I attempted to be respectful in my last post, which dealt with a difficult and potentially sensitive subject.
And so I appreciated the first comment following it:
“Modest, professional, and humble. We need more bloggers with this type of positive, constructive objective. Nice work, JKH.”
I try to make that effort in most cases, but this post will veer slightly from that – for reasons that will become obvious.
Witness this toxic stuff from MMT’s leading light:
Expand the comments, including those that are nested, for the nasty ad hominem flavor of it. The group that gathers becomes divided on exactly what it is they are criticizing. (There is one person there who actually understands the underlying facts of the point under attack.) The leader arbitrates the discussion, but keeps the troops focused on vitriol.
What follows is in part a recap of something I first put forward two years ago. It was picked up favorably around at that time by John Carney of CNBC. That harmless endorsement became a catalyst for a mega-tantrum from the same fellow who put out the recent piece just noted above. The piece from two years ago displays an even nastier ad hominem tone.
This character has been in a hissy fit over the equation S = I + (S – I) ever since.
The equation is simple because it was designed to be simple – as a remedial contrast to MMT’s representation of the monetary system, where they use (S – I) as the hammer that bangs away at everything.
At the time, MMT routinely misrepresented private sector saving (S) as net financial saving (S – I). It probably still does. That was documented at the time of the original debate. A number of people observed it and confirmed it then. Unfortunately, for many MMT acolytes who learned their accounting through the MMT prism, confusion was rampant. It probably still is.
So for a genuinely dysfunctional equation, consider MMT’s own stealth version:
S = (S – I)
The MMT focus on (S – I) disregards the massive accumulation of US private sector wealth that arises from private sector investment over time. The effect is right there in the expression in brackets: investment (I) is subtracted from saving (S).
(This fellow seems to have a hard time understanding bracketed algebra, which is explored further below.)
So the idea of the equation is to add back investment, in order to depict a partition of private sector saving into two exclusive and complementary sources: (I) and (S – I). It’s a clarification primarily designed to undo an obfuscation. That is the fact of the matter that this character is so up in arms over.
(S – I) is the saving delivered from outside the private sector; (I) corresponds to saving delivered from within it. This is in effect a two sector model for the flow of private sector saving. This hasn’t been controversial to those who see the simple fact of the matter. It’s mostly the MMT group that has been roiled and apoplectic about this point.
And given the intended simplicity of such a two sector expression, there was no need to use a more detailed sector expansion such as (S – I) = (G – T) + (X – M). It is implicit and should be obvious that that (S – I) can always be expanded to sub-sector components, but that this would be a secondary decomposition relative to the core point being made about the relative importance of the role of the private sector’s investment function in providing for its own saving. More on this importance below.
In fact, I haven’t made much of this equation since that post two years ago, other than revisiting it once or twice. I had hoped this business was done with, because the basic message regarding MMT’s paradigm was obvious and simple. Yet this fellow still persists after 2 years. Now that we’re reminded of it yet again, it’s an occasion to revisit some aspects of it.
One kind of “net financial asset” calculation for the private sector cancels out issuer and holder perspectives. It treats such items as the $ 20 trillion in US stock market value held directly and indirectly by the household sector (US Flow of Funds Accounts – December 2013) as a negative number from the perspective of domestic issuers of such financial claims. This calculation for the private sector as a whole nets out all such internal financial claims, so that in effect the balance sheet reduces to one of physical assets and net worth – without financial assets except for (S – I), which MMT would refer to as net financial assets (NFA) in flow and presumably stock form.
