Monetary Realism

Understanding The Modern Monetary System…

JKH On Saving And Sector Balances (WONKISH)

Wynne Godley’s sectoral balances approach can be extremely helpful in understanding the relationship between the three sectors of the economy (private, public and foreign).  But if misunderstood, it can be extremely misleading.   The recent discussion on S=I+(S-I) was intended to clarify the position of the private sector because MMR has noticed a tendency in some MMT literature to lack clarity in describing this relationship.

For instance, when the USA runs a current account deficit and a budget deficit that does not offset the leakage in the current account the private sector position has been described as experiencing a “net loss” in some MMT literature.  But no clarification as to the specifics of this “net loss” is provided (in terms of real or financial wealth) and the reader is likely to come away from the lesson believing that the private sector position is automatically worse off if the government does not deficit spend at all times.   But this is clearly not the case as the majority of private sector real wealth creation occurs through the horizontal banking system through credit creation.  This can clearly be seen over the period from 1997q1 to 2008q2 when the government budget deficit failed to offset the current account deficit in 38 of the 42 quarters and household net worth increased by 110% while corporate profits rose by 140%.  Clearly, the private  sector did not experience a “net loss” over this period even though the budget deficit failed to offset the current account leakage.

The confusion arises from the difference between real wealth and financial wealth as well as misunderstanding saving.  A good way to think about all of this is to understand that the private sector can create real wealth entirely independent of the government.  A farmer does not need the government to turn 1 cow into 10.  But the farmer has achieved real wealth creation regardless of the government’s spending position.  What the government must generally do over time is help to facilitate the wealth accumulation process by providing the net financial assets to help the private sector monetize this real wealth.  But it’s important not to put the cart before the horse here.  It’s best to think of government as being a facilitator of wealth creation and not the driver.  Hence, our focus on S=I+(S-I) with the emphasis on the idea that “the backbone of private sector equity is I, not Net Financial Assets.”   The idea is not novel, but simply clarifies the understanding of the private sector component.

So, the private sector can achieve a “net loss” in financial wealth under the aforementioned scenario (taxes reduce your financial wealth), but the private sector can also continue to expand real wealth at the same time (create 10 cows).  In some cases such as the 1997-2008 period this can result in massive real wealth creation (yes, the housing boom and internet bubble did result in massive real wealth creation) so the key is to understand that a budget deficit that doesn’t offset the current account does not automatically result in a deterioration of the private sector’s overall financial position.  Clearly, if this position is sustained over a long period there can be potential downside effects as the balance sheet recession clearly proves, but that’s a different matter.

The other misunderstanding here revolves around the term “saving”.  If one were to focus simply on the sectoral balances equation and the idea of the “net loss” you might be inclined to conclude that I>S is automatically bad.  But that would lead to terribly misguided policy proposals and a fragmented understanding of the private sector wealth creation process.  JKH has brilliantly summed up this confusion in the comments:

“The correct economic definition of saving is disposable income not spent on consumer goods.

Individuals often save and deploy their saved income into financial assets such as stocks, bonds, and pension funds. (They may also invest saving in newly constructed residential real estate, which is separate from financial asset acquisition, of course).

Such financial assets represent direct and indirect claims on corporations and governments.

The recent blogosphere kerfuffle about saving arose in part because MMT embraces the sector financial balances model (SFB), which features the consolidation of household and corporate sectors as a unified private sector. The model treats financial claims on corporations as negative financial assets for corporations, so the consolidated result is that household saving deployed in such financial assets makes a zero net contribution to private sector saving after counterparty corporate netting. At the margin, such deployment of funds becomes a net financial asset for the household, a net financial liability for the corporation, and a net financial asset wash for the private sector as a whole.

The private sector as a whole adds net financial assets when either the household or corporate sub-sectors deploy funds from saving into the acquisition of financial claims on either the government or foreign sectors. This can occur for example with the purchase of government bonds or foreign financial assets. Saving thus used can be identified as a particular subset of saving, but by no means does it account for saving per se.

Private sector consolidation within SFB is not an indicator of saving per se. Consolidation obscures the core underlying saving dynamic of the private sector.

All private sector saving can be condensed, in effect, to a measure of household saving alone – by projecting the cumulative value of corporate saving onto the household balance sheet. This occurs when household financial claims on the corporate sector are valued by the marketplace to reflect those underlying corporate saving changes. E.g. the value of stocks tends to increase when corporations save and invest in real assets. The issue there is one of valuation translation, rather than the conceptual correctness of corporate saving being reflected at the separate level of household balance sheets as well.

MMT alludes on occasion to a definitional change for saving that it deems desirable for purposes of delineating saving as portrayed in the sector financial balances model. It sometimes describes the act of deploying the proceeds of normally defined saving into physical asset investment as spending, without associated saving. This revised interpretation of saving treats spending on consumer and investment goods similarly, with zero associated saving under such a revised definition.

But on that basis, it would only be consistent to extend the implied revised definition of “non-saving” to include the use of normally defined saving proceeds to acquire financial assets. In either case, funds that have been saved according to the normal definition of saving have been “spent”, which would allow for consistent abandonment of the idea that saving has been the source of such spending. (Indeed, MMT has occasionally referred to central bank acquisition of financial assets and associated creation of reserves as “spending”.)

The problem here is that the correct definition of saving precisely specifies the passive act of not spending on consumer goods. It does not specify how the proceeds of such saving should be used, whether to acquire real or financial assets. Saving is described in proper accounting terms as funds sourced from income by virtue of being saved from income. The eventual deployment of that source of funds is described properly as a use of funds – whether such deployment and use occurs in the form of a bank deposit, a bond, a stock, newly produced residential real estate, or newly produced plant and equipment. The deployment or use of funds is separate from the act of saving itself.

