Briefly Revisiting S = I + (S – I)

Introduction

Some readers of Pragmatic Capitalism and Monetary Realism have been underwhelmed by the aesthetics of this equation:

S = I + (S – I)

This says that private sector saving consists of an amount required to fund investment I plus an additional amount (S – I). The structure of the equation is a tautology that cannot be falsified in purely symbolic form, of course. There has been some criticism of it for that reason. For example, one reaction (from a few people) is that a 6 year old could derive the same thing. That criticism is perhaps understandable – absent further consideration of the reason for this decomposition.

Those interested in reviewing the reasoning behind the tautological form – or perhaps seeing it explained for the first time – may wish to read further.

But before that, some earlier references:

Michael Sankowski provided an excellent, brief introduction here:

http://monetaryrealism.com/s-i-s-i-the-most-important-equation-in-economics/

I elaborated at length here:

http://monetaryrealism.com/jkh-on-the-recent-mmrmmt-debates-2/

And Cullen Roche summarized it in part 6 of his paper here:

http://pragcap.com/understanding-modern-monetary-system

With that background, we briefly revisit the reasoning behind the equation. Despite its simple appearance, there is a more nuanced explanation behind it, based on an element of Keynesian style macroeconomic intuition.

Expenditure/Income Sector Decomposition

The standard expenditure/income model:

C + I + G + (X – M) = C + S + T

For purposes of this discussion, the pivotal variable is S, which corresponds to private sector saving.

S = I + (G – T) + (X – M)    *

This says that private sector saving is an amount required to fund investment I, the government budget deficit (G – T) and a current account surplus (X – M).

Subtracting investment I from both sides,

(S – I) = (G – T) + (X – M)  **

This decomposes (S – I) into its two components – funding for the government budget deficit and a current account surplus.

Substituting the left side of **  into the right side of *:

S = I + (S – I)

And that is the equation in question. It says that private sector saving is the amount required to fund investment I plus a residual amount in excess of that, equal to (S – I). The excess amount is deliberately left un-decomposed. The occasional complaint about this form is that it is a self-referencing tautology, since it can also be derived by simple rearrangement of symbols without reference to their underlying meaning.

The ‘Keynesian Skew’

Assume temporarily that the government budget and the current account are both in balance.

Then, from the Keynesian expenditure income model above:

S = I

This equation does not mean that S is the same ‘thing’ as I.

Suppose private sector saving in the current period consists entirely of household saving of S, with the result being an addition to household net worth and a corresponding bank deposit. Suppose also that a corporation has borrowed an amount equal to S to make a new investment I during the same period. Under these assumptions, S = I. But it is obvious that the substance of I (the material substance whose value is recorded on the corporate balance sheet) is different than the substance of S (a net worth increase whose value is measured on the household balance sheet and which equals an amount held in bank deposit form).

It is measured value and not substance that is being equated in S =I.

While this may seem too obvious, it is an important distinction in following the meaning of national income accounting construction and sector financial balances using such symbols.

For purposes of this post, we’ll coin the phrase “Keynesian skew”. This will refer to the idea that government deficits are a rational response to shortages in aggregate demand, as roughly prescribed by Keynes. This translates directly to corresponding saving dynamics. According to the Keynesian skew, the private sector generally desires to save in excess of what might achievable in the absence of government deficits. This means that, unless the country is running a sufficiently large current account surplus that adds to saving, there will be a tendency for S to be insufficient in quantity to satisfy private sector saving desires in full.

Our temporary assumption above was that saving S equals investment I. The Keynesian skew suggests that the quantity of investment I will be insufficient in allowing for enough private sector saving. Aggregate demand and economic output and employment will be stopped out below potential – because the private sector is starving for more saving. A temporary equilibrium has been reached where S = I, but the economy has not yet created GDP sufficient to reach potential.

Again, suppose S = I now holds in a real world situation, and that the economy is performing below potential. There are two ways in which the economy can expand from here. Either investment I increases or something else has to give. In framing the situation, we also make the upfront assumption that investment I has pretty well maxed out.

So assume the government starts to run a deficit as a deliberate policy response.

Then:

S = I + (G – T)

Recalling the distinction mentioned above between substance and the measure of substance, the above equation means:

Private sector saving S equals an amount of saving equal to the amount of investment I, plus saving in the amount of the budget deficit (G – T). Thus, private sector saving funds both private sector investment and the government budget deficit.

(The term “fund” is used here in the sense of standard flow of funds accounting and sources and uses of funds accounting. This does not contradict the dynamic of macroeconomic construction, which is that for any accounting period, it is the expenditure on investment and the act of government deficit spending (as well as foreign sector effects in the more general case) that allows the actual private sector saving result. This dual interpretation is analogous to that emphasized in the case of banking, as described in a previous post on ‘loans create deposits’, where it is also the case that ‘deposits fund loans’:

Now bring an active current account into the picture:

S = I + (G – T) + (X – M)

That says that the quantity of private sector saving funds private sector investment, the government budget deficit, and a current account surplus.

This equation might be represented as:

S = I + SAVEGAP

Where SAVEGAP = (G – T) + (X – M)

So,

Why not just write:

S = I + (G – T) + (X – M)

Or,

S = I + SAVEGAP

S = I + (S – I)?

This is the question.

The Keynesian skew suggests that investment alone is not capable of delivering an adequate supply of saving to the private sector. Notwithstanding the amount of saving that must be generated by the same amount of investment, there is a residual shortage of saving relative to private sector desires in total – a shortage that can only be alleviated by finding outlets other than investment.

Thus, there need to be two components of private sector saving:

a) The amount corresponding to investment I – which is the amount of saving that at the macro level is created by investment, and which funds investment in the sense of both macro/micro flow of funds accounting and micro level competition for the form of financial intermediation

b) An additional amount, which by residual (tautological) equivalence, is (S – I)

And according to that decomposition,

S = I + (S – I)

This decomposition is logical, according to the assumption of the Keynesian skew. The equation is derived without direct reference to further detail in the national income equations. And that accounts for the simple term (S – I), instead of the explicit sector decomposition (government deficit and current account surplus) noted earlier.

As an alternative, the notation might have been something like:

S = ISAVE + SAVEGAP

But the logical association still holds:

ISAVE = I

SAVEGAP = (S – I)

Those whose instinct is to dismiss the relevance of such a tautology might consider that the chosen decomposition has a meaning that supersedes the mere observation that it is a tautology. The message of the decomposition is that the Keynesian skew suggests a natural inclination by the private sector to save more than the amount required to fund private sector investment alone – i.e. an excess amount which is (S – I) by residual decomposition.

More generally, the basic idea behind a residual or tautological decomposition is found in Boolean Algebra and Venn diagrams – where a given set is split in two subsets, according to the defined outer set (S), a known subset (I), and the residual gap that remains (S – I).

S = I + (S – I) delineates the idea that (S – I) is the additional saving component, when investment I alone is insufficient to deliver enough saving to achieve economic capacity. That said, a good deal of saving comes from investment I, not (S – I), and that should be a point of emphasis as well. The comparison between those two quantities is important. From there, further sector decomposition of the component (S – I) is naturally of interest. And the full expansion as derived earlier, is:

S = I + (G – T) + (X – M).

The Keynesian skew suggest that the private sector wants to save more than the amount that corresponds to investment I alone. It doesn’t exactly specify that desire as a desire for net financial assets (NFA). The fact that the demand for saving gets satisfied through net financial assets is a consequence of monetary configuration. If investment I is assumed to be maxed out, then additional private sector saving is forced into net financial asset form. But that’s not necessarily because the private sector seeks net financial assets because of their financial form alone. It’s because net financial assets is the only form in which that additional saving can be manifested, given the assumption of maxed out investment I. If investment I could be expanded, a similar aggregate demand impetus and overall private sector saving result might be achieved. In this sense, the NFA ‘solution’ is the result of the ‘failure’ of private sector investment to produce enough saving on its own. It is consistent with the judgment that government needs to act in these circumstances, absent additionally compensating export expansion.

Moreover, the circumstantial nature of NFA compositional demand can be revealed further by looking one more level down in sector decomposition terms. The private sector is composed of the household sub-sector and the business sub-sector. From the perspective of their own balance sheets, households save in the form of both real assets (e.g. residential real estate) and net financial assets (e.g. bank accounts, bonds, stocks; net of financial liabilities). And the household NFA component is present even when private sector S = I. This is because much of investment I is present on corporate balance sheets, from where it is intermediated back to household wealth through financial claims. And that puts the household sector into its own ‘NFA long position’, even when S = I. So when the private sector as a whole is in a state of seeking additional saving beyond the level of investment I  – i.e. seeking positive (S – I) – one should remember that the household sector already holds considerable NFA of its own via financial intermediation from the business sector. It is saving that is the primary quest – not so much NFA – and the NFA result at the private sector level is a function of the assumption that investment has been maxed out, with NFA expansion being the private sector saving outlet beyond that.

(MMT was the original blogosphere promoter of the NFA concept. Like most ideas, it’s been subject to scrutiny and interpretation. The equation in question has been involved in that process.)

• vimothy February 25, 2013 at 10:02 am

JKH,

This is a neat defense of your equation from a Keynesian point of view. But I have a (slightly tangential) question: What does your “Keynesian skew” analysis suggest should be the response when private saving is very low (perhaps even negative), and/or quantity (S – I) is negative? I’m thinking of recent US experience in particular.

• JKH February 25, 2013 at 11:31 am

This was more of an explanation for the framing of the equation, partly in response to at least one recent request for it.

I don’t think I have a great answer to your specific question.

The MMT people have done a close study of the Clinton era government surpluses, which in combination with current account deficits produced negative (S – I), and associate that with the recession that followed.

The subsequent housing boom added to saving, but was also associated with a current account deficit – so didn’t do much for private sector saving.

Private sector saving was too low throughout both periods, but the current account deficit was a consistent factor.

I think this was a complex pattern overall. It certainly warrants a decomposition of (S – I) in order to assess best policy responses. It’s not clear to me that (higher) government deficits would have been the best policy response. But I just haven’t considered that question enough.

• Ramanan February 25, 2013 at 1:59 pm

“The MMT people… in combination with current account deficits produced negative”

The MMTers have some Monetarist inclinations. For example, I have seen Mosler arguing that the government doesn’t control the money stock but “controls” the NFA!

The private sector deficit cannot be said to be the result of the budget surplus or the current account deficit. The private sector deficit is the result of decision/behaviour of the private sector in the discussed scenario. More importantly the budget surplus/deficit is not under the control of the government. The governments sets the expenditure and the tax rates.

If however the propensity to save is not low enough and the government’s fiscal stance is low, unemployment results.

Also their tendency to argue about deficit level itself is counterproductive. One has to look at the story – as it moves forward in time. The deficits in the Clinton era was problematic because growth was the result of rising private expenditure relative to income. (As in PX/PI kept rising). And so if the private expenditure falls relative to private income, a recession is likely because the motor of the growth itself was a rise in PX/PI, rather than increase in the fiscal stance.

Same thing happened before the crisis. Private expenditure again rose relative to private income in the mid 2000s and a sharp reversal led to a recession.

Of course fiscal policy is important in this because if fiscal policy doesn’t take these into account, and the stance of fiscal policy is not relaxed (policy ≠ deficit), recession is likely to be long.

There is however some logic to discussions around private sector deficits. Typically the private sector has a small surplus – historically speaking.

There is a nice 2001 exchange between Wynne Godley and Jan Hatzius and he initially misinterpreted the sectoral balances approach.

“As the Implosion Begins . . . ?” A Rejoinder to Goldman Sach’s J. Hatzius’ “The Un-Godley Private Sector Deficit” in (27 July). US Economic Analyst

http://www.levyinstitute.org/pubs/implos_rej.pdf

• JKH February 25, 2013 at 2:05 pm

agreed – too much ‘reasoning from identities’ is dangerous – my sentence read that way (although MMT leans that way I think)

although ignoring identities as constraints may be more dangerous

• Ramanan February 25, 2013 at 2:25 pm

Yes of course I understood/noted that.

Tobin’s quote comes to mind – identities should be respected (and we saw a violation recently elsewhere and they tell nothing about causation.

• Jose Guilherme February 25, 2013 at 4:51 pm

A great way to visualise these issues is Krugman’s cross:

http://krugman.blogs.nytimes.com/2009/07/15/deficits-saved-the-world/

By plotting the “desirable”, full employment GDP on the horizontal axis one can clearly see what kind of behavioral and policy changes by the government and/or the private sector that would be needed to end the recession.

Actual GDP is at the intersection of the private surplus and government deficit lines; the 2008 crisis, for instance, can be explained by a sharp increase in the desired private sector surplus at every level of income (the S-I line) that in the end led to a lower level of GDP, higher (G-T) and higher (S-I).

Scott Fullwiler even said that Krugman’s diagram “…would be a much better framework for understanding macroeconomics than the traditional IS-LM model”.

No mean achievement for a neoclassical economist

• vimothy February 27, 2013 at 7:44 pm

JKH,

Thanks. I realise that this is a bit off-topic for the post.

***

One idea that you often come away from PK blogs with is that the basic macroeconomic problem facing society is that people want to save a greater amount than is invested, or can be invested, and so this is either going to lower aggregate demand cause unemployment, or the government is going to have to step in and fill the “saving gap”. But it’s not always the case that saving exceeds investment. Just as saving can exceed investment, so investment can exceed saving.

[We could even rewrite the above expression as I = S + (I - S) to show the sources of finance for investment exceed private saving in this scenario. But maybe we shouldn't go there ]

In fact, the whole approach at times seems to lead some of the more naive commenters to a point of view from which saving is bad generally.

***

And even though, as Philip Pilkington has been keen to point out, these identities are only tautologies (which is, itself, a kind of tautology), I find that they are quite helpful when trying to understand why saving is not bad generally, what it actually does and where it goes.

• Geoff February 25, 2013 at 11:29 am

You can count me as one who was initially “underwhelmed” by the aesthetics of the equation. I might have even called it ugly. But I stuck with it and eventually came around to understand its true power.

I do like the S = ISAVE + SAVEGAP terminology in that it emphasizes that private sector Saving has two components. The first is the main one, i.e. Investment. The second is sort of a residual that fills the gap when Investment is too low.

Nice job, as usual, JKH

• JKH February 25, 2013 at 11:42 am

Thanks.

I was actually thinking of including the phrase “ugly duckling” in the post.

At the time, we talked about ‘I’ being the ‘backbone’ of the economy and of saving – in contrast to the (S – I) piece, which at least in the case of the government deficit is sort of a filler.

I’m still not sure how to think about vimothy’s question – for one thing, housing as part of the ‘backbone’ investment got a little too strong.

• Michael Sankowski February 25, 2013 at 12:48 pm

HI Geoff,

I was pretty similar to you- the first few times through reading JKH and SRW over at Steve Rs place, I was not sure why they were spending time on this.

But one major point is once you accept the possibility of a savings gap, then thinking about what to do for the economy becomes much more complex, and much more like the real world. If you don’t accept a savings gap, then the neo-classical approach is everything, and you want to get government out of the way because it just crowds out investment.

But what happens instead of crowding out, there is a savings gap? The neo-classical approach – and really the hard core libertarian approach too – is to assume it’s all crowding out. But that means the most primitive societies should out grow the most governed societies. What we see in the real world is nothing like that. That to me says the “savings gap” idea probably explains more of the S <> I issue we see in the real world.

Jan Hatzius has a good approach to this. I can’t find the article right now, but he says something like “The accounting identities are just the beginning. The analysis comes in with the projection of the levels of the inputs and how these changes will feed on each other.” This was Godleys approach, and this savings gap identity helps to think about how we can best structure the rules of our society so we see high, sustainable, and enjoyable growth.

• Geoff February 25, 2013 at 4:10 pm

Interesting, Michael. It sounds like the “savings gap” idea is not generally accepted by the mainstream?

• Cullen Roche February 25, 2013 at 5:11 pm

That’s a really nice summary of the way I think a lot of people feel about this. It’s a very powerful idea that gets the orders of magnitude right. We have an economy where I is the backbone of private saving. But we also have tools at our disposal that can be used when that backbone is weak.

I wish MMTers wouldn’t get so defensive about this discussion and would instead try to see the balance in it and how well it relates to the real economy. It’s perfectly consistent with the realism (wink) of the way the monetary system works. And yes, contrary to some people’s opinions, it is a “game changer” with regards to how we should approach not only our understanding, but also our policy.

• Geoff February 25, 2013 at 5:59 pm

Yeah, I saw a couple of very defensive tweets from some prominent MMTers recently. Your exchange with Dr.K was particulalry interesting. They clearly think you’re trying to attack them, which is just weird. Your gratitude and respect for them was obvious in your primer.

• Tom Brown February 25, 2013 at 1:00 pm

Thanks JKH! I read through quickly once, but I’ll peruse it more thoroughly.

• Tom Brown February 25, 2013 at 1:29 pm

Regarding your comment and my response back in your Say’s Law piece recently, How would your S* come to play here?

http://monetaryrealism.com/krugman-on-says-law/#comment-15614

• JKH February 25, 2013 at 1:57 pm

Tom,

The S = I + (S – I) is written from a (natural) perspective where the private sector is in a surplus saving position relative to I.

I.e. the private sector is ‘funding’ more than just investment I.

So part of its saving includes a surplus or NFA in the amount of (S – I)

Importantly, the equation focuses on S as a source of funds.

S* = S + (T – G) + (M – X) is written from the (natural) perspective in which the world is funding domestic investment I.

I.e. the private sector is ‘funding’ less than investment I, and it takes other sources of funds to do the job.

So funding for investment I includes private sector saving, a government surplus, and a current account deficit (which corresponds to funding supplied by the rest of the world – i.e. a capital account surplus).

So that S* = I always by this definition.

Importantly, the equation is focused on I as an application or use of funds (the language used in flow of funds) and S* is defined so as to be the corresponding global (domestic plus foreign) source of funds.

(IMPORTANT: Signs for actual values can be flipped around in either of these equations, so that you can have things like a government deficit in combination with a current account deficit as part of the funding for investment I. There are many possible combinations. )

• stone February 25, 2013 at 1:15 pm

I think it is so important to think hard about how and why the savings gap is occurring and whether policy changes would avoid it, rather than just willy nilly saying it needs to be accommodated by government. My impression is that a positive feedback loop can be (has been) set off where attempts to meet “net saving desires” simply lead to ever more effective skimming off by the financial sector. If the aim is to satiate net saving desires then you have to ask what amount of money does Goldman Sachs consider “enough”?

• JKH February 25, 2013 at 2:00 pm

agreed – the policy response should not be on automatic pilot

• Michael Sankowski February 25, 2013 at 2:06 pm

It also seems reasonable to think about this gap as the natural state of the world, and the gap is zero only in special cases.

• stone February 25, 2013 at 3:57 pm

I guess it also seems reasonable to think about the natural state of the world as being one with economic systems that need to be rebooted with a massacre every generation or so and perhaps also with conquests of new territories or capture of slaves or whatever. The natural state of the world is generally pretty screwed up. I think it is worth at least considering whether the answer is to aim to attain that special case where the gap is zero.
We have a global economy; it is not as though there are not immense real opportunities for as much investment as could possibly satiate saving urges. Imagine providing all 7B people with clean water, sanitation, electricity, a refridgerator, a rudimentary education and rudimentary health care. That would be an immense investment. We have the saving gap because making such an investment does not currently make financial sense. Our financial system is our own political construction. It will drive the real economy in whatever direction we choose to set it. Just my opinion.

• Greg February 25, 2013 at 5:45 pm

” it is not as though there are not immense real opportunities for as much investment as could possibly satiate saving urges. Imagine providing all 7B people with clean water, sanitation, electricity, a refridgerator, a rudimentary education and rudimentary health care. That would be an immense investment. We have the saving gap because making such an investment does not currently make financial sense. Our financial system is our own political construction. It will drive the real economy in whatever direction we choose to set it. Just my opinion.”

Stone, that is about as concise one can express what I have wished to express for about 4 years.

Thank you

• Ramanan February 25, 2013 at 4:31 pm

I think this is a nice intro of the sectoral balances approach:

Hatzius from “The Private Sector Deficit Meets the GSFCI: A Financial Balances Model of the US Economy” (2003)

“The Income/Spending Balance—A Key Driver of the Cycle”

“Desired changes in financial balances—the differences between income and spending in the economy’s various sectors—are key drivers of cyclical growth. For example, when households “try” to improve their balance by cutting spending, this weighs on demand and causes the economy to slow. The initial slowdown has negative multiplier effects via changes in employment and income.”

• jt26 February 25, 2013 at 5:50 pm

“Keynesian Skew”
The other interpretation is to look at the savings gap as being transactional (i.e. mistiming of savings vs. investment in the short term, or perhaps the “medium” term (due to say birth rate and generational skew). I.e. we want some small amount or transactional “working capital” to smooth fluctuations in investment and saving, but we shouldn’t interfere by satisfying all private sector demands on the gap, which could perhaps turn us into a rentier, risk-adverse society. You can see the behaviour in China, where our federal deficits are financing their trade deficit, and all they want to “buy’ is Tsys, energy and infrastructure assets in return.

• stone February 26, 2013 at 2:15 am

jt26, I agree that government deficits funding trade deficits might have been central to moulding the world into being how it is. It sometimes seems as though trade consists of real goods going to places such as UK and USA in return for paper account statements going to oligarchs in Africa etc. The net saving desires that our deficits are accommodating to some extent are those of third world oligarchs. We design our economy around trying to entice in their money to ride asset price inflation of pre-existing assets over here. To me it looks as though a lot of the 1980-2000 great moderation had a striking mirror image of capital flight and impoverishment in much of Africa etc. The tragedy to me is that it doesn’t benefit anyone. If the Congo sold minerals to us to make mobile phones or whatever we do with them and the proceeds were used to buy mechanical diggers to put sewers in Kinshasa then that would actually create jobs here too. If the 2B people essentially excluded from the global economy were fully in it then that would be that many people more paying for things we are trying to sell. It is fixable with very crude low skill technology. Let’s face it Singapore was just like any other equatorial slum sixty years ago and now has the best health statistics in the World. In the mid 1800s cities in the UK had 50% child mortality rates from lack of sanitation. I don’t think we need to send aid we just need to make less effort on “anti-aid” such as making USD denominated government loans that get converted to capital flight. A big part of “anti-aid” IMO is our using government deficits to accommodate trade deficits rather than using an asset tax to balance government spending.

• Fed Up February 25, 2013 at 11:35 pm

“(S – I) = (G – T) + (X – M)”

I find it easier to write that this way (and more informative).

current account deficit = gov’t deficit plus private deficit (after algebraic rearrangement)

Now all deficits are negative numbers and surpluses are positive numbers.

Next, does MOA/MOE move between the entities?

• Fed Up February 25, 2013 at 11:40 pm

“(S – I) = (G – T) + (X – M)” or

current account deficit = gov’t deficit plus private deficit

Does that assume all new MOA/MOE is “borrowed” into existence from a bank or bank-like entity?

• Fed Up February 25, 2013 at 11:44 pm

“A temporary equilibrium has been reached where S = I, but the economy has not yet created GDP sufficient to reach potential.”

Are you assuming real AD is unlimited?

• Fed Up February 25, 2013 at 11:54 pm

“Assume temporarily that the government budget and the current account are both in balance.”

Let’s make that a permanent assumption!

“(S – I) = (G – T) + (X – M)” or

current account deficit = gov’t deficit plus private deficit

Are those missing an entity?

• JKH February 26, 2013 at 6:15 am

In general, re:

(S – I) = (G – T) + (X – M)

These things are subject to personal interpretation.

All I can tell you is what that equation says to me.

It says that the private sector financial surplus equals the government deficit plus the current account surplus (i.e. the capital account deficit).

In the macroeconomic flow of funds, the source of funds is the private sector surplus, and the use of funds is the sum of the deficits being running by the government and the international capital account.

Signs can flip (and surpluses and deficits can flip) so long as the equation remains in balance.

• Fed Up February 26, 2013 at 11:02 pm

“It says that the private sector financial surplus equals the government deficit plus the current account surplus (i.e. the capital account deficit).”

I find it easier for myself and others to move both surpluses to the other side(s) of the equation so that:

CA deficit = gov’t deficit plus private deficit

Sorry, I picked up that habit answering Bill Mitchell’s quizzes. Doing it that way makes answering the quizzes a lot easier.

Next, is the equation actually CA deficit = gov’t deficit plus private deficit plus the currency (or the demand deposit equivalent) printing entity deficit? The problem is central bankers and bankers have convinced people that “printing money” with no bond attached is price inflationary so that cannot be allowed. The way the system is set up now the currency (or the demand deposit equivalent) printing entity deficit must be zero. I believe that is the problem. Set CA deficit = 0, gov’t debt = 0, and private debt = 0. Allow private savings (say +2). The equation becomes:

0 = 0 + (+2) + (-2)

In other words, private savings = the currency (or the demand deposit equivalent) printing entity deficit

Plus, does gov’t debt = 0 and private debt = 0 mean no debt deflation? I think so.

• Geoff February 26, 2013 at 7:02 am

Given the key role of the banking sector within the MR framework, does it make sense to separate out the banks in the sector balance equation?

• flow5 February 26, 2013 at 12:30 pm

Savings never equals Investment. CB held savings are a leakage in Keynesian National Income Accounting. JKH implies that CBs loan out savings (espouses the Keynesian macro-economic persusaion that maintains a CB is a financial intermediary). The modus operandi of the CBs within a system’s context is that the CBs pay for what they already own. Whether the public saves, dissaves, or chooses to hold its savings in the CBs or to invest them directly, or indirectly through the non-banks, etc., does not determine the lending capacity of the CBs.

The use or non-use of savings held by the CBs is a function of the velocity, not the volume, of their deposit liabilities. CB held savings have a zero payments velocity. CBs would be more profitable if they were out of the savings business altogether.

• Philip Pilkington February 26, 2013 at 2:49 pm

Oh man… what are you guys doing? I don’t even know where to start. But look: you’re confusing an accounting statement for a behavioral equation. Joan Robinson always took the neoclassicals to task for this. Okay, I’m going to be brief:

“S = I + (S – I)”

This is true. In the same sense that saying: “2 = 2 + (2 – 2)” is true. Yeah, pretty stupid thing to say, right? That’s what we call a tautology. What you’ve “derived” in your manipulations is a tautology. Great. Okay.

“And that is the equation in question. It says that private sector saving is the amount required to fund investment I plus a residual amount in excess of that, equal to (S – I). ”

Yeah, since I=S, that “residual” is zero. Let’s run through that:

I = S

Put I and S at 5.

5 = 5

Now substitute that into your above “residual”:

(S – I)

(5 – 5) = 0

Congratulations. Another tautology. But then you’re deriving some bizarre behavioral ideas from this. This is like the old Pre-Socratic debates. Look them up. They’re more interesting than the above…

• JKH February 26, 2013 at 3:17 pm

That interpretation would never have occurred to me

I would have put it in the post if it had

Maybe I’ll revisit the subject and include that sometime

Very smart thinking

Thanks

• vimothy February 26, 2013 at 3:20 pm

Philip,

If S = I, then (S – I) = (G – T) + (X – M) = 0, but that’s not necessarily true, or the sectoral balances equation wouldn’t be very interesting to MMTers.

• Philip Pilkington February 26, 2013 at 3:29 pm

“If S = I, then (S – I) = (G – T) + (X – M) = 0, but that’s not necessarily true, or the sectoral balances equation wouldn’t be very interesting to MMTers.”

Yeah…

(S – I) = (G – T) + (X – M) = 0

This is true if we allow for the following conditions:

1. G = T
2. X = M

Alternatively, you could set them as follows:

1. X = T
2. G = M

Either way you’ll get zero.

But once you assume that some things on the right-hand side are larger than zero, the left-hand side will also be larger than zero.

Do you actually understand sectoral accounting? This is an IDENTITY. Not an EQUATION.

• Oliver February 26, 2013 at 3:32 pm

Very clear, thanks!

• Philip Pilkington February 26, 2013 at 4:00 pm

Maybe I should be more clear on this. But honestly, I thought everyone understood we were doing accounting here. And I would have thought that, since a lot of this stuff is in an introductory macro book, we’d all be familiar with what we were doing. Okay, let’s run through a few things.

S = I

This is an identity. It is how the national accounts are constructed. Set S and I equal to 10 and let’s keep them there for the rest of the exercise.

S = I
10 = 10

BUT it assumes a closed economy with no government sector. Let’s add a government sector.

S = I + (G – T)

Oh, look… S is no longer strictly equal to I. If the government runs a deficit then S will be larger than I. Magic? No. Accounting. Let’s see what happens when the government runs a deficit:

10 = 10 + (10 – 5)

Eeeek! That’s not right! Our accounting must be wrong. Aha! It’s the left hand side that’s wrong. Let’s fix it:

15 = 10 + (10 – 5)

Phew! Felt like an idiot there for a minute.

Now, back to our identity. Subtract I from each side.

(S – I) = (G – T)

Do both sides add to zero? Well, only if we set:

G = T

Otherwise, we will get a non-zero result. Let’s continue running a deficit:

(10 – 10) = (10 – 5)

Oh no! We’ve screwed up the accounting again… quick fix it!

(15 – 10) = (10 – 5)

Phew! That was close.

Do I really need to carry on or is that enough? This is accounting guys… come on. Sharpen up!

• JKH February 26, 2013 at 4:16 pm

Very illuminating

Thanks

I must study accounting some more

• Philip Pilkington February 26, 2013 at 4:19 pm

“A type of accounting related equality that is required to be true, even in light of the fact that the related variable may not be consistent with the result.”

==========================

“An ex-post accounting identity, which records what happened over, say, the past year, cannot explain causality; rather it shows what has to be explained.” (Joan Robinson and John Eatwell, “An Introduction to Modern Economics” pp216)

==========================

“Recall that gross domestic product (GDP) is both total income in an economy
and the total expenditure on the economy’s output of goods and services. GDP (denoted as Y) is divided into four components of expenditure: consumption (C), investment (I), government purchases (G), and net exports (NX). We write:

Y = C + I + G + NX.

