional account’
https://axecorg.blogspot.de/2017/07/how-money-emerges-out-of-nothing.html

Matt Franko said...

Neil, Accrual Basis methods (vice Cash Basis) allow you to anticipate a future transaction...

I agree Cash Basis is 100% ex post... but not Accrual...

Matt Franko said...

Neil you are describing Cash Basis accounting not Accrual accounting ...

Matt Franko said...

Neil,

If you are a restaurant and a Saturday is the last day of the month and a big day for sales and you do all credit card sales, if somebody comes in and eats on the 30th and pays with a credit card, you as the restaurant record the sales for the month as of COB on the 30th under Accrual but you will not get the USD balances in your operating account until maybe Tuesday or Wednesday... which is in the next month...

Or think about accepting Purchase Orders with net 30 terms... you record the sale when you have delivery and sign off but dont get paid for another 30 days... the receivable becomes an asset TODAY in anticipation of a FUTURE payment... under Cash Basis, you could just hold the signed invoice and wait to record the sale when you get paid...

US govt chooses to use Cash Basis on the left hand side and use Accrual on the right hand side in what they term 'Modified Accrual Accounting'.... no one else does this...

Morons then apply selective use of the "govt as firm" analogy as if these idiots really want to look at "govt as firm!" then they should at least use the same accounting methodology as any other firm out there...



Matt Franko said...

Its interesting to watch the CBO morons get all twisted up trying to "score" Trump's healthcare thing where Trump is proposing 'advance refundable tax credits' which will show up as a NEGATIVE entry on the left hand side for the CBO morons... its really giving them fits....

So as they cant accrue the left hand side, they cannot anticipate the budgetary effect and they are coming up with wild budget projections some say the budget will balance and others say the deficit will increase, etc.

they are in way over their heads and dont know what to do... Trump is rightly criticizing the CBO morons...

Matt Franko said...

Egmont,

"If government spending G is greater than taxes T then govt debt increases "

You are redefining "G" as under the NIA, "G" does not include transfer payments...

"G" only includes direct govt purchases... so if govt transferred USDs to a Medicare provider in reimbursement for services, that is not in "G"... or if govt paid interest on its Treasury securities, that is not in "G" either, etc...

Better way to look at it might be "if govt withdrawals exceed govt deposits, then govt debt increases..." This is Cash Basis...

Matt Franko said...

Trump could just say thru executive order that he is converting his OMB over to normal Accrual Basis and CBO can go F themselves and the horse they rode in on.. if anybody there understood any of this...

AXEC / E.K-H said...

Neil Wilson, Matt Franko

Neil Wilson maintains: “Accounting is an historic convention. You tot up *after* the date.”

This is an old cliche from the pre-computer era and it is downright false with regard to money. Money in our days is, in the most elementary case, deposits at the central bank which is nothing else than the debit side of the central bank’s balance sheet. In the general case of a differentiated banking system, this translates into the consolidated balance sheet of the banking sector (= central bank + commercial banks).

So, when the firm wants to pay its workers it orders the central bank to transfer the amount x. The initial deposits of the firm are zero. Then the central bank makes a book entry: firm’s overdrafts -x and worker’s deposits +x. The balance sheet of the central bank lengthens. Thus, money is created out of nothing BY accounting, or UNO ACTU with the book entry, and NOT ‘after the date’.

Money = information, and creation/destruction of money = accounting at the CB.

The problem of economists is that they are storytellers and when it comes to do the elementary mathematics of accounting, that is, to simply write down effective real world monetary transactions and to eventually sum them up, one-half of their two brain cells burn through.#1

The mathiness problem of economists does not consist in the application of advanced mathematics but in the incapacity to apply the straightforward arithmetic of accounting.#2

The whole intellectual misery of economics reveals itself when somebody says “It’s only an accounting identity”.#3

Egmont Kakarot-Handtke

#1 The Common Error of Common Sense: An Essential Rectification of the Accounting Approach
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2124415

#2 A tale of three accountants
https://axecorg.blogspot.de/2017/07/a-tale-of-three-accountants.html

#3 For details see cross-references Accounting
http://axecorg.blogspot.de/2016/12/accounting-cross-references.html

peterc said...

EKH, this is more in relation to a previous thread, but you mention it here also that you think money is better thought in general terms as information rather than an IOU.

I actually think the IOU construction adopted by MMTers and some others captures the nature of money better.

If society ever reached a point where people were happy to do stuff without anything in return (i.e. no quid-pro-quo), there would be no need for money, because nobody would think anybody owed them anything or that they owed anything to anybody else. But in such a society there would still be a use for information.

So I think the money as IOU construction holds up well as a general depiction of the nature of money. We need money (IOUs) because we require of each other (at least for the foreseeable future) reciprocation in many areas of life.