In summary, the consolidated private sector account obscures, not only the view of saving as it materializes within a given accounting period in bifurcated fashion across household and corporate sectors separately, but also the view of total private sector saving as it is projected fully into the household balance sheet, when captured as a cumulative measure over a sequence of such accounting periods. As a result, the consolidated private sector presentation within the sector financial balances model obscures the measurement of the core component of saving.”

I hope that clarifies the thinking here.  And a big thanks to JKH for offering his thoughts here.


Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering asset management, private advisory, institutional consulting and educational services. He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance and Understanding the Modern Monetary System.

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61 Responses

  1. Ben Wolf says

    “But this is clearly not the case as the majority of private sector real wealth creation occurs through the horizontal banking system through credit creation.  This can clearly be seen over the period from 1997q1 to 2008q2 when the government budget deficit failed to offset the current account deficit in 38 of the 42 quarters and household net worth increased by 110% while corporate profits rose by 140%.  Clearly, the private  sector did not experience a “net loss” over this period even though the budget deficit failed to offset the current account leakage.”

    I think part of the problem is that MMT doesn’t discuss running government deficits as a form of non-legalistic market regulation. While wealth was generated during the period you discuss in absence of deficits sufficient to make up financial leakage, the bursting of those credit-driven bubbles also destroyed great wealth, which is the expected outcome from the perspective of government failing to facilitate real wealth creation by issuance of sufficient NFA’s to satisfy private sector demand. In other words the private sector is the generator of real wealth but lacks the means to sustain it without government intervention to support its desires.

    One of the lessons here (I think) is that government must provide sufficient facilitational wealth to supress credit demand to a sustainable level.

  2. Detroit Dan says

    I meant “Private sector saving” (a flow of funds) (c:

    • JKH says


  3. Detroit Dan says

    An observation on the wonkishness of this post. When Paul Krugman says that a post of his is wonkish, it is generally beyond my comprehension. The framework he (and most neo-liberal economists) uses to explain the workings of the economy is unnecessarily complicated.

    On the other hand, the MMT/MMR equation that we are describing as wonkish is really quite straightforward:

    Private sector savings = investment + fiscal deficits + trade surplus

    I find this so much easier than IS/LM. Basic economics does not need to be so complicated, and that is one of the great advantages of MMT/MMR…

  4. imtheknife says

    What do you think of this:

    Rather than taxes, modern fiat money is actually driven by the private sector desire to save.

    We keep talking about the net desire to save, and obviously it is the last allocation of financial resources among the priorities of a household or firm- bills are paid, payments on debt are made, food purchased, etc, before any savings can be allocated, and it is always *only* what is left over that is saved (by definition!). So if the net desire to save being unmet is what drives unemployment as connected by the use of state money, isn’t it really that desire to save that drives the use of said state money?

    Or perhaps I should say that the desire to save drives employment, and they are linked by the use of state money, therefore state money is driven by the desire for employment, which is driven by the desire to save.

    • Detroit Dan says

      imtheknife– Perhaps it would be helpful to distinguish between the proximate and fundamental factors driving the use of fiat money. The desire to spend and save is proximate (immediate). The need to pay taxes may be a more fundamental factor.

      I first encountered the idea of proximate and fundamental factors in Jared Diamond’s “Guns, Germs, and Steel”. The Europeans easily conquered the Americas with the proximate factors being that the Europeans had advanced technologies such as steel and guns, as well as germs which decimated the native Americans. The more fundamental causes were that the Europeans had long herded the animals from which the devastating germs evolved, and thus had developed immunities. And the agricultural advances in the old world freed many people from the need to directly procure their own food so that they could specialize in other areas such as the development of steel and guns and all the technologies which these are built upon.

      So the desire to save is certainly a proximate cause for the value of fiat money, but the more fundamental cause may be that the state long ago imposed taxes based upon fiat money, and supported its use by establishing a framework of laws…

      • Dan M. says

        Detroit Dan,

        Interesting… but if we’re really driving to “fundamentals,” shouldn’t we consider it well-past taxes themselves.

        Maybe we have come to save in dollars simply because it’s more convenient given our tax code, but since we are a democracy and have a certain degree of control over our government, then I’d imagine there’s something more “fundamental” to all of this.

        I think what that is society’s seeming will to net save.. which can be accomidated by government properly issuing verticle currency because we’re not ALWAYS producing at-or-near full capacity, and therefore the horizontal system alone becomes quite fragile.

        I’m starting to think that THIS is the true fundamental reason we save in our common currency, as a society we know there’s going to be times in the future where we won’t be churning at full capacity, so we desire those things that are liquid and can act as a cushion (NFA’s).

        I think that is the true “fundamental” behind it all… with taxes simply being one tool to get the positive feedback loop of modern money to flow… it’s like saying the starter is the fundamental driver of the car… not quite true.

        • f says

          you’re ignoring the question of why ‘vertical’ money is considered to be money in the first place.

        • Obsvr-1 says

          because it is was denominates all other forms of value. It is the most liquid of all assets and what is “legal tender” as mandated by the gov’t. Every exchange in asset must effectively transition into the vertical “dollar” and thereby allow the money changers to hook a rent off the transition. Certainly there are exchanges the occur outside of the vertical money exchange, but outside of the gaussian distribution. The tight coupling between the horizontal and vertical is well guarded by the cartel that controls the game.

        • imtheknife says

          I think of it like this:

          The desire to save provides the pressure, the potential, or perhaps the ‘current’ in the circuitry, while taxation (w/spending) serves as the switch that completes the circuit and allows funds to flow. Without the desire to have stuff both now AND later, taxes would be sufficient; since people also consider the future, they have an additional motivation- a need to plan- possibly one that outweighs the initial motive of tax liabilities (& gov fees).

          So perhaps taxes explain the use of money to the extent of the total tax and fee liabilities, and a combination of the desire to save, and- obviously- convenience, accounts for the rest.

