Steve Roth — Wealth and the National Accounts: Response to Matthew Klein

Accounting and national accounts.

Asymptosis
Wealth and the National Accounts: Response to Matthew Klein
Steve Roth

Ramanan — A Short Biography Of Robert Neild

Robert Neild was an associate of Wynne Godley in the Cambridge Economic Policy Group.

Keeper Godley quote, too.

The Case for Concerted Action
A Short Biography Of Robert Neild
V. Ramanan

erablogdotcom — Bank income and spending

One of the most common difficulties many people encounter in understanding the mechanics of the financial system lies in their failure to understand the difference between stocks and flows.

erablogdotcom

Bank income and spending

John T. Harvey — Dear President Trump: Your Tax Plan Needs Bigger Deficits!

What I want to highlight here is this: the private sector needs government deficit spending if it is going to recover properly from both the heart attack of the Financial Crisis and the decades of disease brought on by income redistribution and rising debt levels. This is so because government deficits are private-sector surpluses.

The logic is really very simple. What number do you get when you add up every trade surplus and trade deficit on the planet? Zero, of course, because one nation’s trade surplus is another’s trade deficit. This is a specific application of the general rule that in any closed system, the sum of all deficits and surpluses must be zero. If you and I are the only two people in the economy and I spend more than I earn, then you earn than you spend (and by the exact same amount, of course). There aren’t many inescapable truths in life, but this is one.

Now think about the U.S. government budget deficit. If Washington is spending more than it earns, then non-Washington must be earning more than it spends. In 2016, for example, the US federal government spent $585 billion more than it collected in taxes.

That money did not disappear in a puff of smoke. It became the excess of income over spending earned by non-Washington. Non-Washington had a $585 billion surplus or, which is the same thing, $585 billion of savings.

This is an inescapable accounting truth and it implies that any tax plan that hopes to stimulate the private sector must create a budget deficit. Federal government budget surpluses drain non-Washington income. That’s hardly what we need. Pundits and policy makers need to stop worrying about Washington’s deficit and start focusing on non-Washington’s surplus.

“Wait,” you may ask, “true or not, doesn’t this just lay the foundation for bigger problems in the future?” Almost certainly not. Let me address a few of the most common worries:

Forbes — Pragmatic Economics
Dear President Trump: Your Tax Plan Needs Bigger Deficits!
John T. Harvey | Professor of Economics, Texas Christian University

Steve Roth — Why Economists Don’t Know How to Think about Wealth (or Profits)

MMT, SFC, NIPA, FFA, etc. Must-read.

Longish and detailed. Weekend reading.

Angry Bear
Why Economists Don’t Know How to Think about Wealth (or Profits)

Steve Roth

originally published at Evonomics 2016

Lars P. Syll — The true nature of saving

Keynes quote.

Lars P. Syll’s Blog
The true nature of saving
Lars P. Syll | Professor, Malmo University

Steve Roth — Why Economists Don’t Know How to Think about Wealth (or Profits) Evonomics

What's wrong with economics? "It's a dumpster fire."

Evonomics
Why Economists Don’t Know How to Think about Wealth (or Profits)

Steve Roth

Eric Tymoigne — Money and Banking Part 13: Balance Sheet Interrelations and the Macroeconomy

Past posts have focused on the mechanics of a specific balance sheet, specifically that of the central bank and of private banks. This post looks at the balance-sheet interrelations between the three main macroeconomic sectors of the economy: the domestic private sector, the government sector and the foreign sector. This macro view provides some important insights about issues such as the public debt and deficit, policy goals that are more likely to be achieved, the business cycle, among others.…

New Economic Perspectives
Money and Banking Part 13: Balance Sheet Interrelations and the Macroeconomy
Eric Tymoigne | Associate Professor of Economics at Lewis and Clark College, Portland, Oregon; and Research Associate at the Levy Economics Institute of Bard College

Mean Squared Errors — Economists and accounting identities

Here's a rule of thumb for talking about accounting identities: Accounting identities do not constrain behavior; they constrain accounting. If you find yourself saying or implying that an economic actor cannot do something they want to do because of an accounting identity, you have lost the thread. Backtrack and rethink.

Mean Squared Errors

Economists and accounting identities

JEC

ht Mark Thoma at Economist's View

Michael Pettis — Internal and external balance

Even if you don't read Michael Pettis's post, this one is worthwhile. It is about trade, capital flows, and accounting identities, and what can be learned from them now as well as similar occurrences in economic history. Those even superficially knowledgeable will recognize that this is an issue of sectoral balance with each country's domestic private sector balance, government sector balance and external sector balance summing to zero as an accounting identity. Pettis invites us to look at the consolidated balance sheet of the global economy as closed system in terms of each country's place it in it, and what that implies.