In my recent posts, though, my purpose has not been to argue for a particular history of money (though I agree with the MMT view of this history) or to argue that deficit spending is necessary. In the "short & simple" posts the context in which money as an IOU was discussed was in explaining how, logically, spending (whether public or private) can occur independently (i.e. autonomously) of income. The answer of course is (broadly conceived) money creation of some kind -- generalized to issuance of IOUs.

It's true I use the thought experiment of an economy from inception, but this is not to prove a historical point or even a temporal point (about the timing of events, although unlike you, I do think temporality is important in understanding causation in most circumstances) but rather to make a logical point (in the "short & simple" posts) about spending being able to occur independently of income or (in the post to which this thread indirectly applies) a point about the government's capacity to spend without a need to obtain its funds from anybody else.

More generally, it often seems to me that you are attributing ideas or arguments to me that are not my ideas, but are ideas already expressed by many others that I happen to agree with. This is especially so in the "short & simple" posts. Nothing is intended to be original in those posts. So, for example, when you refer to "Cooper's view" of money as an IOU, it is of course not my view, but a view developed by others who I am in agreement with.

AXEC / E.K-H said...

Matt Franko

You say: “You are redefining "G" as under the NIA, "G" does not include transfer payments.”

This is correct. In order to keep things simple G is spending on goods and services analogous to the consumption expenditures C of the household sector. All other things have to be dealt with separately.

Egmont Kakarot-Handtke

Tom Hickey said...

Money as an IOU and as information are two aspects or facets of money. They are complementary rather than mutually exclusive.

Money also has other aspects considered from other angles such as function. Money is used as a unit of account (measure of value), medium of exchange, store of value ("savings" as opposed to chattel ownership or real property), and record of credit-debt (IOU). The fundamental function of money is as unit of account, that is, an established standard of measurement.

In addition, as Randy Wray has pointed out, it is necessary to draw a distinction between money as an institutional artifact and the money-thing that goes proxy for it as a token. Money is defined institutionally and is dependent on the institutional arrangements involved. The use of money began with custom and was further elaborated in law.

Perhaps the most general characteristic of money is what differentiates money from barter. In barter commodities are exchanged for commodities whereas monetary exchange involves exchange of money and commodities as items for sale. In barter real goods are exchanged, whereas in monetary exchange at least one side of a transaction is financial and income cases both.

Matt Franko said...

Well transfer payments can add to the govt "debt".. under Cash Basis...

AXEC / E.K-H said...

peterc

(i) You say: “EKH, this is more in relation to a previous thread, but you mention it here also that you think money is better thought in general terms as information rather than an IOU. I actually think the IOU construction adopted by MMTers and some others captures the nature of money better.”

This is a misunderstanding. Money = information, and money = public IOU, and money = the debit side of a credit relationship on the CB’s balance sheet are only different ways of expressing the same thing. Whether the IOU takes the form of a clay tablet, a piece of paper, or of a series of 0/1 in the working memory of a CB server is only a question of technical sophistication.

(ii) You say: “So, for example, when you refer to ‘Cooper’s view’ of money as an IOU, it is of course not my view, but a view developed by others who I am in agreement with.”

I am not refuting you as a person but your argument and by implication all others who come forward with the same argument.

The point at issue is NOT the policy proposals of MMT or their proponents but the lack of sound theoretical foundations.*

Egmont Kakarot-Handtke

* See cross-references
https://axecorg.blogspot.de/2017/07/refutation-of-mmt-all-proofs-and.html

Six said...

This is a bizarre and convoluted thread, perhaps due to the differences in Dollar and Euro monetary operations. Matt seems to be stating that Dollar monetary operations that occur in real time on a cash basis are somehow influenced by the treasury balance sheet, which occurs after the fact and is presented in "modified" accrual format. EKH seems to indicate that reserve balances are not spent into existence by Government, but instead are leant into existence by the central bank upon orders from a "firm". This may well be true, as I know nothing in regards to Euro monetary operations and have been curious about the genesis of Euro reserve balances.

Matt Franko said...

Six,

In US we run the Daily Treasury Statement in Cash Basis and we run the Monthly Treasury Statement and do the budget process both at the OMB and at the CBO under Modified Accrual Basis...

Modified Accrual here:

http://www.businessdictionary.com/definition/modified-accrual-basis-accounting.html


Trouble is all the CBO and OMB people are economists and political science majors ... none there are accountants by training... if I were Trump I'd just order my OMB to convert to regular Accrual like the rest of us and tell the CBO/Peterson people to go F themselves and back to school and study some accounting science ...

Matt Franko said...

And hire some accountants at OMB instead of idiot Mulvaney ...

jrbarch said...

$money is something that vaporises, on private balance sheets at least. Always a surprise ....

AXEC / E.K-H said...