        • imtheknife says

          It also explains the profit motive:

          A firm is in the business of selling something- a good or service, but in order to sell something, you must have it first. The way a firm typically fulfills it’s desire to save is by making or acquiring the good or service for cheaper than the market price, then selling it at the market price, instead of buying it at the market price and then selling it at the market price, which would not produce any savings.

          When a firm achieves this net savings, or ‘profit’ (economic or accounting- doesn’t really matter for my point), it has fulfilled a desire to save, which is really the desire to fund the future. Since it now has savings, the firm is now ready to spend them into the future, which we call investment. Investment, then, is essentially savings used for future consumption.

          Accounting profits also contribute directly to the capacity of individual shareholders to save.

          From this perspective, it is quite easy to see that the desire to maximize profit is motivated by the desire to save, both institutionally and as individual shareholders (having the more familiar individual desire to save, which I won’t bother to explain as it is quite obvious).

    • Dan M. says

      I like this… I’ve been trying to think of the meaning of all this and this helps, IMO.

      I tend to think of it as a bit odd to suggest that the gov’t can simply PRINT assets (especially when trying to explain this to people), and your point about net saving holds those same weird implications that the government can simply hit a print button and the net worth of our society rises…

      But then I thought more about these assets. You mention unemployment, and it really all comes back to our economy running lower than capacity.. and I think this is where NFA’s really come in and have some bite. The reason we CAN net save is because there are times when our economy will be under capacity, and those dollars can act as claims on widgets that would have otherwise not been produced.

      That’s why, in an economy like we have now, our government can deficit spend and it does REAL good, and doesn’t simply debase the dollar. It simply fits in with all the contracts we’ve formed and the lack of demand in sectors A-through-Y because of a legitimate collapse of sector Z (housing).

      If a monetary system consisted purely of a horizontal sector, there would be a very large amount of fragility to it, because the whole system of claims is dependent on the other party fulfilling their part of the bargain… and often, the reason they can’t is because the demand for their product/service has fallen.

      So a society DOES NOT want a monetary system that MERELY consists of claims on productive assets (likewise, they do not want a pure verticle system where only taxes drive the value of money and leverage is outlawed). They want something that will act as a very liquid claim, not tied to a fallible private entity, and usable at any time. This actually STRENGTHENS the horizontal money, as these entities need a pretty steady rate of demand, and there have to be enough “empty” claims on unused productive capacity in the economy for it to efficiently function, and therefore make the horizontal level more stable.

  5. Detroit Dan says

    What is the definition of Net Financial Assets (NFA)? Is this reserves + cash + government bonds?

  6. Detroit Dan says

    Thank you very much, JKH!

    Yes, I did mean flows, so I will use the term “private sector saving” in the future.

    Interesting that aggregate investment (flow) can be negative in theory, due depreciation and amortization exceeding new investment, I wonder if that ever happens. Maybe I should check (pointed out previously by you or Ramanan). Any other suggestions on references for this topic?

    Private sector saving = investment + fiscal deficit + trade surplus.

    I realize this is not at all new, but it is straightforward.

    Thanks again…

    • Ramanan says

      You can check Table F.8 here

      Gross Private Investment was just minorly above consumption of fixed capital in 2009.

      • Detroit Dan says

        Thanks Ramanan!

    • Ramanan says

      Could happen if there is an Act of God. Maybe you can check Japan or Haiti for 2011?

  7. JKH says

    Detroit Dan,

    “Can (aggregate) investment be negative?”

    First, consider investment as a flow:

    Aggregate gross investment can’t be negative.

    I.e. it can’t make a negative contribution to GDP.

    Aggregate net investment as a flow can be negative in theory – it requires depreciation on the outstanding investment stock to exceed new gross investment flow.

    Second, consider cumulative or outstanding investment as a stock:

    The sensible measure of outstanding investment stock, I think, is that of its value taking into account all past depreciation charges – i.e. outstanding net investment.

    That can’t be negative, at least not in any sensible interpretation that I can see.

    If the outstanding net stock gets close to zero, it means depreciation on it also converges to zero, so the net stock can’t go negative.

    • Joseph Laliberté says

      A word of caution here, I stand to be corrected, but gross investment includes change in inventories. Therefore, massive decrease in corporate inventories could theoretically produce a negative I.

      Linked with the treatment of inventories in national accounting identities, elevated level of S and I (taken separatly) could in this regard be associated with a very sick economy, where the household sector saves and the corporate sector accumulates inventory.

      I am not sure about the original logic of including an increase in inventories in gross investment, but since the whole equation is an accounting identity, it means that an increase in inventories resulting from an increase in savings had to be fit somewhere.

      BTW- Warren Mosler is wondering about your equation over at Winterspeak.

      • JKH says

        Thanks, Joseph. Excellent point re inventory declines, which I overlooked.

        I think of it sometimes as all consumer goods that hit the store shelf are initially investment, for some period of time at least in theory, until sold to end buyers. The actual case would depend on accounting periodicity, etc.

  8. JKH says

    Detroit Dan,

    Referring to your proposed expression:

    Savings = Horizontal saving (investment) + vertical savings (fiscal deficit) + foreign savings (trade surplus)

    That’s an interesting one.

    It translates to a standard rearrangement of the sector balances equation, as in:

    S = I + (G – T) + (X – M)

    And that is S = I + (S – I), of course, where:

    (S – I) = (G – T) + (X – M)

    Remember that S here is “private sector saving”.

    And we should be consistent using saving or savings, depending on whether we’re referring to flows or stocks; in this case, I think you mean flows, so it’s “saving” for all three sector.

    What’s more interesting here, IMO, is how to use the vertical terminology.

    The way I view it, the vertical/horizontal distinction, if used, should be used in a way that is consistent with the designated sector decomposition.

    E.g. the high level MMT decomposition is the 2 sector government / non-government.