This equation is an identity because every dollar of expenditure that shows up on the left side also shows up in one of the four components on the right side. Because of the way each of the variables is defined and measured, this equation (sic) must always hold.” (Gregory Mankiw, “Principles of Macroeconomics” pp277)**

**N.B. Mankiw is sloppy in calling it an “equation” in the second part of the last sentence.

• BF February 26, 2013 at 4:22 pm

What did MMTers make of sectoral accounting? Here is J. Galbraith, R. Wray, and W. Mosler, ‘The Case Against Intergenerational Accounting’, Public Policy Brief No. 98, Levy Economics Institute, Annandale-on-Hudson, NY, 2009, p.9:

“The private sector’s ability to deficit-spend, to spend more than its income, depends on the willingness of another sector to spend less than its income. For one sector to run a deficit, another must run a surplus. This surplus is called saving—claims against the deficit sector… In the real world, we observe that the U.S. federal government tends to run persistent deficits. This is matched by a persistent tendency of the nongovernment sector to save. The nongovernment sector accumulates net claims on the government; the nongovernment sector’s “net saving” is equal (by identity) to the U.S. government’s deficits. At the same time, the nongovernment sector’s net accumulation of financial assets (or “net financial wealth”) equals, exactly, the government’s total net issue of debt—from the inception of the nation. Debt issued between private parties cancels out; but that between the government and the private sector remains, with the private sector’s net financial wealth consisting of the government’s net debt [Emphasis in original].”

The private surplus (positive financial balance) is not called and does not equate to ‘saving’ but only a portion of total private saving. Galbraith, Wray and Mosler (2009) see no problem in referring interchangeably to a sector’s surplus as ‘saving’ or ‘net saving’… why conflate terminology? Why did they invoke Godley’s (1999) Sectoral Financial Balance approach? The intent appears to be to associate the public sector as a supplier of private sector (total) “saving” and “net wealth” via budget deficits ergo the more deficit-spending the richer and better off everyone must be.

The “nongovernment sector” is too higher a level of aggregation to be of any academic usefulness (and it is all private liabilities that ‘net out’ from analysis in the two- or three- sector SFB model and not just “debt issued between private parties”).

Context for JKH’s original critique was MMT discussion such Wray, ‘Blog 39: MMT for Austrians: Disagreements Among Reasonable People’, New Economic Perspectives Weblog, 4 March 2012, .

Wray (2012) argued that the SFB concept of ‘saving’ (used interchangeably with ‘net saving’) provides a measure of aggregate saving (and remarked that it is the same as the NIPA concept except for imputed values). The exchange between Wray and Ramanan in the comments section was also telling as it showed that the former had very little comprehension of what should be a basic economic concept (i.e. ‘saving’).

An oft made dictum by SFB proponents is that “budget deficits create disposable income and wealth for the private sector.” Through the ex post SFB identity the public sector adds to disposable income when its expenditures exceed revenues. Technically, what is correct from ex post vantage point may not be so in ex ante terms; and it is only by way of a qualified argument (e.g. underemployment equilibrium) that an analyst can begin to build a case that a planned increase in public spending will raise disposable income and increase ‘wealth’ relative to an ex ante decision to consolidate or keep the budget stance unchanged. When it comes to MMT the above dictum takes on an additional deterministic/totalising meaning owing to the purported ‘net’ money creating and destroying powers that MMTers attribute to the Treasury:

“Budget deficits lead to net credits to bank accounts and budget surpluses lead to net debits [note: the authors mean net money creation and destruction]… If banks already have the quantity of desired reserves (which would be the normal case), Treasury spending creates excess reserves in the system… In order to provide a substitute for the excess reserves and hit its target rate, the Fed sells Treasuries to the private sector, thereby transforming the wealth held in the form of bank deposits and reserves into Treasury securities… In other words, sales of Treasuries should be thought of as a monetary policy operation… To recap, a government deficit generates a net injection of disposable income into the private sector that increases saving and wealth, which can be held either in the form of government liabilities (cash or Treasuries) or noninterest-earning bank liabilities (bank deposits)… A government budget surplus has exactly the opposite effect on private sector income and wealth: it’s a net leakage of disposable income from the nongovernment sector that reduces net saving and wealth by the same amount (Y. Nersisyan and Wray, R., ‘Deficit Hysteria Redux? Why we should stop worrying about US Government Deficits’, Public Policy Brief No. 11, Levy Economics Institute, Annandale-on-Hudson, NY, 2010, p. 11-2).”

The authors intermingle and confuse why the central bank conducts open market sales of T-bonds (i.e. to drain excess reserves in the banking system) with why the federal government sells bond in the first instance (i.e. to procure financing in order to spend).

‘S = I + (S – I)’ developed I believe as a way to succinctly highlight that whatever MMTers were on about in their verbal discussion it was not ‘(S – I) = (T – G) + (X – M)’. Yes, it is a tautology, though I do think the context is over-simplified MMT analyses which for whatever reason (possibly wanting to overstate the macro role of the public sector) neglected that private saving has a physical investment component within the private sector and a financial claim component occurring with other sectors.

• BF February 26, 2013 at 4:35 pm

Scott Fullwiler (‘The Sector Financial Balances Model of Aggregate Demand’, Wall Street Pit, 18 July 2009, http://wallstreetpit.com/8568-the-sector-financial-balances-model-of-aggregate-demand) extended the SFB approach into a model of aggregate demand that is reminiscent of the IS-LM figure. His figures have surplus/deficit on the horizontal axis and output on the vertical axis; and, record the intersection point between the private FB and the sum of the government deficit and current account. There are three issues here.

Firstly, the main source of growth in aggregate demand and national income (of which saving is the unconsumed portion) is neither the public nor foreign sector but transactions within the private sector, but these ‘net out’ in Fullwiler’s diagrams simply through consolidation. Secondly, if the model of aggregate demand is intended to inform theory, then it should consider the array of intra-private sector variables which Godley (1999, p. 12) bypassed to make the SFB identity useful as a parsimonious means to query the medium-term plausibility of ‘official’ estimates for economic growth and the government budget:

“The central point in the present context is that as the stock of liquid financial assets does not, as an empirical matter, fluctuate wildly and is not high relative to the flow of income, it is acceptable to bypass the specification of (several) consumption and investment functions as well as the labyrinthine interrelationships between the household and business sectors, for instance, the distribution of the national income between profits, proprietors’ income and employment income, the retention of profits, and the provenance of finance for investment.”

The SFB three-sector model offers an ex post snapshot of economic activity but only hints at some of the determinants. Fullwiler’s (2009) government-centric model of aggregate demand depicts shifts in the budget balance as pivotal to propelling GDP growth and private savings when the economy is driven principally by complex interrelationships within the private sector. Thirdly, while changes in the aggregate size of the budget deficit can provide a floor under aggregate demand, it is not the only lever in the fiscal toolkit. MMTers typically abstracts from the budget composition; specifically, how changes to taxing-and-spending activities could raise aggregate demand while leaving the overall budget stance relatively unchanged (but improving the budget balance). I think everyone should be careful about drawing conclusions from an ex post accounting framework.

• vimothy February 26, 2013 at 4:49 pm

BF, Excellent comment.

• JKH February 26, 2013 at 4:47 pm

Philip,

(How’s he doing?)

What’s really going on here?

Why are you so upset?

• Philip Pilkington February 26, 2013 at 5:01 pm

Um… because you guys aren’t actually saying anything new at all. This has nothing to do with MMT/MMR. I don’t care about that. This whole thing is just dumb. This identity:

S = I + (S – I)

It’s the same as this:

S = I + 0

Or this:

S = I + 2 – 2 + 5 – 4 + 3 – 4

Or this:

S = I + (S/I) – (S/I)

These are completely meaningless statements, but you guys are imbuing them with some sort of mystical aura. It’s completely weird. They’re not conveying any extra information than the original S = I, but you guys seem to think they are. They’re not. Seriously, they’re not. You’re just restating the identity over and over again without actually saying anything new. And then from time to time you’re slipping in a behavioral assumption.

• JKH February 26, 2013 at 5:18 pm

I don’t think you read the post.

• BF February 26, 2013 at 5:30 pm

Philip Pilkington ‘Debt, public or private?: The necessity of debt for economic growth’, 4 June 2011.
http://www.nakedcapitalism.com/2011/06/philip-pilkington-debt-public-or-private-the-necessity-of-debt-for-economic-growth.html

“Before we take a closer look at this – for there is an irony embedded in this narrative that is truly fantastic – we need to first understand how debt is incurred by various institutions in society. This is called the ‘Sectoral Financial Balances of Aggregate Demand’ model and I know of no clearer demonstration the article ‘Sectoral Financial Balances of Aggregate Demand – Revised’ by Scott Fullwiler over at New Economics Perspectives.”

“The key point here is that when the private sector decided to save, all else being equal, the government had to offset this by running deficits. To put this another way – and in keeping with our previous discussion – when the private sector was less interested in taking on debt, the government had to step in and do so instead.”

Prior to the crisis many of the Levy Strategic Analyses conveyed the message why we should be worried about a private deficit by supposing a stable relationship (at least ‘stable’ enough to give plausibility to modelling projections) between the private sector’s FB (percentage of GDP) and private nonfinancial sector’s net borrowing in credit markets (percentage of disposable income). Godley and Zezza’s (2006, p. 2) comments on such a projection suggest econometric derivation: “This may or may not be a correct inference, but the history of the relationship between the two series gives it some plausibility.”

The astute reader may wonder why Levy scholars decided to infer an econometric relationship between the private sector FB and net credit market borrowing by the private nonfinancial sector. Where does the debt of financial businesses fit into the picture? During 1997-2007 the financial sector’s FB summed to \$478bn while its debt outstanding mounted by \$11,475bn. What should one make of the US financial sector “net saving” in the SFB jargon while amassing credit market debt on a record scale: it was not getting more liquid and less fragile.

I know the SFB 3-sector model does gives clear picture on saving or debt relations and to think otherwise must be to use your own words Philips “Yeah, pretty stupid thing to say, right?… whole thing is just dumb.”

• BF February 26, 2013 at 5:31 pm

Typo: “I know the SFB 3-sector model does gives [NOT] clear picture on saving or debt relations and to think otherwise must be to use your own words Philip “Yeah, pretty stupid thing to say, right?… whole thing is just dumb.”

• Philip Pilkington February 26, 2013 at 5:50 pm

This is not the issue we’re dealing with here. I don’t care about MMT vs. MMR. I do care about people being amazingly pretentious and claiming that in the identity S = I + (S – I) they have discovered something that three generations of Keynesians using these identities have missed, when they have clearly not.

We are all entitled to our own opinions. You’re entitled to the one you hold above regarding the financial sectors deficits and all that. But charlatanism is charlatanism. That’s a whole different game.

• JKH February 26, 2013 at 5:57 pm

I’ve given you far too much credit over the past 2 hours.

You’re just a total bullshitter.

You have no idea what you’re talking about here.

I’m not even sure that you understand that the entire discussion is premised on the 3 sector model in which S is defined as private sector saving. That has been specified in the post, which was a REVISIT of previous discussions – and is standard in all of the discussions that have been background to this over the past year.

Do you actually read anything you criticize?

• Philip Pilkington February 26, 2013 at 6:02 pm

I didn’t follow the debate, no. But I have read the above. And, of course, S is private sector savings. It always is. What difference does that make?

• BF February 26, 2013 at 6:09 pm

Philip Pilkington, ‘MMT, Functional Finance and Dirigisme – Sketch of an Alternative Economic Approach for Developing Economies’, 10 April 2012.
http://www.nakedcapitalism.com/2012/04/philip-pilkington-mmt-functional-finance-and-dirigisme-sketch-of-an-alternative-economic-approach-for-developing-economies.html

“These are some of the problems that Randy Wray dealt with in his recent post on a jobs guarantee program as it might be implemented in developing countries. Wray says that in order to overcome inflation from higher incomes, the program should be implemented very gradually. While this seems like a sensible approach I think that Wray is being slightly too modest about what sort of policies Modern Monetary Theory (MMT) can facilitate to ensure both full employment and price stability.”

As a self-professed non-academic scribbler I’ll cut you some slack Philip though I will correct your errors.

“In applying this first law of Functional Finance [i.e. tailoring spending to full employment], the government may find itself collecting more in taxes than it is spending, or spending more than it collects in taxes. In the former case it can keep the difference in its coffers or use it to repay some of the national debt, and in the latter case it would have to provide the difference by borrowing or printing money. … The printing of money takes place only when it is needed to implement Functional Finance in spending or lending (or repayment of government debt). [In footnote] Borrowing money from the [private] banks, on conditions which permit the banks to issue new credit money based on their additional holdings of government securities, must be considered for our purpose as printing money (Abba Lerner, ‘Functional Finance and the Federal Debt’, Social Research, vol. 10, no. 1, February 1943, pp. 40-1).

In the above quote that Lerner (1943) is arguing: (1) the federal government can finance spending using receipts from taxation and bond sales to non-bank agents as well as “printing money” which in his framework subsumes purchases of T-bonds by the central bank or by private banks (note that in the 1940s the US Fed could buy T-bonds directly at auction); (2) when tax receipts are insufficient to pay for spending there is a policymaking choice between “borrowing money” (from nonbank agents) and “printing money” (“banks” as financiers of government debt), (3) “money printing” is thought to occur not all the time but “only” in the limited set of procedures defined. Here is what MMTers says in respect to the how the federal government / Treasury finances expenditures:

“Economists have long believed that the government must either ‘print money’ or ‘borrow’ whenever it deficit spends. However, as we have shown, government always spends by crediting reserves to the banking system (Wray, R., Understanding Modern Money, Vermont, Edward Elgar, 1998 (R. Wray, ‘Seigniorage or Sovereignty?’, Chapter Five in L.P Rochon and S. Rossi (eds.), Modern theories of money, Edward Elgar Publishing, 2003, p. 93).”

“It is commonly believed that fiscal policy faces a budget constraint according to which its spending must be “financed” by taxes, borrowing (bond sales), or “money creation.” Since many nations prohibit direct “money creation” by the government’s treasury, it is supposed that the last option is possible only through complicity of the central bank—which could buy the government’s bonds, and hence finance deficit spending by “printing money”. Actually, a government that issues its own currency spends exclusively by crediting bank accounts—using banks as “agents” of government (R. Wray, ‘Banking, Finance, and Money, Levy Economics Institute, July 2006, p. 11).”

“But he [Krugman] is wrong about the “choice” of selling bonds or relying on “the printing press”. There is no such choice. Spending is done by keystrokes; bond sales mop up the resulting reserves (R. Wray, ‘Paul Krugman Still Gets it Wrong’, EconoMonitor, 16 August 2011).

Lerner (1943) would surely be a critic of the MMT description of the mechanics of fiscal policy and “keystroking money”. Two more quotes side-by-side to demonstrate the point:

“The functional finance approach of Lerner was mostly forgotten by the 1970s. Indeed, it was replaced in academia with something known as the “government budget constraint”. The idea is also simple: a government’s spending is constrained by its tax revenue, its ability to borrow (sell bonds) and “printing money”… There is no recognition that all spending by government is actually done by crediting bank accounts—keystrokes that are more akin to “printing money” than to “spending out of income”… From inception, taxpayers and financial markets can only supply to the government the “money” they received from government (R. Wray, ‘MMP Blog #31: Functional Finance’, New Economic Perspectives Weblog, 8 January 2012).”

“If the money that comes in to the government treasury from selling, borrowing, and taxes is equal to or greater than the money needed for buying lending, and bonus distribution, there is no need for any money to be printed. If the money coming in is less than the money that has to be given out, and there does not happen to be enough money in the stock in the government vaults, the printing press can called upon to provide the money needed to carry out the government policies (Abba Lerner, The Economics of Control, Macmillan, New York, 1944, p. 314).

In the above quote Lerner (1944) is not arguing that the Treasury finances its spending exclusively or even mostly by “printing money / keystroking money into existence” but highlighting that this option is always available when needed. It is strange that he is oft claimed as the forefather of MMT when Chartalism and neo-Chartalist are in conflict on the mechanics of fiscal policy.

Wray (18 February 2013) is still teaching MMT counterfactuals as factual: http://www.economonitor.com/lrwray/files/2013/02/Mexico-how-to-teach-money-pdf.pdf. BIG MISTAKE TO ARGUE FISCAL RECEIPTS ARE NEVER FINANCING OPERATIONS AND BOND ISSUES FOR MONETARY POLICY.

Philip, do you believe in the MMT counterfactuals, or is it just convenient for you to just play along with their blundering of Lerner’s functional finance? Keep the answer to yourself. Perhaps when the mood imbues you to be an aggressive putdown critic have a second thought about the merits of doing so.

• BF February 26, 2013 at 7:23 pm

In my long comments I have relayed that you Philip believed: (1) Fullwiler’s “SFB model of aggregate demand” is really good in general and to understand trends in private debt in particular (it’s not and abstracts from a number of macro issues); and, (2) that MMT is getting Abba Lerner right.

A google of your NC posts reveals you as a card-carrying MMTer. Strange now you speak of the “evil MMTers” (which would make sense as an admission of your bad manners but I don’t think you meant that). So being an MMTer is now a matter of convenience. And whatever gave you the idea that JKH was claiming Keynesians (sidenote for MMTers) don’t understand NIPA identities it was not from the words written.

You want to throw words around like “dumb”, “stupid” and “charlatanism” then I will hold the mirror back. You’re writing here today seems quite unbalanced. Great to have opinions but name-calling is a pointer to an ego trip and/or lack of substance to arguments.

• Philip Pilkington February 27, 2013 at 3:53 am

This isn’t a real debate. You guys are just trying to generate tribal animosity. Waste of time.

• Philip Pilkington February 27, 2013 at 3:57 am

“…a pointer to an ego trip and/or lack of substance to arguments.”

Says the guy who has just furiously Googled my name… Right…

• BF February 27, 2013 at 4:59 pm

Philip Pilkington February 27, 2013 at 3:57 am: “Says the guy who has just furiously Googled my name… Right…”

Philip you’ve been furious spewing out words with a warring mentality from the get-go with your choice of words including “stupid”, “dumb”, “crap”, “freaking weird”, “vacuous statements”, “primitive activity” and “charlatanism”.

In your comments you pretended not to be an MMTer when you are (albeit only when it is convenient for you to do so). I provided links to these NC posts: (1) ‘Debt, public or private?: The necessity of debt for economic growth’, 4 June 2011; and, (2) ‘MMT, Functional Finance and Dirigisme – Sketch of an Alternative Economic Approach for Developing Economies’, 10 April 2012.

Since you were not being upfront about your MMT leanings I suggested that if people wanted to know the truth they could google your NC posts. You’ve written quite a bit on MMT over the years and that has served you well. I understand how it worked: your non-academic scribbles suddenly got hits when you discussed MMT. It’s okay to admit to being an MMTer (it’s not like leprosy).

Philip Pilkington, February 27, 2013 at 3:53 am: “Shadow boxing. This isn’t a real debate. You guys are just trying to generate tribal animosity. Waste of time.”

A full 19 words above, well, you have must been exhausted from all that non-academic scribbling. My comments at February 26, 2013 at 4:22 pm, February 26, 2013 at 4:35 pm, February 26, 2013 at 5:30 pm, February 26, 2013 at 6:09 pm, February 26, 2013 at 7:23 pm summed to plus 2,800 words. Now it’s not all about quantity, indeed, quality matters. An honest arbiter would struggle to tally your input at 0 quality words or a negative number. Why? Everything you’ve written on JKH’s post has been an exercise in futility and an ode to your miscomprehension of the subject plus appalling web etiquette and non-academic debating method.

Philip, you flung yourself callously onto this post; as an MMT-wolf in sheep’s clothing. It began with you getting the subject wrong and inflamed by your petty name-calling. A sometimes overt and other times closet MMTer emits baseless vitriol and then accuses that it is others who are not doing ‘real debating’ and seeking to generate tribal animosity. Ironic and the inverting of reality as per Orwell’s 1984 certainly fit.

Philip Pilkington, February 27, 2013 at 1:36 pm “So this identity formed in the course of the Great Struggle against the MMTers. You used it to “get across” to the MMTers something which (you think) they didn’t understand.”

Brackets reveal your MMT leanings. What you have written since your first remark at February 26, 2013 at 2:49 pm has been as exactly confused as per Wray‘s remarks “I might mention that I’m taller than Wilt. By how much?, you ask. By the excess of my height over his, of course (‘Blog 39: MMT for Austrians: Disagreements Among Reasonable People’, NEP, 4 March 2012.” MMTers managed to misunderstand a basic concept like ‘saving’: there is no reasonable debate on that.

Yet, you are now unreasonably inferring otherwise within brackets that it was only people like JKH who thought MMTers were misunderstanding the accounting of saving and investment; when they did repeatedly bungle basic economic accounting identities. The links to the discussion that occurred around one year ago reveal your attempt at revisionism as entirely spurious and your comprehension and reliability both as sorely lacking.

I know that Marc Lavoie was very taken with JKH’s first post on ‘S = I (S – I)’ because it explained in meticulous precision the errors that some of his colleagues on the accounting of saving. So Philip when you wrote—at February 27, 2013 at 3:21 am “If the purpose of JKH’s “most important equation in macro” is to attack a strawman or a silly error then its just as redundant as I thought it was when I first looked at it” and at “This S = I + (S – I) is NOT, however, a real debate”—you are disagreeing with the academic who coined non-academic scribblers.

Philip Pilkington, February 27, 2013 at 12:36 pm: “What appears to have happened here is that some in the MMR crowd became annoyed with the left-wing taint of MMT. But they didn’t want to just come out and say “Hey, look, we agree on the monetary system, but we’re not as left-wing as you guys”.

Cullen Roche thought sensibly that the MMT ‘employer of last resort’ policy should be trialled at a lesser scale and not imposed system-wide. He was derided and excommunicated for that thought (even though James Galbraith was on the same wavelength). In time I played a part in MR coming to question the MMT counterfactual understanding of the monetary system (which you subscribe to).

There is little to be gained in communicating with aggressive, arrogant and sinister characters who decide to dispense with reasoned argument for manipulation and trickery. You have been short of logical arguments but full of insulting non-replies; and, in doing so raised queries about your own motivations and integrity.

Even if there were reason to query JKH’s post it could have been done with courtesy and respect. Why you have shown only disrespect is unclear. Perhaps it is your nature or perhaps you thought that attacking JKH would increase your standing in the eyes of your MMT buddies. I care not. Nor do I care what you make of this comment for whatever words you may scribble down there can be no good reason for being so manically disrespectful.

• beowulf February 27, 2013 at 5:36 pm

“But he [Krugman] is wrong about the “choice” of selling bonds or relying on “the printing press”. There is no such choice.

Right, Krugman surely meant “the Mint” instead of “the printing press”. :o)
Seriously though, isn’t “the printing press” just a colloquialism for the Fed buying up T-bonds in the secondary markets? With beneficial income flowing back to Tsy its the functional equivalent of Tsy minting interest free Greenbacks (of course, even with Greenbacks, Fed owned debt or trillion dollar coins, Tsy is still on the hook for the additional IOR costs incurred if it wants to maintain a positive interest rate).

Also, neither here nor there, but the two things MMTers neglect are 1. (as Ramanan often mentions) the present danger of current account deficits but also 2. the future danger of inflation resulting from full employment policies.

If the govt is pursuing demand side policies to close output gap (which it should), long before we get to full employment, cost push inflation (from commodities and markets controlled by rent seekers) will spike inflation long before the wage pull inflation of a full employment economy will kick in (high inflation + high unemployment = 70s style stagflation). To that end, Abba Lerner and David Colander added a fourth rule of Functional Finance.

“4. The government must establish policies which stabilize the price level and coordinate both the money supply rule and the aggregate total spending rule with this stable price level at the unemployment level it prefers.”

Colander would later write, “To integrate the necessity of dealing with the institutional problem of sellers’ inflation by changing institutions rather than accepting whatever unemployment was required to stop inflation, Lerner and I arrived at [this] modification of the rules of functional finance… With this fourth rule the rules of functional finance can once again be relevant to modern economic problems”.
“Functional Finance, New Classical Economics and Great Great Grandsons”
http://community.middlebury.edu/~colander/articles.html

Just as hunger is a more pressing issue than obesity, the govt should first focus on closing output gap and the current account deficit. But as the result of fixing those problems, it must necessarily then focus on controlling inflation (“stabilize the price level”).

• BF February 27, 2013 at 5:49 pm

“Right, Krugman surely meant “the Mint” instead of “the printing press”. Seriously though, isn’t “the printing press” just a colloquialism for the Fed buying up T-bonds in the secondary markets? ”

Yes, by the “printing press”, Krugman meant the Fed buying T-bonds in the open market and the Treasury auctioning new bonds. That policy coordination is what most economists have in mind when they refer to the public sector doing “printing money” or a “money-financed fiscal stimulus”. The exception is MMTers who have their novel “keystroking money” paradigm where all spending by “government” is financed by “government”.

You may recall that Palley, in his recent critique of the modern money tree, misinterpreted the novel MMT understanding of how fiscal policy works as along the conventional lines of ” printing money” (perhaps because he did not read the literature or after reading it thought the positions to be so absurd that he assumed that MMTers meant something conventional rather than their unconventional counterfactuals).

• beowulf February 27, 2013 at 6:27 pm

Yeah, going to a keystroke financing system is such a break from current practice (to say nothing of current law) that Palley probably figured if that’s what they meant, they’d surely have offered a plausible explanation of how we get from here to there.

• Philip Pilkington February 26, 2013 at 5:26 pm

I mean look at this crap. You write:

“You’re [Steve Waldman] saying that you can increase S as a result of increasing I rather than (S – I), which is true, and very important, as you explain.”

This is gobble-dee-gook. All the S’s and I’s must be the same value. Otherwise we would denote them with different letters. So, what the hell does this mean: “you can increase S as a result of increasing I rather than (S – I)”? Wha!?

If you increase I then your (S – I) changes too. They’re THE SAME VARIABLE! That’s why they’re denoted in the same way! Look:

S = I + (S – I)

Set them all equal to 5 (remember, they MUST equal if S = I is to hold).

5 = 5 + (5 – 5)

Now, increase I to 10:

10 = 10 + (10 – 10)

Oh look, they all increased… BECAUSE THEY’RE THE SAME VARIABLES AND THEY EQUAL ONE ANOTHER!

This is all complete and utter mush. You’re talking yourself around in circles. It’s bizarre. And yes, I did read the post. It’s just a giant exercise in tautology. You’re not saying ANYTHING new. You’re just chasing your tail by adding variables that cancel out to your identities. Anyone can do this. Watch.

Set a balanced budget equilibrium:

G* = T*

Oh, look, I can add two completely meaningless variables that cancel out:

G* = T* + (G* – T*)

Have I conveyed ANY additional information? Nope. But I could probably fool a few people on here into thinking that I have have.

• JKH February 26, 2013 at 5:34 pm

Where’s the Waldman reference from?

It’s not in this post.

• Philip Pilkington February 26, 2013 at 5:42 pm

One of the links above. I’m trawling through this stuff with utter amazement. And no I won’t “get a grip”. You guys are bamboozling people big time here with this stuff. S = S + (S – I) conveys no new information as the original S = I identity and you’re pretending that it does. I can run through this a million different ways to show the silliness of this.

The latter two variables, (S – I), are just zero. We know this because S = I. And if S = I, then S – I = 0. That makes these variables completely redundant from the point-of-view of the identity. You’re adding them in and then imbuing them with some mystical authority. It’s freaking weird.

• JKH February 26, 2013 at 5:46 pm

You’re embarrassing yourself. You apparently aren’t even aware of the definition of the variables in the 3- sector financial balances model.

• Philip Pilkington February 26, 2013 at 5:58 pm

Enlighten me then. Tell me why:

S = I + (S – I)

S = I

It shouldn’t be hard. From a purely mathematical perspective the former statement, as an identity, contains NO additional information than the latter. But I’m willing to listen if you tell me why the former contains some insight that the latter obscures.

• JKH February 26, 2013 at 6:03 pm

so you’ve confirmed what I suspected

you don’t even know the definition of S in context

for a change

then come back – after you’ve calmed down

• Philip Pilkington February 26, 2013 at 6:12 pm

You just said it was private sector saving. So, let’s pop that into the identity:

Private Sector Saving = Investment + (Private Sector Saving – Investment)

Now, since we know that: Private Sector Saving = Investment, then Private Sector Saving – Investment = 0.

What the hell am I missing here? What information is the (S – I) adding to our identity. If I’m wrong that it adds none, explain why.

• JKH February 26, 2013 at 6:27 pm

private sector saving does not equal investment

you really do not know what you are talking about

please take a breather and check with your MMT pals on how the national accounts work

and BTW your internet manner is absolutely atrocious

• Philip Pilkington February 26, 2013 at 6:31 pm

Private sector saving DOES equal investment in an ex-post accounting sense (excluding other sectors, of course), which is what the national accounts do. Where does this “residual” come from? If it comes from the other sectors then we don’t need this (S – I) expression (it becomes redundant, as I pointed out above). But maybe it comes from somewhere else. I’m waiting for you to tell me where.

• JKH February 26, 2013 at 6:35 pm

private sector saving does not equal investment in the national accounts

I’m waiting for you to get educated on accounting

• Philip Pilkington February 26, 2013 at 6:39 pm

You have to be more specific. Do you mean that S = I doesn’t hold in the national accounts because of the other sectors? Or are you talking about something to do with net/gross investment?

• JKH February 26, 2013 at 6:47 pm

look, I don’t have to be more specific

you need to learn the accounting

and some manners

as far as the S = I + (S – I) is concerned, apart from the fact that you are completely ignorant of the definition of S in the context of this expression, which is absolutely fundamental to the whole thing, you’ve made no coherent comment whatsoever about what is actually written in the post – you’re just frothing at the mouth at the sight of a tautology

this is exactly the ‘method’ of response that Wray made a year ago – exactly

absolutely zero understanding of the points being made here

talk about charlatanism – you’ve got some nerve

I’ve invested enough time in this discussion

you’ll have to change your attitude enough to actually read the material if you want to discuss this further with me

• Philip Pilkington February 26, 2013 at 6:59 pm

Well, if you don’t want to actually debate this then I’ll level with you: I think you’re saying absolutely nothing new in your post. And I’m not the only one who thinks it — and no, I’m not just talking about the “evil MMTers”. I think you’re adding two redundant variables to an identity and then you’re engaging in all sorts of mysticism.