‘Monetary Economics’ by Godley and Lavoie employs financial asset netting as well – but mostly as a mathematical device for convenience in the matrix algebra manipulation in their closed accounting stock/flow computer simulations. This technique is used throughout the book for coherent matrix mathematics – for “watertight” consistency as the authors might say. The purpose of financial netting in the book is mostly that. In fact, in the case of equities, the authors are careful to distinguish between this netting device and standard corporate accounting for equity net worth, and they advise caution in the interpretation of such netting and its potentially artificial effects on more standard financial measures:
“We shall stick to balance sheets … which include equities as part of the liabilities of firms, keeping in mind that the measured net worth of firms is of no practical significance. Indeed, in the book, no behavioural relationship draws on its definition.” (Page 30)
The private sector balance sheet incorporates a comprehensive financial interface between household and business sub-sectors. It is because of this interlocking balance sheet characteristic that all private sector wealth is reflected ultimately as household wealth. That representation takes into account physical assets such as real estate held directly on the books of the household sector, financial assets that are liabilities issued by the business sector, and the (S – I) component (the net aggregate financial claim on the government and the foreign sectors – i.e. everything outside of the private sector). All of that asset value is netted against the value of household financial liabilities in order to arrive at household net worth. Indeed, most household wealth is in the form of net financial assets. Most of the rest is residential real estate. (Current numbers are summarized and explained further below.)
(S – I) is obviously not the only form of net financial wealth reflected on the books of the household sector. As the private sector grows, there is a significant marginal contribution of net financial asset wealth delivered from the business sector to the household sector for the benefit of the private sector as a whole. Growth in stock market value through retained earnings, or new issues of debt and equity, or newly created bank loans and deposits may all correspond to increasing private sector investment and its translation to financial wealth. In addition, upward valuations of the stock market separate from book value investment constitute another potential component of private sector financial wealth accumulation. Finally, investment in new residential real estate and upward valuation of existing residential real estate over time constitute a rounding out of the full marginal contribution of the private sector to its own accumulation of wealth, in addition to any marginal (S – I) component. All of these internal private sector factors operate at the margin of economic growth. Thus, (S – I) is misleading when positioned as the exclusive marginal contributor of net financial assets to household and private sector wealth.
Godley and Lavoie point to the framing for this in ‘Monetary Economics’:
“In the standard macroeconomics textbook, households and firms are often amalgamated within a single private sector, and hence, since financial assets or debts are netted out, it is rather difficult to introduce discussions about such financial issues, except for public debt … Let us deal for instance with the balance sheet of households and that of production firms. First it should be mentioned that this is an essential distinction. In many accounts of macroeconomics, households and firms are amalgamated into a single sector, that is, the private sector. But doing so would lead to a loss in comprehending the functioning of the economy, for households and production firms take entirely different decisions. In addition, their balance sheets show substantial differences of structure, which reflect the different roles that each sector plays.” (Pages 24 – 26)
Ironically then, the MMT emphasis on (S – I) parallels a mainstream bias. Note from above the cautionary phrases “except for public debt”, “essential distinction” and “loss in comprehending”. On the other hand, ‘Monetary Economics’ is meticulous in the financial analysis of the interface between household and business sectors.
It is a distortion to rely on financial asset netting when comparing government contributions of net financial assets to those sourced from within the private sector itself, or to make claims about the marginal uniqueness of the government’s contribution to the relevant measure of net financial assets. Households are part of the private sector and they hold trillions in net financial assets apart from (S – I) forms. And most of that amount constitutes a very large household net financial asset position.
In effect, the MMT construct of the private sector “net financial asset” position requires double netting through consolidation. It not only nets out private sector investment, but it nets out corresponding financial assets held by households other than (S – I). If the analysis concerns the private sector’s broad “desire” for net financial assets, then it is the desire of the household sector interfacing with the business sector (primarily) that is the correct reference point – not the segregation of an (S – I) component that is constructed specifically to eliminate forms of financial wealth within the private sector. Furthermore, to suggest otherwise is to ignore the purpose of the monetary and financial system as the lubricant for the transmission of wealth within the private sector itself. So it is the household wealth position and its net financial asset position that becomes of paramount importance. The availability of net financial assets produced by the government and/or the foreign sector must be viewed in that context – i.e. in comparison to the household net financial asset position – not the artificial zero position that is derived by eliminating private sector finance, such as used in computer simulations that force financial asset and liability equivalence in order to ensure accounting consistent simulations. Nobody actually believes that the business sector makes a gross contribution of “negative financial wealth” to private sector financial wealth overall, simply due to the fact that the business sector balance sheet has a real asset side corresponding to the financial asset transformation of it.