    In that context, it is very clear that non-government saving has a horizontal component – the amount required to fund I, and a vertical component – the amount required to fund (S – I).

    So, while MMT has not taken a shine to the S = I + (S – I) expression, the horizontal/vertical decomposition maps consistently for the 2 sector case.

    But when you decompose further into 3 or more sectors, there’s the possibility of a choice to be made about how to use that word “vertical’, at least in my mind.

    For example, consider the 3 sector breakdown – government, private, and foreign.

    In the context of 3 sectors, first suppose the foreign sector is in balance.

    That specific case reduces to the general 2 sector case already described; i.e.:

    S = I + (G – T); horizontal and vertical.

    Now, again in the context of 3 sectors, suppose the government sector is in balance and there is a current account surplus.

    Then S = I + (X – M).

    The thing is that (X – M) has vertical characteristics in this case, just as (G – T) does in the first case.

    In each case, this second component is the NFA position for the private sector.

    So the interesting question becomes, is the term vertical used because of its NFA generating characteristic, or is it a bit more complicated than that?

    I’d say it’s more complicated, because it’s clear from this example that the NFA generating characteristic is not unique to the government in a 3+ sector model.

    So I think the answer is that MMT has intended the vertical terminology as being descriptive of the 2 sector breakdown, which seems fine to me.

    But it can be potentially confusing if you interweave that description with 3+ sector models, I think. So I think I might avoid it in the context of your equation.

    It’s a particularly wonky point.


    It’s even trickier than all that, so here’s a tangential point.

    I said above:

    “It is very clear that non-government saving has a horizontal component – the amount required to fund I, and a vertical component – the amount required to fund (S – I).”

    In fact, horizontal finance is only a subset of the amount of S required to fund I. This is because horizontal finance is not involved with the I components that reside on household balance sheets – particularly as they relate to the addition of new residential real estate when it finally settles on household balance sheets in stock terms. The “amount of equity” homeowners have in a new house is by definition their cumulative saving component, marked to market, that relates to their “investment” in that house. So that piece of I, as a cumulative outstanding stock, is unrelated to horizontal finance, because the homeowner isn’t financing that piece.

    But we can still generalize the broader idea of a “horizontal component” for I and S – to include at the margin that non-financed piece of I, given that this component still has nothing to do with vertical (S – I).

  9. Detroit Dan says

    What do you think of this rewording of S = I + (S – I)?

  10. Detroit Dan says

    Savings = Horizontal saving (investment) + vertical savings (fiscal deficit) + foreign savings (trade surplus)

    Can (aggregate) investment be negative? I imagine the value of investment varies considerably depending upon the accounting technique to value past investments (book value, market value). Can anyone help me with this?

  11. Rafael says

    When speaking of the government or the business sector is it not important to understand that the terminology is in reference to the institutions? Although members of the household sector work within these institutions, when a claim is accepted on an institution, it is not directly connected with any individual. In fact does it not occur that members of the household sector whom also trade their labor/human capital/time in the business sector accept claims against their very institution in exchange.

    “Suppose out of honesty or competition for my labor, the owners of the firm want to pay me the full value of my work, less some small epsilon of profit we’ll ignore. They have a choice: They can all give me ~9% of their existing shares (0.1/1.1), or they can have the firm issue 10% more shares and give me those.”

    This passage makes it clear that the labor can willingly accept a claim in the form or shares in exchange for their time and skills. The owners of the firm may be described in such a way as well because as owners they have a majority amount of claims in the form of shares against the business institution.

    This is why breaking up the private sector into businesses and households is very fascinating. Even when thinking about the foreign sector, this can be broken up into foreign governments, central banks, businesses, and households as well. Each have their own unique characteristics which can be delved into.

  12. Geoff says

    Yo, first time poster here, though I have occasionally posted on Pragcap. It was difficult enough for me to grasp MMT, but this Savings stuff is really making my head hurt! I had gradually come to the understanding that inflation was caused mainly by too many NFA’s (i.e. vertical money), or perhaps too much NFA velocity. Horizontal money was not really inflationary because it netted to zero. Was I mistaken?

    • Michael Sankowski says

      It’s all new to many people here. I like to think of it as the real economy generates wealth on its own. This can be captured by the terms Saving and Investment.

      The private sector is really two major sectors which get smashed together in the Sector Balance account, the business and personal sector. We like it when businesses become more valuable and owe us valuable stuff.

      The private sector can create money, then this “can” get translated into Financial Assets, FA. This private money nets out to zero except for interest payments. The private sector can also create equity, which has a value in nominal terms.

      The government creates NFA by deficit spending.

      What this all means is the private sector can create value and even money without the government being involved at all. That’s awesome!

      BUUUTTTT – keeping that value and money stable and universially accepted isn’t something the private sector does well. And, as soon as you get a few hundred people together, they start forming a government of some sort.

      We build governments always and everywhere. Why would anyone even want to dispute this idea? Let them take it to their town board if they have problems.

      And the government can help solve the problems of the private sector value creation process.

      First, it can demand taxes get paid in a single script. Voila! We’ve established a unit of account which can be applied to all of the private and public sector assets.

      Then it can buy stuff as part of normal government actions to help give that unit of account a known value. Now, it’s not the only or even major purchaser of goods, but it can be a huge factor in setting prices.

      That action helps to solve the other problem of big changes in the value of the unit of account, and the value of assets.

      Then, if we trust the government, we can allow it to run deficits forever. We trust it to behave with some wisdom, so…

      However, the government doesn’t respond to market incentives very well. So when it solves problems the private sector doesn’t solve well, it can create other problems.

      So we need to keep the government in it’s place. It’s a massive help, but not a universal solution.

      Gotta run – note that much of this isn’t about savings until later! It’s really more about just recognizing how people like the real world to work!