I also think that if you have a real argument you should write it in a paper and we’ll get it published in an academic journal — provided it passes peer review, of course. If this mysterious (S – I) is really as important as you claim it is, and isn’t in fact completely redundant, then I think the rest of the Keynesian community should be allowed the opportunity to understand where they’ve got it so wrong all these years. Until then I’ll maintain my extreme scepticism.

• Geoff February 26, 2013 at 5:36 pm

What is says to me is that Saving is driven by Investment while NFAs (s-i) play a secondary role.

• Geoff February 26, 2013 at 5:39 pm

Other schools of thought seem to imply, intentionally or not, that Saving is driven by NFA’s.

• Ramanan February 26, 2013 at 10:35 pm

Phil,

You say:

“Now, since we know that: Private Sector Saving = Investment, ”

which is incorrect.

The private sector saving is equal to the sum of its investment expenditures and its net lending to other sectors (or net accumulation of financial assets in old terminology).

In “S=I” equation in all textbooks, the LHS is the sum of saving of all sectors of the world and the RHS is the sum of all investment expenditures of all sectors of the world.

I think JKH wants to capture the “sequence of national accounts” in the equation

S = I + (S – I).

As opposed to the previous equation, the S above is the domestic private sector saving.

In national accounts, after generation of income accounts and disposable incomes have been recorded, consumption expenditures are then recorded saving is calculated as a balancing item. After this, one records the capital account – in which saving is carried over from the previous step and investment expenditures are recorded. The balancing item after this step is net lending. This is carried over to the financial account with details about the net lending – acquisition of financial assets of various sectors and incurrence of liabilities etc.

So the S = I + (S – I) tries to capture a part of this procedure.

So there are two aspects about saving – one is the Disposable Income Minus Consumption part and the other its counterpart.

Originally the equation arose because it was realized that most peer-reviewed Neochartalist authors confuse saving and “saving net of investment” and claimed that if the government budget is in balance or in surplus, the private sector cannot save. And it is IMPOSSIBLE they claim.

This is inaccurate and misleading. And very very counterproductive.
Wray for example was forced to defend his (incorrect) statements over ages and screwed up again – claiming Saving = NAFA. Funnily he also claimed other Keynesians think this is so. Bill Mitchell to this day continues to err on such simple matters. This error has also been noted by many others – such as Nick Rowe and Robert Murphy.

• Philip Pilkington February 27, 2013 at 3:21 am

“In “S=I” equation in all textbooks, the LHS is the sum of saving of all sectors of the world and the RHS is the sum of all investment expenditures of all sectors of the world. ”

Ramanan, you should know better than this. The S = I equation assumes a closed economy with no government. When we “open it” and add a government of course S not longer strictly equals I. This isn’t an insight, its in every introductory macro book I’ve ever seen.

Criticising the S = I identity for not including the effects of the other sectors is like criticising the Kalecki equation for not including workers’ savings or a foreign sectors. Its not a mistake. Its done on purpose to highlight a special case.

“Originally the equation arose because it was realized that most peer-reviewed Neochartalist authors confuse saving and “saving net of investment” and claimed that if the government budget is in balance or in surplus, the private sector cannot save. And it is IMPOSSIBLE they claim. ”

If someone said that on a blog or something at one point then that’s called a “mistake”. No one makes this claim. If the purpose of JKH’s “most important equation in macro” is to attack a strawman or a silly error then its just as redundant as I thought it was when I first looked at it.

• Philip Pilkington February 27, 2013 at 3:33 am

http://mainlymacro.blogspot.co.uk/2012/01/savings-equals-investment.html

“Total output = total income = total expenditure = Y. In the most simple model of a closed economy without government, income (Y) = consumption (C) + saving (S), but also expenditure (Y) = consumption (C) + investment (I). So S=I by definition.”

See? S = I in a closed economy with no government. Again, not controversial.

• Ramanan February 27, 2013 at 5:12 am

Phil,

“Ramanan, you should know better than this. The S = I equation assumes a closed economy with no government. When we “open it” and add a government of course S not longer strictly equals I. This isn’t an insight, its in every introductory macro book I’ve ever seen.”

Not necessarily. Even for the whole world with various currencies and governments,

S = I.

(ex-post if you like)

So the S above here is not the saving of one individual sector but the sum of savings of all sectors in the world. Such as Chinese government, Peru households, US banks etc with appropriate definitions of saving of each.

I however feel digressed, so I will leave it at that or write something if I feel undigressed.

Of course the idea of saving versus allocation of this saving into various assets is known to Keynesians:

Here is from G&L 4.3.2:

“We now move to the household sector. A key behavioural assumption made here, as well as in the chapters to follow, is that households make a two-stage decision (Keynes 1936: 166). In the first step, households decide how much they will save out of their income. In the second step, households decide how they will allocate their wealth, including their newly acquired wealth. The two decisions are made within the same time frame in the model. However, the two decisions are distinct and of a hierarchical form. The consumption decision determines the size of the (expected) end-of-period stock of wealth; the portfolio decision determines the allocation of the (expected) stock of wealth. This behavioural hypothesis makes it easier to understand the sequential pattern of household decisions.”

Of course if the MRists think it is better to say this with their equation, you can’t stop them

• JKH February 27, 2013 at 5:50 am

as usual, right again on S and I – this time in global context

• JKH February 27, 2013 at 5:53 am

agree with G&L quote obviously

although that’s not exactly the functional purpose of the I plus (S – I) split, which is not necessarily linked directly to the idea of financial instrument allocation, but is reflected in the household asset mix decision at a higher level – e.g. real estate versus financial assets

• Ramanan March 1, 2013 at 5:02 pm

Oh missed seeing this before.

In their approach the financial versus non financial aspect – although not their book but in other papers – is tackled by the same method of Tobin’s theory of asset allocation. So once the amount of saving is decided, households will have different portfolio preferences for different types of assets – nonfinancial and financial.

• Ramanan March 1, 2013 at 5:04 pm

Sorry meaning once saving is allocated, it will be allocated into various assets – both nonfinancial and financial according to portfolio preferences.

• JKH March 1, 2013 at 6:06 pm

I think we’re saying things that are not mutually inconsistent.

The portfolio allocation ‘methodology’ is seamless across financial and non-financial

But the sectioning of I and (S – I) categories can drill down a level below the private sector and apply to businesses and households in the same way

(although I recognize national accounts treats residential real estate I ‘flow’ at the business sector level, while the ‘stock’ result ends up at the household portfolio allocation level)

so I think we’re in synch there

• Ramanan March 1, 2013 at 6:14 pm

Yes of course – not mutually inconsistent.

• Philip Pilkington February 27, 2013 at 6:03 am

“Not necessarily. Even for the whole world with various currencies and governments,”

Ramanan, I know that you’re well-read enough to know that when economists say S = I they’re referring 99.9% of the time to a closed economy with no government. There are plenty of other applications. Yes, the world system is an example. But that isn’t usually what economists actually mean.

“Of course if the MRists think it is better to say this with their equation, you can’t stop them.”

No, they can say anything they want. But they’re putting it out there as if its some Grand Truth (“The most important equation…”). That is charlatanism and sophistry of the highest order and I will call out anyone doing this as engaging in silly semantics and not real economic debate. As one economist I talked to said of this debate: “I’ve seen idiocy before, but discussing tautologies…”. Yeah, that sums it up.

Some of your criticisms of MMT were actually quite interesting. The balance-of-payments constraint (Thirlwall’s Law) is a real debate that should be had and has garnered real consideration from the other side. I’m not convinced, but I can appreciate that its a real debate.

Some of the stuff you talk about on institutional currency relationships and swap-lines is somewhat interesting too. Again, I’m not personally convinced that these can directly lead to crisis in the modern world that isn’t just straight-forward devaluation (which the MMTers highlight), but I keep an eye out for these things in case that I’m missing anything. So far, I haven’t come across anything that dissatisfied me, but you never know.

This S = I + (S – I) is NOT, however, a real debate. It just isn’t. Yes, we can discuss behavior and causality. Yes, we can ask how important business sector deficits are in economic growth. We can ask all these things. No problem. But let’s not engage in mysticism. Let’s keep the debate to a certain standard, shall we?

• Ramanan February 27, 2013 at 8:59 am

Phil,

Let us keep the balance of payments constraint aside. (how untypical of me to say this!).

I think you should look at JKH’s point of view more closely rather than simply seeing it as a debate. I think he has supreme knowledge, command and control over flow-of-funds and if you read his posts and comments across the internet carefully, you will see this. I have realized many of his points after a long time many times.

There are a lot of things in the national accounts than simple accounting. Things such as how something is recorded, how accrual is done and things such as that – although appear as mere technicalities at first sight – have great importance when one tends to think of them carefully.

I think his approach more fundamentally is to educate some very fine conceptual points. For example, last year around this time, we saw Winterspeak continuously struggle to understand what saving is. He thought if one buys a house, one is saving – which isn’t the case. One can have a negative saving and still buy a house. Or one can be a big saver and a big borrower at the same time.

In my experience, people genuinely struggle in such things.

About S=I and discussions such as that it isn’t always the case and in fact it is used quite regularly.

For example here is how Mankiw pushes the US government to tighten fiscal policy – or used to in the 90s/2000s.

In the simplest case of no investment by the government, we have

S (priv) + S (govt) = I + CAB

so Mankiw and many others argue that the US needs to save more to decrease the CAD (i.e., improve the CAB). Since the left also has the government’s saving (and equal to deficit in the case of zero govt investment), the only way is to tighten fiscal policy – without realizing that it is a deflationary way. In a closed economy context, it is argued that the government should save more (and hence cut its deficit) to increase investment – using the same identity.

• Ramanan February 27, 2013 at 9:13 am

“and equal to deficit”

Sorry typo: meant surplus.

• Philip Pilkington February 27, 2013 at 12:36 pm

First, on the neoclassical use of the identity. I’m aware of it. It’s fine, it works, I don’t think it has any ideological overtones. Mankiw’s use of it is just stupid. But that’s just Mankiw. He’s not a good economist. If you listen to him for policy or investment advice then tough luck; you’ll get screwed. However, I’d never try to argue with his version of the identity. What would be the point? It’s just an identity. No big deal. Maybe “government saving” is misleading language; but then, I know a very good economist who thinks that “private sector saving” is misleading (because he thinks that saving is just a residual), he has a point too. No big deal.

Which brings us to the next point: is this S = I + (S – I) meaningful. No. It’s not. Is it true? Yes. But so are:

G = T + (G – T)
X = M + (X – M)

Those are true as well. Indeed they’re the “clones” of “the most important equation in the world”. Are they important? Not remotely. In fact, they’re pretty redundant. If you examine their construction carefully you’ll see that they’re probably two of the most banal identities in the national accounts.

The problem here is that a bunch of people studying the national accounts are trying to encroach on the territory of actual economic modelling — and they’re coming out looking very silly indeed. They seem to think that certain identities actually “say something”, but they don’t say anything at all because they’re just identities. In order to “say something” we have to set some behavioral constraints and then identify the endogenous and exogenous variables. But you know this well, Ramanan, so I don’t think I need to tell you.

S = I + (S – I) contains no more information than S = I. And it contains significantly LESS information than 0 = (S – I) + (G – T) + (X – M).

What appears to have happened here is that some in the MMR crowd became annoyed with the left-wing taint of MMT. But they didn’t want to just come out and say “Hey, look, we agree on the monetary system, but we’re not as left-wing as you guys”. Instead they wanted to come off as if they’d “discovered” something new. So, they found this completely redundant identity, set up a strawman version of the MMT argument based on a few loose comments on some blogs and proceeded to attack. This then descended into tribalism which is all we see in this comments section.

Me? I wouldn’t mind a real debate on the merits of the MMT argument. But in order to get there the nonsense has to be filtered out. People need to be called out for making vacuous statements. And unless someone can tell me clearly and succinctly WHY S = I + (S – I) contains more information than S = I — and no, saying that S no longer equals I when we open the economy is NOT an argument here and if you don’t understand why its not an argument kindly exit the debate through the door on your left — unless someone makes this case very succinctly I will criticise this identity-fetishising for the primitive activity it appears to be.

• Ramanan February 27, 2013 at 4:00 pm

“S = I + (S – I) contains no more information than S = I.”

Take an example.

Private investment is 100. Private Saving is 120. No government investment.

120 = 100 + 20

Of the 120 of saving, 100 was allocated in investment and 20 as net lending to the government.

Private Saving is 120 and not equal to private investment (100).

Private sector net worth increased by 120 and not by 20 – as maintained by MMT till it was pointed to them.

For the whole economy, saving is 100 and investment is 100.

Unfortunately, it doesn’t tell us how much the net worth of the private sector increased because of flows.

So obviously 120 = 100 + 20 has more information than 100 = 100.

• stone February 27, 2013 at 4:08 pm

You say that, “Private sector net worth increased by 120 and not by 20 – as maintained by MMT till it was pointed to them.”

I’m really struggling with this. Won’t subsequent deflation caused by that saving reverse that 120 back down to 20? The economy will still have the real asset built by the real investment but deflation will prevent an increase in nominal wealth?

• Ramanan February 27, 2013 at 4:13 pm

Stone,

In the example, there is not much information on whether the economy is deflating or reflating. Even if it is deflating, 120 may go to 100 or 80 or whatever.

• Jose Guilherme February 27, 2013 at 1:38 pm

“…the S above here is not the saving of one individual sector but the sum of savings of all sectors in the world. Such as Chinese government, Peru households, US banks etc with appropriate definitions of saving of each.”

Yes – but in that case we’re not talking only about private sector saving; we’re including all the governments’ “savings” (surpluses) in the definition of saving.

And when we mention 8I), we’re referring to private sector investment only. Government investment expenditures are included under (G).

Let’s illustrate with a concrete example: the U.S. economy in 2009.

Private investment was \$1,629 (in trillions), whereas (G) stood at \$2,931. But this (G) included such key investment expenditures for the U.S. economy as spending on N. I.H., Pentagon R&D, etc.

So, let us please not allow a rather naive enthusiasm for the role of private sector investment, aprioristically defined as “key” (that is, the whole basis for the S= I + (S+I) initiative) forget about that very important factor behind the dynamism of the U.S economy in the last decades: government investment expenditures.

• Ramanan February 27, 2013 at 11:15 pm

“Yes – but in that case we’re not talking only about private sector saving; we’re including all the governments’ “savings” (surpluses) in the definition of saving. ”

Caught you

Government saving is not its surplus.

• Fed Up February 26, 2013 at 11:23 pm

“It’s because net financial assets is the only form in which that additional saving can be manifested, given the assumption of maxed out investment I.”

Is the saving done in medium of exchange (MOE) / medium of account (MOA)? Are the financial assets denominated in MOE/MOA?

• stone February 27, 2013 at 2:53 am

When I read Billyblog, I did get the impression that the story was that the NOMINAL VALUE of private sector saving could only increase long term if net financial assets increased due to government deficit spending. My impression was that if everyone built lots of fantastic productive machines and buildings and such like using private saving and the government ran a balanced budget, then the NOMINAL VALUE of private sector net worth would not be increased. It would be what people on gold-standard nostalgia forums would call “good deflation”. We would get more real goodies but prices supposedly would fall such that in NOMINAL terms no saving was happening. My understanding was that Bill Mitchel was saying that if expansion of private debt was relied on to allow NOMINAL private saving to mirror the increase of real investment then inevitably that expansion of private debt would lead to crisis and massive deleveraging to the point where we would be left with just the net financial assets (aka government debt) as the backstop to NOMINAL private wealth.

Basically to me the whole argument between MMT and this site is over who is in the driving site in the quest to keep private debt expansion aloft long term. It almost seems as though your model is that private debt expansion pushes the nominal economy forward until the malign consequences of too much private debt lead to a lot of (S-I) at which point the government needs to step in and fill that gap. Your hope seems to be that periodic episodes of “beautiful deleveraging” will periodically bring (S-I) under control again and so allow another phase of private debt expansion driven real and nominal growth. As such I don’t think you are disagreeing with the substance of what the MMT people are saying. You would only be making a break from MMT in my opinion if you claimed that NOMINAL private sector wealth could expand indefinitely without government deficits and not cause (S-I) to balloon up to the point of collapse and reversal. Are you saying that?

Sorry if I have made glaring misunderstandings and please tell me if I have.

• JKH February 27, 2013 at 5:27 am

“When I read Billyblog, I did get the impression that the story was that the NOMINAL VALUE of private sector saving could only increase long term if net financial assets increased due to government deficit spending. “

Exactly – and a lot of readers were making that error, because that’s what was being SAID in words – persistently – as Ramanan noted in more general terms.

I’m not making any judgements about normative policy under a given set of circumstances here, and certainly not in comparison with MMT. There’s no argument with MMT about policy in this post. That’s a separate issue.

• JKH February 27, 2013 at 5:37 am

Ramanan @ February 26, 2013 at 10:35 pm

Thanks, Ramanan

That’s very nicely and simply stated, and factually correct

The fact is that you as much as anyone were present around the time that this expression “emerged” and understand full well the circumstances of its birth and the reason for it – which as you say had to do (at least in good part) with some well documented examples of PERSISTENT language and conceptual confusion on the internet, around the correct versus incorrect definition of saving

Of course, that’s all in my earlier, longer background post to this

And I know that you fully understand all of this

(And as does BF of course – as is very clear – and as very thoroughly and accurately reflected in his series of comprehensive comments above)

And I know you have the mathematical maturity to understand when a tautology is written for strict purposes of emphasizing a particular decomposition of the whole into its parts – although I think understanding the context point made it easier to understand this point – and that the writing of such a tautology is not equivalent to presenting it as an equation to be “solved”.

Those who respond with childish ‘gotcha’ simulations of the latter type are entirely missing this point, of course – and in some cases there is an agenda for doing this that seems to be panic for more general reasons, in a desperate way, which only reveals the naiveté of aggressors in these cases

And the reason for revisiting it here was not to bring the original agenda source of the problem back into full behavioral display, but to respond to those who in good faith haven’t appreciated the distinction being made between the compositional information within the tautology versus its apparent redundancy for the tautological property itself – and that if anything, the first reason is emphasized by the second

And while the tautological appearance of the equation can be understandably quite puzzling to some of those with less knowledge of the background here, it’s rather Spartan representation is a fitting tribute to the sheer stupidity of the kind of language and obfuscation of meaning being propagated at the time of its creation (and which astonishingly continues in comments under this post in the case of the definition of private sector saving in a 3 sector model, which is the basis for all of this) – and which was one motivating force behind its creation. In short, the reason for the deliberate awkwardness of the tautological appearance of the expression includes its role in serving as a stark reminder of the sheer embarrassment associated with the very consistent public display of ignorance that was in part the motivation for creating it.

And given that it is a particular take on sector balances, and that certain people and groups have regularly written reams on other “more conventional” approaches to sector balances, that the idea of putting some lengthier description around it in this case is not unusual

Ironically, it was you of all people who I half expected might come in here when it comes to the importance of decomposing (S – I) into its domestic and foreign components – and that in that sense the idea of the “Keynesian skew”, being an emphasis on a natural inclination toward a particular government policy orientation, can be more complicated when you bring in an aberrant current account magnitude. In a way, the simplicity of the single expression that is the add-on to investment ‘I’ implicitly submerges the complexity of the more aberrant cases for current account behavior – for example how an outsized current account deficit might factor into the interpretation of such a “skewed” government policy. You’ve been a leader in pointing out consistently and correctly that such interactions aren’t that simple. That’s a very valid point and it’s somewhat ironic that you’ve had the wisdom and good faith to put that very legitimate point into some accommodating background perspective here in the context of the simpler point being made about the definitional issue.

• Ramanan February 27, 2013 at 9:10 am

Thanks JKH.

This was said well:

“In short, the reason for the deliberate awkwardness of the tautological appearance of the expression includes its role in serving as a stark reminder of the sheer embarrassment associated with the very consistent public display of ignorance that was in part the motivation for creating it.”

And I would add that it was a simpler point where the truth can be established immediately without worrying about empirics and still it takes a long time to get the point across. Imagine more complicated discussions where some things are vague and uncertain and it is difficult to pinpoint to the other person where he/she is wrong. When someone struggles at some simple stuff, harder battles become more difficult.

• JKH February 27, 2013 at 10:30 am

Ramanan,

It was a good point you made that this shouldn’t be – and never was, IMO – about a debate. It’s about a particular perspective that really was a function of a specific issue about communication that developed over quite a long period of time, and then came to a head about a year ago – as you know. So the source of this odd expression really was very much circumstantial in that regard.

And it was suggested that this presentation purports to convey something “new” in the sense of disputing some more conventional view of how Keynesian economics works. This is absolutely not the case – and I think BF pointed this out by observation. More generally, there is not much “new” in economics in such a sense anyway.

This is just one way of entering the discussion of sector financial balances in the specific context of the 3 (or 4) sector model.

BTW, the following analogy has occurred to me, which I think you also alluded to in your other comment:

Suppose we observed some material resistance to the basic economic idea that saving is equal to the residual that results from income that is not consumed. I’m sure you’ll agree that this question in fact has surfaced on occasion in blog discussions – e.g. as you noted – i.e. the idea that saving must be defined as a residual, which indeed is the case. If one were presenting the full logical argument as to why this must be the case, it might well include the following at some stage (ex taxes):

Y = C + (Y – C)

And that would be a simple way of emphasizing by tautology that the actual calculation of saving indeed MUST include (Y – C) as the definition of saving, and that it logically CAN’T be done any other way.

The (S – I) component is not quite the same, and was not developed for quite the same rationale, but there is a similarity in the motivation for the tautology form of expression.

And it’s interesting that one involves the investment side, and the other involves the consumption side, and both involve saving.

Finally – and this has nothing directly to do with you Ramanan, but I’ll just record it here for convenience – in fact, I have never said that the equation in question is “the most important …” (among other things that I did not say). I have NEVER indicated that this expression should assume that sort of extreme importance of any kind at any time. I do think it makes an important specific point in the context of the specific background – for the purpose of clarification. And I do think it makes an important point about the central role that investment plays in sector saving, which is what Cullen likes about it I think. But this equation thing is of relatively minor importance to me personally. And the only reason I did a post on it was to REVISIT it in the context of good faith questions that had recurred over the past year – quite acknowledging that lots of people don’t like the form of it so much.

And so there’s no debate as far as I’m concerned. It’s just a point of view for the purpose of emphasizing the composition of saving. And anybody who comes in from left field to attack the think aggressively for its tautological form alone, without perusing the background and context for the thing, is in my view ignorant, myopic, and not particularly bright, to be blunt about it. The equation in question was formulated at a specific time for a specific purpose. It is one expression of sector financial balance dynamics whose construction responded to the persistent misrepresentation by some people of the meaning of private sector saving in the more conventional SFB partitioning. That misrepresentation was thoroughly documented in the background material, something you are well familiar with yourself. And as far as anecdotal economists’ opinions on this whole topic is concerned … well, Paul Krugman doesn’t even seem to know yet that loans create deposits … so, I’m not exactly quaking in my boots about that larger jury. Neither should anybody who’s interested in economics make any such blanket assumption about the uniform wisdom of a profession that is obviously at war, not only with those outside the profession, but with itself.

• Philip Pilkington February 27, 2013 at 1:36 pm

There we go. Problem solved.

” It’s about a particular perspective that really was a function of a specific issue about communication that developed over quite a long period of time, and then came to a head about a year ago – as you know. So the source of this odd expression really was very much circumstantial in that regard.”

So this identity formed in the course of the Great Struggle against the MMTers. You used it to “get across” to the MMTers something which (you think) they didn’t understand.

But then why didn’t it disappear? Why did it become “the most important equation in the world”? I’ll tell you why it didn’t disappear: because this has more to do with a different type of identity which we call “branding”. This is an exercise in branding. This has less to do with identities as it has to do with identity-formation. Good sales pitch, guys, but I was never going to buy it.

• Cullen Roche February 28, 2013 at 4:12 pm

Phil,

First of all, you MMT guys need to drop your attitudes. Everywhere you go you fume and lash out at people. If you ever want anyone to take you seriously you should try to behave a bit more kindly. I am not sure why this is a common personality trait across all of MMT, but it’s very strange, immature and wreaks of insecurity. If you can’t back up your arguments without fuming and name calling then don’t bother arguing.

More importantly, this whole debate stems from an important misconception within MMT. The entire MMT model is govt centric. It’s all based on the govt, the hierarchy of money leading to reserves and a very unbalanced view of the world. It’s fairly ironic that you guys claim to be an endogenous money group when you actually build your entire argument around reserves and govt money. You’re not truly endogenous. You’re exogenous thinkers and you do the exact same thing that the neoclassicals do by building some inapplicable theory around the reserve system. The entire concept of “taxes destroy money” is wrong. The entire idea of “From inception, the purpose of the monetary system is to move resources to the public sphere” (Wray) is wrong. The entire idea of private saving being focused on (S-I) is wrong. It’s all an absurd unbalanced view of the world as if we are all flailing through life waiting for a govt to come along and give us meaning to live. Endogenous money precedes exogenous money. The private sector precedes the public sector. Resources precede taxation. MMT literally gets all of this backwards.

You can’t appreciate the essence of S=I+(S-I) because your view is totally unbalanced and biased. And you haven’t followed the debates so you haven’t even figured out why MMT’s theory is wrong. And frankly, given your attitude, I don’t know why any reasonable person would engage in trying to help you figure out why the theory you so fervently back, is wrong.

• JKH February 27, 2013 at 1:29 pm

“S = I + (S – I) contains no more information than S = I.”

I’m fully confident you’ll know exactly how to deal with that, Ramanan.

• Matthijs February 27, 2013 at 10:00 am

Feel like asking a stupid question now, but I stil need to know. Can someone give the exact definitions of I and S? From Cullens paper:
“Private sector saving can be decomposed into the amount of saving created by investment “I” and the amount of net financial assets transferred from other sectors (S – I). That is the focus of the equation S = I + (S – I) as it highlights the fact that the private sector is the primary driver of economic prosperity while government is a powerful facilitator.”
So as I understand, the first I is investment. In other words, a company gets a loan from a bank (= new money) and pays some workers to build something.
The pay the workers got is the first S.
But what are the definitions of (S-I) then? Cullens says above “financial assets transferred from other sectors”. It’s not entirely clear to me what those are.

Read all articles linked in the above article but it’s still very confusing. Hope someone can help.

• jt26 February 27, 2013 at 10:51 am

” But what are the definitions of (S-I) then? Cullens says above “financial assets transferred from other sectors”. It’s not entirely clear to me what those are.”

…But what are the definitions of (S-I) then…
(S – I) = (G – T) + (X – M)

… financial assets transferred from other sectors …
(G – T) , government sector and
(X – M) . foreign sector
Symbol definitions are the same as on Cullen’s site.

• Matthijs February 27, 2013 at 11:07 am

Thanks for your reply jt26. Your answer seems obvious and of course I have seen and read that statement (S – I) = (G – T) + (X – M) many times. So what is actually meant with
S = I + (S – I)
is
S = I + (G – T) + (X – M)

That’s a simple enough statement to understand. The total amount of saving is equal to and a result of:
1) the Investment being made by the private sector (new money created by banks)
2) the amount the government spends more then it taxes (it issues/creates bonds, worth money)
3) the current acount balance (export minus import)

But why confuse so many people by changing that to S = I + (S – I)?

• jt26 February 27, 2013 at 12:01 pm

“But why confuse so many people by changing that to S = I + (S – I)?”

(1) reason 1: (see the old posts in the references and on Cullen’s site)
MMT likes to politicize that when S-I = 0, you need the government, otherwise there will be no investment. This is false, see e.g. these recent comments on the parallel thread: http://pragcap.com/briefly-revisiting-si-s-i/comment-page-1#comment-138890; http://pragcap.com/briefly-revisiting-si-s-i/comment-page-1#comment-138902. I think you’ve been on this page commenting so you might have already seen them.

BTW, in this context, don’t think of S = I + (S – I) as an equation like E=mc^2. It has no insight without the accompanying verbal interpretation. Here is the verbal insight: “S or I can be large even when S-I=0″ or “*Real* private investment can occur without the government being involved”. See my parable.

(2) reason 2: in the context of this post think of S = I + (S – I) as a dynamical equation. And in this case (S-I) is just shorthand for (G – T) + (X – M).

An example of the interpretation of this dynamic equation could be:

“If your neighbors want to save this year, and there is nothing you can do to change their mind, and this is resulting in unemployment, but the community needs to fix the hospital, let’s “borrow” that from another sector (the government); win-win.” (PS the Keynesian slant is the unemployment part. When there is no unemployment, you could say the investment is a necessity such as “fighting a war against an invader”.)

• JKH February 27, 2013 at 1:12 pm

“It has no insight without the accompanying verbal interpretation”

right

• Matthijs February 27, 2013 at 2:22 pm

Thanks a lot for your further elaboration jt26, really appreciated. Still not entirely convinced if the equation is really that helpful, but I do understand better what is meant. I guess if only for my own understanding I stick to the somewhat longer version of (G – T) + (X – M).

I do get the point that it’s important to understand that investment and saving can occur without the government. That’s a point I have been confused about before by reading MMT blogs, before reading this site and pragcap.

Again, thanks for the help.

• JKH February 27, 2013 at 2:46 pm

that’s good

consider the equation a bit of necessary water boarding – before returning to the long form

• jt26 February 27, 2013 at 6:01 pm

Personally, I find Reason 1 the most persuasive use of the artistic form, because, surprisingly there is no shorter way to express “S or I can be large even when S-I=0″, explictly; maybe S,I>>0, S-I=0, but that’s kind of boring. I think it’s all kind of fun, and I sometimes grin when I think how an accountant probably agonized over the expression and then gave in to an artistic impulse. Th audience reaction has proven the choice a good one. Just like Nike’s “Just do it.” rankles some people (why do you need the “just”?; what does it really mean?), it expresses a certain je ne sais quoi.

