Monetary Realism

Understanding The Modern Monetary System…

More on Savings and Investment

Here is a mashup of comments from Steve Waldman, from the comments section over at Steve Roth’s excellent Asymptosis.

“It is perfectly possible to hold the international balance constant, have the government reduce debt, and have “people” save more.

“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.

But much of what we call saving is exchanging real resources for claims on the private business sector. And as long as the private business sector doesn’t entirely squander those real resources, that act contributes to macroeconomic S. If the private business sector does squander the resources, then while I still perceive my contribution as “saving”, the value of macroeconomic S = I does not increase, and my claim amounts to a transfer from other shareholders of the firm.

But even in today’s terrifyingly %$&*-ed up world, people make a lot of productive contributions to private business in exchange for financial claims. The act of doing so increases S = I, but has no effect on “net private-sector financial assets” and requires no government accommodation.

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.

In real terms, the effect is the same. I end up owning ~9% of the firm (the fruit of my labor), and they end up epsilon better off for my efforts. But the dollar value of the shares will be different by virtue of the two choices.

If they give me 9% of preexisting shares, there will be “deflation”. The value of each share will have increased by 10%. They will have 91% of their original number of shares, each worth 10% more, so they’ll retain 100% of the original value. There will be “deflation”, if we consider company stock as a kind of currency.

Alternatively, if they issue new shares to cover the increase in value, the old owners will hold the same number of shares that they held before, and they will each have the same value that they had before. The extra value that I created would be diluted away from them by the issue of new shares.

In a world of stock, “deflation” or “price stability by dilution” is a choice of the firm. In either case, I have genuinely saved in a real economic (terms).

It’s just a question of how we account for the savings, by holding the unit of account stable and making direct transfers to me, or by “inflating” the unit of account and accounting for the real value inflated away from the old owners by giving claims made from thin air to me.

There’s no such thing as a fixed supply of nominal assets in a world where banks can issue nominal claims. If we are in a regime where the central bank targets consumer price stability, my creation of firm value will not necessarily cause any policy response.

But suppose that the value that I produce means that the firm can sell consumer goods more cheaply, and this puts downward pressure on the consumer price level. The status quo response to this (before the Great Recession & ZIRP) would be for the central bank to lower interest rates to prevent the deflation. The lowering of interest rates corresponds to a reduction in the rate with which net financial assets are issued to the private sector, as the transfers of interest from the government are diminished.

Another policy response, much discredited during the “Great Moderation” but nevertheless potentially effective, would be for the government to spend money into the economy to counter the recession while the central bank held interest rates constant.

So, while it is true that one potential reaction to economic value production is issue of NFA by the state to hold the price level constant, that is a consequence of one uncertain conjecture and two discretionary policy choices:

  1.  the economic value production must impact consumer prices of existing goods;
  2. The state must hew to an anti-deflationary price stability commitment; and
  3. The state must implement that commitment via fiscal rather than conventional monetary policy. (Conventional monetary policy involves no issue of net financial assets.)

There is no “to the penny” sort of accounting relationship between household-sector financial saving and government issue of NFA. You can tell stories of how there might be a positive relationship between the two, but those are a function of policy choices and behavioral models, not logically necessary as a matter of accounting.

And it is household-sector saving that conventional morality so strongly proclaims as a virtue. No bourgeois moralist ever complains when the value of a firm’s assets rise, implying an increase in business-sector “indebtedness” to shareholders. (Firms owe their full value to financial claimants, as their value rises, so does what they owe.)

It is a bad rhetorical trick that MMTers sometimes pull, to confuse an increase in “private sector net financial assets” with an increase in household-sector savings in order to recruit bourgeois support for the latter in the cause of promoting net issuance of government securities.

There are a lot of perfectly good reasons to support net-issuance of government securities during times like now, and I’m certainly allied with MMTers in their promotion of wise fiscal policy. But claiming “saving” is impossible as a matter of accounting without a government deficit is a bait and switch, a game played with definitions by rhetorical confusing household sector financial surplus with an aggregate private sector surplus.”

Steve is pretty sharp. Godley’s theorem tells us we need some sector to run a deficit, but it doesn’t really have to be the government sector. It can easily be a private company or bank which runs this deficit, as long as it’s willing and able to do so, and as long as the rest of the world accepts the “NFA” created.