  13. Erik V says


    It was a great post, and does clarify things, but the problem is, MMR/T is so new to people that posts of this length always put more questions in people’s minds than they answer. Sometimes I wish I had an “ask an MMRer hotline” or something because there is so much that I want to know.

    • Cullen Roche says

      Yes, we need video. It’s in the pipeline. I know we need to break this stuff down into super simple concepts….

      • Michael Sankowski says

        We do need video. That would be very helpful

  14. Cullen Roche says

    Well, gauging from the response on a few other websites it looks like this didn’t really clarify anything for a lot of people…..Oh well. I guess we’ll keep trying.

  15. Dan M. says


    The government (federal) does a few major things:

    1) Issues base fiat money
    2) Administers a handful of social insurance programs
    3) Regulates some industries
    4) Defends the Country
    5) A few other things like NASA and the post office and interstate freeways

    State and local governments get much more in to broad education, other freeways and roads, more social safety nets, and other more detailed infrastructure.

    These are all incredibly important, but they don’t DRIVE the wants, needs, and desires of the public… they simply facilitate the process of the public getting what it wants, needs and desires much easier and in a more stable way.

    • Michael Sankowski says

      The non-market driven actions of the government can be very useful in making the market actions of the private sector more stable and fruitful.

      • Rafael says

        Conversely, the response of the government can also add to instability as well. This is also true of the household sector as well as the business sector. That is why I cannot whole agree that the government is ever solely responsible for crises.

        MMT/MMR offer the best description of how the system works, but this is still a flawed human construct. A monetary system where the government decisions were non-discretionary would go a long way in eliminating abuses while allow for this sector to participate actively. This world is very complex, but can be understood to a certain degree.

        • Ben Wolf says

          That’s why I support government contribution of NFA’s in the form of a guaranteed income to each household. It eliminates the distortive effect of spending through large programs and enhances the freedom of each american to pursue their interests as they see fit. In fact given the realities of our monetary system a minimum income is one of the most logical method of enhancing individual quality of life.

        • Michael Sankowski says

          yep, we’re just trying to get a little bit better here.

  16. jrbarch says

    Cullen: “What the government must generally do over time is help to facilitate the wealth accumulation process by providing the net financial assets to help the private sector monetize this real wealth. But it’s important not to put the cart before the horse here. It’s best to think of government as being a facilitator of wealth creation and not the driver.”

    Still having trouble conceiving govt. in just a passive role as ‘facilitator’. To ‘govern’ means to ‘steer’. The role is as broad as human creativity itself and the current human need for good governance; not singular. Again, who is steering govt? Not the People. Would say that Desire is the driver. It’s kind of funny that everything is accommodated by credit (promises) so it’s probably a good thing that govt. in its own inept way monetises (makes ‘real’) these promises, or everything would really go apesh*t. JKH’s forensic analysis is interesting, but can’t see it having any impact on the global picture? Then again – straws break camels backs ….

    • Cullen Roche says

      Dan’s comment is very good. I should not have given the impression (that some people have gotten) that govt can’t create real wealth or that real wealth is ONLY created through credit. Clearly, neither of those points are true so I should have clarified. Personally, I think govt can and does serve as more than a passive facilitator in creating wealth for the private sector. But when I use the word facilitator in this piece I am more referring to the fact that govt must make the NFA’s available to keep the pvt sector nice and liquid and not driving itself into unsustainable debt binges. Hope that helps.

      • Rafael says

        Is it possible that individuals could still partake in an unsustainable debt binge irrespective of the government making NFA’s available? If this can be true, does this mean that increasing levels of public indebtedness can lead to greater tax revenues which work to decrease the government sector deficit?

        The reason I ask is because I’m not quite sure why the banking sector (or any sector other sector) can’t create new NFA as well as long as the government is willing to step in when their liabilities come due or become troublesome. If the banking sector becomes accustomed to this treatment over the course of many cycles, can they not game the system so they do in fact have the ability to create NFA knowing that once the system is threatened the government will step in?

        Sure the monopoly creator must step in at the crisis point to make the new NFA available, but the private sector can force the issue. If this can or has occurred how does the government sector protect the system from these abuses?


        In regards to the post above, it really did a great job of highlighting a relationship that felt forced together in keeping the corporate sector and household sector as one unit. In my thinking, I am beginning to treat the corporate and government as the institutions they are. These institutions must be run by people who reside in the household sector. Then, if the household sector were to accept a claim on the corporate sector it is doing so because of their net assets as well as their productive capacity. If the household sector were to accept claims on the government it is doing so because the US government has the ability to always adhere to the contracts by creating new NFAs.

        Is any of this correct?

        • Cullen Roche says

          Rafael, only the govt can create the NFA’s. Banks don’t create NFAs. Can you clarify your question a bit? I must be misinterpreting….

        • Rafael says

          Yes, sorry this occurred to me only when reading the above post in conjunction with the post titled More on Savings and Investment.

          “People’s” financial savings consists of claims on firms and claims on government. If I perform some work for a firm that (however infinitessimally) increases the firm’s real economic value, and I accept as payment a share of that firm’s stock, I have performed the economic act of saving, and increased the net saving of “people” — of the household sector. Net private sector financial assets have not increased: my “savings” is the firms’ obligation, the household sector’s surplus is offset by the business sector’s deficit.”

          If I am reading the above correctly, the household sector can accumulate claims on the corporate and banking sector. As mentioned above the household sector’s surplus is offset by the business sector’s obligation or liability resulting in the creation of no new NFA.

          This situation can be reversed as well where the business sector can accumulate claims on the household sector (credit cards etc, personal loans, consumer loans). In each case the party that accepts a private sector financial asset does so with the belief that the issuing party will be able to generate claims on other agents in the economy. In doing so, the issuing party can use the newly generated claims to meet their original obligations.

          Luckily, all these claims are contracts that are all denominated in the same unit of account.