I explained this two years ago.
Consolidation can end up obscuring, which is convenient if one’s agenda benefits from it. The MMT net financial asset emphasis obscures in a way that is similar to the case of its “consolidation hypothesis” for the government sector. Private sector NFA consolidation is somewhat analogous to saying (in the government consolidation case) that the government doesn’t have a bank account that has money in it which it uses to interact with the rest of the financial system – merely based on financial statement consolidation. The actual facts in that case are crystal clear. So is the unobscured interpretation of them. Financial consolidation is not the same as operational or institutional consolidation. For example, Paul Krugman’s recent piece on government consolidation is hardly a case of MMT’s “consolidation hypothesis”. Krugman wrote a straightforward piece comparing two different operational routes for getting to the same consolidated financial statement outcome – a factual deconsolidated operational route (QE) and a counterfactual consolidated operational route. That’s also how I described the comparison. MMT seems to be allergic to the idea of counterfactual. They don’t seem to use the term. To do so would unravel a “paradigm” of serpentine conceptual construction, including the “consolidation hypothesis”.
The full expansion of (S – I) in three sector national income accounting is of course (S – I) = (G – T) + (X – M). According to double entry bookkeeping, (S – I) exists both on private sector books (flow and stock) and outside of the private sector in mirror image form. The issue discussed above concerns the consolidation treatment of the private sector apart from (S – I). It does not concern the consolidation of the financial claims that correspond to (S – I). As a derivation of national income accounting, ( S- I) can be linked to financial claims in flow of funds accounting which in aggregate constitute a net claim on or issued by the “non-private sector”. The accounting is straightforward – domestically issued government bonds and bills and reserves commingle in aggregation with foreign counterparty balance sheet positions in financial claims such as interbank deposits, corporate bonds, and equities. The totality calculates to a net position between the private sector and everybody else. Thus, flow of funds accounting for a “non-private sector” does not obscure the relevant financial effect on the private sector in the same way as financial netting does within the private sector itself. And consistent with our earlier discussion, the (S – I) position that hits private sector books transmits through valuation to a direct effect on household sector net wealth.
In fact, the private sector financial markets are the great net financial asset contributor to household balance sheets. (S – I) equates to only a small proportion of private sector wealth accumulated over time. US household net worth was $ 77 trillion according to the most recent calculation (December 2013) taken from the US Flow of Funds Accounts. As noted, that is also a representation of private sector net worth. Considering the net international investment position (which is a net liability and a negative drag on the value of the (S – I) accumulated stock position) and the double counting of some internally held government debt, the net contribution of (S – I) in stock terms is likely around $ 10 trillion. Thus, (S – I) is a pretty small proportion of the total (S) through accumulation. And of the $ 77 trillion total, the household NFA position is roughly $ 50 trillion, of which (S – I) is still a small subset.
Now, we should spend a bit of time going through this fellow’s silly rote response to the simple algebraic decomposition that is S = I + (S – I).
Do we suppose that if this were written as S = I + NFA, everything would be OK?
As if substituting the symbol NFA for (S – I) changes the truth of the decomposition?
Or would he claim that S = I + NFA also reduces to 0 = 0?
One way or another he arrives at 0 = 0 because apparently he can’t fathom that the purpose of logical decomposition is to break things into constituent parts, or that numbers lurk behind the letters, or that terms in brackets are grouped that way for a logical reason. In this case, it is to rebalance a conceptual structure for saving that has been distorted by MMT.
As noted above, S = I + (S – I) corrects the false MMT stealth version S = (S – I).
(The work of his PHD computer colleague that is mentioned in the nested comments has nothing directly to do with this. Ironically, that work relates to a model for a new definition of aggregate demand that is structurally unsound from an accounting perspective and therefore stock-flow inconsistent. The problem in the current case rather is confusion in the cross-sectional analysis of stocks and flows. In addition, the issue at hand is not about investment-saving causality – also a straw man floated in those comments. That’s a standard post Keynesian insight, already assumed and beside the point in this context. This is about stock-flow decomposition, not causality, once again demonstrating that this fellow has no idea what he’s talking about after two years of beating up on it.)