(RE: Equity in a firm. The nominal value is the number of shares which can be expanded or destroyed at will.  The real value is the economic value of the firm. It’s like a mini-government, able to create script, which is only dependent on the willingness of others to accept that script.)

It’s extremely misleading to claim the government is the only possible source of savings. It’s not true. And admittedly, it’s really hard to talk about Savings in a non-confusing way, so I cut those others a bit of slack.

But these points about savings are really important for people to understand, and it’s crucial to be able to discern when fiscal or monetary or trade policy or private money creation “should” be used, and also how these things impact our economy. Yes, we’ve been relying exclusively on monetary policy for a long, long time, so it seems reasonable to blame monetary policy for everything that’s gone wrong.

But banks are an important part of what humans do. Credit has been part of human society since we started recording documents. Some of the first written documents we have are tallies of credits and debits. We humans like banks and credit, even if banks are not net profitable over their entire history.

It seems dangerous to me to ignore the ability of the private sector to create savings out of nothing.

(P.S. I frequently have a “problem” with Steve W’s posts and comments. Every line seems to demand a book length exploration! )


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931 Responses

  1. Ramanan says

    My comment:

    ….from this same post under the heading MMP Blog #20.

    “…this also means it is impossible for the aggregate saving of the nongovernment sector to be less than (or greater than) the budget deficit.”

  2. Ramanan says

    It’s not that straightforward to just look at the balance sheet and not the flows. But anyhow, you can see that the highly indebted ones are Portugal, Ireland, Greece and Spain in that order (% of GDP). And the measure is the Net International Investment Position (or the negative of that). Like 90%+ !

    These have been accumulated as a result of huge current account deficits (except the case of Ireland which is due to revaluation losses of assets held abroad). “Hedge Fund Ireland” as Krugman put it.

    Now it’s easy to play the blame game and all economists have kept doing it. That is not the best way to proceed because the Euro Area design was troublesome to begin with. Some argue that nations were fiscally profligate while others present the evidence of a fiscal surplus to argue that they weren’t. There’s problem with both. For the latter case, a surplus does not imply that the government’s fiscal stance is tight. Because the private sector expenditure can react in ways which leads to a surplus of the government. So I personally believe Spain was profligate. For the former, again one can think of ways in which they are wrong. A current account deficit implies a higher budget balance because of the identity linking the two (both directly and in a behavioral sense).

    At any rate, the problems brought about by the external sector is clear from the data.

    Unfortunately, to put the debts on a sustainable path, the Euro Area politicians have taken the route of contraction. That doesn’t mean that a unilateral fiscal expansion is a good thing because soon the current account deficit problems will come back.

    Back to balance sheets. It is also important how much of the government debt is held by foreigners even though a nation as a whole may not be as highly indebted. So you may find some data from Banca d’Italia on holding of Italian government securities by foreigners and I think it’s huge.

    Other than that I remember having looked at Spain’s household balance sheets and comparing it to the UK. And there is a lot of difference if you compare assets/income ratios, assets/liabilities etc.

  3. vimothy says

    Actually, the quote comes from a comments thread here:

    there can OBVIOUSLY be saving without govt deficits or a current account surplus, but not NET saving

  4. Ramanan says

    Which one Vimothy? Did you mean NEP?

  5. Cullen Roche says

    Do you have a link there Vimothy? Thanks.

  6. vimothy says

    So I see from a thread at MNE that Scott Fullwiler knows the correct definition of saving. Wonder if this will register with the rest of the crowd who have denied this over the last few weeks…?

  7. vimothy says

    Thanks Ramanan,

    I’m thinking of writing a balance sheet-centric study of the GFC / unfolding EZ crisis, and would be interested to hear your thoughts on the above…

  8. Steve Roth says

    Worth going back to what Wray has said (quoting from memory): all money is credit, but not all credit is money.

    I think the first statement is brilliant and true. But I actually question the second. I think he’s saying that credit embodied in many financial assets (equities, CDSes or whatever) cannot be used to buy a pack of gum. So it’s not money in the sense that you can use it to buy real goods. Or maybe to pay taxes?

    I’m not sure what his exclusionary criterion/criteria is/are.

    I’m still liking my definition of money: exchange value embodied in a financial asset. (Money does not, cannot exist except as so embodied.)

    This would suggest gross financial assets. This would include mortgage deeds (claims on land) and most (?) gold.

    Does this help any?