I was recently asked by an Australian economics journal to write a review of a book I had already read, The Leaderless Economy, by Peter Temin and David Vines (published in 2013). Because the book is a great place from which to start a discussion on the links within the global economy, I decided to base this essay on the book. I had already read Peter Temin’s Lessons from the Great Depression (1991), The Roman Market Economy (2012), and Prometheus Unshackled (2013), and I know his work fairly well.

There is substantial overlap between the way Temin and Vines view the global economy and the way I do. I am a regular reader of Diane Coyle’s blog, The Enlightened Economist, in which she reviews books, usually on economics-related topics but also on anything else that might catch her attention. Besides having said very nice things about my book, The Great Rebalancing, and including it in her shortlist of top books for 2013 (I am bragging a little) she has also reviewed The Leaderless Economy, and has noted the similarities in the way both books approach the balance of payments.

She is right. Both books analyze the global economy in pretty much the same way, as an economic system in which any country’s domestic economy is inextricably linked to other economies through the balance of payments mechanisms. The ability to place events within their global context is consequently crucially important in understanding any country’s economic performance, but actually doing so tends more to be the exception than the rule....

The Leaderless Economy makes the same point I try to make in The Great Rebalancing: the economic analysis of any country is largely useless if it ignores, or treats as a minor issue, links with the external sector – i.e. other countries – and this is even more true today than in the past....

In their book Peter Temin and David Vines don’t discuss the US savings rate but they do a lot of the same thing by changing the focus slightly. Whereas in my book I argue that because global savings and global investment must balance, if any country’s savings exceeds its investment by some amount, investment in the rest of the world must exceed savings by exactly the same amount. Temin and Vines express the same relationship between conditions in one country with conditions abroad in a way that can be summarized in two sentences. First, the domestic imbalance in any economy – i.e. high levels of unemployment or demand, large gaps between savings and investment, and so on – must be consistent with and equal to that country’s external imbalance at all times. Second, that country’s external imbalance must be consistent with and equal to the external imbalance of the rest of the world at all times. 

These two statements are basically identical. Any country’s capital account of course is simply the gap between its domestic savings and its domestic investment, and because the capital account must balance the current account (the two always add to zero), to say that the gap between savings and investment in any country must be equal to an opposite gap between savings and investment abroad is simply to restate the far more intuitively familiar claim that every current account surplus in the world must be matched by a current account deficit. Until we begin trading with extra-terrestrials the total must add up to zero.

This should all be obvious, but if an imbalance in one country must be matched by an opposite and equal imbalance abroad, there are only two possible explanations. Either the imbalances in every country are set endogenously, and, by some miracle, at every point in time, they balance out perfectly, or an imbalance in one country can force imbalances onto other countries. The first explanation is obviously absurd, so the gap between the amount a country saves and the amount it invests is as likely to be determined by external conditions as by internal. This is why it is possible to argue that a country’s savings rate (or its unemployment rate, or its investment rate, etc.) is determined by policies abroad as much as by policies at home. This is what it means to live in a “globalized” world....

Pettis reminds that the household analogy applied to other sectors is wrong. It is like based more on moral sentiment than factual reasoning.

Countries that run large and persistent trade deficits, on the other hand, buy more from foreigners than they sell, and because this seems to suggest they are living beyond their means, we usually think of these people, let’s call them grasshoppers, as lacking discipline and prudence. Grasshoppers excite our scorn, even if we sometimes envy their carefree ways and their bohemian morals.

If households that are careful to spend less than they earn, making sure to save part of their earnings, are seen as admirably thrifty, while households that are too quick to pull out their credit cards to buy things they cannot afford are seen as foolish, and will in the end implicitly require that their prudent neighbors bail them out, the same, we assume, should be true of countries. It is unfair that ants have to bail out grasshoppers, and so naturally we tend to abhor policies aimed at favoring grasshoppers over ants, and by extension we also abhor policies that seem to favor trade deficits over trade surpluses.
But countries are not at all like households....

But Pettis is still caught up in his saving-investment analysis and.I think, gets the causality wrong. He misses the simple explanation that if a country runs a current account deficit, like the US or the EZ periphery, then it has to allow net exporting countries to save in its currency and vice versa. If a country wishes to run a trade surplus with another country then it has to save in the currency in order to accommodate it. In the global economy net exports* and net imports** must always sum to zero***.

Where I think the ant colony analogy that Pettis employs in his explanation breaks down is in explanation of motivation as a matter of causality.