• beowulf February 27, 2013 at 5:09 pm

I is wealth that can destroyed by a B-29 raid.
S is wealth that can be destroyed by a computer virus at your bank .

Hmm since land will survive either, I guess the Georgists are right to count it as is separate factor of production. :o)

• stone February 28, 2013 at 1:48 am

“I is wealth that can destroyed by a B-29 raid. S is wealth that can be destroyed by a computer virus at your bank . Hmm si…”

I’m still left floundering by this because the nominal value of the real stuff that can be destroyed by a B-29 raid seems ENTIRELY determined by the stuff that can be destroyed by a computer virus at the bank which in turn is ENTIRELY dependent on the size of the stock of government created net financial assets.

So far, for me, the S=I+(S-I) story described here seems to be the worst of all possible worlds. It obscures the MMT story about nominal increases in private wealth being dependent on government deficits. It also leaves unsaid what MMT leaves unsaid which is that perhaps nominal increases in private wealth are not conducive to improvements in human welfare and genuine prosperity. Chasing nominal increases in wealth is NOT the same as getting more real assets and perhaps the way to facilitate creation of valuable real assets by the private sector is to AVOID government action aimed at increasing nominal wealth.

• beowulf February 28, 2013 at 4:41 pm

I see what you’re saying. I don’t mean a B-29 monster raid, just one bomber that takes out your house and work vehicle, and the computer virus is of the discriminatory sort that drains YOUR bank accounts but everyone else is cool. I take your point that burning an entire nation to the ground will destroy its currency and siphoning off all its bank accounts will be destroy its real economy.

• Paul February 27, 2013 at 11:31 am

JKH,

The stylized example was very helpful – if initially confusing – for me.

Can you kindly confirm if the below is correct? Assuming a very simple closed economy w/ no govt sector. And no cash flows other than those stated in your example.

Total income for the period in your example was 1.5X

This is derived from the X investment you made and the X/2 initial in wages you received.

Those X/2 wages you received were for consumer goods when the consumers had dis-saved, ie the rest of the economy purchased consumer goods from you via negative saving.

We know they were consumer goods b/c total investment was assumed to be X and we know they dis-saved b/c there were no other cash flows (previous wages).

Then your investment of X resulted in X of wages for the rest of the economy, ALL of which were saved, which resulted in X/2 net saving by the rest of the economy (the initial negative X/2 + the new X).

Is that correct? I want to confirm for my understanding and b/c what confused me from your initial example was “All these factor payments which will end up totaling X/2…”

It took me a bit to get that the X/2 (net) = – X/2 initially + X later.

And of course the other X/2 saving is the saving you made by forgoing consumption (investing your X/2).

And from that stylized example (again no govt in a closed economy) it’s clear to see consumption does not change macro saving and investment creates saving..

Thanks very much for all your (and MR’s) hard work. If this comment wasn’t so long already I would write more about how much it’s helped me and how it’s amongst the best I’ve seen.

• JKH February 27, 2013 at 1:00 pm

thanks

that was pretty crazy example I constructed – but that’s necessary sometimes, in order to transform problems that are complex in aggregation to something that is simpler for illustration purposes

let me run through it again, and make it slightly more tangible

Suppose I own a house building business, and I produce one house with a value of X

the house is an ‘investment good’

I pay myself X/2, my income for the period

All other costs are X/2, which is income to the other factors of production

So total expenditure (GDP) for the period is X – the value of the output

And total income for the period is X (not 1.5 X) – paid to all factors of production, including myself

Everybody involved saves their entire income for the period

So total saving for the period is also X

And total investment (the house) is also X

Suppose I buy the house produced by my company for X

The bank might have loaned my company X so the company could pay my salary and the other factors

I buy the house, using X/2 from my salary and X/2 from my previous savings

Both amounts, in my bank account, are transferred to the company’s account

My company uses the total of these amounts to pay off the bank loan

So, after all that:

I have purchased the investment good (house) for X

I’ve used my income/saving of X/2 plus my previous savings of X/2 to buy it

The other factors of production earned income of X/2 and saved that

The economy has produced investment of X, and saved X, in the current period

I think that captures the point of the previous comment

• Fed Up February 27, 2013 at 11:57 am

Assume gov’t debt = 0 and a closed economy.

Would S = I if there were no financial assets, including MOA and MOE, to financially invest in?

• JKH February 27, 2013 at 2:41 pm

Sounds like barter to me, where S = I in both quantity and substance.

A rather difficult exchange environment though.

• Fed Up February 27, 2013 at 5:03 pm

OK about the barter. How would that affect entities trying to retire?

• JKH February 27, 2013 at 5:29 pm

good question

• vimothy February 27, 2013 at 6:42 pm

There are no nominal assets.

• vimothy February 27, 2013 at 8:13 pm

I.e., it means: buy a farm.

• Fed Up March 2, 2013 at 8:43 pm

I think it means no nominal assets so either the kids will have to help with retirement or have the right real assets to barter with.

• stone February 27, 2013 at 12:08 pm

Please clarify, – you are saying that NOMINAL private sector wealth can expand indefinitely without government deficits ??????????? Yes or No

My previous query was:
“You would only be making a break from MMT in my opinion if you claimed that NOMINAL private sector wealth could expand indefinitely without government deficits and not cause (S-I) to balloon up to the point of collapse and reversal. Are you saying that?”

You seemed to be answering in the affirmative. Basically are you saying that the level of private sector indebtedness can increase infinitely? Or are you saying that increases in private sector nominal wealth don’t require increases in government indebtedness nor private sector indebtedness? If everyone were to save 20% of what they earned by spending it on materials to build machines, then we would have a lot more machines BUT the level of NOMINAL wealth would not increase because people would have no more to spend overall on previously constructed machines so their would be deflation in the resale-price of machines. Everyone would go from having few real assets and net worth of say \$100k to having fantastic real assets that were now only worth \$100k and yet everyone would be reaping the real benefits. I don’t understand how you get around this. Please explain or point me to previous explanations. Thanks.

PS to me a lack of NOMINAL increases in wealth is not a problem. Personally “good deflation” looks to me to be what we should aim for.

• JKH February 27, 2013 at 1:06 pm

no

• stone February 27, 2013 at 2:09 pm

Thanks, so is the quibble with MMT down to you saying that government deficits are needed as a secondary consequence to keep up with private sector action whilst MMT implies that government deficits can push growth rather than be drawn along behind it?

• JKH February 27, 2013 at 2:35 pm

I noted the basic idea several times in the post, such as:

“This will refer to the idea that government deficits are a rational response to shortages in aggregate demand, as roughly prescribed by Keynes. This translates directly to corresponding saving dynamics. According to the Keynesian skew, the private sector generally desires to save in excess of what might achievable in the absence of government deficits. This means that, unless the country is running a sufficiently large current account surplus that adds to saving, there will be a tendency for S to be insufficient in quantity to satisfy private sector saving desires in full.”

This is not what “I’m saying” as much as it’s an interpretation of what others have said about saving dynamics, as it relates to the private sector saving decomposition that is the subject of the post.

And as I noted to Ramanan above, this entire thing about the equation is a relatively minor concern of mine. This post was a housekeeping item, an anniversary note to myself, as in the introduction.

I don’t know exactly what quibble you’re referring to – but more than a quibble, I have a fundamental problem with the MMT analytical framework, which I didn’t mention in the post, and some of which I haven’t mentioned anywhere yet. It will be coming later.

This post only concerns background clarification about the composition of private sector saving, with a bit of colour on how that clarification might be interpreted relative to what I think is some pretty basic Keynesian stuff.

I haven’t prescribed any policy here – just made a few observations on how Keynesian type policy in general would intersect with the private sector saving decomposition noted here.

• kpm February 28, 2013 at 9:58 am

Stone – I am probably missing something here, but if you own stocks or a house, the nominal value of your assets can go up without more government NFA’s…

• JKH February 27, 2013 at 2:44 pm

from above:

“I do get the point that it’s important to understand that investment and saving can occur without the government. That’s a point I have been confused about before by reading MMT blogs, before reading this site and pragcap.”

And so it went – and so it goes

• Matthijs February 27, 2013 at 2:47 pm

Hi JKH, sorry but what do you mean with “And so it went – and so it goes”?
(I’m not a native English speaker so I might miss something)

• JKH February 27, 2013 at 2:56 pm

the confusion you experienced has been of viral proportions for the same reason you experienced it – and that was one of the motivating forces in constructing the equation of interest a year ago – as a partial antidote or offered assist for that problem

• Jose Guilherme February 27, 2013 at 2:58 pm

“it’s important to understand that investment and saving can occur without the government.”

Right.

And it’s also important to understand that investment can occur without the private sector – as per the investment part of (G).

Taking both instances into account, we can have a more balanced and realistic view of the economy.

• JKH February 27, 2013 at 3:05 pm

ditto that

they don’t account for that (G investment) very consistently, do they?

• JKH February 27, 2013 at 3:07 pm

i.e. in terms of national income accounting etc., G tends to be commingled versus private sector treatment?

• Jose Guilherme February 27, 2013 at 3:47 pm

Government investments are not included in (I), and are instead part of (G).

That means very important investment expenditures – for instance, in R&D – may end up not being properly attributed to the government.

But they should be, in order to enable direct comparisons between the contributions of the private and public sectors to overall investment (and thus potential GDP growth) in the economy.

• Fed Up February 27, 2013 at 5:07 pm

So should the G in Y = C + I + G + NX be broken down into Gi and Gc?

• Jose Guilherme February 27, 2013 at 5:10 pm

That would provide useful, extra information.

A bit like S = I + (S-I)

• Fed Up February 27, 2013 at 10:30 pm

How about breaking down Gi and Gc into direct Gi and direct Gc along with indirect Gi and indirect Gc? The indirects would be get entities more MOE/MOA and hope they consume or invest.

• beowulf February 28, 2013 at 4:53 pm

Remember too that G does not include transfer payments. Social Security deducts \$700B from workers (who consume that much less) and kicks out roughly the same to retirees (who consume that much more) so its a wash.

• JKH February 27, 2013 at 5:20 pm

That’s the right intuition I think

I believe it is decomposed to some degree in the detail of the accounts (how well I don’t know), but the point is that it’s not done in the core high level equations in a way that’s symmetric with private sector treatment

I haven’t thought about it much, or what the implications are, but Steve Waldman did a post in this general area a few years back

• Ramanan February 27, 2013 at 11:06 pm

“Government investments are not included in (I), and are instead part of (G).”

Not really – at least misleading.

• stone February 27, 2013 at 3:16 pm

JKH, I’m sorry if I’ve caused some exasperation. I guess I’m still struggling to get my head around “some pretty basic Keynesian stuff”.

I’m still utterly non-pulsed by all of this. I’m still left with the impression that MMT is correct to say that sustainable increases in the nominal value of private sector wealth are entirely a consequence of government deficits. From what I can see all of the private sector saving and investment will fail to increase the nominal value of private sector wealth unless government deficits follow on behind. That seems straight up MMT. The private sector is able to determine whether increases in private sector wealth are beneficial (eg better machines, buildings, technology and organisation) or pointless (eg higher gold price) but is utterly powerless to influence the amount of the increase. That is at the behest of government. I guess I must be misunderstanding this but I’m failing to see how.

• stone February 27, 2013 at 3:29 pm

Would it be fairer if MMT said that the private sector can of course save and invest without government deficits and of course that could increase welfare by creating real assets with real utility BUT without government deficits the result of that saving and investment will be asset price deflation and consequently no increase in nominal wealth?

• Greg February 27, 2013 at 7:12 pm

Well it seems to me there is savings of stuff, which the private sector creates and then are savings of dollar balances which are the result of deficits. While dollar balances alone cant make you wealthy, stuff alone doesnt have a value or price we can all agree on. There is interaction between the two that is necessary for modern transactions. Virtually every citizen on earth wants their dollar balances to increase on a regular basis and they think of that as their savings. You cannot get that from a bank loan. You get a 1000\$ loan you also owe 1000\$ so your net position is no better. Its our net position that makes us feel wealthy or financially secure. Sure you can borrow 1000\$ and create something that increases in price to 1500\$ but we know everyone cant do that. Eventually someone has to have 1500 of dollar balances for you to realize that increase in value. Rising prices in and of themselves is not rising wealth. Thats Sumner type of thinking………………moronic.

• vimothy February 27, 2013 at 8:06 pm

Actually, Philip Pilkington’s comments in this thread have been quite unfair and unwarranted. Apart from their unnecessary rudeness, rearranging accounting tautologies to try to tease out their meanings is a large part of the work of anyone trying to “do” macroeconomics. JKH and all the other writers of this blog spend their free time and effort going into the weeds with this stuff so that their readers can come to understand these subjects for themselves, and I don’t see that that’s anything that can be disparaged.

• JKH February 28, 2013 at 5:41 am

Yes – that being part of the bigger picture of the relationship of accounting to economics – and the correlation from naive interpretations of that relationship to aggressively uncivil discourse (accompanied by desperately extensive depictions of math simulations by 6th graders).

One of my favorite variations on the former was Krugman’s original ‘Dark Age of Macroeconomics’ theme. His main point there was that although accounting identities are not causal in themselves, they are entirely constraining on the feasibility of economic outcomes. And although they are entirely constraining on the feasibility of economic outcomes, and while they are static as general expressions of that constraint, they are obviously dynamic in their decomposition according to constituent quantities as that evolves. And Krugman’s basic point against Lucas was that the latter erroneously treated accounting identities as constraining and static in a specific area of constituent quantity – hence Say’s Law and the Treasury view.

• vimothy March 1, 2013 at 5:40 am

Krugman seems to be someone who has a good head for this sort of thing, in that he pays careful attention to accounting identities–both in the sense of what they can tell you, and what they can’t.

• wh10 February 27, 2013 at 8:41 pm

Hey guys, what’s going on in this thread?

Totally off-topic. JKH, I would like to try to close the loop on our bank reserve management discussion, if you have interest (finally just re-read our discussion at NEP). I still I have a point :). Are you able to reach out to me via email? Thanks.

• JKH February 28, 2013 at 5:49 am

“Hey guys, what’s going on in this thread?”

To answer that, I’d refer you to Donald Rumsfeld’s wisdoms, starting out with, “there are known knowns….” etc., etc.

On reserve management, why don’t we first take a shot at nesting that as a comment conversation beneath your question here? It’s very technical, and I think people will appreciate some nested privacy for that. This overall thread is open for another 10 days or so. If that doesn’t work, and it becomes unwieldy or dysfunctional as a conversation, we can always go to email.

• wh10 March 1, 2013 at 12:24 pm

Hey JKH,

I wanted to embed some graphs in my response to make sure we were thinking of the same thing. That’s mostly why I prefer communicating via email.

• beowulf March 1, 2013 at 11:14 pm

But then we’d all have to hack JKH’s email to know what you’re talking about.

• Ramanan March 2, 2013 at 5:03 am

Yeah my suspense is increasing. I saw the two discussing central bank desk operations somewhere in the blogosphere – where did graphs come from?

• wh10 March 2, 2013 at 10:06 am

Hey Beo, I don’t have the capability to put them online somewhere. Also, don’t get too excited- they’re quite simple – just illustrating some of the points JKH/I was making in terms of the shifting of supply and demand curves (but wanted to make sure we were on the same page). How about this? Here’s the furthest JKH and I got on this at NEP – http://neweconomicperspectives.org/2013/01/understanding-the-permanent-floor-an-important-inconsistency-in-neoclassical-monetary-economics.html#comment-101942

Part of me thinks we won’t get further than that, given the degree of abstractness to which the conversation has progressed, in which case it’d be a waste of space and time to post here. But if we do make progress via email, I’d be happy to repost our convo online.

• vimothy March 2, 2013 at 10:16 am

Perhaps you could just embed the pictures in your comments, if MR has HTML enabled?

• Ramanan March 2, 2013 at 10:51 am

wh10,

My suggestion to you is to not think of it as supply and demand curves (JKH also says that). Supply and demand have meanings but the supply and demand curves cannot be represented so easily as in textbooks.

I don’t think the diagrams have any meanings – it is a cheat.

One has to be very careful using supply and demand functions.

• beowulf March 3, 2013 at 2:36 pm

What format is the graph in? I can see if we can embed it either in this comment or JKH’s original post. Otherwise we can just hotlink to a google docs file.

• JKH March 2, 2013 at 6:21 am

Yes, wh10, can you attempt as suggested by Beo and Ramanan?

This post is open for comments for another 7 days, and we can probably expand that incrementally if desirable.

Again, we have the option of going off-line separately if that approach becomes chaotic, but I’d like to try it.

I prefer the Keynes approach to graphs myself – ultra minimalist – but that’s just me. As Steve Keen note, economics gets its price and quantity co-ordinates for supply and demand backwards. Not a good start for graphical journeys into the unknown.

• Ramanan March 2, 2013 at 7:44 am

If I am not wrong wh10 was discussing open market operations in addition to the ones required by the factors affecting reserve balances formula right?

• Fed Up February 28, 2013 at 2:11 am

JKH, I have plenty of questions/ideas about what is wrong with this post.

Is it possible to go over it with you? I believe everyone would find it very, very, very enlightening.

I’m not just picking on Nick. I think a lot of people and economists would say similar things. Thanks!

• JKH February 28, 2013 at 5:53 am

Sure.

I haven’t read it yet. If you start off with some comments/questions, I’ll read it and we can go from there.

We can nest the conversation under your question here. This overall thread is open for another 10 days or so.

• Fed Up March 1, 2013 at 1:46 am

OK. Let me get my thoughts together. Thursday wasn’t a good day for that.

• Fed Up March 1, 2013 at 9:41 pm

“People use money as:

A medium of exchange. They sell everything else for money, and then use that money to buy everything else.

A unit of account. They talk about prices in terms of money.”

First, I don’t like the term money at all. Too many definitions. Plus, I’d rather use medium of account instead of unit of account. My idea is that currency plus demand deposits is MOA and MOE as long as there is 1 to 1 convertibility and entities accept demand deposits just like they accept currency. MOA is not currency plus central bank reserves (monetary base).

• Fed Up March 1, 2013 at 9:51 pm

“Nearly always, those two defining functions [my add, MOA and MOE] go together. It’s easy to understand why. It’s more convenient.”

OK. I think MOA = MOE is a good idea.

“So used cars aren’t very liquid. Portability, storeability, divisibility, etc., could also be a problem with used cars.”

I agree that portability, “storeability”/durability, and divisibility are important. Liquidity probably.

• Fed Up March 1, 2013 at 10:17 pm

“The Bank of Canada is the central bank. Central banks are the bankers’ bank.

But how is it that the Bank of Canada is the one that controls Canadian monetary policy? If both the Bank of Canada and the Bank of Montreal issue IOUs that people use as money, shouldn’t we say that both partially control the supply of money in Canada?

There’s one big difference.

Bank of Canada monetary IOUs aren’t really IOUs. They aren’t a promise to pay anything. The Bank of Canada might choose to target 2% CPI inflation, in which case they are indirectly convertible into the CPI basket of goods. But the Bank of Canada might change its mind.

Bank of Montreal monetary IOUs really are IOUs. They are promises to pay Bank of Canada IOUs on demand, at a fixed exchange rate. It’s the Bank of Montreal’s job to ensure that one Bank of Montreal Dollar = one Bank of Canada Dollar. It’s not symmetric. The Bank of Canada can make its dollar worth whatever it wants, and the Bank of Montreal has to follow along and make its dollar worth the same amount.

That’s what gives the Bank of Canada the power to control the total supply of money in Canada.”

I don’t get this at all. Junk IOU’s. If \$1 of BMO demand deposits = \$1 of BOC currency, then BOM can add to MOA/MOE possibly leading to price inflation?

• Fed Up March 1, 2013 at 11:32 pm

EDIT “BMO” to “BOM”

• stone March 2, 2013 at 1:27 am

Fed Up, to me the really crucial point that Nick Rowe didn’t emphasize enough IMO is that deposits created by loans can only stay in existence IF the loans can be serviced by the debtors. That is the constraint on the money supply – it is the limited opportunities for credit worthy borrowing.
I think he is left scratching his head because he has a world view that is not compatible with limited opportunities for credit worthy borrowing. In his view supply always creates ample demand and so in his theory it doesn’t make sense that private banks can’t expand the supply of credit to infinity and beyond. He makes it clear that he dismisses the idea of AD in this reply of his:
“primed: Because:1. a shortage of AD is usually not the problem, Y is usually limited by AS, not AD. 2. Even if AD is a problem, there’s monetary policy. 3. Even if (for God knows what reason) monetary policy can’t be used, there’s a lot more to fiscal policy than making transfers from low MPC to high MPC people. 4. It’s not MPC that matters. It’s Marginal Propensity to not hold money. For example, if the people who had a low MPC had a high Marginal Propensity to Invest, it wouldn’t work.”

Is it possible that he is conflating the marginal propensity to bid up the price of pre-existing assets such as land or the secondary stock market or commodities for “marginal propensity to invest”? In my opinion, it is possible to drive a depression by having speculative price spikes in commodities causing disruption of the real economy. So a low propensity to hold money can lead to depression from rent extraction by the finance sector from the real economy by means of commodity speculation. He’s an economist and I’m a no-mark though.

• stone March 2, 2013 at 3:50 am

Is Nick Rowe in the uncomfortable no-man’s land that comes from him accepting the operational realities of “loans create deposits” bank mediated credit expansion and yet steadfastly maintaining that aggregate demand is never a constraint on economic expansion? I guess more archetypal monetarist supply-siders would see that since they maintain that lack of aggregate demand isn’t limiting credit expansion, the “loans create deposits” description of bank money needs to be replaced with some fictional account that provides some alternative constraint in place of aggregate demand. The money multiplier fiction allows everything to hang together as a tidy, internally consistent, nonsense.

• Oilfield Trash March 2, 2013 at 11:07 am

Stone

Not a expert on this but below is my understanding

“loans can only stay in existence IF the loans can be serviced by the debtors.”

Default of the debtor does not extinguish banking assets and their corresponding liabilities. They stay on a bank’s balance sheet until the hypothecated collateral backing the loan is sold. I never like the term” loans create deposits”, it makes more since to me that loans create assets and liabilities.

As an example in RE loans if the hypothecated collateral is not sold to a third party in a foreclosure sale, the lender ends up taking ownership of the collateral which is classified under GAAP rules as “other real estate owned” or REO property.

In balance sheet terms, other real estate owned (OREO) are now assets of the bank (not hypothecated collateral) and are considered non-earning for purposes of regulatory accounting. In other words the earning assets (created by the loan) is simply shifted to a non-earning asset with a corresponding liability.

If a bank sells its hypothecated collateral or REO property at a loss, the bank must recognize the actual loss and only then does it affect its balance sheet and reserve requirements. However, as far as I know, there is no regulated time limit for disposing of REO.

By timing the sale of REO property, the bank can manage its balance sheet until the real estate market improves or that the bank’s balance sheet is otherwise able to absorb the loss, which gives the bank additional flexibility in balance sheet management activity.

“That is the constraint on the money supply – it is the limited opportunities for credit worthy borrowing.”

Banks also have capital constraints in their ability to maintain and expand endogenous money creation.

• stone March 2, 2013 at 11:34 am

Oilfield Trash, I’m also not an expert by any stretch of the imagination as you can probably tell. I was meaning that the expansion of the money supply by bank lending was constrained by the banks’ foresight that loans that could not be paid would ultimately lead to a loss for the bank and so such loans would not be made. Although capital requirements give an immediate constraint, if credit worthy borrowers keep coming then the consequent bank profits and retained earnings will quickly build up the capital such that it merely slows down the expansion of credit rather than really putting a long term lid on it.

• Oilfield Trash March 4, 2013 at 8:34 am

Stone

My point in all of this is Endongous money creation by banks is constrained via the fact that banks must remain solvent (positive shareholder equity on their balance sheets).

• Fed Up March 2, 2013 at 11:39 pm

“Fed Up, to me the really crucial point that Nick Rowe didn’t emphasize enough IMO is that deposits created by loans can only stay in existence IF the loans can be serviced by the debtors. That is the constraint on the money supply – it is the limited opportunities for credit worthy borrowing.”

From what I can tell, Nick does not believe banks can expand the money supply (MOA).

• Fed Up March 2, 2013 at 11:45 pm

“4. It’s not MPC that matters. It’s Marginal Propensity to not hold money. For example, if the people who had a low MPC had a high Marginal Propensity to Invest, it wouldn’t work.”

Is it possible that he is conflating the marginal propensity to bid up the price of pre-existing assets such as land or the secondary stock market or commodities for “marginal propensity to invest”?”

It seems to me there are 4 MP’s. They are MP to consume, MP to invest (NIPA definition), MP to financially invest in financial assets that are not MOA/MOE, and MP to financially invest in financial assets that are MOA/MOE or close to them.

• JKH March 2, 2013 at 6:34 am
• stone February 28, 2013 at 2:55 am

I hope I have at last got a glimmer of understanding

Does it all revolve around whether all of the revenue stream created by a new real asset manages to feed back to the consumers of whatever the new real asset is providing? If that is true, then creation of such new real assets can support an increase in nominal private sector wealth without government deficits? It all depends on all of the cash flows flowing right around to the consumers such that no deflationary sink holes develop. If debt financing was involved, then the revenues from that also need to feed around back to the consumers.

So a bank creates credit that I spend to build a factory and I sell factory output to bank workers and bank shareholders and to workers and shareholders of those firms who supplied me with materials to build my factory. The increase in private sector nominal wealth that has come from my investment is down to the fact that the credit expansion used to finance the investment can be rolled over indefinitely due to the financing costs trickling back round from the spending of the financiers.

• Ramanan February 28, 2013 at 3:58 am

Awesome!

In my opinion, it is unlimited fun to look at these things much much more carefully – investment, profits, undistributed profits, inventories, working capital financing, depreciation and then debt and equity financing etc etc etc. (Plus bank liability management).

Of course that doesn’t mean that fiscal policy is not important – it is highly important – as it drives the economy via “demand management” as the government itself is a big contributor to demand. But oversimplified arguments along the lines that “private sector cannot save without government deficit” (which is incorrect) is a total fake argument and way of thinking.

• JKH February 28, 2013 at 5:59 am

“unlimited fun”

yes – relating to the real world can be a catalyst for that

• stone February 28, 2013 at 7:31 am

Do you think the “private sector cannot save without government deficit” MMT suggestion is because they take it as a certainty that much of the financing costs won’t trickle around? I think Michael Hudson does explicitly say that in practice they don’t. My impression from billyblog was that Bill Mitchell simply says that private sector debt expansion is never sustainable and hasn’t padded it out further than that. I’ve probably missed a lot of what the MMT people were trying to say though. I guess I’m a test bed for what impression a naive reader is likely to come away with though.

• Ramanan February 28, 2013 at 8:15 am

“Do you think the “private sector cannot save without government deficit” MMT suggestion is because they take it as a certainty that much of the financing costs won’t trickle around? ”

Oh it is not that complicated. The private sector can have positive saving even with the budget in surplus and the current account in deficit. So the statement “… cannot save ..” itself is incorrect.

In fact an expansionary fiscal policy targeting full employment can result in a surplus budget. The budget balance would have been the result of higher activity and not the result of a surplus target by the government.

• stone February 28, 2013 at 7:43 am

Ramanan, when you say that it is really important to unpick the detail, I completely agree. Perhaps facing up to the detail might allow much more effective and less disruptive government policy inputs as well. The “increase the deficit by whatever means until unemployment is <2%" stance might be a blunderbuss that fails to help. I know that is a bit of a mischaracterization of what the MMTers actually say but it isn't too far off.

• Ramanan February 28, 2013 at 8:30 am

Stone,

If someone holds paradoxical views, a mischaracterization is easy purely as a result of their paradoxes.

I learned it debating it with someone else sometime back.

Suppose my theory has 2=1. I can prove anything including 3=3 using my own calculus. So I proceed 2=1 and 1=2 and hence add these two to reach 3=3.

Now if you come back and tell me that in my theory has 4=3, I show you the above proof and claim everything is right.
—-
Yes it isn’t easy because there may be many other things which need to be done in addition to doing a fiscal expansion.

• Oliver February 28, 2013 at 10:35 am

I think the MMTers distinguish very sharply between micro and macro issues, theirs being purely a macro discipline. To me, their reasoning is only understandable within these self-imposed boundaries. And as always, there is a trade-off between conceptual clarity and explanatory power.

• Oliver February 28, 2013 at 9:51 am

Let me see whether I can wrap my head around this.

Investment is the change in monetary value of gross capital formation of a nation for a period (i.e. it includes government investment, but not government expenditure (G)) (I=Y-C-G).

National saving is the residue of money not spent on consumption by all sectors (S=Y-C-G).

They are defined as being the same because it is implicitly assumed that all money not spent on consumption is invested in the sense of capital formation.

The balancing item for capital depreciation is the change in net worth of both corporations and government.

If so, some questions:

Government saving is defined as the budget surplus (T-G). Private saving is defined as Y-C. There is no mechanism specified by which any financial asset/liability is produced or destroyed, i.e. it’s a zero sum game.

Where are real assets captured in this?

Is the idea behind S = I + (S-I) to show that the fact that not all investment flows into capital formation, i.e. has no counterpart in the physical world? And that the Keynesian theory is that this reflects a natural desire to save in financial assets beyond the willingness to invest in real capital? And that the Chartalist position is that this desire is best met through government deficits instead of through private balance sheet expansion?

• Ramanan February 28, 2013 at 11:33 am

Investment itself is gross fixed capital formation (rather than change) and change in inventories. The word “formation” is flow-ish.

The government expenditure consists of consumption expenditures, investment expenditure and transfers and others such as payment of wages to its employees, interest etc.

Although your idea of national saving looks fine, one doesn’t subtract all G. G itself has investment expenditure.

It needn’t be the case that everything saved is used for capital formation because in an open economy, a nation as a whole can run a positive current account balance and hence as a result, a part of the saving is investment and the other part net lending to foreigners.