          Now, what happens when an issuing party is unable to generate enough claims on other sectors to the point where they cannot meet their original obligations? An example would be if I, as part of the household sector, were to apply for a loan. The banking sector would have a claim on me and in exchange I would obtain a deposit balance. This would represent two sectors creating offsetting assets and liabilities. Thus, no new NFA have been created. After exhausting the account balance, I come to realization that I can not meet this obligation. I am unable to meet my obligation because I am not able to generate claims on other parties in the system. If I had been able to, I would have been able to meet my obligation to the bank. Since this is not the case, the bank is stuck with a household claim, while the original deposit amount has been moved to another agent’s balance sheet through my spending.

          This deposit is still the bank’s liability. By me being unable to meet my obligation, it jeopardizes the bank’s ability to meet theirs. The public sector can resolve this issue by stepping in and accepting the banks’s defunct claim on me in return for a public sector obligation in the form of a reserve balance. As a result, the public sector is left to hold my worthless claim, while the banking sector has acquired the safest claim that exists in the entire system.

          By the public sector intervening in this way, does this constitute an increase in new NFAs? If so, what prevents the banking sector from always engaging in this risky behavior as long as the public sector is always willing to intervene by creating new NFAs?

          If nothing prevents this from happening, the banking sector can then always force the public sector into creating new NFAs.

          With that said, I do agree that the government is the only sector that can create the NFAs, but it can be potentially forced to do so against their will for the sake of the system/lubrication.

        • Michael Sankowski says

          This is one of the points of MMT where I do have a big disagreement. There seems to be this assumption that a sufficient issuance of NFA by the government will pre-empt private sector credit bubbles from forming.

          This link isn’t proven or even always true. It’s probably partly true.

        • Rafael says

          At points in this lecture, Nassim Taleb and_Daniel Kahneman discuss the relationships between the business sector and the members of the household sector who run these institutions. Essentially, it can be understood that the household sector makes up the business, public, and foreign sectors but have separate balance sheets when applying the sectoral balances approach.

  17. DkN says

    What is more essential? the stomach (government) or the brain(private sector)?

  18. Rafael says

    “If equally spread between everyone, I still question this if it gets too large… the only thing that makes these things “assets” is that they serve their function as lubrication or cushion within the economy. This is suposed to serve as lubrication/cushion to the financial contracts in society, not necessarily pad every person’s life equally.”

    To emit them proportionally does not involve crediting accounts equally. Essentially the idea would be to credit accounts in a way that does lead lead to a change in the overall structure of preferences. With that said, it probably cannot be done.

    Also, padding every person’s life in aggregate would require the net increase in real goods and services not NFA.

    I am not sure what the lubrication/cushion metaphor means anymore seeing as financial contracts that need cushioning are problematic in the first place. If those troublesome contracts are causing a problem, I do not see how transferring them to the public balance sheet solves the issue outside of socializing the acquisition and probable loss.

    What it comes down to from my view point is how can we as a race coordinate in a way that leaves us with more time and higher living standards in the future present. I could care less how many financial assets I have as long as my life is vastly improved and improving.

    • Michael Sankowski says

      lol – this is exactly how I think. In the end, we’re tying to get real world richer and everything else is a distant secondary concern.

  19. Dan M. says


    Your first assertion is right, but all things being equal, dispersement of NFA’s will emit claims on real assets into the economy. This is ok to an extent… I’m really not trying ot go on some conservative tirade… in fact I lean left.

    If equally spread between everyone, I still question this if it gets too large… the only thing that makes these things “assets” is that they serve their function as lubrication or cushion within the economy. This is suposed to serve as lubrication/cushion to the financial contracts in society, not necessarily pad every person’s life equally.

    I don’t know though, as this is getting into a lot of details.

  20. Rafael says

    “Any NFA, it seems to me, represents a claim on real wealth that is a product of government, not private sector activity. If that number gets to be too large within a domestic economy, it means that government, not the private sector, is at some point making a decision about the fire hose of credit (in this case, NFA’s, not bank credit) that usually is better made by the private sector in terms of successfully facilitating productive activity.”

    The government sector coordination function does not necessarily need the ability to emit NFA into the system once they have done so in the past. They can use a regulatory framework and legal system to direct resources throughout the private sector. This framework can be used to reduce while increase claims from different sectors while leaving the net amount of NFA unchanged.

    Controversially, the government could increase the total supply of NFA without playing a role in the coordination of the economic system as long as the disbursement of such claims are proportionally distributed at the same time.

    With that said, I may be completely wrong so keep that in mind!

  21. Rafael says

    If the physical goal of human existence is to increase happiness by an ever increasing standard of living, is it fair to say that the acquisition of real consumer goods and services constitutes an increase in economic well being in that given moment? The increasing rate of production and distribution of real consumer goods across time then would constitute an increase in the rate of economic growth.

    Thus, the monetary system in totality serves as the mechanism to coordinate the factors of production and distribution across time with the goal of improving the economic well being in mind. This is why I fundamentally disagreed with the job guarantee program seeing as more employment does not necessarily lead to higher production of consumer goods. Theoretically, it may even reduce the total supply of such goods overtime if the program leads to a less efficient coordination among each sector of the economic system. Couple this with the loss of free time and the overall standard of living can decline. This is not to say that such a program can not succeed relative to the prior state of coordination, but that would depend entirely on the construction of the program.

    As a result this jobs program theoretically does not need to be central to a future macroeconomic reality. Moreover, these monetary premises discussed in this blog exist now in an economic reality that does not involve that jobs program further proving that this modern monetary system can exist outside of this program as it already does! I define central as meaning unable to exist apart of the underlying premise.

    The interpretation of the modern monetary system promoted by this blog is starting to resemble an evolved form of Mises’ work The Theory of Money and Credit coupled with MMT.