The ultimate ― analytical ― origin of money

Methodologically it holds: “Questions of origin are ‘how and why’ questions. They are comparatively unimportant theoretically and usually have only a specific historical interest. (Popper) So, monetary theory deals not with the historical origin of money in a nation state but with the logical origin.

Suppose the business sector consists initially of one giant fully integrated firm. There is no central bank and no sovereign political entity. The firm fixes the wage rate W arbitrarily at 1 dollar per hour. We then have a unit of account but nothing that looks like money. In principle, it suffices that the firm’s accountant keeps track of wage payments and the purchases of each employee at the firm’s store. We then have a nominal but not yet a monetary economy.#1

In the next step, the firm pays the monthly wages with a standardized IOU and declares that this conveniently denominated title will be unconditionally accepted at the firm’s store. The employees accept that the IOUs discharge their wage claim against the firm. Since the household sector’s budget is balanced by the initial condition C = Yw, whatever the firm issues returns until the end of the period under consideration. The firm creates IOUs and destroys them again within a given time span. No IOUs are carried over to the next period and therefore the IOU is not suited as a store of value. The firm’s IOU is a pure transaction medium.

We now split the business sector into two identical halves. Firm A’s wage rate remains unchanged at 1 dollar but firm B pays a wage rate of two bancor per hour and issues its own IOUs for the payment of wages. Now the question arises whether store A could accept the IOUs of firm B and vice versa. Technically there is no problem to fix an exchange rate between the IOUs. The advantage for the households consists in no longer being restricted to buy their firm’s product in their firm’s store. This increase in the number of buying locations, though, is not so impressive because both firms produce an identical output and sell at the same price in dollar or bancor. At the end of the period under consideration firm B presents firm A’s IOUs and gets its own IOUs in return. Under the given ideal conditions the mutual claims cancel out exactly.

One important element of a functioning IOU economy is the unconditional mutual acceptance of IOUs and the final clearing of balances between the different issuers of IOUs.

IOUs have a time dimension, a duration. Because the duration between creation and destruction is relatively short, IOUs are only suited as transaction medium but not as a store of value. This duration, though, is enough to explode General Equilibrium Theory: “… it is generally acknowledged that no kind of exchange intermediary or, in common parlance, ‘money’ can be introduced into conventional general equilibrium theory without violating its logical underpinnings …”. (Clower) Equilibrium theory cannot handle duration because it is formally predicated on simultaneity.

As the number of firms increases the number of exchange rates multiplies by n(n-1)/2 and the handling of privately issued IOUs becomes obviously more and more cumbersome even under the ideal condition that each firm’s store voluntarily accepts all other IOUs, that all households fully spend their incomes in the period under consideration, and, above all, that all participants honor their obligations. A host of practical problems arises when people start gaming the system, e.g. by counterfeiting or over-issuing IOUs.

See part 2

AXEC / E.K-H said...

Part 2

The final step on the way to money proper consists of the introduction of the central bank and of the definition of the means of payment. Instead of issuing their own IOUs, the firms now become the debtors of the central bank in the form of overdrafts and get deposits in return. These deposits are then used for wage payments and subsequently for the households’ purchases of the consumption goods. Thus, the firms’ overdrafts are eventually reduced again to zero. There is no constant quantity of money in the economic system. This idea is the fundamental blunder of the Quantity Theory.

In marked contrast to private IOUs central bank money = deposits has no built-in short term duration. This means that central bank money morphs from a pure transaction medium into a store of value.

The fact that deposits can at any time take the form of bank notes and vice versa in no way affects the characteristics of money but means that the central bank loses sight of that part of transactions that are carried out with cash. This feature is a precondition for the use of money in the black economy.

In the pure consumption economy money starts as an IOU of the single firm. The transaction medium is created out of nothing for wage payments and is destroyed when the households spend their income by buying the firm’s output. In the case of multiple firms, this leads to many different IOUs. The multiplicity of private IOUs, which becomes exponentially impractical as the number of firms increases, is finally replaced by the central bank’s generalized public IOU which is money in the proper sense.

The ultimate rationale for central bank money is the enormous productivity gain for the economy as a whole that comes from the replacement of private IOUs. Central bank money is the most efficient transaction medium and it has the additional property of a store of value.

Because the central bank is an institution that has to be established by the legal authority of a nation state money is, as the MMTers do not get tired of emphasizing, ultimately a creation of ‘the state’. This does not mean, though, that the government is needed to endow the economy with money.#2 This is the basic function of the central bank.

Egmont Kakarot-Handtke

#1 The pure consumption economy is for a start defined by three macro axioms (Yw=WL, O=RL, C=PX), two conditions (X=O, C=Yw) and two definitions (Qm≡C-Yw, Sm≡Yw-C).
#2 See Refutation of MMT: all proofs and arguments you ever need
https://axecorg.blogspot.de/2017/07/refutation-of-mmt-all-proofs-and.html