So S = I + (S – I) works for a nation as a whole. The second term on the right is net lending to foreigners.

Am not sure about your point on balancing item on capital depreciation. You probably wanted to write balancing item on capital account – but this is net lending to other sectors. “S-I” as pneumonic.

The government’s saving and surplus aren’t the same as this differs due to investment.

Nonfinancial assets is already captured (in a flow sense) in all this because purchases of houses for example is counted.

• Oliver February 28, 2013 at 1:45 pm

Thanks

Ramanan
Although your idea of national saving looks fine, one doesn’t subtract all G. G itself has investment expenditure.

This is what Jose Guilherme said above.

Not really – at least misleading.

It needn’t be the case that everything saved is used for capital formation because in an open economy, a nation as a whole can run a positive current account balance and hence as a result, a part of the saving is investment and the other part net lending to foreigners.

I was talking about a close economy with government.

So S = I + (S – I) works for a nation as a whole. The second term on the right is net lending to foreigners.

The (S-I) term is net lending to foreigners? That’s the first time I’ve seen that said. Is this what you meant, JKH?

The government’s saving and surplus aren’t the same as this differs due to investment.

from Wikipedia: The term (T – G) is government revenue though taxes minus government expenditures which is public savings, also known as the Budget surplus.

• Ramanan February 28, 2013 at 2:01 pm

“The (S-I) term is net lending to foreigners? That’s the first time I’ve seen that said. ”

Oliver,

In the context where S = I + (S-I) is used. JKH uses it for households or private sector.

So the saving of the whole nation is investment plus net lending to foreigners. But understood you were talking in the context of a closed economy.

Wikipedia shouldn’t be believed in matters of macroeconomics!

http://www.salon.com/2013/02/19/how_paul_krugman_broke_a_wikipedia_page_on_economics/

Jose’s whole comment February 27, 2013 at 3:47 pm is a bit misleading.

• Oliver February 28, 2013 at 2:14 pm

So the (S-I) term is always the surplus from lending of sectors outside the model in consideration. For households that is net lending from corporations, government and foreigners. For the private sector from government and foreigners and for the nation only from foreigners. That’s about what Phil Pilkington said, bad manners notwithstanding (he’s Irish, if I’m correctly informed :-)).

• JKH February 28, 2013 at 2:26 pm

S is defined explicitly in this post as private sector saving – strictly according to the normal definition of S in a 3 sector model of the economy – which is the standard or base model used in sector financial balances analysis, as well as in the usual Keynesian income and expenditure equations. It is explicitly stated so in the second sentence of the post – and in all of the background documents that are linked in the introduction. It is not being used actively in any other way in the discussion that relates directly to this post and/or those background documents.

• Ramanan February 28, 2013 at 7:22 pm

Oh I see.

But it can be used generally I think.

• JKH March 1, 2013 at 5:20 am

no problem

of course you’re right on that, and I understand what you’re saying

but the use of it as private sector saving ONLY is made VERY explicit in this post and the ones that preceded; that definition is common, and it is also fundamental to this whole discussion

in fact, read the first few pages of my long post to see what lengths I went to not only to make this assumption clear, but to explore briefly the options you allude to around that

its important to be clear on this – and on the fact that this is something that has been made clear – for one thing to put the case of those who deliberately disrupt in favor of their own agenda, using the leverage of either willful or negligent ignorance about this fact (one primary example of that in the earlier comments), into the pathetic context that it deserves

• Ramanan March 1, 2013 at 6:04 am

on the leverage.

The debates become painful and counterproductive when the use of logic is dissuaded by various means.

The amount of confusion created is unbelievable. A few weeks back I was seeing a video of Jan Kregel – a senior Post Keynesian and Joan Robinson’s student (!) and noticed him saying firms are dissavers.

• JKH March 1, 2013 at 6:18 am

Yes

And I know you’ll recall discussions where one economist with an Australian accent very explicitly – VERY explicitly – characterized investment as being an instance of dissaving – which is so wrong, its almost unbelievable – and which points to a VERY calculated agenda on the issue of language and algebra usage

And that is POWERFULLY dysfunctional from an educational standpoint

which is very much part what this is all about too

and which motivated my boomeranging Mosler’s meme about “in the public interest” (or something like that) right back at him, via the Winterspeak discussions that are referenced in great detail in the big post linked above

• Ramanan February 28, 2013 at 7:33 pm

Oliver,

The sectoral balances approach itself is quite solid. Wynne Godley used to write on it with everything precisely defined and used language which clearly identified such as what is endogenous and things such as that.

Unfortunately it gets misused when net lending or surplus is confused as saving.

• Oliver March 1, 2013 at 3:17 am

It can become confusing when saving is used interchangeably with saving net of investment which, according to the identity, cannot happen in a closed economy because S=I by definition? My opinion is the identity S=I itself is useless because the the definition of the terms it is comprised of are poor and misleading and that it should therefore be forbidden to use it. Except for href=”http://www.youtube.com/watch?v=2UbtcmjfKa8″>the knights who until recently said S=I, of course :-).

• Oliver March 1, 2013 at 3:20 am

Sorry, mucked up my bb code. Should have read:

the knights who until recetly said S=I+(S-I)

• Ramanan March 1, 2013 at 4:02 am

Oliver,

Assume a closed economy.

S = I in more detail is

S(economy) = I (economy)

i.e., S is the sum of savings of the private and the public sector and I is the sum of investments of the private and the public sector.

However the S in

S = I + G -T

refers to the saving of the private sector.

This S is different from the previous S.

“It can become confusing when saving is used interchangeably with saving net of investment which, according to the identity, cannot happen in a closed economy because S=I by definition? ”

What cannot happen?

Good authors always specify. Bad authors confuse the two Ss.

• Ramanan March 1, 2013 at 4:03 am

Wasn’t referring to you as “bad” :-).

• Oliver March 1, 2013 at 7:07 am

Yes. But since it’s the same letter there is an inherent potential for confusion, especially when an equation that is generally used for one model has terms in it that are generally used in the other. But I am getting the hang of it, I think. I guess 2 confusions make one understanding. Or as they say in German, detours expand the knowledge of your surroundings.

• Jose Guilherme February 28, 2013 at 4:40 pm

“Jose’s whole comment February 27, 2013 at 3:47 pm is a bit misleading”.

But that is perhaps in the very nature of things.

I’d even like to introduce the hypothesis that all our comments (mine, Ramanan’s, et alia) necessarily conform to the following mathematical identity:

Tr = Co + (Tr-Co)

Where Tr stands for Truth and Co for Comments.

Truth is always greater than our comments and our comments are always in a deficit position relative to the Truth.

Which is not to say that comments (including on this proposition) are not welcome

• JKH February 28, 2013 at 5:02 pm

now THAT is excellent

and as comment – is within epsilon of the truth

• Ramanan February 28, 2013 at 11:38 pm

Jose,

“Government investments are not included in (I), and are instead part of (G).

That means very important investment expenditures – for instance, in R&D – may end up not being properly attributed to the government.

But they should be, in order to enable direct comparisons between the contributions of the private and public sectors to overall investment (and thus potential GDP growth) in the economy.”

First government investment is treated as investment in national accounts.

The GDP = C+I+G is a simplified textbook presentation of national accounts in which there is no government investment.

But you cannot use this simplified presentation to argue that government investments are not included in I. Government investment expenditures is both part of G and I in a sense. This cannot be captured by the simplified GDP = C+I+G.

Nor is the simplified representation (no government investment) suppose to imply that government participation in the economy is reflected poorly in reality. It is as if you are trying to say that the physicist who teaches the student projectile motion on flat surface seems to say that the earth is flat.

Now R&D used to be not counted till the 2008 SNA proposed some changes but the treatment is same for the government as well as private sector.

• Jose Guilherme March 2, 2013 at 4:01 pm

“But you cannot use this simplified presentation to argue…”

S = I + (S-I) is a simplified presentation.

Does the I in this simplified presentation include government investment or not?

A simple question requiring a simple answer: yes or no.

• Ramanan March 3, 2013 at 1:09 am

“S = I + (S-I) is a simplified presentation.”

No it is not.

“Does the I in this simplified presentation include government investment or not?

A simple question requiring a simple answer: yes or no.”

I is private investment. Plus not my equation.

At any rate it has nothing to do with what I specifically wrote about your comment which honestly I thought was designed to mislead.

• Jose Guilherme March 3, 2013 at 1:45 am

So, we agree.

I is private investment.

S = I + (G-T)

Where a part of G is public investment.

Maybe even higher than I itself. We don’t know – depends on the specific numbers, case by case.

But wait: wasn’t the main purpose of the identity to show how private saving is the backbone of investment in the economy? Independently of whether the govt. is running a deficit?

“Our great private sector”, as CR put it?

Well, turns out that the govt. can also be a backbone of investment in the economy.

And this fact – indeed, the mere possibility of it – was being obfuscated in the whole debate. No one remembered that the govt. also invests.

How strange!

So, I’ll reframe your question: who was trying to “mislead” on this issue of S = I + (G-T)?

Sometimes it’s the case that “realism” may stand dangerously close to “ideology”.

• Cullen Roche March 3, 2013 at 1:50 am

Uh, 50 trillion of the pvt net worth is non- govt. About 15 is govt. Those are the facts in the USA no matter how much you try to mislead people. So yes, the backbone of pvt saving absolutely is pvt investment. Except maybe in your alternate reality where facts don’t matter.

• Ramanan March 3, 2013 at 2:01 am

Look my comment was pinpointing specific point to yours about how you tried to mislead using intentionally vague and suitable choice of words by claiming that national accountants do not count government investment. You seem to suggest that national accounts is biased to the private sector.

Talk of ideologies!

Your point about S = I + (S – I) has nothing to do with the above. Is it not my equation either – although I appreciate it.

At any rate that equation is designed specifically to show that the first term on right has more importance in terms of contributing to private sector net worth purely in quantitative terms.

It doesn’t claim that government investment is not important. It is not designed to show private investment is more important than government investment.

Your equation Tr = Co + (Tr – Co) is cute but look: heteredox people try to take Co close to Tr. You on the other hand leverage this difficult part to mislead.

• Jose Guilherme March 3, 2013 at 8:05 pm

“Uh, 50 trillion of the pvt net worth is non- govt. About 15 is govt. Those are the facts in the USA…”

Let’s get some other interesting facts, then:

(Source – NIPA tables, USA, year 2009, as reproduced in the book “Applied Intermediate Macroeconomics”, by K. D. Hoover)

Private domestic investment: Gross – \$1.626 trillion; minus consumption of fixed capital of \$1.534 trillion equals net investment of \$90 billion.

Government investment: Gross – \$514 billion; minus consumption of fixed capital of \$325 billion equals net investment of \$189 billion.

That is, net investment by the government was more than twice as large as net investment by the private sector.

2009 was a year of crisis and recession – the role government was key in preventing an even worse downturn.

This is why it’s very important not to lose the overall perspective: investment has a public as well as a private component.

That was the purpose when I pointed out that (I)private must be completed by (I)public when we’re analyzing the S = I + (S-I) identity.

In other words, a contribution intended to help introduce ever more realism into MR.

And reduce a bit that inevitable (Tr – Co) gap.

• Cullen Roche March 3, 2013 at 10:21 pm

I’ve been writing about the reasons for weak private investment for 4 years running now. My entire work on the balance sheet recession is predicated on understanding that. Of course govt spending has played an unusually large role. Private investment fell more in 2008/09 than it ever had in the last 80 years! No one ever said govt spending is always bad. But it’s a terrible misrepresentation to imply that govt investment is a more central component of historical pvt sector well-being just because of a very unique environment.

Sorry Jose, but I don’t see anything original in your comments here. You’re basically just regurgitating MMT talking points about govt spending, the reserve accounting errors, the centrality of govt in the economy, etc.

• Jose Guilherme March 4, 2013 at 4:45 am

“.. it’s a terrible misrepresentation to imply that govt investment is a more central component…”

Could you accept that?

And please, stop mentioning “MMT” in every paragraph. It sounds obsessive and in this case, particularly inappropriate – I was just reproducing a couple of NIPA tables, remember?

• Jose Guilherme March 4, 2013 at 6:16 am

Although anyone equating NIPA tables (facts!) with “MMT talking points” is really providing a ringing endorsement for that theory.

But this is really not about MMT – it’s about not letting the important contributions of public invesment go down the memory hole.

• Ramanan March 4, 2013 at 11:13 am

Very shady way of arguing for the importance of government investment. I would argue for the importance of it and argue for more investment but not by shady empirics – choosing data to suit the need.

One year gross investment less consumption of fixed capital of the private sector is less than the government – so what?

Plus your whole argument is strange – it is like:

Mr X: my disposable income less expenditure is equal to net lending to others and my disposable income less consumption is saving. The two concepts are different. Etc …

Jose: You neglect the government, you are wrong!

The other reason you are being called an MMTer is that logic takes a backseat in discussions. Instead one keeps hearing the same punchlines over and over again.

• Jose Guilherme March 4, 2013 at 5:13 pm

“The other reason you are being called an MMTer is that logic takes a backseat in discussions” – Ramanan (above)

“The neo-chartalist analysis is essentially correct…the framework of modern monetary theory has been validated” – Marc Lavoie (http://www.boeckler.de/pdf/v_2011_10_27_lavoie.pdf, page 25)

The mysterious workings of the post-keynesian mind?

Or time to redirect the auto-da-fé against an old master?

• Ramanan March 4, 2013 at 11:00 pm

Told you you are a hardcore MMTer come here to defend them and regurgitate the nonsenses. Why not simply state it rather than going in circles and changing your positions to suit your needs conveniently.

As for “essentially correct” obviously that is being generous.

In the context we are discussing: Firms are dissavers according to one MMTer (Jan Kregel) video I saw recently. Ya right – essentially right! (Student of Joan Robinson who wrote “The Accumulation of Capital”. )

• Jose Guilherme March 5, 2013 at 5:40 am

“As for “essentially correct” obviously that is being generous.”

Sorry, I thought he was one of your gurus.

Or is it Joan Robinson? N. Kaldor? Jan Kregel? Cullen Roche?

It’ so confusing. Perhaps you’d be kind enough to publish your list of officially approved icons – as of today?

Sort of, like, a PC roadmap through the PK jungle?

Additions and withdrawals could then occur on a monthly basis – with MMTers and fellow travelers permantently barred, of course.

And all list sales computed as “Investments” (private) on the NIPA tables.

• Ramanan March 5, 2013 at 6:06 am

Look dude. It is being clearly pointed that MMTers regularly err on concepts of saving – they confuse saving and saving net of investment. According to them a government surplus is a loss to the private sector and “it is impossible for the private sector to save without a government deficit”. This confusion runs across their theory and is not a minor one.

There is no amount of defense you can put up to the kind of nonsense that is being spewed on this by them.

Now, stop defending them by quoting others. Lavoie’s paper says clearly that his critique doesn’t go beyond settlement of government accounts and gives a right description. He defends the Chartalists by saying that there are some messages from the settlement system and they are correct. By no means can you extrapolate it to defend your own ideology.

The fact that I like Lavoie a lot doesn’t mean I have to agree with his statement on Neochartalists.

As for vindication – Ronald McKinnon also clearly pointed out the inability of the Euro Area governments to make a draft at their central bank in his 1997 book “Rules of the Game”. Also Tim Congdon – who was a Monetarist (as per Wynne Godley’s article Maastricht And All That).

So is Monetarism right?

Even Tom Palley stopped Wray from dancing around claiming victory by showing he wrote about it before them.

It is also clear that you have been trying to obfuscate the debate by slightly changing the topic to government investment.

• Jose Guilherme March 5, 2013 at 1:19 pm

Look, pal, I just happened to introduce the subject of public versus private investment in a thread about the S = I identity, so I don’t see how that could be interpreted as changing the topic, even if “slightly”,

Then I called the attention to the special case of recessions, when public investment becomes even more crucial – and my data points were dismissed under the pretext that, you guessed it, they represented a recessionary period!

My quotations from Lavoie and other people I inderstand you appreciate were meant to show that such people can say some positive things about MMT without provoking irrational outbursts of venom against them on your part. If you keep it that way with everybody else such behavior can only enhance the civilized tone of the debates as well as your reputation for objectivity, ok?

Look, if one says positive things about a doctrine, a political regime, party, whatever, that does not necessarily mean a full endorsement or card-carrying membership of the entity being referred to. Why is that so difficult to understand by some people, especially when engaged in sectarian debates?

When MMT says that taxes destroy deposits (money) I think they are right. When they say taxes don’t finance spending I think they are wrong. When Krugman attacks austerity in the middle of a recession, I say he’s right. When Nixon ends the gold standard, I say he’s right.

In every one of these cases I may be right or wrong. But does that make me a MMTer, a neoclassical or a GOPer? No!

These should be trivial and obvious statements – even more so in discussions dedicated to “realism”. Can we then carry on and stop making baseless accusations? Thanks in advance.

And yes – I do hope I have made myself clear, unambiguous and certainly not misleading.

• vimothy March 5, 2013 at 1:46 pm

Jose, Not that I agree with your particular examples necessarily, but I think the substantive point you make here is a good one. Because reality is so vast and complex it would be quite surprising if one group of people were ever totally right or totally wrong about it. All the different ways of thinking about the economy have something to offer, including but not limited to MMT.

• Ramanan March 5, 2013 at 2:31 pm

Look again, my debate started with I as I seriously believed and still believe that there was an attempt to mislead on your behalf (instead of an unknowing attempt). Your original comment claimed that national accountants are partial to the private sector which is not the case in reality.

Later you attempt to appeal to authority to claim that my criticisms are not valid. How fake can a logical debate get. Seriously!

Your thought process seems to have been forever distorted is what I meant. If you take it as outbursts of venom, nothing I can do. I have attempted many times to get some points across but everytime someone sneaks in to deviate. One example, you mix a surplus/deficit issue with transfers. A government can be in deficit and yet be making large transfers. A transfer payment in national accounts is not defined whether it is financed by taxes or by borrowing, it is defined as a non quid-pro-quo. Whether the government creates financial assets (which it does) for the private sector is a bit tangential to whether there are transfer payments happening. If the economy is purely demand constrained, then it isn’t necessarily an issue but in case where there are supply side pressures, then it is a complex issue – neither purely good nor purely bad. You are being misled by the narrative around creation/destruction.

There is a sectoral balances approach and there is a misleading sectoral balances approach.

• Jose Guilherme March 5, 2013 at 6:09 pm

“Because reality is so vast and complex it would be quite surprising if one group of people were ever totally right or totally wrong about it. All the different ways of thinking about the economy have something to offer, including but not limited to MMT.”

Very well said.

• Cullen Roche March 5, 2013 at 7:01 pm

Jose,

We get it. You love MMT and you think it’s almost entirely right (even though it gets big things wrong). We never said it was ALL wrong. But you’re not interested in understanding our points and you’re not interested in viewing the world through any lens but the MMT lens. That’s fine. But please stop antagonizing people here and acting like you’re trying to resolve anything when you’re obviously only interested in confirming some bias you have. Thanks.

• Ramanan February 28, 2013 at 11:39 am

Btw this is an awesome book: http://unstats.un.org/unsd/nationalaccount/docs/SNA2008.pdf

Instead of using it as a guide/handbook one should use it as a textbook.

Everything is carefully and patiently done in there.

• Oliver February 28, 2013 at 9:59 am

And what’s the counterpart for corporate equity for the government sector? Nad how does it capture depreciation?

Sorry for all the, hopefully not completely dumb, questions. This must be basic stuff for you but it’s pretty complex for a non-accountant mortal such as myself.

• beowulf February 28, 2013 at 5:16 pm

“And what’s the counterpart for corporate equity for the government sector?”

That’s a good question, there’s no such thing as a National Asset clock even though the govt sector itself owns trillions of infrastructure. There was a McKinsey & Co infrastructure report last month that put US infrastructure at approx \$10 trillion.

• Oliver February 28, 2013 at 10:23 am

I see that this is quite different from what Stone wrote above. Is it incompatible?

• stone February 28, 2013 at 12:18 pm

Oliver I think in practice a lot of the “investment” that takes place is in the form of unsold inventory that perishes and goes to waste. Basically if well thought out productive real investment is made then saving is an accounting record of that. Equally if people don’t buy what firms produced such that it remains unsold and gets thrown on the dump; then saving is equally an accounting record of that. The second type of saving would not lead to sustainable increases in nominal wealth without government deficits. The first type of saving might do so long as all the financing cost managed to trickle round to support the price of the new real assets.
I’m still groping for comprehension of this.

• ftm February 28, 2013 at 2:10 pm

I appreciate the detailed discussion here of national income accounting. Much is lost by just writing down GDP = C + I + G + (X-M) . I see no reason why G still groups together government consumption and investment. US NIPA has segregated government investment from other expenditures for many years now. By dividing G as government investment plus government consumption , the saving balance equation becomes domestic saving Sd ( Sp + Sg) = domestic investment Id ( Ip +Ig) + trade balance (x-m) or:

S = I + (X-M)

(where S an I are domestic saving and investment. And which makes the balance equation to my eye is much more attractive than ( S= I + ( S-I) but I understand its genesis. )

Still outstanding are many issues:
1. How should excess inventory investment be accounted for ? Given that its enduring value is in question.
2. Why are consumer durables accounted for the same way as consumer non-durables? Aren’t these a form of investment?
3. Could it make sense to dis-aggregate the foreign sector into trade in consumable and durable goods?

All of these questions drive at the idea that saving implies outlasting the measurement period, yet the basic saving balance equation relies on expenditure concepts which commingle durable and non – durable items.

• stone February 28, 2013 at 3:18 pm

ftm, I guess investment has to be making things that have a potential to gather an income. Inventory might be sold so counts as investment. Making a taxi counts as investment, making a car for domestic use is counted as a consumer durable.

• ftm February 28, 2013 at 4:30 pm

yes the NIPA accounts have a production orientation but there are exceptions, Housing is categorized as investment and (imputed housing income) is consumption. It’s not clear to me that consumer durables should be treated differently. The distinction between what is productive and what is not seems very fuzzy. Certain types of government investment seem very productive (interstate roads, utilities) and other not so much (DOD) so its unclear as to what is productive and what is not. A cleaner distinction is to classify expenditures based on whether the goods obtained will have value that survives the period. This also matches up well with the concept of saving on the income side.

Inventory is very interesting because planned inventory obviously has lasting value but unplanned inventory accumulation suggests value is impaired.

• Cullen Roche February 28, 2013 at 5:40 pm

To anyone who appears confused about all of this. No one ever claimed the equation was anything more than a clarification of a point that MMT often confuses or at least misleads people on.

As I explained above, this whole debate stems from the fact that the entire MMT presentation is govt centric. It’s all based on the govt, the hierarchy of money leading to reserves and a very unbalanced view of the world. The concept of “taxes destroy money” is wrong. The entire idea of “From inception, the purpose of the monetary system is to move resources to the public sphere” (Wray) is wrong. The idea of private saving being primarily focused on (S-I) is wrong. It’s all an unbalanced view of the world that misleads people about the actual operational realities of the world. The private sector precedes the public sector. Resources precede taxation. MMT literally gets all of this backwards.

This equation simply clarifies the point about private sector saving being driven by the private sector. MMT often implies that (S-I) MUST be positive or we experience a “net loss” or the world will come to a halt. That’s categorically false and was proven during the period of 1993-2008 when (S-I) was negative despite a concurrent negative CAD. Yet GDP doubled and pvt net worth almost tripled. It’s no wonder that MMTers like Randy Wray went through the entire 90′s saying we were in a “contained depression” when the reality was that the pvt sector was doing quite well. Wrong analysis leads to wrong conclusions….

It’s all a clarification and an accurate presentation that perfectly represents the actual balance sheet composition of the private sector. MMT’s problem is that it’s not a balanced view of the world. And as a result, it gets a bunch of things wrong. This is an attempt to add more clarity. Many people see the clarity. The only ones who don’t appear to be MMTers who are in denial over the fact that their theory is not an accurate presentation of our reality.

• Jose Guilherme February 28, 2013 at 6:05 pm

“MMT often implies that (S-I) MUST be positive or we experience a “net loss” or the world will come to a halt. That’s categorically false and was proven during the period of 1993-2008 when (S-I) was negative despite a concurrent negative CAD. Yet GDP doubled and pvt net worth almost tripled…”

Right!

And yet the statement seems incomplete.

Perhaps it should close with the following sentence: “However, that situation of I > S for an extended period ultimately proved unsustainable and laid the foundations for the current 2008-20?? crisis, thus vindicating one key aspect of the worldview shared by MMT and other currents of thought.

And then the founders of MR may be ready to rejoin MMT in a new synthesis, thus fulfilling the old “Hegelian dialectic” prediction according to which social phenomena follow a 3 stage process, starting with affirmation, suceeded by negation and concluded by a negation of the negation

• Cullen Roche February 28, 2013 at 8:00 pm

MMT does NOT state that private debt is always unsustainable. Don’t take it from me. Take it from this guy:

No wonder there’s so much confusion on these points! This is what’s frustrating. MMT builds this govt centric view of the world where they falsely claim that all money comes from govt “creation” of money through deficit spending. Then they claim that (S-I) and NFA is the focus of private saving. And then their followers start thinking that no one can save if the govt doesn’t spend. Except these people have it backwards. The MMT founders have the focus of money creation wrong because govt taxation does not “destroy” money (but only redistributes existing bank money) and pvt saving is about much more than (S-I).

I am quite confident that 99% of the people discussing MMT do not even understand the depth of these concepts. Yet they run around claiming that we’ve “rebranded” MMT or contributed nothing unique. It’s absurd coming from people like Phil and yourself who, pardon my directness, don’t fully understand the theory they so aggressively push on everyone else. So let’s be a bit more careful in the future when we go around claiming there’s no differences between MR and MMT or that we’re just pawning “original coke” off as “new coke” (as Kelton so absurdly claimed to me on Twitter). The personal attacks are tiresome coming from a group of people who clearly can’t agree on their own theory or don’t even fully understand it.

• Jose Guilherme March 2, 2013 at 3:44 pm

“MMT often implies that (S-I) MUST be positive or we experience a “net loss” or the world will come to a halt” – CR (version 1)

“MMT does NOT state that private debt is always unsustainable” – CR (version 2)

Hint: perhaps it all hinges on the difference between “always” and “often”

• Cullen Roche March 2, 2013 at 5:21 pm

Or perhaps it hinges on MMT trying to always have everything both ways….bottom line is, taxes don’t “destroy” money so the whole debate is a moot point. The MMT paradigm doesn’t apply so forget trying to justify a policy agenda based on some mythical “money monopoly”.

• Jose Guilherme March 2, 2013 at 7:26 pm

Or perhaps it’s time to re-read the classics, free from obsessive visions of MMT lurking in every corner:

“public deficits and balance of payments surpluses create income and financial assets for the private sector whereas budget surpluses and balance of payments deficits withdraw income and destroy financial assets”.
- Wynne Godley

• Cullen Roche March 2, 2013 at 8:03 pm

Or maybe it’s about understanding that an entity that taxes must necessarily redistribute that income through the system. The entire paradigm of “taxes destroy money” is incorrect. Taxation is always a necessary redistribution. That’s all. MMT gets the focus entirely wrong. It’s not even a debate. The paradigm is wrong. So let’s move past the inaccurate description of “taxes destroy money” and focus on what’s correct. You can support all the MMT proposals with an MR understanding. The difference is, you don’t have to make up a fairy tale about how money is created and destroyed in our system. So let’s just stop pushing this MMT nonsense and move on to the right description. I don’t even know why this is a debate to be honest.

• Jose Guilherme March 2, 2013 at 8:50 pm

“Taxation is always a necessary redistribution”

That’s not correct.

Taxation may finance a redistribution after the proceeds from taxes are spent again into the economy.

But before and until that happens taxes only served to mark up the government’s accounts at the central bank – that are not a part of either money or the monetary base.

When I pay taxes my deposits at the bank are destroyed. Ergo – Money was destroyed.

• Jose Guilherme March 2, 2013 at 9:00 pm

Also, one could analyze the following snapshot description of the (G-T) process:

Taxation = destruction

Government spending = creation

Food for thought for monetary realists.

• Cullen Roche March 2, 2013 at 10:04 pm

See my earlier comment. The idea of “taxation = destruction” is ridiculous. Exactly equal to saying that “ATM withdrawal = destruction”. Sorry, but it’s amazing that MMT got this far for 20 years without anyone pointing this major flaw out.

• Cullen Roche March 2, 2013 at 10:00 pm

No. This view of the world is patently absurd. The money system is designed around inside money. The entities that create money are banks. Only banks can permanently destroy money. When the govt taxes you a loan is not destroyed. The money is necessarily redistributed. The MMT claim that taxes destroy money because of the reserve settlement is an absurd misrepresentation of what really happens. It’s like saying that you “destroy” money if someone takes out a loan and then draws down a bank account from their ATM. Taking money from the ATM or settling a tax payment in inside money absolutely does not destroy money because the money is directly and permanently tied to the loan that the bank issued in creating that money. MMT needs to stop poisoning the world with this misunderstanding. We have a system designed around bank money, not govt money. It’s that simple. So let’s stop telling this reckless myth about how money is “created” by govt deficit spending. I’m very sorry to inform you that the MMT paradigm is wrong. The right view is understanding that money is created by banks and redistributed by the govt. The reserve system serves to facilitate inside money. It absolutely does not nationalize the money system or create a system in which bank money gets “destroyed”.

• Jose Guilherme March 2, 2013 at 10:40 pm

“The idea of “taxation = destruction” is ridiculous. Exactly equal to saying that “ATM withdrawal = destruction”

Wrong again – the two situations are not similar.

Here are the comparative accounting entries on my balance sheet:

Situation 1: I pay taxes.
Minus deposit (asset), minus equity
I lost money: destruction.

Situation 2: I withdraw cash from the ATM.
Minus deposit (asset), plus cash (asset)
I exchanged one form of money for another: no destruction in this case.

And note that this has got nothing to do with MMT: it’s pure accounting.

That’s the reason non-MMT Godley also referred to “destruction” when talking about a budget surplus – that is, when the government taxes without injecting the proceeds from taxation back into the system.