  9. Ramanan says


    Even I have been noticing this phrase “key strokes”. That said, IMO MMT is indeed full steroid MMT.

  10. JKH says

    those look very interesting

    thanks, vimothy

  11. vimothy says

    Ramanan & JKH (and anyone, really),

    Just read a couple of papers that you might enjoy on an international macro tip:

    Philip Lane, “International financial integration and the external positions of euro area countries”

    Maurice Obstfeld, “International Liquidity: The Fiscal Dimension”

  12. JKH says

    First read – it looks like Whelan is again glossing over the basic point, which is that there is a real opportunity cost risk to the Bundesbank. The fact that they can recapitalize an actual loss with a “key stroke” (practicing my MMT) is not the issue (unless you’re full steroid MMT). There’s still a differential loss in the outcome.

    The risk is analogous to contingent credit risk on derivatives, which is counterparty credit risk. If the Eurosystem breaks down, Germany is exposed to counterparty failure on its TARGET credit balances (up to $ 500 bill Euro now I see!).

    But Whelan does make the practical point that there would likely be some sorting out of the actual full loss settlement such that it was less than the full TARGET exposure as it stands.

  13. JKH says

    thanks, Ramanan

    I’ll have a look

    Not much else going on

    some JKH


  14. Ramanan says

    Completely unrelated to anything recent here and Only for JKH:

    Comments for this entry are closed:


  15. Cullen Roche says

    No, not really.

  16. p says

    I think you might be stretching it a bit there

  17. phil says

    um, what do you think?

  18. Cullen Roche says

    Okay fine. Banks don’t issue money. Never mind that the money they issue makes the entire economy function. Never mind that I can buy anything on credit. Let’s just change the meaning of everything so MMT can spread their ideology. Perfect. Are you satisfied?

  19. phil says

    And btw the statement “Socrates is an old man” is not the same as the statement “an old man is Socrates”.

  20. Cullen Roche says

    Then how can anyone claim the state has a “money monopoly”? That’s a direct quote from MMters all over the place. Either their point is a semantic one, not detailed enough, or they’ve been publishing inaccurate research for decades….

  21. phil says

    I’m pretty certain mmters haven’t said that anyone has a monopoly on credit.

  22. Cullen Roche says

    That’s our whole point. It is a hybrid system. There’s no such thing as a “money monopolist”. Money is a social construct. No one has a monopoly on social constructs. Not even the govt that oversees that society. They might have a monopoly on elements of that social construct, but you can never say they have a monopoly on the social construct unless you’re living in a fully vertical system.

  23. Cullen Roche says

    It’s a semantic point is my point. You can pay your taxes with a credit card. It settles in bank money, but who cares? It doesn’t mean the state has a monopoly on credit. This is what MMTers try to do. They try to marginalize the moneyness of credit by saying you can’t pay your taxes with it. Except, credit is the definition of money (THEIR definition of money!).

  24. phil says

    Well, even if you don’t think that the currency is a “public monopoly”, I’m still, predictably, veering towards the view that it is.

    But anyway, the ‘kicker’ for the MMRists is that even if the state actually is the so-called ‘issuer’ of money, the state can in reality only ever issue its money *against* a pre-existing private guarantee, asset, or security. So from the outset it’s probably actually a hybrid system.

  25. Dan M. says

    Then can you clarify “the government accepts credit for the payment of taxes?” You don’t mean bank credit, do you?

    Sorry to beat a dead horse, just making sure I understand what your point is.

  26. Cullen Roche says

    Taxes get settled by the bank in base money. But this is a semantic point. It has nothing to do with the fact that the banks issue tons of credit independent of the state. Unless you can try to marginalize the moneyness of credit, which is nonsense. As Innes said, “credit and credit alone is money”.

  27. Dan M. says


    I was under the impression that taxes were only payable with base money, not credit… could you clarify that?

  28. Michael Sankowski says

    Unprecedented 900 Comments!

    Also, It’s a bit funny that Paul Krugman would post something so, so obviously S = I + (S+I).

    It’s almost like he’s reading this blog. I mean, here we are with 800 900 comments and all of a sudden the easiest to visualize representation of it happens to show up on Paul’s blog.

    Odd that. 😉

  29. Cullen Roche says

    My brain short circuited when it hit 900.

    PS – I posted your excellent Krugman comment. Thanks for that.