  22. Dan M. says


    To your first point about trying to use cash to finance growth. On a micro level, you are right, and even on a macro-level I think you want enough NFA-money in the domestic economy to keep it from locking up… but I’m trying to decide whether we really “want” large projects to be financed by cash in this country… here’s why:

    Any NFA, it seems to me, represents a claim on real wealth that is a product of government, not private sector activity. If that number gets to be too large within a domestic economy, it means that government, not the private sector, is at some point making a decision about the fire hose of credit (in this case, NFA’s, not bank credit) that usually is better made by the private sector in terms of successfully facilitating productive activity.

    That said, we still want enough NFA’s as lubrication to that activity, as people DO have a demand for NFA’s in a domestic economy.

    I really am still forming my thoughts on this so I’m not totally sure, but I really don’t think a system based heavily on using gov’t-issued NFA’s as the basis of a lot of long-lived asset purchases is necessarily a sign of a healthy, productive economy.

  23. Obsvr-1 says

    Refreshing to see the CR and MMR folks are expanding the conceptual framework to more closely match reality.

    1. As for the farmer and the cow, creating more cows from his initial investment creating value; It is even better for the farmer and wealth/value creation if he can finance the expansion (barn, feed lot, etc) out of his own cash flow. The cheapest form of finance is your own cash, which is just another method of the savings/investment process.

    2. Think about all of the credit extended in the private sector that is in parallel to the horizontal money (credit) provided by the bank; in the form of accounts receivable. Every time a company allows for terms of 30,60,90 days on receivables they are creating short term credit in the system — this is billions of dollars. Some companies convert this into traditional credit from the banking sector by factoring their receivables — but at the end of the day there is a tremendous amount of credit cycling in the market which is funding business operations.

    3. It would be good to start a discussion on the merits of separation of powers, so to speak, between the horizontal and vertical and political actors. What are the pros/cons of folding the FED operations into the US Treasury with strict oversight and open/transparent processes from the congress. One of the problems in todays world the FED is pseudo private, but in reality it is creating liabilities to the US Gov’t . The balance sheet in reality is ‘owned’ by the gov’t, acting effectively as an off-balance sheet vehicle for the Gov’t. If one argues against that, then how do they explain the fact that the FED sends all profits from the bal sht (minus a fee of course) to the US Trsy. To be able to evolve to a truly competitive free market “Horizontal” banking system, the gov’t back stop has to be removed. Bankruptcy and market dynamics would determine the winners and losers, eliminate the gov’t intervention – and FED intervention. In such system the market clearing and reserve system would still function, albeit inside the US Treasury, as prescribed by MMT.

    4. Fiscal policy used to regulate/moderate inflation. The problem defined by MMR is that the process is encumbered by politics and time lags as not being an effective tool. Given todays franken-tax, that is certainly true. However, if the tax system was overhauled with a cap and balance, flat tax based on consumption (e.g. fair tax), then a more dynamic/instantaneous stabilizer would be in place. Such that if the economy heats up, more tax is collected to slow down the spend and vise versa. Additional tax on secondary (read short term) and derivative capital gains should be taxed to moderate the ‘casino’ speculation driven market.

    5. Deficit vs Surplus — both should be viewed has having deleterious impact. The goal would be to revert to the mean of balance. Given a consumption tax with a cap on gov’t spend if the tax revenue exceed the target, creating a surplus, the rates can be adjusted down. The important point is the cap, what is the size of gov’t and discipline in maintaining that goal.

    6. The system needs a form of regulation that lives outside of institutions and agencies of the horizontal and vertical players. Without the gov’t guarantees and back stop bailouts, the market could more effectively regulate the banks. The strong will survive and the weak will collapse. Losses extended to the investors and owners, instead of socialized to the taxpayer would reduce the leverage and risk that these organizations take on. It may be harsh in the transition, however the parties associated with failure, fraud, or otherwise unethical behavior will suffer from the failure. Shouldn’t this in the end be a more effective tool for limiting leverage and risk. However, for this to work there has to be a much more hawkish enforcement of fraud, unethical behavior, and circumvention of what is right and just (not to be confused with the current law, that is written and/or influenced by the industry). Regulation and law is not to be taken lightly, as any system can be corrupted as we have witnessed. It does not matter how much knowledge is gained in respect to the monetary, fiscal and credit systems without also discussing the overarching need for a regulatory/enforcement system to ensure that integrity and ethics are maintained within the system.

    It’s a tall order, but getting more people to understand the current reality will certainly help drive change.

    Keep up the great work, as information is power, and as more people understand how the foundation of economy operates the better chance we will have in effecting change !!

    • Michael Sankowski says

      Hi Obsvr-1 thanks for the support.

      “Every time a company allows for terms of 30,60,90 days on receivables they are creating short term credit in the system — this is billions of dollars. Some companies convert this into traditional credit from the banking sector by factoring their receivables — but at the end of the day there is a tremendous amount of credit cycling in the market which is funding business operations.”

      This is entirely true – and I’d note this is entirely outside of the regulatory powers of govt.

      I don’t know if I support using market based regulatory/incentives to try and oversee banks. Steve W brings up banks are nearly impossible to determine solvency and are necessarily opaque. This structure makes using the strengths of markets difficult.

  24. Dan M. says

    This helps a lot, Cullen… or at least will help a lot of people who are coming in fresh. It sums up a lot of what I’ve had to pontificate about quite nicely.

    It’s the ignoring of real assets that really the key issue here. If these assets were disconnected from the monetary process, that’d be one thing (though since when is any productive realm detached from the money it uses???), but they aren’t only functionally linked (I need a loan to buy a cow and barn to make more cows… the cows and building being REAL assets that the loans have facilitated the production of), but they are also CONTRACTUALLY linked… where the very foundation of the value of the financial asset is the REAL asset.