Perhaps it’s about time self-proclaimed realists take the plunge and decide to make peace with accounting realities?

• Cullen Roche March 2, 2013 at 10:50 pm

Here’s the actual reality.

Situation 1: Paul pays taxes
Minus deposit, minus equity

Plus deposit, plus equity

Govt’s don’t tax so they can “create demand for money”. They tax so they can move resources from the pvt sector for public purpose which results in a necessary SPENDING of money. You just conveniently leave out the most important part of the entire story so you can propagate a myth. Your “accounting” neglects the use of tax funds and misrepresents the complete flow of funds in the process. It’s a blatant misrepresentation of what really happens.

This is pure accounting from a total flow of funds perspective. Not your incomplete flow perspective.

Perhaps it’s time for MMT to stop telling the world a lie about how money is created and destroyed?

• Jose Guilherme March 2, 2013 at 11:11 pm

“They tax so they can move resources from the pvt sector for public purpose”.

Not when the budget is in surplus and part of the proceeds from taxes does NOT get spent.

Precisely, the situation we were discussing and that you’re now running away from after making an elementary accounting error (considering a tax payment to be equivalent to withdrawing cash from an ATM!).

Likely, an instance of what may happen when one reacts in haste motivated by a persistent obsession with the MMT bogeyman.

Anyway, since you’ve now shifted to a “govt. taxes Peter to spend for Paul” story (that is a balanced budget narrative) you’re implicitly admitting that taxes without spending do correspond to “destruction”.

Welcome to the world of monetary reality, then.

• Cullen Roche March 2, 2013 at 11:20 pm

Show me all these mythical govts who tax and don’t spend? Can you name one? Include off balance sheet spending via a current account surplus so you don’t spread your absurd myths here. Of course you can’t do it. The only reason taxes exist is because a nation wants to mobilize pvt resources for public purpose. That’s not even controversial, but you’re basically rejecting it. Further you don’t understand that reserves are outside money and that the money system is designed around inside money. Per your view, one could claim that every interbank transaction results in a “destruction” of money because it “destroys” inside money by settling in reserves. Which is why I used the ATM example because cash is outside money. But you didn’t understand the example because you have this totally flawed version of the world where all govt spending is the “creation” of money.

It’s fine by me if you guys want to spread this myth, but it will get you nowhere. We don’t have a system designed around outside money or the reserve system. This is a neoclassical myth that MMT propagates via their reserve centric description of the money system. You can claim that taxes “destroy” money, but until taxes start destroying loans (which create the money) then your whole story is wrong. Only a bank loan repayment can “destroy” money. Again, this should be a basic element of double entry bookkeeping, but you guys somehow manage to defy the laws of accounting by claiming that money gets created not once (during loan creation) but also during govt spending.

• Jose Guilherme March 2, 2013 at 11:21 pm

Perhaps it’s better to put it in simple, neutral, non emotional terms. And please – please! – let’s not mention MMT again.

Situation 1: govt. taxes Peter and does not spend for Paul (budget surplus) – there is destruction.

Situation 2: govt. taxes Peter to spend for Paul (budget balance) – there is redistribution.

Situation 3: govt. does NOT tax Peter and spends for Paul (budget deficit) – there is creation.

I’m sure all monetary realists – once passions have cooled down – will agree with the three descriptions.

• Cullen Roche March 2, 2013 at 11:28 pm

Your “situation 1″ is like claiming that inside money accounts can be drawn down via ATM cash removal permanently. That’s ridiculous. It cannot occur in any meaningful way which is why it doesn’t. It would be destabilizing. A money system is not stable if everyone draws down their inside money accounts via ATMs. There is a necessary flow of funds where cash must flow back into the banking system because all of our money is attached to a loan that created the money in the first place. There is an undeniable and necessary relationship between the loan and money’s flow. Yet you deny it because you don’t seem to understand that all money is truly endogenous and not created by the govt. The entire system is designed around inside money. This is what you don’t seem to understand. There is no such thing as everyone drawing down their bank accounts and not spending it back into the banking system. It literally cannot happen because then it destabilizes the very entities that the system is designed around. I don’t even understand how this is controversial.

And let’s stop claiming that we are the ones being “emotional”. It’s MMTers who have called us “retarded” and claimed we were just “rebranding” or “stealing” their ideas. You don’t even understand our ideas so you can’t even understand how they’re different. Yet you insult us with these crude accusations. It’s absurd.

• Jose Guilherme March 2, 2013 at 11:57 pm

“Show me all these mythical govts who tax and don’t spend”.

Every govt. running a budget surplus has taxes that don’t get spent. Clinton had surpluses. Sweden ran many years of surpluses. The EU wants to impose 20 straight years of surpluses on periphery Europe, etc.

“Per your view, one could claim that every interbank transaction results in a “destruction” of money because it “destroys” inside money by settling in reserves.”

No, one could not. Interbank transactions don’t change the total amount of reserves. Bank A loses reserves and deposits, Bank B gets reserves and deposits. Tax payments, however, do reduce the total amount of reserves. Commercial banks lose reserves and deposits; the NCB debits commercial bank deposits (reserves) and credits govt. deposits (that are not a part of the monetary base).

” Which is why I used the ATM example because cash is outside money”.

Depends: cash with the non bank public (as per after ATM withdrawal) is both part of the monetary base (though not part of reserves) and of money; only cash held at bank vaults (reserves) is strictly outside money.

“Only a bank loan repayment can “destroy” money. Again, this should be a basic element of double entry bookkeeping”

Here’s some basic bookkeeping:

Loan repayment: minus loan (bank asset), minus deposit (bank liability)

Tax payment: minus reserves (bank asset), minus deposit (bank liability)

Money supply definition: notes and coins held by the public plus bank deposits.

Are you still sure tax payments don’t destroy money?

I beseech you to stop and yield to the power of MM…, pardon, MR!

• Cullen Roche March 3, 2013 at 12:15 am

No, govt’s who run a budget surplus generally run a trade surplus. I believe MMT refers to that situation as “off balance sheet deficit spending” or something like that. So I am one step ahead of you. You’re again viewing the world through the narrow lens that satisfies whatever myth you’re trying to propagate. I asked you to show me a nation that doesn’t do this, but you went straight to a CAS nation as expected. Try again please. You will fail because it doesn’t exist. Nations tax so they can spend. End of story.

Yes, I am aware of your reserve centric focus on the world. That’s what we’re discussing! I am precisely aware of how MMT states that reserves are destroyed. You’re being rather disingenuous by ignoring both sides of the taxing/spending flow. In the USA the govt cannot spend until its TT&L account has been credited, yet you’re claiming that it does exactly that. Tell me how MMT rationalizes the contradiction in which money is a creature of law, yet “self imposed” laws are null and void when they prove the theory wrong (as is the case in the flow of funds allowing the US govt to spend). Of course you can’t rationalize the contradiction because it’s another case of MMT trying to have it both ways.

There is no reserve settlement without the account credit from inside money. Yet you’re skipping that entire step to claim that all that matters is the reserve settlement. But the only reason there is even a reserve system is because inside money exists. You don’t understand that the only reason inside money exists is because the money systems is designed around banks who create all the money. A one bank nationalized system would have no inside money because all money would be outside money. That is not our system! Our system is designed around inside money with a Fed system that supports inside money. The greatest irony here is that the reserve system, which MMT builds its whole paradigm around, proves that the reserve centric focus is a flawed view of the world. If you don’t see it then you don’t see it. I can’t make you understand it. You have to be open-minded enough to consider that the system we have is designed around banks and for banks. But you don’t want to see it. You want to see the mythical MMT world where reserves are the center of the money system.

• Jose Guilherme March 3, 2013 at 12:11 am

“Your “situation 1″ is like claiming…”

Is like claiming that budget surpluses exist – just like balanced budgets and deficits exist.

” It would be destabilizing…”

Glad that you recognize that budget surpluses are destabilizing. You see, they destroy money and a growing economy is incompatible with money destruction (unless when compensated by current account surpluses, but let’s not change the subject – at least not yet).

Yet the EU wants to impose surpluses on a whole continent for the next two decades (search under “Fiscal Compact”). Crazy, isn’t it?

I wonder where MR stands on these pressing issues of today.

Btw, neoclassicals of the Krugman strand have taken a clear stand on said issues: a correct and courageous one.

Boy, where are the heterodox schools when they are needed the most?

• Cullen Roche March 3, 2013 at 12:22 am

Budget surpluses are not necessarily destabilizing. I never said that so let’s not just go and put words in people’s mouths as you continue your misleading line of argument. Again, you’re excluding other sectors which is a narrow and absurd view of the world.

• Jose Guilherme March 3, 2013 at 12:47 am

“No, govt’s who run a budget surplus generally run a trade surplus”.

Yeah, I remember those magnificent U.S. trade surpluses of the Clinton budget surplus era.

“In the USA the govt cannot spend until its TT&L account has been credited, yet you’re claiming that it does exactly that.”

NO SIR, i haven’t claimed anything of the sort.

(Digression: You should really stop misrepresenting my views by automatically confusing them with your perception of where your private bogeyman MMT stands on several issues. You (rather sadly) seem to have a worldview where every human being must belong to a school or sect. Please remember that not all of us are religious or ideological believers or followers of creeds. There is, you now, a thing called independence and putting the crude, harsh facts above all ideologies).

So let me complete the accounting entries of a tax payment – on the NCB’s books:

Minus commercial bank deposits (reserves), plus TT&L accounts

And when the government spends said tax receipts, we have on the NCB’s books:

Minus TT&L account, plus commercial bank deposits.

And on the banks’ books:

Plus reserves, plus (Paul’s) deposits.

See? Your definition of my position was a bit premature. The govt. only spends after the TT&L account has been credited.

“You have to be open-minded enough to consider that the system we have is designed around banks and for banks”.

(Disclosure: the following paragraphs assume the “we” referred to the U.S.).

A system designed around banks and for the banks? Naive me, who thought the American system was designed around the people and for the people!

I guess I must have been watching too many Lincoln films. I’m now truly scared that you may have – no doubt unintentionally – betrayed the secret of the American system.

• Cullen Roche March 3, 2013 at 12:53 am

You can lead a horse to water, but you can’t make it drink. If you want to believe that govt spending is the source of all money creation then be my guest. Just don’t be shocked when you spend entire periods being way too pessimistic about the state of the global economy because govt spending isn’t high enough for your taste (as MMTers were bearish through the entire 90s)….

• Ramanan March 3, 2013 at 12:55 am

Look Jose, MMT misleads and you are trying to do so also.

First, the Chartalists try desperately to prove that money is destroyed when taxes are paid. Mosler’s story about all taxes paid by cash getting shredded is one example and Mitchell’s dustbin is another. The language “it doesn’t get anything” is another and banning usage of phrases such as funding etc is another.

It is conceptually okay to think of money being destroyed but then you try to desperately prove that this is what happens in practice. And moreover there is a tremendous amount of misleading in the process.

Now whether the budget is in surplus or not, the government needs x amounts of taxes to spend y. So if the government wants to spend 20% of GDP, it may need 18% or 22% or whatever. In the process of incurring a deficit, the government increases the net worth of the private sector. However, it is redistributing the remaining. If the government needs to increase its expenditure, this decision is *not* independent of how it raises taxes and from what sources. But if you are an MMTer, it really such things are cast aside

If you look at the sequence of national accounts, such things are clear. The primary act is production and income is created by acts of production.

• Ramanan March 3, 2013 at 12:57 am

“So let me complete the accounting entries of a tax payment – on the NCB’s books:

Minus commercial bank deposits (reserves), plus TT&L accounts”

TTL accounts are specific to the United States!

• Fed Up March 3, 2013 at 12:58 am
• Jose Guilherme March 3, 2013 at 1:07 am

“The system we have is designed around banks and for banks” – CR

On second thoughts, that might make a great title for CR’s classic paper on understanding the monetary system.

I’m afraid, however, we cannot say the same as far as a political slogan is concerned.

A party running under that platform might well get a severe beating at the hands of the American people.

Taxpayers really don’t love banks – and hate watching their taxes being raised (and their hard-won assets being destroyed) to pay for the consequences of “mismanagement of risk” by the financial sector.

Even if said sector is fulfilling God’s work

• Jose Guilherme March 3, 2013 at 1:14 am

“TTL accounts are specific to the United States!” – Ramanan

Yeah, I know. In the UK it’s “government deposits”, in Brazil it’s “depósitos do…”. Who cares? Different names for the same reality.

And the discussion was about the U.S. case, anyway.

You must try harder, next time,

• Cullen Roche March 3, 2013 at 1:26 am

Trying is obviously pointless. You will believe what you want to believe.

• Jose Guilherme March 3, 2013 at 1:28 am

“Look Jose, MMT misleads and you are trying to do so also.”

I don’t appreciate being confused with “MMT”. Whether it misleads or not is beside the point here. I can only speak for myself – and have no intention to mislead.

“It is conceptually okay to think of money being destroyed”

I agree.

When taxes are levied, deposits are destroyed; money is destroyed; even “base money” is destroyed.

However, said tax receipts are credited to the govt.’s account at the NCB.

And the govt. can then spend said receipts back into the economy (it can also decide to not spend them, however).

So taxes do fund/finance govt. spending.

They destroy money; and they finance spending.

These are the facts. How diverse theories choose to interpret these facts – I don’t really much care.

• Cullen Roche March 3, 2013 at 1:38 am

Again, this is incorrect. Saying that taxes destroy money is exactly like saying that an ATM withdrawal destroys money because it reduces outstanding bank deposits. You have to seriously misunderstand the actual flow of funds in the economy to believe such a thing. Its a concept that is almost entirely void of value.

• Ramanan March 3, 2013 at 1:28 am

“And the discussion was about the U.S. case, anyway.”

Ha ha ha!

US doesn’t have an “NCB”

“So let me complete the accounting entries of a tax payment – on the NCB’s books:

Minus commercial bank deposits (reserves), plus TT&L accounts”

Totally incorrect.

When taxes are paid in Europe, although your first part is correct, your second part is inaccurate. The funds are in government’s account at the central bank not TTL accounts.

“You must try harder, next time, ”

First learn some proper way of describing instead of stumbling at the first step itself.

• Ramanan March 3, 2013 at 1:34 am

“When taxes are levied, deposits are destroyed; money is destroyed; even “base money” is destroyed.”

Deposits reappear as government deposits at the central bank.

Base money is destroyed because you define base money so as to not include the government funds at the central bank.

At any rate a tax paid by cash – does it destroy the cash??

“They destroy money; and they finance spending.”

In a conceptual sense alright. Funds used to pay taxes reappear as government deposits at the central bank.

“These are the facts. How diverse theories choose to interpret these facts – I don’t really much care.”

With nice amount of misleading hidden between.

“I don’t appreciate being confused with “MMT”. Whether it misleads or not is beside the point here. I can only speak for myself – and have no intention to mislead.”

Your language is heavily MMTish. You seem to be suitably choosing your position when it suits your purpose.

• Cullen Roche March 3, 2013 at 1:39 am

He’s being disingenuous. He defends all of MMT’s points and then doesn’t want to be called an MMTer.

• Ramanan March 3, 2013 at 1:52 am

“You have to seriously misunderstand the actual flow of funds in the economy to believe such a thing. Its a concept that is almost entirely void of value.”

Exactly right!

It’s like taxing at 75% and when the taxpayer comes and cribs saying “go eff yourself I am just destroying money to reduce aggregate demand”.

These are complex matters – the right burden of taxation. Redistribution is a good thing and can sometimes be bad.

So in India we have subsidies on diesel – nothing wrong with that per se but when rich people buy cars on diesel it hurts. In India we have luxury cars running on diesel because of subsidies. Since the government is heavily subsidising, it has to maintain a higher tax rate than otherwise on others.

Nobody here is denying that a deficit increases the net worth of the private sector as a whole but the narrow focus on destruction and ignoring the connection to the full flow of funds is counterproductive.

• Jose Guilherme March 3, 2013 at 2:10 am

“like saying that an ATM withdrawal destroys money because it reduces outstanding bank deposits.”

You don’t get it, do you?

An ATM withdrawal does NOT destroy money.

Deposits are changed for cash – and cash IS money.

Deposits down, cash up (inside ATMs, cash is not “money”) – money is not destroyed.

If you keep making such confusions (no doubt a result of an emotional, sectarian view of the world, where every debater who dares to doubt MR holy writ is automatically labeled MMT) your Nobel Prize for understanding the monetary system may have to wait an extra couple of years.

Anyway, today even Ramanan is exhibiting a disappointing performance. Falling to arguments at the level of “the Fed is not a NCB”, frankly…I expected better

Finally, before getting some sleep, I must remind everybody of the important secret revealed today by CR: the “system” is truly designed around and for banks.

On second thoughts, considering the shattering nature of this revelation, perhaps he’ll deservedly get that Nobel – and sooner than expected.

• Cullen Roche March 3, 2013 at 2:15 am

An ATM withdrawal is a debit in inside money to obtain outside money. When the govt settles a tax payment a debit in inside money results in the TGA account credit in outside money. Money is not destroyed in either case. It changes composition (temporarily), but doesn’t get destroyed. It’s not a difficult thing to understand.

Ramanan, of course, has it all exactly right. This is all a redistribution of existing money. Its a precise flow of funds. Why make it more complex than it really is???

• Ramanan March 3, 2013 at 2:20 am

“Anyway, today even Ramanan is exhibiting a disappointing performance. Falling to arguments at the level of “the Fed is not a NCB”, frankly…I expected better ”

Look. If you want to throw jargon like NCB and TTL know what they are. Your analysis started with errors – which adds comedy to mixing the jargon. You claimed that in a situation banks’ reserves fall and simultaneously TTL accounts increase. These two are different situations.

In the case where reserves fall, government’s account at the CB increases. In case where TTL increases, government’s account is the one increasing without any effect on bank’s reserves due to the transaction you discuss.

The reason I pointed that is that you confuse institutional designs across the world and add your own confusions on top of that.

Talk of performance!

• beowulf March 3, 2013 at 4:30 pm

“Every govt. running a budget surplus has taxes that don’t get spent. Clinton had surpluses”

Sure they are, budget surpluses are used to buy back existing T-bonds.

• Jose Guilherme March 3, 2013 at 4:46 pm

Yes, but buybkacks are asset swaps that do not add up to GDP.

• Matthijs March 1, 2013 at 12:14 am

Cullen, I do understand what you are saying. And I believe you are right. But I think the confusion around the S = I + (S – I) equation can *also* come from the fact that the equation is difficult to understand and explain on its own. The fact that so many very long articles are needed to explain this and so many long discussion threads follow them, at least partially shows that, I think. So even though the equation might be correct, I do believe there should be better ways to explain the concepts behind it.

• JKH March 1, 2013 at 5:09 am

You can charge me with being a poor writer. That’s one thing.

But the equation itself opens up to the entire scope of Keynesian economics, at least.

You can’t limit the openness of its interpretation any more than you can limit the openness of discussions of economics.

The perspective is unlimited in that sense.

• Matthijs March 1, 2013 at 5:28 am

Well I can only speak for myself. But for me:
- as a non-economist but interested reader knowing a bit about economics (probably more then 95% of the people, although that’s not so hard)
- asuming I’m not stupid
- not being a MMT-er at all or having any interest in MMT
- that equation is still highly confusing

Took repeated reading of this article and all others referenced, plus carefully reding the comments and only then it slowly got clear. Please don’t see this as an attack or something. This site and the work you put in is great and highly apreciated. It’s just my constructive criticism.

• BF March 1, 2013 at 6:01 am

Matthijs there’s certain papers I read around two dozens time over multiple years before I fully grasped the meaning. The many times I knew I didn’t quite get things, well, that just compelled me to keep reading. If economics was easy then the crisis that hit in 2007 would have been widely predicted or avoided.

• Matthijs March 1, 2013 at 6:24 am

Well personally I’m fine with reading things many times and putting the work in. But the bottom line is, if you want to be able to convince more people then just a few loyal readers here to understand and agree with the MMR story (/theory), that story must be easier to explain. Sure, if you get to the nitty gritty details of economics and being able to predict the future, things get very complicated. But the basics shouldn’t be and aren’t. An equation with only a few elements just shouldn’t be so difficult to explain. I still fail to see the advantage of I + (S – I) over (G – T) + (X – M)

But of course, I don’t know the exact goals and target audience for this website. As I said, I’m just an interested amateur. So maybe these articles are just not for me.

• JKH March 1, 2013 at 6:32 am

Keynes wrote the General Theory entirely around the framework of

C + I + G + (X – M) = C + S + T

If you’ve been paying attention, you’ll know that the 3 sector financial balances equations are a derivation of that, and that the equation here is a variation on that

Now, examining the origin of these derivations:

The General Theory is a massive work that is still being debated

And please don’t say that I’m saying that the equation in question is equivalent to the General Theory – that’s just not logical

People really need to get a grasp on their own expectations in understanding economics – everything is connected to everything else

• vimothy March 1, 2013 at 6:36 am

I think you have to see the whole discussion in context, which is that many people seemed to have the idea that saving is only possible when G > T, which is clearly false, and which you can clearly see from the equation: S = I + other_stuff, where other_stuff includes lending to the government and lending to the foreign sector. The point being that private saving is not totally reliant on government deficits for its existence. In fact, government deficits only make up part of the difference over and above investment in new capital, which is the major component in (or use of) private saving.

• stone March 1, 2013 at 7:07 am

I think that there is the crucial issue of time lags. Debt may be taken out in order to finance building factories or whatever BUT a consequence of how the cash flows from servicing that debt get distributed MAY result in subsequent dissaving that undoes the nominal increase in private wealth that came about from building that factory. The debt might default and be worthless AND no one might be able to pay for the factory so it also is financially worthless.

• Matthijs March 1, 2013 at 8:02 am

Well yes, that’s absolutely clear (that saving is not totally reliant on government deficits). However, even now I find it very difficult to deduce that fact from the I + (S-I) equation.

Anyway, I just wanted to bring this forward. Again, no attack or whatever. Just hopefully constructive feedback. If that’s not the case, nothing lost (except a few minutes of our time).

• JKH March 1, 2013 at 6:41 am

and this issue of the “audience” keeps coming up

or who we’re trying to “convince”

we’re not selling house ware door to door here

the work defines the audience – not vice versa

whoever is interested

• Cullen Roche March 1, 2013 at 10:57 am

More importantly, we’re not selling an agenda. Some people are looking at the focus on banks and pvt investment and claiming we have an anti-govt position. Well, I hate to break it to these people, but the economy and the balance sheet of that economy just so happen to be made up of a vast majority of PRIVATE assets and liabilities. And, contrary to MMT’s presentation, our system of money is one in which money is privatized and its creation revolves around private banks. In order to construct a govt centered presentation you have to seriously distort this reality, which is precisely what MMT does in trying to convince people of a rationale for permanent deficit spending, job guarantees and other politically motivated views….this reminds me of the piece I wrote a few years ago when Scott Sumner said MMT focuses too much on reality. I guess it turns out that now MMT seems to think MR focuses too much on reality….

• stone March 1, 2013 at 12:02 pm

Cullen, It is fantastic that you guys are putting all this work into focusing on reality.
I totally understand that we have a bank orientated system. I guess the banks need the government as a tool for them to do what they are doing. We perhaps are ruled by the banks with the government as an agent of the banks. Do you monetary realism guys go with the MMT standpoint that bank bail outs are damaging for “public purpose”?

• Cullen Roche March 1, 2013 at 12:32 pm

Bank bailouts are an unfortunate, but necessary piece of the current monetary design (because, in my opinion, we don’t regulate bank risk taking very well). What we have in the USA is a system run by the banks in a private purpose oriented fashion. The banks are private entities owned by private shareholders. Their executives don’t answer to the US govt. They answer only to one master – their shareholders. So, they must maximize profits. And that sometimes involves taking a bit more risk than they might otherwise want to take. So the banks reach for risk, mismanage the risk (sometimes) and then the US govt needs to leverage its taxing power to help them out because the banks are such an essential piece to the US money system through the payments system.

So, what this whole MR vs MMT debate really comes down to is whether private banking is better than public banking. MMT is a public banking based view of the world. It must be. There is a clear contradiction in the MMT view of the world if you allow private bankers to dominate the money system in pursuit of private purpose. It goes against the very nature of functional finance and money for public purpose. Further, MMT’s “money monopolist” concept ONLY works in a system where money is a true public monopoly. We do not have that today. On the other hand, private money is consistent with the capitalist and skeptical govt views of the US people. From inception, we have been skeptical of a govt controlled money supply. So, it’s not surprising that we have a money system controlled by private banks who create money by competing for customer loan demand. It’s entirely in keeping with capitalism and our form of govt. Is this system better than a system of public money? That’s the question MMT SHOULD be answering, but doesn’t. If MMT really wanted to impact the world they’d go on a campaign explaining why pvt banking isn’t consistent with public purpose and then explain why public money would work better. Instead, you get this nonsense about “money monopolists” and how the USA “destroys” and “creates” money. It’s not only wrong, it’s terribly misleading. So not only do they muck up the “operational realities”, but they compromise their political views in not being forthright about all of this.

• stone March 1, 2013 at 12:57 pm

Cullen, I’m not sure it is necessary to choose between Bill Mitchell’s public banks or the bankers’ banks. There are other potential choices. I think going with the flow and accepting happily whatever our private banks choose to morph into, will lead to all of us becoming ever more subservient to the banks’ interests. Probably we would get the same kind of slippery slope if we went with the flow and accepted whatever hypothetical public banks chose to subject us to. I think we need to USE government to set up constraints on a private banking system so that it is configured such that its private interests are somewhat aligned to those of the wider private economy. Perhaps separating the payment system away from the loan granting system would be a way to have a properly private banking system that didn’t use government bailouts. Once you have government bailouts I think the state bank / private bank distinction becomes utterly blurred. IMO you get what amounts to state banks but with a banks’ state. So the state is run for the private purpose of the banks – that can’t be viewed as an ideal form of capitalism can it?

• Cullen Roche March 1, 2013 at 2:01 pm

Well, I disagree. We have a payments system run by entities that serve private purpose. As long as the profit motive dominates the system there will be a conflict between the MMT view that money should serve public purpose and the reality where banks serve private purpose. There’s only one way to resolve that issue. Bill Mitchell has the answer. Tom Hickey supports it. Rodger Mitchell gets it. And so does Joe Firestone. The “we are funded by banker Warren Mosler” crowd obviously doesn’t support it.

• vimothy March 1, 2013 at 6:03 am

But these things are just generally a bit tricky to get your head round at first. I don’t think there’s any “royal road” or short path to understanding. You have to put some work in yourself–and the more work you put in, the easier understanding gets.

• Iluvatar February 28, 2013 at 9:28 pm

Hi JKH:

Whew!

This was a major effort@!

Dude! Are you retired or something! I have *never* seen so much effort on a simple post before!

It’s all good.

Hey listen – 1st time poster here (although I recognize many names here).

So, put your bricks back in your pockets – you would be exercising a *useless* exercise here, *dude*.

You don’t throw bricks @ a tyro/newbie – get it?

As a result of your efforts here, it is kind of clear why you couldn’t get back to my post over @ TPC’s site. You must be exhausted by now.

But I did want to posit a couple of important things/questions:

Point #1: S= I + (S-I).

Please *lose* the tautological aspects of this! In JHK’s response to J.Carney over @ TPC, it was re-written as: S= I + SAVEGAP.

OK whatever, the algebra derived from the GDP equation holds. No Problem!

I fail to understand any algebraic issues anyone might have unless you don’t understand algebra.

Now, you might argue that the tautology is confusing, but not really:

S= I + (S-I) is nothing more than
S= I + W, wherein we know by sectoral balances is: W= (G-T)+(X-M),

so we’re good.

I think JKH’s point was to elucidate conditions under which the ‘PVT’ sector desired to *have* more savings over what was available and so W had to *amp up*, so to speak. He also elucidated conditions under which S was too high, and therein resulted in an increase in “C” (consumtion), which has the untoward effect upon (price) inflation.

But that is all he did. His comments can be viewed @ this cross-posting in the comments section w/ John Carney – it is an excellent exhibit, and well worth one’s time.

Point #2: Also in the discussion w/ John Carney. It’s all about “I”.

The bell finally rang (and JKH is a double-entry accounting boss if ever I saw one!), when he indicated that investment, I. leads to savings, S. But it wasn’t until he cited *how* ‘I’ got to ‘S’ that it came home much more clearly.

By virute of “the factors of production, leading to wages and capital…”, bingo!

The COPR sector turns that ‘I’ into ‘S’ by gaining capital equipment/assets that goes on their sheet as an asset (==’S')! The wages go to the HH sector as savings in their bank account (==’S').

But did you notice that (being the semi-accountant that I am!)? The ‘I’ got split into *TWO* ways: first to the CORP sector, 2nd to the HH sector.

very cool.

But, by making this argument, you have essentially made th case for doing sectoral balances wherein, the ‘PVT’ sector is further decomposed into 3 sectors: ‘HH’, ‘CORP’, & ‘BNK’ sectors. My rationale for that can be found over @ TPC – not repeating it here.

Point #3: Understanding variables that are *dependent* vs. those that are independent (algebraicly & statistically). The rant over @ TPC suffices.

Please ignore typos – I don’t tpye so goood.

• JKH March 1, 2013 at 5:05 am

that’s pretty good

you’ve taken the time to read what is written and to try and understand it – thx

regarding the internal construction of the private sector – you’re preaching to the converted

I’ve written mass quantities on that subject; although it’s scattered about

However, I think if you review my long post linked in the introduction, and also go into the sub-links of that post, particularly the Asymptosis blog discussions – you’ll see quite a bit on that aspect

And just consider the final paragraph in this post above:

“Moreover, the circumstantial nature of NFA compositional demand can be revealed further by looking one more level down in sector decomposition terms. The private sector is composed of the household sub-sector and the business sub-sector. From the perspective of their own balance sheets, households save in the form of both real assets (e.g. residential real estate) and net financial assets (e.g. bank accounts, bonds, stocks; net of financial liabilities). And the household NFA component is present even when private sector S = I. This is because much of investment I is present on corporate balance sheets, from where it is intermediated back to household wealth through financial claims. And that puts the household sector into its own ‘NFA long position’, even when S = I. So when the private sector as a whole is in a state of seeking additional saving beyond the level of investment I – i.e. seeking positive (S – I) – one should remember that the household sector already holds considerable NFA of its own via financial intermediation from the business sector. It is saving that is the primary quest – not so much NFA – and the NFA result at the private sector level is a function of the assumption that investment has been maxed out, with NFA expansion being the private sector saving outlet beyond that.”