So if households [ants in his analogy] consume a declining share of what they produce, either they must increase investment commensurately, so that savings rise and GDP remains the same, or, if investment cannot rise fast enough (in fact in most cases it is likely to fall), unemployment must rise fast enough to keep total savings from exceeding total investment. Of course if they force the demand shortfall onto the rest of the world, they can keep unemployment down by exporting their excess savings and running a current account surplus, the counterpart of which is a current account deficit somewhere else. These are just accounting identities – the internal imbalance between a country’s savings and investment is at all times consistent with and equal to its external imbalance, and a country’s external imbalances is at all times consistent with and equal to the external imbalances of the rest of the world. To understand which country will run the corresponding external imbalance depends on the nature of the institutions through which economic behavior is mediated, and this is why a deep grounding in economic and financial history is so important.

Countries like Germany and China are not net exporters because the German and Chinese peeople desire to save in another currency. Their elites choose to be net exporters and this necessitates saving in the net importers currency or investing in that country, FDI being "real saving" externally. Moreover, while it is correct to say that in aggregate, "countries" do this, that doesn't imply that this is a mutual decision, even in so-called democracies. This is a matter of policy, and that policy benefits interests that play a key role in shaping it.

Pettis admits this toward the end of the post.

...we failed to work through the logic of the balance of payments, to the point where in some countries we actually applaud measures that reduce the share of production allotted to hard-working households on the grounds that their real reward is a higher national trade surplus [that benefits owners of exporting countries and top management that can extract a share, but not ordinary workers].

Pettis also makes another important point.

By showing us how useful history is in understanding current events, the authors also reveal, indirectly, how little value there is in the vast literature of economic theorizing that emerges from the abstract and distorted world of academia, bereft as it is of historical context.

For most economists, history is usually little more than a data sequence whose values are plugged into mathematical models – whose implicit assumptions too often these same economists fail to understand....

Finally, while Pettis is on the right track by taking at accounting-base approach, his explanation would greatly benefit by incorporating either the MMT three sector model or a four sector model that doesn't consolidate the household and firm sectors based on the conventional income-expenditure model based on accounting identity, Y= C + I + G + NX. I think it would be clearer than his present approach.

China Financial Markets
Internal and external balance
Michael Pettis | Professor of Finance at Peking University’s Guanghua School of Management

 * actually current account surplus
**  actually current account deficit
***  equating trade balances with the current accounts for convenience

Andrew Lainton — Is State (outside) money a liability, and if so to whom?

Readers of this blog will now that I have strongly argued that economics must be rebuilt around the accounting constraints of capitalism- balance sheet economics -, that these constraints are underlying laws of the economics system not legal conventions. Whether or not conventions align with them is just contingent however if account don’t match them that are likely to lead to false economic decisions with real consequences. From this perspective the resolution to such theoretical debates is straightforward in method but not always easy in practice, it is to determine what the accounting mistake is. 

From the balance sheet perspective a liability will be held by an economic agent if it readers an economic service. So what is the nature of that service?

Decisions, Decisions, Decisions
Is State (outside) money a liability, and if so to whom?
Andrew Lainton

How many critics of neoclassical economics have heard of Resource, Events, Agents? 

It is important because it offers a way of doing mathematical modelling in economics that meets the Lawson critique.

Decisions, Decisions, Decisions
Mathematical Modelling in Economics that Meets the Lawson Critique
Andrew Lainton

Noah Smith — Thinking out loud: Do government deficits equal private surpluses?

(Shaking head) Noah Smith is a professor of finance and he doesn't know the answer to this — although granted it is not very clearly stated as "government deficits equal private surpluses," as Jan Hatzius does, whom Noah quotes.

It is clearer to say that the government fiscal deficit equals the consolidated nongovernment fiscal surplus in aggregate, since the government balance plus the consolidated domestic private sector balance plus the external balance must sum to zero as an accounting identity. Transposing, the government balance will be the inverse of the consolidated nongovernment balance in aggregate.

If the external balance is zero, then the government balance and the domestic private sector balance must sum to zero, therefore, must be in inverse relationship. In this case, if government net spends by running a deficit, then the domestic private sector saves the same amount in aggregate wrt net financial assets. And vice versa.

If the both the external sector and the government sector are in balance, then the domestic private sector must also as an identity. There can be net savers but not net savers in aggregate, since accounts within the sector must balance, i.e., net to zero.

Hint to Noah: Read Godley and Lavoie, Monetary Economics for an explication of stock-flow consistency in sectoral balance accounting. Jan Haztius learned this from Wynne Godley, and it is the basis of MMT SFC macro modeling. This is really simple when you do the accounting properly.

While accounting identities don't say anything about the causality, they do reveal what is necessary and what is impossible in terms of stock flow consistency. Mixing up stocks and flows is a novice error.

Noahpinion
Thinking out loud: Do government deficits equal private surpluses?

Noah Smith | Assistant Professor of Finance, Stony Brook University

Ramanan — Income ≠ Expenditure? [Steve Keen]

Ramanan critiques Steve Keen's view that aggregate income is not identical to aggregate expenditure in a closed economy.

The Case for Concerted Action
Income ≠ Expenditure?
Ramanan