    The financial assets may net to zero, but the real one doesn’t, and it is fundamentally linked to the loan until I pay it off, so it’s almost PART of the horizontal money system. So I’m going to make the following statements with the realization that it’s not really 100% correct, but serves to kind of throw a wrench in our thinking that might help us see things differently and challenge our terminoligy:

    Because the nature of most horizontal money is to be contractually linked to a REAL asset that has been developed as a result of the horizontal activity, then it does NOT really net to zero, because the real asset is PART of the horizontal contract. Don’t think so? Quit making loan payments and see if you can still operate your business.

    Further, since the NFA’s issued into an economy by gov’t are held by people expecting to be able to pull real wealth out of the economy at some future point with those, there IS a liability attached to them in the sense that the government has to sustain an environment in the future that is conduceive to productive activity. For if the gov’t doesn’t sustain that environment, was the paper ever an asset to begin with?

    I’m not about to challenge the terms “net to zero” or “Net Financial Asset,” but if you open your mind a bit you can see that many of the REAL assets of the economy are contractually linked to the horizontal money, and the government DOES have a responsibility to uphold when it issues NFA’s.

  25. binve says

    This is a very good post, and I too appreciate JKH’s thoughts on this. Thanks to Cullen and the rest of the MMR team for pushing the state of the art on bringing all these ideas together.

    • Cullen Roche says

      Binve, nice to see you here. Glad we’re adding some clarity to these ideas for you and everyone else. I know it’s a lot to digest. Hopefully we’ll see you around.

      • binve says

        Thanks Cullen, I appreciate that. I really do like how you are digging into the operational realities more deeply and continuing to illuminate behavior and expose fallacies that (all of us) hang on to. MMT has been and continues to be a great driving force in dispelling myths about how our monetary system operates, and this is largely because of Godley’s work on sectoral balances. As far as ‘changing the paradigm of economic perception’ MMT is the most eye-opening education that exists.

        But no economic theory is ever ‘complete’ and MMR is digging into some of the areas of MMT that are less developed. And I think that all of us are going to be much better off for it.

        I know there has been a confrontational aspect between MMT and MMR, and that is most unfortunate. Because I see the work to be largely parallel and complementary. I continue to an avid reader of both PragCap and this site, and thank you for all your contributions (reading you is what drew me to MMT in the first place) and look forward to all of your future work and thoughts!

        • Dan M. says


          I think the first thing I ever read was “Understanding the Modern Monetary System” when I was searching the net trying to get a solid answer on how the fed/treasury actually operated and what our limitations were.

          Ever since then I’ve literally changed my entire view of the system, and feel like I now visualize it correctly, but still have plenty to learn about the nuances that can take the wheel at times (aka, driving us into a housing bubble and the ultimate crash).

        • Cullen Roche says

          Thanks Binve. The infighting has been unfortunate. I am guilty of saying stupid things at points and not defending people I respect. But I’ve always only had one intention here and that was to provide a better understanding of the monetary system. That’s why my mind was blown when MMTers described the JG as “central” to MMT. How could a policy proposal be “central” to “macroeconomic reality”? Well, it’s not. And so the split was necessary. I didn’t realize the split was even deeper than that though as I totally disagree with the very foundation of MMT, the state theory, the vertical focus, etc. I think when you understand how the pieces all come together you come away with a superb understanding of the way this all works and how it translates to real world wealth creation and the role that govt plays there. It’s a rather nuanced view as we’re finding out. There are almost layers of understanding here and getting that first bit of MMR understanding (eliminating the household = govt myth) is just the first bit.

          Anyhow, I always read your blog so I’ll look forward to seeing your future content and feel free to pop in here any time. And thanks for the kind words. We really are just trying to help provide a better understanding so it’s nice to see we’re achieving that to some degree.


        • Colin Sugioka says

          I second Binve’s comments and am heartened by your response.

          I also am encouraged by the European interest in MMT described in the Michael Hudson posting (cited in a comment on your TPC piece outlining steps to a Greek ‘exit’).

          I;m not sure how much I can or should try to contribute to the more technical aspects of discussion here, but will be interested in conclusions. i continue to appreciate the broad scope of your postings at TPC.

        • Michael Sankowski says

          We will be heading in a more reader friendly direction soon. We had to set down the distinctions between MMR and MMT, but I think we’ve (JKH and Cullen really) has done this.

        • binve says

          I agree that it has been unfortunate. But as far being guilty of saying stupid things, well I would have been sentenced and serving time long ago :)

          . But I’ve always only had one intention here and that was to provide a better understanding of the monetary system.

          Exactly, And that is precisely why I will always be a reader of yours. The amount of effort you put into thinking about this concepts and describing the reality of how they exist is extremely laudable, but when you combine how much time you spend responding to comments and furthering the discussion, the effort is positively heroic. And I am very grateful for it.

          It’s a rather nuanced view as we’re finding out. There are almost layers of understanding here and getting that first bit of MMR understanding (eliminating the household = govt myth) is just the first bit.

          Completely agreed. I have to say that I have been very intrigued on your thoughts regarding state money. When I first read the concepts of horizontal vs. vertical money creation by Warren on PragCap years ago, it was eye-opening. Because most economic analysis really ignores the vertical aspect of money creation and what it really means from a macroeconomic sectoral balance standpoint. But you are right, calling our current system a ‘completely’ state-money driven system is not completely accurate, and I am really interested in how you are discussing the distinction and its implications.

          Anyhow, I always read your blog so I’ll look forward to seeing your future content and feel free to pop in here any time.

          Thanks, I appreciate that!

          We really are just trying to help provide a better understanding so it’s nice to see we’re achieving that to some degree.

          I think that is undeniable. And the discussions in the comments have been outstanding. There are a lot of great thinkers contributing here.

  26. Cullen Roche says

    JKH makes CNBC. JKH, should I just set-up an account here for you so you can write whatever you want? :-)