So the private sector can be deconstructed – and often should be – and that is in no way incompatible with the private sector S level measure

But the S definition and the S level equations here are fundamental to the background context of the discussion, and there needs to be a primary association at that level, on the basis of that sector composition and the definition of S on that basis

• Iluvatar March 1, 2013 at 11:59 am

JKH
It was *both* the discussion w/ J Carney & the last paragraph that begged the question Re: breaking up the PVT sector into HH, CORP & BNK sectors.

And from this post, apparently I was preaching to the converted.

So the idiot-savant (that would be me) guessed correctly! +1 (big grin)

Be well, ok? best,
Iluv

• stone March 1, 2013 at 1:12 am

To me the 1993 to 2008 period vindicates the MMT (as interpreted by a naive reader) message that economic expansion built on debt expansion typically will reverse unless government steps in. During that period debt servicing costs did NOT trickle back around to those who were needing to pay out to sustain those debts and asset prices. All of the 1993-2008 gains in private nominal wealth (and more) would definitely have vaporized if the government had not leaped in to keep the creditors rich. Whilst I now see that sustainable debt financing for productive real assets CAN in principle expand private sector nominal wealth without government deficits; 1993-2008 shows to me that private sector credit expansion CAN also just be like stretching a bungy cord until it snaps back with a vengence.

• Cullen Roche March 1, 2013 at 2:46 am

No, it doesn’t vindicate anything. It just shows that credit can be extremely unstable in certain environments. As MMT states, debt is not inherently unstable. The period of the 2000′s don’t vindicate anything about MMT except the obvious fact that credit can be unstable if it’s abused.

• BF March 1, 2013 at 5:51 am

Jeepers, Stone, you are correct about being naive (intended only as read more on the subject as one must ask to know). Wynne Godley was a post-Keynesian who predicted a crisis as early as 1999 due to the at time the implied excessive debt build-up in the US private nonfinancial sector to maintain growth rates given the official projections for macro policy (he never wrote a published word on MMT). The Bank of International Settlements also warned about a bust in the early- to -mid 2000s related to household debt imbalances (and they’re mainly Austrians). You’ve probably heard of Minsky: he was a post-Keynesian who took very seriously the consequences of private sector debts (he also never wrote a published on MMT). The crisis vindicates mainly post-Keynesian theory of which MMT identifies itself as as sub-branch.

• stone March 1, 2013 at 6:17 am

Cullen, I’m genuinely floundering at understanding what you are saying. On the one hand you seem to be saying that 1993 to 2008 shows that private credit expansion can build sustainable increases in nominal private sector wealth without government deficits and on the other hand you seem to be saying that it was obvious to everyone and not just MMTers that it couldn’t because it was an example of abused credit ????

• Greg March 1, 2013 at 4:59 am

Its about the credit/income ratio is it not? As long as the percentage of your income going to debt payment doesnt get too large, you can still consume in the present period and not default. If it gets too high you either miss payments (default)or sacrifice present period consumption (reduce sales). Of course private debt, in and of itself is not unstable, but steadily rising debt levels, in the face of incomes that cant rise in proportion to the debt will end the way it ended in 2007/8. There are two ratios which seem important, one is the ratio of debt to income the other is ratio of debt relative to the price of the asset one is lending against. Banks appeared to be operating under the idea that as long as house prices continued to rise the ratio of their lending to asset price would be within stable bounds and the borrowers would be protected form default by the high value of their asset relative to what they owed.

• stone March 1, 2013 at 6:12 am

Greg I think the asset values that the lending is against are in themselves set by the spending power of consumers. A factory is only as valuable as what its out put can be sold for. Debt can crush consumers’ spending power if the money received by the creditors does not find its way to consumption.

• Greg March 2, 2013 at 5:50 am

I dont think its as simple as you describe but there is certainly a large element of that at work.

The primary asset value we are talking about was driven by realtors, lenders, builders and a govt system which pushed folks toward real estate. Obviously one cant make a monthly payment higher than their income so there is a limit in that sense but its not as simple as our spending power determining prices. An entire edifice of institutions were designed to urge us to spend our money in this way and create a herd mentality. Yes our incomes set a limit but we were willing to put a higher and higher percentage of our incomes towards this because we were convinced it was good, necessary, smart….. and everyone else was doing it!!!

• stone March 1, 2013 at 2:14 pm

Even if you want bank bailouts do you really want them as they were done? Couldn’t it have been done in a more government of the people for the people style? For instance the central bank could have said that unlimited borrowing through the discount window would keep ALL deposits safe of whatever amount. But the penalty rate on the discount window could cause losses such that banks capital ratio was breached. Once the capital ratio was breached, then ALL stock and preferred stock of the bank would be written off and the bank’s bond holders would suffer a debt to equity conversion such that they would be the new owners of a bank that now would have lost its leaverage and so be solvent. In the 1800s the Bank of England used to accept stuff such as land titles as collateral for lending through the discount window. Deposits and the payment system are totally safe even though bank bondholders are faced with true capitalism.

• Cullen Roche March 1, 2013 at 2:26 pm

I don’t want bank bailouts. I am just pointing out the reality that an unstable payments system will require support at times. And yes, I think there are ways to run a private bank based money system that is more conducive to stability than the way we currently operate the system.

• JKH March 2, 2013 at 6:25 am

Fed Up

Re your:

http://monetaryrealism.com/briefly-revisiting-s-i-s-i/#comment-16351

…………….
“First, I don’t like the term money at all. Too many definitions. Plus, I’d rather use medium of account instead of unit of account. My idea is that currency plus demand deposits is MOA and MOE as long as there is 1 to 1 convertibility and entities accept demand deposits just like they accept currency. MOA is not currency plus central bank reserves (monetary base).”
…………….

I think a lot of this is a matter of personal preference as opposed to right or wrong.

I have no problem with the term money. It is infinitely expandable or compressible in definitional and context terms – a matter of expanding or shrinking whatever specific definition fits a particular situation. The term should never be used in discussions where specificity is required but the corresponding context has not been framed. In other words, never get sloppy. But also I think there is no perfect, universal definition of what money means because of the inherent flexibility of the term.

I feel roughly the same way about UOA, MOA, or MOE. Personally, I’ve yet to come across any discussion or paper where I find the distinction between these things to be remotely interesting in context. In fact, this exchange with you is already ranked number one as most interesting. On the other hand, monetarists seem to be in a state of permanent rapture on such things.

If I sell 100 Canadian dollars to buy 100 US dollars, the Canadian dollar is the medium of exchange for the purchase of US dollars. The US dollar is both the unit of account (the value of a single dollar) and the medium of account (the entire value of the 100 US dollars that I’ve purchased, in US dollars, I believe – or maybe that’s wrong) for the ‘thing’ that I’ve purchased, which is a basket of US currency, and vice versa for the ‘thing’ consisting of the basket of CDN currency that I’ve sold.

And I’d say there’s a good chance I’ve just gotten that wrong due to my general disinterest in the topic.

That’s an interesting paradigm alternative you propose for definitions. I’m not sure, but I really do think it depends on context of discussion. I think it’s a case of wrapping a definition around a situation and describing that wrapping specifically.

……………….
“OK. I think MOA = MOE is a good idea.
“So used cars aren’t very liquid. Portability, storeability, divisibility, etc., could also be a problem with used cars.”
I agree that portability, “storeability”/durability, and divisibility are important. Liquidity probably.”
………………..

Agreed, I guess.

Maybe it’s just me, but I’ve found buying a Ferrari with apples to be most challenging. Of course, that was just a showroom discussion with the salesman – since I can’t afford a Ferrari. Maybe both reasons are why the salesman suggested I go away and think about my priorities (and also asked me if I was related to Nick Rowe).

………….
“Bank of Montreal monetary IOUs really are IOUs. They are promises to pay Bank of Canada IOUs on demand, at a fixed exchange rate. It’s the Bank of Montreal’s job to ensure that one Bank of Montreal Dollar = one Bank of Canada Dollar. It’s not symmetric. The Bank of Canada can make its dollar worth whatever it wants, and the Bank of Montreal has to follow along and make its dollar worth the same amount.
That’s what gives the Bank of Canada the power to control the total supply of money in Canada.”

I don’t get this at all. Junk IOU’s. If \$1 of BMO demand deposits = \$1 of BOC currency, then BOM can add to MOA/MOE possibly leading to price inflation?”
…………..

This gets more interesting from my perspective. I’ve seen previous posts of Nick’s around this topic, and found myself disagreeing entirely with his general notion of “asymmetry”, although I can’t remember exactly why right now. On this treatment here more specifically, the reason that BMO can assure redemption for BOC currency is because the BOC stipulates an institutional structure in which that is the case. It designs that structure with that redemption characteristic in mind. The key components of the structure are equity capitalization of banking and deposit insurance. Both are forms of banking insurance designed to make the redemption offer (which is a form of insurance for the customer) robust. As far as the growth of bank loans and deposits is concerned, the key components are bank equity capitalization, interest rates, other economic conditions, loan demand, and bank attitudes toward risk in general. It has nothing to do with any monetarist emphasis on some particular category of money lying around. And notice how Nick makes the classic monetarist error of simply assuming that a central bank can force feed its own banknotes into the economy through exogenous strategy action. That is simply incorrect, and they (monetarists) all make that error. And then he starts describing an action of a bank “lending reserves”, which is also incorrect, and they all make that error as well. These people operate in the Playboy mansion of monetary-make-believe.

First year students might just as well cut class, and head over to Pragmatic Capitalism and Monetary Realism.

(Sorry if I’ve been facetious in parts here. It’s not you; it’s the subject matter, and how it’s explained in that post. I don’t particularly admire the child’s colouring book approach to the subject of explaining money – although I also don’t assume that I’d necessarily be better at the task of explaining it myself at an introductory level. I just don’t know why an intelligent university student would appreciate such a dumbed-down approach (albeit with some internal logical cohesion in the fictional tale that is spun) to something that is so interesting in the real world. And they definitely won’t appreciate being taught stuff that is specifically wrong about money flows (such as banknote issuance, and bank reserve usage), that they’ll end up having to un-learn after they get out of university – if they remain interested and actually want to understand it.)

• Fed Up March 2, 2013 at 5:23 pm

Here is what I run into with a lot of people about MOA and MOE. I believe/think they are saying MOA = currency plus central bank reserves while MOE = currency. Get the central bank reserves converted to currency and any shortage of MOE is solved. They don’t include demand deposits at all or try to come up with some reason they don’t matter that I don’t find convincing. I don’t think that is right because MOA = MOE = currency plus demand deposits. Remember my negative IOR example.

• JKH March 2, 2013 at 5:33 pm

If that’s what you “run into” – it is absolutely incoherent to me – monetarist drivel.

You can interpret it as you wish, but I see no basis for responding to that sort of vacuous stuff at all.

It’s just categorical jargon – it doesn’t mean anything to me.

• JKH March 2, 2013 at 5:49 pm

e.g.

bank reserves are a medium of exchange for banks dealing with each other in interbank payments and settlements

bank deposit accounts, and cheques or banknotes drawn on deposit accounts, are a medium of exchange for bank customers dealing with each other in commerce

like that … simple and unambiguous

• Fed Up March 2, 2013 at 7:59 pm

Sorry, I had some “puppy” problems.

Currency can be a MOE in the real economy.

[Central] bank reserves are a medium of exchange for banks [covered by the central bank] dealing with each other in interbank payments and settlements. [They can't be MOE in the real economy.] OK

Can central bank reserves be considered the demand deposits of the central bank? Can they be considered “substitutes” for currency in the banks covered by the central bank?

Demand deposits can be a MOE in the real economy.

Although Wikipedia is probably not the best place for economic references.

http://en.wikipedia.org/wiki/Unit_of_account

“A standard unit of account allows meaningful interpretation of prices, costs, and profits, so that an entity can monitor its own performance and its shareholders can make sense of its past performance and have an idea of its future profitability. In modern economies, money in the form of ***CURRENCY*** usually serves the role of the standard unit of account. The use of money, under conditions of price stability, vastly improves the efficiency of market economies.”

I think MOA = MOE = currency plus demand deposits. Those denominations would be unit of account. I’m going to guess at least 90% of economists and people who comment about economics would say MOA = currency or MOA = currency plus central bank reserves. The MOA = currency plus central bank reserves people say convert the central bank reserves to currency to get them circulating and prices will rise. I think MOA = MOE = currency plus demand deposits so converting demand deposits and central bank reserves to currency will probably not do much. Demand deposits go down and currency goes up 1 to 1. The MOA composition changes, but the amount does not.

Lastly, when entities post prices, it actually means \$1 of currency ***OR*** \$1 of demand deposits as long as there is 1 to 1 convertibility.

• JKH March 2, 2013 at 11:44 pm

As I said, I don’t understand the usefulness of this abstract classification system of UOA, MOA, and MOE. You have your own opinion on it, but unfortunately I’m not that interested in the thing you’re questioning – so I can’t add too much here. I think the monetarist obsession with this sort of thing correlates with their insistence on ignoring real world banking in developing the subject of monetarism. I just can’t relate to such a deliberately cloistered approach – maybe in mathematics – but not in economics.

• Fed Up March 3, 2013 at 12:11 am

MOA is involved with the price level. If people think MOA = currency plus central bank reserves when it is actually currency plus demand deposits, that can lead to incorrect conclusions.

Let me try it this way. Currency = 800 billion, central bank reserves = 200 billion, and demand deposits = 6.2 trillion. Something similar to 2007-2008 happens. Currency = 1.0 trillion, central bank reserves = 2.0 trillion, and demand deposits = 3.0 trillion. One camp says MOA went from 1.0 trillion to 3.0 trillion and prices should rise. Another camp says MOA went from 7.0 trillion to 4.0 trillion and prices will most likely fall.

It seems to me something similar happened right around the Great Depression and Japan from the late 1980′s to mid 1990′s.

• JKH March 3, 2013 at 4:33 pm

Again, I’m not interested in that particular terminology.

But if I understand the basic point you’re making, I think it’s a good one.

And I think the point is that for purposes of understanding how money plays a role in the economy, the amount of currency and demand deposits outstanding is a more useful aggregation than the amount of currency and bank reserves – although the former must still be interpreted in full context.

And I’ll go further and say that the latter aggregation – i.e. the monetary base – is actually a dangerous concept for purposes of understanding what’s really going on in the economy. I’ve been planning a post on this aspect, but it’s going to have to wait for a while.

• Fed Up March 3, 2013 at 7:47 pm

“And I think the point is that for purposes of understanding how money plays a role in the economy, the amount of currency and demand deposits outstanding is a more useful aggregation than the amount of currency and bank reserves – although the former must still be interpreted in full context.”

That’s exactly the point I am trying to make.

• Greg March 4, 2013 at 7:58 am

JKH

Regarding the MOA vs MOE terminology; Here are some of my own conceptions of it and I would like to know what you think and how you might describe things differently.

I conceive of MOA as price or numeraire and MOE as what you can exchange for something. Now they are certainly related in that much of the way a price gets attached to something is that someone has exchanged an amount of the MOE for that. But that price changes and many entities use that “price of asset” as exchangeable money and that can be problematic at times. What Im getting at I guess is when an entity invests in something, a stock, a house or a bond, somewhere an accounting statement puts a price on that and we think of that as our wealth level so to speak. Eventually though some holder will want to redeem the asset for medium of exchange (currency or deposit…. not reserve) so the asset is not really the “money” they want when they wish to spend.

This MOA type money is very important to the health of our banks balance sheets (and individuals too) but the price levels of these assets can widely diverge form the amount of MOE currently in the system to purchase them. Isnt that what a market crash is in affect? An instance where everyone wishes to redeem their asset at current top price but because of the preponderance of those wishing to sell the sale price falls precipitously. In this instance no one has lost any MOE, levels of currency and deposits have stayed the same but MOA levels have plummeted.

Maybe this is all monetarist type garbage(maybe Im a monetarist and dont even know it…….. yikes!!) but I would appreciate you describing what Ive described in terms more comfortable to you

• JKH March 4, 2013 at 8:22 am

Hi Greg,

It’s possible I’ve been too dismissive of this, or dismissive in the wrong way.

Perhaps I haven’t thought about it enough to earn a put option on the concept.

I think what you’ve written is fine.

I’m just not clear on why it’s necessary to become so fancy using this type of vocabulary. A good deal of what you’ve described can be framed in the context of prices and nominal money – within the normal setting where the MOA is the same as the MOE. That’s normal.

I just don’t get the highfalutin discussions about permutations and combinations of MOA, UOA, and MOE – in terms of their usefulness – even in theory. Quite frankly, it gives me a headache to see this stuff debated by the high priests of monetarism. They’re free to do, but I don’t quite get it.

Your description of it is quite straight forward and understandable and reasonable. But does it actually depend on using such refined vocabulary?

• Greg March 4, 2013 at 8:46 am

Thanks for the response JKH

I agree that much of that talk is un necessary and in fact MOA and MOE is almost never in my language, except when someone else brings up the concept and I use my own conceptions of it to try and find out what they are talking about.

I actually like your use of prices and nominal money better.

So let me ask something using your terms. Does a bank when issuing a loan change the level of nominal money in the system?

My own perception is NO, because while they have issued a deposit there is an offsetting debt but please correct my understanding if you see it as wrong.

Additionally I have the sense that nominal money is, in the end, what most people are trying to save. Yes they buy things with it and want the price to rise so they can redeem it for more nominal money but they would be just as happy if they just got the nominal money and didnt have to trade some financialized asset for it.

Thanks

• JKH March 4, 2013 at 9:52 am

“Does a bank when issuing a loan change the level of nominal money in the system?”

I look at this in simple terms.

Yes, the level of nominal money changes (other things equal).

Loans increase; deposits increase.

The money is different than the loan.

The same as the car is different than the rental contract for the car.

• Greg March 5, 2013 at 6:23 am

Hey JKH

“I look at this in simple terms.
Yes, the level of nominal money changes (other things equal).
Loans increase; deposits increase.
The money is different than the loan.
The same as the car is different than the rental contract for the car.”

Boy your simple terms sure leave one with a LOT to think about!!!

I realized after I wrote my question that of course if deposits increase then by definition nominal money would increase as deposits are a component of nominal money. My conclusion was based on a debit and credit cancelling each other out so to speak but in fact the debit on my (borrower) balance sheet has a time component to it as well, so the cancellation is not really at inception I suppose. Is this sort of what you mean by money being different from the loan?

It also is my understanding that this nominal money is what is used to buy stuff, pay back loans and save for future consumption. Being the case, this nominal money must increase relative to the loan values or there cannot be enough to pay back loan contracts with interest. So what in your model keeps these levels of nominal money growing? It doesnt seem like it comes from the loans them selves because the interest isnt created during the loan creation process, it must come from elsewhere. Is this a fair statement or gobbldeygook?

In addition, what process decreases the amount of nominal money in the system if any?

Thanks

• JKH March 5, 2013 at 7:28 am

I should have qualified what I wrote there by saying I broke my cardinal rule – which is not to use metaphors.

Going into tabula rasa territory on loans and deposits:

Loans are not deposits or “money” – these are two very distinct things. The fact that they exist separately in accounting terms means they are separate in substance – one is the record of what creates the money (and what will eventually be destroyed by money) and the other is the money.

The question of money growth is a potentially complicated one (even connected to Marx).

But here’s a very high level simplification:

Suppose you have an economy with one loan and one deposit. At the end of one accounting period, the bank will have earned a net interest margin on that loan. That comes from the interest paid by the borrower less the interest paid to the depositor. Assume the NIM is the bank’s earnings and it pays that all out as cash dividends. That means the bank NIM will be converted back to deposits. So the loan is still there, the deposit is still there, and all interest has been paid.

By inference, that means the circulation of all actual transactions in the economy has allowed all interest to be received and paid from the bank’s perspective. And because the money was available in total at the bank level, it must have been available at the non-bank user level in aggregate – specifically for the borrower to pay that interest.

The rest of it is just a matter of how the original deposit was used in real economy transactions in order to facilitate all that. It becomes a matter of stock/flow reconciliation. Most people make the mistake of thinking that the payment of interest (a flow) requires a corresponding increase in the stock of money. That is not the case.

• Ramanan March 5, 2013 at 8:24 am

JKH,

So you are saying that the “paradox” is resolved by bank owners making expenditures or purchasing financial assets. Gennaro Zezza I think also resolved it like that – also mentioning those who discuss this are unaware of stock-flow consistency methods.

Also other people neglect several flows – so there are black holes in many places.

More generally it is a purely academic problem because it is phrased in a pure private economy but understood by those who try to resolve it unsuccessfully. There is the government sector and the external sector which brings in more flow of funds complications but these are easier in a sense than a pure private economy.

• JKH March 5, 2013 at 9:31 am

Doing a pretty big short cut here Ramanan, but one thing I’m saying is that in a theoretical steady state system, there is no reason for banks to retain earnings, so those can all be dividended back to deposit form. So the amount of deposits is always the same effectively, all the stocks and flows are in equilibrium, and the whole thing becomes a reconciliation of steady state flows to steady state stocks based on a steady velocity of money. Intuitively, the flow of funds is analytically separable from the flow of goods and services and the velocity of money that is required to support that flow. From there, in a dynamically growing economy, it is all a matter of adjustment upward – growing loans and deposits, growing retained earnings (but probably not all retained) and random adjustments to velocity as required up or down etc. etc. This whole thing should not be the mystery that it is – its a matter of recognizing the relationship of the flow of interest to the stock of money, and how everything grows proportionately in a growing economy. I just think the most direct way to go at it is to look at the NIM of banks as covering the essential stock flow connection between interest, equity, and deposits, etc etc.

Alternatively – go to Steve Keen’s model?

That gets you one or two more equations than what I’ve done at least.

• Tom Hickey March 5, 2013 at 10:36 am

JKH, you might consider dedicating a post to this. There seems to be a lot of misunderstanding about the effect of compound interest, i.e., new money always has to supply the interest so the debt stock has to keep growing to the degree that money creation requires borrowing, creating a vicious circle. See for example, Washington’s Blog, “The Magic of Compound Interest,” quoting Ellen Brown:
http://www.washingtonsblog.com/2008/10/the-magic-of-compound-interest.html

• Ramanan March 5, 2013 at 10:38 am

JKH,

Some comments sometime else but: In the most optimistic scenario of the world, Steve Keen and his fans will barely manage to produce what stock-flow models already say (with simulations in excel sheets!).

• JKH March 5, 2013 at 11:10 am

Tom,

So many potential posts in my head, my brain is exploding – and too little space to get to them right away. You’re right on this one – it’s a huge issue in terms of massive misunderstanding of how the flow of funds works – and unfortunately, I must say there is an ideological tinge to the survival of that misunderstanding – as in those bad banks who must keep on lending in order to get the interest paid, and as in Marx ensuring the collapse of capitalism because interest simply can’t get paid. Steve Keen definitely has a view on it although he does his usual complex modeling to come up with the answer. I also don’t recall seeing where the MMTers have written about this, but quite possibly I’ve just missed it. I would expect that Marc Lavoie has covered it, simply given the structure of Godley/Lavoie and the exhaustive detail he goes into there on the flow of funds.

• Oilfield Trash March 5, 2013 at 11:27 am

JKH, Tom

One of Steve Keen paper’s that I like alot ( I can actually understand it). Not offering it as fact, but it may help frame this issue.

• JKH March 5, 2013 at 11:48 am

Interesting thing from Keynes in that paper:

“Keynes concludes with observations about the tendency of economists to confuse finance and saving, and stocks and flows. “‘Finance’”, he emphatically declared, has nothing to do with saving. At the ‘financial’ stage of the proceedings no net saving has taken place on anyone’s part, just as there has been no net investment.”

That’s basically the distinction between flow of funds accounting and NIPA accounting – completely compatible measures – but lethally misleading when incorrectly conflated. And it happens all the time.

• vimothy March 5, 2013 at 12:59 pm

“‘Finance’”, he emphatically declared, has nothing to do with saving. At the ‘financial’ stage of the proceedings no net saving has taken place on anyone’s part, just as there has been no net investment.”

JKH, I have a question. (This is probably a bit of a tangent, but it’s open to anyone.) Given the above, what do you make of the idea that banks can create savings (flow or stock) ex nihilo by making loans?

• wh10 March 5, 2013 at 1:27 pm

This is a really interesting discussion regarding money needed to repay interest. It seems, though, that the temporal relationship between interest/principal payment matters here. Using JKH’s model, the interest can be repaid without new loans. But what if the interest and principal have to be paid at the same exact time? So, let’s say a bank makes a loan of \$10 in period 1, and in period 2, \$11 is owed back (interest + principal) at the same exact time, else there is default. Then it seems we’re in trouble. This is highly stylized and theoretical, but nonetheless…

• Oilfield Trash March 5, 2013 at 2:39 pm

JKH

but lethally misleading when incorrectly conflated. And it happens all the time.

• JKH March 5, 2013 at 2:54 pm

vimothy,

the loan itself does not create saving or savings (flow or stock)

the use of the money, which is separate from the loan itself, may do so in future

but the eventual income and saving effect depends on the sequence of investing or spending that follows on from the loan, and which is separate from the loan itself

• JKH March 5, 2013 at 3:34 pm

Wh10,

So imagine I borrow \$ 10 from the bank and use it to buy a tattoo machine from another tattoo expert who wants to take a sabbatical. I negotiate a 1 year buy back clause whereby I get to sell him his machine back for \$ 10.

The seller leaves his money in the bank. Assume he earns no interest. Maybe he just wants a low risk investment and wants to take it easy without the hassle of being in the tattoo business himself for the next year.

I charge you \$ 1 dollar for a tattoo. I will earn no profit. I am merely obsessed with doing good works in tattoos.

That dollar comes out of your pre-existing deposit.

After I “tattoo you”, I sell the machine back to the original owner for \$ 10.

I pay off my principal and interest of \$ 11.

The original loan and deposit are now gone. The owner has no deposit and has his machine back, ready to go back into business.

The bank now has earnings and equity of \$ 1 – it paid no interest on the deposit.

Tracing it back, the source of that equity was your \$ 1 dollar pre-existing deposit.

Maybe the bank dividends out the \$ 1 back to the stock holders.

Maybe you’re the stockholder.

So you got your tattoo as a real dividend.

Otherwise, your stock reflects underlying retained earnings value 1 \$ dollar higher.

Is there a problem with this in terms of feasibility?

More importantly, are you happy with your tattoo?

• Tom Hickey March 5, 2013 at 3:43 pm

JKH, do I sense that beowulf is coaching you? Very good.

• wh10 March 5, 2013 at 4:59 pm
• Fed Up March 5, 2013 at 11:04 pm

“A good deal of what you’ve described can be framed in the context of prices and nominal money –”

I know you are sick of me saying this, but I believe it is extremely important. If you say “nominal money”, most people are going to think monetary base (currency plus central bank reserves) and some people will think currency. I believe very, very few will think currency plus demand deposits.

“within the normal setting where the MOA is the same as the MOE. That’s normal.”

I believe a lot of people don’t think that is normal. They think MOA does not equal MOE from what I can tell.

• vimothy March 6, 2013 at 5:07 am

“the loan itself does not create saving or savings (flow or stock)”

Why I ask is that I sometimes see the argument that the loanable funds model is wrong because banks can create the savings needed to finance investment by making loans. (Writing it down like that, it doesn’t seem to make much sense, so maybe someone can help me out with a “stronger version” of the argument?)

• vimothy March 4, 2013 at 12:04 pm

Why all this becomes important is because the macroeconomic significance of money depends on its dual role. On the on hand, we have this particular type of financial asset, called money, and on the other hand, we have a set of prices all denominated in money. What this means is that things that happen in the market for this particular financial asset can have implications across the whole of the economy.

• vimothy March 4, 2013 at 12:13 pm

It’s this relationship, when you think about it, that explains why we have monetary policy. If money were just another financial asset, and not the numeraire, then we wouldn’t need to worry about managing it.

• Greg March 5, 2013 at 6:32 am

” If money were just another financial asset, and not the numeraire, then we wouldn’t need to worry about managing it.”

The dollar is both it seems to me. A financial asset AND the numeraire. The numeraire just says how many of those financial assets you need to own this good with the numeraire attached. This is just about having an agreed upon convention to determine price or value. You could quibble about how much we have all “agreed” to the convention, but in practice we are all agreeing.

• Fed Up March 6, 2013 at 4:01 pm

More attention needs to be given to how MOA/MOE (currency plus demand deposits) increases and decreases???

• wh10 March 5, 2013 at 3:59 pm

Sorry, maybe the pre-existing deposit assumption/definition was already stated and I missed it, but I think the key is where my pre-existing deposit came from. Under certain assumptions, if it also came from a loan, I think there is a problem.

Period 1: At the very beginning of Period 1, JKH borrows \$10 (and will owe \$11 at the very beginning of period 2), and wh10 borrows \$1 (and will owe \$2 at the very beginning of period 2). At the end of Period 1, JKH purchases the tattoo machine for \$10, sells a tattoo to wh10 for \$1, and resells the machine for \$10.

Period 2: At the very beginning of Period 2, JKH pays off the \$11, but wh10 cannot pay off the \$2. Wh10 defaults.

So it seems to me, if the source of all deposits are banks loans, principle+interest cannot be paid at the same time without additional loans. However, if wh10’s deposit was not originated from a bank loan, but say a govt deficit, financed via money printing or bonds sales to the banking system, then new private bank loans would not be necessary. So yes, pre-existing deposits make it work, but they cannot be originated from bank loans.

• Ramanan March 5, 2013 at 10:28 pm

Wh10,

You may be going out of debt precisely when someone else is going into debt – so that the paradox doesn’t result.