To assist him in moving past his zero-equals-zero syndrome, here are some entry level readings on mathematical set theory:
The first reading touches on the concept of algebraic complements, which is what constitutes the logical basis for the form of the equation S = I + (S – I).
Specifically, (S – I) is known as the algebraic complement of I in S.
The generic equation for algebraic complements is expressed as (first link):
A u Ac = U
Thus, the equation is in the form of a standard logical decomposition of a set. It’s intended to be that simple, in contrast to the MMT distortion of it.
The second link expands on set theory more broadly, that topic being in effect the mathematical foundation for the logic of accounting closure and stock flow consistency in coherent post Keynesian models.
Notes on mathematical maturity are included as a third link.
Mr. zero-equals-zero needs to graduate from playing with letters taken out of context. He should be considering representative numbers behind the internal expressions that constitute equations. Then accumulate from flow to stock. Then have a look at a US Flow of Funds report and see how the US household balance sheet got to be what it is – through private sector investment and saving and wealth building over time. The marginal action of the rest of the balance sheet can easily overpower the marginal action of (S – I) in terms of household net financial asset production. Indeed, that’s what happens in economic recoveries, with increased tax revenues the usual result.
Some of us have had suspicions about whether some of these MMT folks fully understand the accounting. We keep catching errors with a pronounced ideological scent. But at the same time, it is in MMT’s interest to exaggerate the importance of the government contribution, while setting aside the broader context for that contribution by ignoring investment and by artificially netting private sector financial assets at the consolidated level.
As noted, the artificial device of private sector financial asset consolidation parallels the case of the “consolidation hypothesis”. Consolidation distortion seems inherent to the MMT paradigm. For an example of the polar opposite of this, I recommend (once again) “Monetary Economics” by Godley and Lavoie, which is a pristine analysis of the monetary system in full, cutting across all of its constituent logic in expert detail. It is to MMT as day is to night, methodically explaining the larger scope of monetary analysis that MMT compresses into an ideologically skewed paradigm. ‘Monetary Economics’ handles every aspect of monetary analysis that MMT attempts, but with greater clarity and objectivity. It is a great book with a sweeping logical analysis of all parts of the monetary system, and its conclusions don’t depend on continuous immersion in some pre-conceived policy orientation. It is purely analytical. This belies the densely prescriptive policy presumptions that the writer of that first post insists must be the case in his comments there.
As to the matter of this fellow’s more general slurs on the Monetary Realism project of Cullen Roche, how should one respond to that? To do so threatens to get down into that same gutter of nasty ad hominem slurs. We’ll pass on that for now, although we could easily table a long list of indictments, mostly behavioral. Suffice to say that several years ago a number of respected blogosphere and academic commentators made note of MMT’s ingrained habit of nastiness in interaction with others. It is not so surprising that few outside of MMT want to attribute it for ideas that are easily traceable elsewhere instead. As part of that negative feedback loop, the MMT written mode reveals an ongoing desperation for recognition. It might help overall if there were more adults in the room to supervise a behavioral transition that could pay constructive dividends of broader acceptability.
The style of engagement from MMT in this particular case has been pretty malicious. This is the sort of behavior that shapes the existing MMT brand as viewed from outside of MMT. The equation that has upset MMT sensibilities so much is about a simple idea of balance – an antidote to short circuited thinking and writing skewed by ideological preconception. And this simple point is still confronted by these recurring spasms of offensive behavior even after two years. The equation depicts private sector internal wealth generation (including financial assets) in tandem with the additional financial asset benefit of (S – I). It suggests a mix of private sector wealth sources that is no doubt anathema to certain kinds of ideological extremism. This case is symptomatic of the way in which MMT and its paradigm(s) get in the way of more straightforward analyses of monetary operations and options for change.