This by itself doesn’t resolve it but imagine a situation in which non-banks need to borrow more and more. This will result in banks making more and more and paying dividends and will result in expenditures by the dividend getters – bringing down firms’ debt ratios. So one can think of situations in which debt ratios do not increase forever.

Of course that doesn’t mean it is always the case (debt/income stabilizing) but the original paradox sort of says that (as a corollary) that it is never the case.

• wh10 March 5, 2013 at 10:48 pm

Maybe I am misunderstanding you, but I don’t think your example resolves the paradox (not sure i’d call it a paradox though, it is what it is) because it requires someone else to go into debt to fulfill the prior debt obligation, which was my point. in any case, i think this all depends on the specific assumptions (which i stated, in part), and i wasn’t trying to make a broad generalization.

• Fed Up March 5, 2013 at 11:23 pm

wh10, assume money = MOA = MOE = currency plus demand deposits and assume everyone is what I consider smart enough not to go into debt anymore and elect a gov’t that does not go into debt anymore. What happens to MOA/MOE?

• Ramanan March 5, 2013 at 11:24 pm

Wh10,

Yes was your point in any case. (that someone else needs to go into debt).

My point was incomes also increase – the original link Tom linked to and the kind of story in discussion in the reference there sort of assumes implicitly that it is an inherently unsustainable process where debt/income rises forever. There are regimes where it can become unsustainable and there are regimes where it is sustainable. There is also a question of stability which is slightly separate.

So my point was that someone else going into debt isn’t necessarily bad.

• JKH March 5, 2013 at 11:38 pm

So you acknowledge the example works with pre-existing deposits.

Therefore the only question is whether it works without pre-existing deposits.

We can prove that by demonstrating it can work at the birth of the monetary system – before there were any banks or deposits.

We’ll refer to this as … um… the Garden of Eden monetary system.

Two agents emerge from the wilderness of barter, seek to bite into something of a monetary nature.

X produces something real that he would have exchanged with Y for something of equal value.

So God sets up a monetary system with banks.

God decrees no risk and no capital requirements – things will work out.

So X and Y each borrow an equal amount from the bank and are credited with a deposit.

They each swap their deposit with the other in exchange for the goods they each produce for the other.

The bank charges each of them the same interest on their loan but pays no interest on their deposits.

God in his wisdom instructs the bank to pay a dividend to each of X and Y, based on an initial allocation of equal common shares in the bank for each of them.

All payments occur at the end of the period.

The dividend pays for the interest.

They each have their desired stuff and pay back their loans.

Done.

• Greg March 6, 2013 at 5:33 am

It seems to me JKH that all youve done in your example of a “virgin bank story” is change a barter of goods to a barter of currency or bank deposits. Help me if Im missing something.

That scenario does not sound like capitalism its just a third party accounting record of socialism where all the exchanges result in the parties remaining on equal footing, accounting wise.

Barter is socialism really. I exchange something to you of equal value for something of yours. Neither one of us ends up better off or profiting. To realize a profit someone has to end up relatively better off then the other and in our system a third party bank does the accounting to determine how much better off A is then B……. but the bank gets their piece of every transaction as the mediator.

• JKH March 6, 2013 at 5:45 am

capitalism versus socialism is not the issue

the issue is to demonstrate how interest is paid in banking

one thesis is a categorical statement to the effect of “where does the interest come from”, etc.

• wh10 March 6, 2013 at 7:50 am

JKH – I think I understand this point about dividends taking care of interest payments. However, I think that only works under certain assumptions. I guess, first, do you disagree with what would happen in my specific example, where I used simple numbers and Periods 1 and 2? Secondly, in your Garden of Eden example, if the interest and principle were required at the same exact time, rather than separately, there still seems to be a problem (this basically becomes my example). However, I don’t know what assumptions are most realistic.

• Matthijs March 6, 2013 at 8:18 am

@wh10: your example of not being able to pay the interest only happens on an individual level. Say in a 2 person system, one participant makes money and doesn’t spend it (keeps it in a mattress). The other now has a problem because he can’t earn enough to pay the bank the interest.
But in the system as a whole, you can’t say there’s not enough money, like in “not enough stock of money”. That’s mathematically impossible, as JKH showed before.

It’s only a problem for some participants if the flow of money is going elsewhere and gets stuck there and the participants are not able to earn enough.

Of course in the real world there are billions of participants in a system and there’s trillions going around. So then for each participant it’s just a matter of earning enough individually to pay the loan+interest back. Of course some will not be able to do that and will default.

What can confuse this issue I think is the stock vs flow thing. When people talk about “not enough money in the system to pay the interest”, they talk about stocks, like there’s literally not enough money. Stocks only matter if you would create an artifical situation in which at exact moment X in time every loan plus interest has to be paid. That doesn’t happen of course. And even then, as JKH showed, mathematically there’s always enough to pay loans plus interest.
But in the real world what matters is flows. And in that case, there isn’t even a lot of money needed to pay back loans plus interest: person 1 pays the bank \$10 interest. The bank pays a supplier for a service. Supplier pays \$10 in interest to his bank. That bank also pays someone for something. That person again pays some interest. Etc etc. One \$10 note can pay back many times that amount in interest, just by going around many times.

• Greg March 6, 2013 at 8:36 am

Capitalism vs socialism was the wrong wording, I should have said profit making or surplus. There seems to me to be no profit or room for growing profits the way youve set up your virgin bank story. How does one party become better off than the other?

How does one party have a higher worth, measuring worth in whatever units the bank is using as its numeraire?

Somewhere someone in real life ends up with more relative to the rest. More nominal money AND higher prices of the things they own, how does that happen in your virgin bank example is what I want to know?

Additionally it seems to me that the only way one ends up wealthier is to have more nominal money than someone else. Certainly not JUST more nominal money but the real wealth (or price to use your terminology) difference is accompanied by nominal money difference. Im struggling to find out the mechanism by which that happens in a solely private bank scenario

• wh10 March 6, 2013 at 9:05 am

Matthijs – I think I agree. I used the word “temporal” before, which was my way of getting at “flow.” The idea of principle+interest at the exact same time vs. interest before principle etc is a matter of timing of flows, and in one scenario there’s enough and in one there isn’t. That all said, I must admit, I think the more realistic assumption is that the timing of flows is problematic if you don’t have a base pre-existing deposits, even if comparatively small, not tied to bank loans, but I really have no basis for that other than uninformed intuition. It’s just a sense of what’s needed for stability in general.

• wh10 March 6, 2013 at 9:08 am

BTW Matthjis I do think you’re over-reaching a bit with this mathematical claim. Like I said, it depends on the temporal relationship. \$1 can be used for \$1000 worth of activity, but realistically, it can’t all be done at the same time.

• JKH March 6, 2013 at 9:22 am

wh10

a bit rushed now so I’ll have to look at your example later today

but just a point on overall logic around the question/problem at hand:

as I understand it, the general premise of what we’re talking about is that there are some who believe that it is not “possible” for the banking system to service its interest payments over time without new lending – I would describe that as a categorical proposition – which I think is wrong

so to demonstrate it’s wrong, I try and falsify it

the first example falsified it, but happened to include the condition you pointed, which was the existence of pre-existing deposits

so the next case is to prove that such a condition isn’t necessary in order to falsify the proposition further

in order to do that however, we must understand what the prohibition of pre-existing deposits means – which I conclude as implying a state of the world in which the banking system simply hasn’t been created yet – by implication of there being no deposits yet

so I construct an example where the banking system is created and everything is happening for the first time, and where the proposition is again falsified in my construction

so far, that means to me that I have completely falsified the proposition, because it seems to me that I’ve proven its false in a bisection of all possible world conditions according to the existence or non-existence of pre-existing deposits – if I’ve covered it off in those two states of the world, I’ve covered it off for all space and time, it seems to me

now, beyond that, I can construct any particular case where the proposition as applied to that particular case is true – but that particular mode in itself is not the essence of the proposition, which is supposed to be universal and therefore unfalsifiable

for example, if I am unable to pay my credit card bill and go into bankruptcy and if as a result of my personal financial recklessness there is a butterfly effect that ends up causing another global financial crisis and a world depression, then I have proven the proposition in a particular case, but that is not the same as it being a categorically true proposition, which is what I think I have proven to be false

my guess is that your example(s) may fall into the particular case category, as in my example above, but that does not in itself undo my falsification of the proposition as a universal one

that’s where I am so far – but I’m open on it – but I’ll have to come back later

meanwhile, boys and girls, this post is now # 1 on the most popular post list on MR

pushed the one on diagonal MR out of # 1

• Cullen Roche March 6, 2013 at 2:28 pm

Ha, well the whole “diagonalist” terminology was kind of a play on words anyhow and probably confused more than it helped so it never deserved to be #1.

• JKH March 6, 2013 at 9:28 am

which is sort of interesting because we all know that the content of the post itself isn’t exactly universally popular

• Matthijs March 6, 2013 at 9:33 am

@wh10 “BTW Matthjis I do think you’re over-reaching a bit with this mathematical claim. Like I said, it depends on the temporal relationship. \$1 can be used for \$1000 worth of activity, but realistically, it can’t all be done at the same time.”
True, it’s just an example. But I think it’s enough to show what I tried to explain.
“Matthijs – I think I agree. I used the word “temporal” before, which was my way of getting at “flow.” The idea of principle+interest at the exact same time vs. interest before principle etc is a matter of timing of flows, and in one scenario there’s enough and in one there isn’t. That all said, I must admit, I think the more realistic assumption is that the timing of flows is problematic if you don’t have a base pre-existing deposits, even if comparatively small, not tied to bank loans, but I really have no basis for that other than uninformed intuition. It’s just a sense of what’s needed for stability in general.”
Yes. In fact isn’t this what you see already happening in the real world? Almost as soon as the flow of new loans/investments decreases temporarily, that can be enough to trigger some recession. Even a decrease in economic growth, say from 4% to 1%, while that is still growth, can trigger a recession if a vicious cycle is created. However, that’s more a behavioral thing then a mathematical rule (as in “there is not enough money to pay the interest”). If enough people start saving too much and spending or investing too little, this negative cycle is created and more and more people can’t pay their debts.

• wh10 March 6, 2013 at 10:05 am

Matthijs – right. I do think there is an institutional component as well as behavioral, though; the relative magnitudes of importance, I don’t know. The way loan contracts are structured can increase or decrease flexibility as to timing of payments, which seems like it could affect stability as well.

• Oilfield Trash March 6, 2013 at 10:12 am

Matthijs

Exactly, money circulates therefore the amount of money (stock) doesn’t limit uses over time (flow where stock turns over several times in a given period). Need the variable of velocity to tie this together.

• Fed Up March 5, 2013 at 10:55 pm

“In this instance no one has lost any MOE, levels of currency and deposits have stayed the same but MOA levels have plummeted.”

What happens if MOA = MOE?

What happens if there are debt defaults above capital levels and debt repayments?

• Fed Up March 5, 2013 at 11:31 pm

Greg’s post said: “So let me ask something using your terms. Does a bank when issuing a loan change the level of nominal money [currency plus demand deposits] in the system?”

I’m going to say borrowing from a bank increases MOA/MOE in the present. What about the future?

I’m going to say borrowing from a friend does not increase MOA/MOE in the present.

• JKH March 6, 2013 at 5:39 am

Vimothy,

Loanable funds is wrong because it assumes a fixed money supply (at least that’s the rough idea).

Endogenous money is right because loans create deposits.

The money in either case is separate from the issue of investing and saving.

The money in either case can be used in some cases to spend on newly created investment, which in turn creates new income for the factors of production and forces the creation of saving at the macroeconomic level

(because investment = saving, at the margin, at the macro level).

Banks don’t “create savings” by making loans. They create deposits.

New lending is an asset-liability swap that in itself as a banking transaction creates zero wealth and therefore zero saving.

The saving and the wealth come later, depending on how the money is used.

Banks do “create savings” in the form of their own retained earnings – but that’s not the issue of lending creating deposits that you’re referring to.

• vimothy March 6, 2013 at 5:53 am

JKH, I don’t see why a fixed money supply is necessary for loanable funds. (My reading is that the loanable funds market is a market for intertemporal trade.) Can you explain the connection?

• JKH March 6, 2013 at 5:56 am

that’s my super rough summary of it – maybe too rough

can you explain your interpretation of it?

• Fed Up March 6, 2013 at 4:19 pm

“Loanable funds is wrong because it assumes a fixed money supply (at least that’s the rough idea).”

I thought loanable funds assumed only the central bank can increase the “money supply”?

“Endogenous money is right because loans create deposits.”

So what should people be told who say debt doesn’t matter because we owe it to ourselves, debt doesn’t matter because it is an asset to one entity and a liability to another entity, and debt doesn’t matter because for every borrower there is a lender?

• Fed Up March 2, 2013 at 11:26 pm

“Bank of Montreal monetary IOUs really are IOUs. They are promises to pay Bank of Canada IOUs on demand, at a fixed exchange rate. It’s the Bank of Montreal’s job to ensure that one Bank of Montreal Dollar = one Bank of Canada Dollar. It’s not symmetric. The Bank of Canada can make its dollar worth whatever it wants, and the Bank of Montreal has to follow along and make its dollar worth the same amount.

That’s what gives the Bank of Canada the power to control the total supply of money in Canada.”

“This gets more interesting from my perspective. I’ve seen previous posts of Nick’s around this topic, and found myself disagreeing entirely with his general notion of “asymmetry”, although I can’t remember exactly why right now.”

The only thing I can think of is that there are more demand deposits than central bank reserves. If something like negative IOR causes a bank run, he might be assuming that the central bank won’t allow all the demand deposits to be redeemed for currency.

• vimothy March 2, 2013 at 11:46 am

Hey, if you guys do requests, what about a post on Bitcoin one of these days…?

• vimothy March 2, 2013 at 7:30 pm

Bitcoin appears to be what you get if you cross a really smart computer scientist with Zero Hedge.

• stone March 3, 2013 at 3:35 am

From Cullen vs Jose above:

” “No, govt’s who run a budget surplus generally run a trade surplus”.
Yeah, I remember those magnificent U.S. trade surpluses of the Clinton budget surplus era. ”

My recollection of the billyblog message about budget surpluses was that they were sometimes in exceptional circumstances needed to destroy money so as to reduce aggregate demand so as to prevent inflation. Bill Mitchell gave the example of Norway where he said that the massive oil revenue needed to be taken out of the economy so as to prevent inflation. I realize that that fits in with Cullen’s caveat that it is a big trade surplus. Also the Norway government buys foreign stock market shares with the budget surplus. I think Bill Mitchell would say that that is an afterthought and that the primary driver of the taxation is to reduce aggregate demand BUT Cullen could also make the case that the tax money is being used to buy stocks rather than going into a shredder.

Bill Mitchell also used the example of Iceland in the 2000 to 2006 period. Then Icelandic banks were raking in crazy amounts from global asset bubble blowing. The Icelandic government ran big surpluses from all of the tax money coming in from the banks. I guess that is very much like the Clinton surpluses that were driven by capital gains tax receipts from the tech stock bubble. Speculative capital flows into a country can result in government surpluses that are not really driven by the government seeking to have spending money ?????

• stone March 3, 2013 at 7:40 am

This is a really stark example of how investment doesn’t increase nominal wealth if there are not customers paying enough to support the financing costs:
http://www.scotsman.com/news/climb-base-firms-won-t-get-a-penny-1-1019812
I know that this is an example of dumbness on a fairly small scale but it does illustrate that there is the potential for the private sector to spend millions building real assets and to end up with not a penny more in nominal wealth. I guess it is the prospect of the same phenomenon that is stopping the private sector from doing all of the sensible things that everyone wants done. For instance I guess the two billion people without access to clean water or sanitation are largely within reach of global capitalism since they are fully able to buy coca cola and Marlboro cigarettes BUT providing them with sewers would be as financially dumb as building that Scottish climbing gym for the same reason, the end users don’t have the money.

To me the bottom line is not whether there can be flows of saving by private investment in building real assets but whether or not those flows subsequently reverse due to lack of customers. That prospect is what often stops investment happening in the first place.

• vimothy March 5, 2013 at 7:17 am

“The dollar is both it seems to me.”

Right, and what I am saying is that it’s this dual rule that makes “dollars” a macro-economically important variable. Because the price of every good is quoted in dollars, when the price of dollars changes, the price of *every* good changes. (This is why the naive comparison between prices at different times fails–the units are different. Hence the need for price indices to measure changes in the value of the dollar.)

Since changes in the value of the dollar result in changes in the price of every good, changes in supply and demand for the dollar can affect supply and demand throughout the whole economy. That’s what makes money so significant. This is the channel through which you get Keynesian / monetary business cycles. But you do need both sides of money–the MOE *and* the MOA function (or whatever terms you prefer)–so that supply and demand in the money market can have system-wide effects.

If prices were quoted in, I don’t know, some other good X rather than dollars, then supply and demand for good X would affect supply and demand in all other markets, but supply and demand for dollars would not be significant on a global level–at least, no more than any other financial asset.

• Greg March 5, 2013 at 8:02 am

Well certainly the value of the dollar changes every minute literally, but one must ask relative to what of course, and we dont see prices change by the minute, so Im not sure the connection you make between the dollars prices and goods prices is as strong as you suggest. In a given day a currency might fluctuate 10% but prices of things in that currency stay the same.

“f prices were quoted in, I don’t know, some other good X rather than dollars, then supply and demand for good X would affect supply and demand in all other markets, but supply and demand for dollars would not be significant on a global level–at least, no more than any other financial asset.”

There would be no need for dollars at all in this example, there would be a global currency of that good you speak of. Which is essentially what a gold standard was and why we no longer use gold standards.

• vimothy March 5, 2013 at 9:20 am

Greg: How could the value of the dollar fluctuate when no prices change?

Dollars are priced in “goods” (i.e., in everything else available for sale). If the price of these goods goes up, then the value of the dollar comes down. The value of the dollar going up (or down) is logically equivalent to prices going down (or up). That’s money’s unit of account function.

Because dollars are also exchanged for goods, demand for dollars equates to supply of everything else and supply of dollars equates to demand for everything else. That’s money’s medium of exchange function.

Taking both of these functions together, the result is that if supply and demand for money changes, but prices do not (because prices adjust gradually, for example), then there can be excess supply or demand for goods across the whole economy.

• stone March 5, 2013 at 8:40 am

JKH
By inference, that means the circulation of all actual transactions in the economy has allowed all interest to be received and paid from the bank’s perspective. And because the money was available in total at the bank level, it must have been available at the non-bank user level in aggregate – specifically for the borrower to pay that interest.
The rest of it is just a matter of how the original deposit was used in real economy transactions in order to facilitate all that. It becomes a matter of stock/flow reconciliation. Most people make the mistake of thinking that the payment of interest (a flow) requires a corresponding increase in the stock of money. That is not the case.

Doesn’t it all depend on there being enough flow back from the creditors to the debtors? If creditors only buy stuff from other creditors (eg they sell each other stocks, mansions and art works) then things get messy. I guess the idea that interest means more and more money is needed is based on the impression that in practice creditors don’t buy enough from debtors? Is there a good historical example of a debt based financial system persisting in a fairly stable way for many decades?

• JKH March 5, 2013 at 9:40 am

not sure I can answer those bigger systemic history questions, but one way to think about the paradox is that the payment of interest in general is a flow of funds – it is the result of a transaction that is part of the overall velocity of money moving around the system – and in itself, it doesn’t require an increase in the stock of money outstanding. Other things put upward pressure on the demand for an increased stock of money more generally – but interest at the end of the day just moves money from one pocket to another – except that intermediaries like banks take their cut – but as I said to Ramanan above, all of that gets dividended back to deposit form EXCEPT for what is retained as incremental capital – and the ONLY reason to retain incremental capital is to support growth in the banking system and growth in the economy – and it is that general growth that puts upward pressure on the need for the creation of new money and new deposits – again from new lending – so that’s where the pressure for more money creation comes from – not necessarily from the current level of interest payments in the economy

… hey, that wasn’t too bad for some mid-morning scribble

• stone March 5, 2013 at 11:07 am

JKH, you describe it beautifully but I’m still left thinking that real life tends to mess it up. I guess the issue is that creditors almost by definition have surplus money over what they choose to spend. As such, the interest they receive is also likely to add to that surplus and so I guess just sit there rather than flowing back. I suppose it is very important to describe how it could work sustainably just as you described but equally important to describe how it goes off the rails when it does.

• JKH March 5, 2013 at 11:16 am

I certainly agree that its important to consider the “off the rails” piece as well, but that the problem of paying interest as its sometimes perceived may not be quite the right analysis to do that.

• vimothy March 5, 2013 at 12:20 pm

JKH, Excellent (pair of) comments (on interest payments in the steady state, somewhere above (if I’m nesting this right)).

• Oilfield Trash March 5, 2013 at 3:36 pm

Ramanan

Some comments sometime else but: In the most optimistic scenario of the world, Steve Keen and his fans will barely manage to produce what stock-flow models already say (with simulations in excel sheets!).

Very bold, below is a link to the developement of his model.

http://www.kickstarter.com/projects/2123355930/minsky-reforming-economics-with-visual-monetary-mo?ref=card

If you can do all he is proposing in excel, my hat is off to you. I guess time will tell. A “beta” version of Minsky is out on the web running if you are interested.

• Ramanan March 5, 2013 at 9:32 pm

Yes have seen that. A complicated analysis isn’t necessarily right if one gets basics wrong.

• Oilfield Trash March 6, 2013 at 9:30 am

Ramanan

Most criticisms of the new theory are often based on alternative theories, rejection of the abstract-mathematical method, misunderstandings, and alleged errors in the theory.

As Minsky pointed out

Can “It”—a Great Depression—happen again? And if “It” can happen, why didn’t “It” occur in the years since World War II? These are questions that naturally follow from both the historical record and the comparative success of the past 44 thirty-five years. To answer these questions it is necessary to have an economic theory which makes great depressions one of the possible states in which our type of capitalist economy can find itself. (Minsky, 1982a, p. 5)

At a minimum Keen’s economic theory and models can product and explain a Great Depression with out the need for black swains. DSGE models or Krugman’s attempt to breathe life back into IS-LM cannot.

I doubt he is Einstein of economics but I also doubt he is the Silberstein.

• Ramanan March 6, 2013 at 10:39 am

Oilfield Trash,

I have given up on him.

He definitely needs to get his accounting right. He had this fashionable idea called anti-money but seems to have gone out of fashion.

He now has this

aggregate demand = GDP + change in debt

which looks like the engine of his model.

Aggregate demand is simple. It is C – IM + I + G + X and differs from aggregate supply by change in inventories. That is the former doesn’t include change in inventories but the latter does and one can be higher than the other. (although in neoclassical theory it is a curve which intersect the aggregate supply at a price).

The bad thing about accounting models is that the accounting needs to be tight – else one can produce strange self-inconsistent results. Also from a behavioural point of view, he uses the same variable for the actual and expectation of the variable. He can write big models and even manage to get a supercomputer to solve models but unless he gets the simple things right, he is not going anywhere. He will keep getting Dirac’s runaway solutions.

• wh10 March 6, 2013 at 11:10 am

Ramanan, but do you think it’s useful to at least have a robust computer model to work off of, even if the accounting isn’t right? For example, some one down the road could re-engineer it to get the accounting right, but it’d maybe be useful to have what Keen’s doing as a starting point.

• Ramanan March 6, 2013 at 11:40 am

Yes I think he needs to make small changes in the sense that it won’t affect his infrastructure – but if irons out some starting points, he can come to the right track. Simple tweaks can be useful to him – such as assuming a econometric relationship – variables at any time depending on variables at t – delta so that accounting constraints are not violated. My pessimism is because he doesn’t seem to realize it in spite of various people saying it.

He knows a lot of literature/history of economics etc., so won’t be stuck by those things – it’s just that someone needs to put him in the right track but he has a track record of going off track.

• Tom Hickey March 6, 2013 at 1:29 pm

Getting an open source model up and running is hugely important since it will attract “crowd-wisdom.” One person working alone and not full time at that is not going to solve this.

• JKH March 6, 2013 at 3:18 pm

“aggregate demand = GDP + change in debt”

People may have forgotten this, but that was the equation that set off the Krugman/Keen debate a year ago.

That’s the equation that PK called Keen on very specifically in PK’s initial post – i.e. that it made no sense in terms of an internally consistent conceptual framework. And he’s right about that.

From there it generated into a peeing contest about endogenous money. And Krugman strayed off course on that. But that stuff was all a red herring relative to the original issue, which was the equation.

• Ramanan March 6, 2013 at 3:48 pm

Yes right.

He later changed it to effective demand – as if the change makes any difference.

There was a strange defense of his accounting here – written at the time:

http://rwer.wordpress.com/2012/03/29/keen-krugman-and-national-accounting/

• JKH March 6, 2013 at 3:55 pm

strange and mystical

• Fed Up March 6, 2013 at 3:52 pm

Ramanan said: “Aggregate demand is simple. It is C – IM + I + G + X and differs from aggregate supply by change in inventories.”

JKH said: ““aggregate demand = GDP + change in debt”

And, “That’s the equation that PK called Keen on very specifically in PK’s initial post – i.e. that it made no sense in terms of an internally consistent conceptual framework. And he’s right about that.”

I believe that Keen includes financial assets in aggregate demand. I think that is a poor definition, but definitions matter once again.

• Oilfield Trash March 6, 2013 at 5:36 pm

Ramanan

Yes I know, I followed JKH and your spirited debate with Matheus, who does not seem to have the same concerns with Steve’s model as you do.

In the end all of you are smart and my hope is in collaboration ya’ll can work it out.

• Fed Up March 6, 2013 at 3:58 pm

“Can “It”—a Great Depression—happen again? And if “It” can happen, why didn’t “It” occur in the years since World War II?”

Yes, it can.

… because World War II destroyed excess supply and excess labor so economies went back to being AS constrained instead of AD constrained. It took awhile to go from AS constrained back to AD constrained again. I think the 30-year mortgage also played a role.

• stone March 6, 2013 at 2:51 am

JKH
, I must say there is an ideological tinge to the survival of that misunderstanding – as in those bad banks who must keep on lending in order to get the interest paid, and as in Marx ensuring the collapse of capitalism because interest simply can’t get paid. ……. I also don’t recall seeing where the MMTers have written about this, but quite possibly I’ve just missed it.

Does Michael Hudson count as a MMTer? He is a standard bearer for the “miracle of compound interest = disaster” brigade. To my mind however Michael Hudson’s stuff seems entirely compatible with all you are saying because Michael Hudson is so clear about unsustainability being a consequence of those receiving interest NOT choosing to spend it back to those paying the interest. He is repeatedly very explicit about that. After all “compound interest” by definition means compounding the interest rather than spending it on tattoos or whatever . To my mind all the issues regarding wealth inequality etc are actually brought into sharper focus by the clarity you are giving this.
Before I started reading this blog I had a go at wrapping my head around the whole “miracle of compound interest” thing; it is on page 11 “Monetary expansion attempts to realise the miracle of compound interest” of this link:
http://directeconomicdemocracy.files.wordpress.com/2013/01/direct-economic-democracy8.pdf
Looking back at it, I still think it is compatible with what you are saying because you are talking about servicing a steady state of debt that can be funded out of the current economy whilst “the miracle of compound interest” is all about creditors not wanting to spend and more debt being issued to compound “imaginary” wealth.

• stone March 6, 2013 at 3:30 am

Further to what I just wrote, I do see that debt funded real wealth can sustainably grow in a compounding way if debt is used to finance real expansion of the means of servicing that debt through improvements in technology, infrastructure and organisation that can find paying customers. Those are crucial caveats though.

• JKH March 6, 2013 at 4:45 am

I think you’re right.

I’ve noticed Hudson writing on compound interest but haven’t read his stuff closely.

I think he’s pretty much associated with MMT.

What he writes may be compatible, or perhaps more accurately, not necessarily incompatible.

What I’m responding to I think is a “theory” that it is impossible to earn enough interest to service loans without more borrowing. That’s VERY rough, and as I understand it the idea is associated with Marx and with the Circuitist school (according to Steve Keen). I believe Keen is correct in identifying the theoretical error as one of stock/flow consistency – which is basically accounting. I can’t follow his demonstration of this but I agree with the premise.

The Hudson issue I think is more associated with how debt and interest payments play a role in economic cycles. I can’t disagree with that – except that I don’t think the problem is with compounding of interest per se, although that doesn’t help. The problem is one of distribution of credit and debt, which is always an issue in recessions and depressions.

• stone March 6, 2013 at 7:55 am

JKH, I think Michael Hudson was saying that compounding of interest was symptomatic of the problematic distribution of credit and debt you mention and that it exacerbated that problem. AFAIK Michael Hudson says that although Marx also said the same thing about distribution of credit and debt, Marx mistakenly presumed that industrialists would force the finance system to serve industrialization and so problems with finance would NOT be the problems with capitalism in the future. I don’t know anything about Marxism though (apart from it didn’t seem to work ).
Perhaps (as Tom Hickey mentioned above) Ellen Brown is the one to blame for so many people being muddled about this. Unlike Michael Hudson, she doesn’t give much (if any) prominence to the issue just being one of distribution and spending patterns rather than being an intrinsic accounting property of debt based money.

• Tom Hickey March 6, 2013 at 3:40 pm

I didn’t intend to single out Ellen, since Michael Hudson and others are also factors in that they are widely read and quoted. But this is also a pervasive idea I have seen all over the place without attribution. It’s an idea that seems intuitive and has caught on. In fact it has sort of become a meme that self-propagates.

• Ramanan March 6, 2013 at 1:43 pm

I think circuit theory doesn’t conclude it happens like that because outside sectors can add to profits for example but take issue if anyone comes with a resolution with a purely private economy because they think the attempts are not satisfactory enough – at least there is no consensus. They believe however that it can be explained – unlike Marx who I believe thought capitalism is doomed because of this.

The idea has however helped them come up with great insights.

• JKH March 6, 2013 at 2:39 pm

My interpretation of the circuitist interpretation flows through a Keenian filter.