How Accounting “Constrains” Economics

There’s been a running discussion of this on various blogs (sorry if I missed linking some!), inflated simultaneously by Krugman and by magisterial and mysterious commenter JKH’s “paradigm riff,” here.

That discussion has brought me to the following conclusions.

Assuming you have a coherent and accurately representative System of National Accounts*:

• Accounting, and accounting identities, do (or should) impose a constraint on our economic reasoning and predictions.

• If some piece of economic reasoning predicts something that simply can’t happen according to the accounting (things don’t add up, balance), that reasoning/prediction is wrong.

• Accounting can’t tell us whether a piece of economic reasoning is right. It can only tell us if it’s wrong.

• Accounting won’t necessarily tell us that a piece of economic reasoning is wrong. There are plenty of economic ideas out there — behavioral notions about how people (will) respond to incentives and constraints – that conform to accounting identities and balances, but are nevertheless wrong.

• Accounting tells us exactly nothing about how people will behave, nor can it cause or constrain that behavior. It can only tell us that that it’s logically impossible for them (all) to behave in a given way.

Takeaway: Conformance to the rules and balances of accounting is a necessary but not sufficient condition for economic reasoning and predictions to be correct.

Or to put it another way: Accounting is a constraint on economics, not economies.

Simple example: if somebody suggests that all countries should/can get out of depression by increasing their net exports, it’s false/bad reasoning. Because global imports equals global exports; the books can’t add up that way.

Or suppose someone says:

1. We should reduce government debt.

2. There’s not much we can do about net imports, the trade imbalance. (Exports are determined largely by international demand, and we don’t want to use trade policy to deny our people the benefits of cheap imported goods.)

3. People should save more.

This is impossible, by accounting identity. The only way to increase private savings (the stock of net financial assets) without changing imports is to increase exports or run government deficits.

People, institutions, and policy makers could certainly try to achieve these mutually incompatible goals. They could even believe that it’s possible to achieve them all. But the arithmetic of stock-and-flow accounting tells us that they will fail — and that if they believe they will succeed, they’re wrong.

That’s all.

* Even though I have real qualms about the conceptual structure of the current system — I find it much easier to do good thinking using Wynne Godley’s modification of that system — the current system is coherent and accurately/usefully representative. It’s coherent in that all the stocks and flows balance out, and representative in that it covers most of the important stocks and flows. No system could be perfectly representative, of course; the map is not the territory. In both systems there’s a great deal that’s not considered — nonremunerated work, for instance. But that doesn’t discredit, is peripheral to, the logical thrust of this post.

Cross-posted at Angry Bear.

 

  1. vimothy
    February 1st, 2012 at 12:46 | #1

    Steve,

    Good post! I like your line of thinking here.

    One quibble though:

    Or suppose someone says:

    1. We should reduce government debt.

    2. There’s not much we can do about net imports, the trade imbalance. (Exports are determined largely by international demand, and we don’t want to use trade policy to deny our people the benefits of cheap imported goods.)

    3. People should save more.

    This is impossible, by accounting identity. The only way to increase private savings (the stock of net financial assets) without changing imports is to increase exports or run government deficits.

    I don’t think this is quite correct.

    (Assuming a closed economy here for simplicity).

    In proportionate, real and nominal terms, its possible for the private sector to both increase its savings and to pay down the govt debt. At the margin, the private sector will have lower savings than it would have otherwise.

    What is not possible is to simultaneously have,

    S – I > 0
    G – T > 0

  2. vimothy
    February 1st, 2012 at 12:52 | #2

    @vimothy

    Sorry, rereading my comment–it doesn’t really make sense to talk about “paying down” the debt in proportionate terms. But it is possible for the debt to be reduced in proportionate terms while private sector savings increase.

  3. February 1st, 2012 at 12:52 | #3

    @vimothy:

    We’re using different definitions of “savings” here.

    1. When I make it plural here I’m talking about a stock, not the NIPA flow called “S.”

    2. I’m defining the plural “savings” to mean “the stock of net update: private financial assets.” Even beyond the stock/flow difference, it’s totally different from NIPA’s “S” because in the NIPAs, financial assets don’t exist.

    This “S” business breeds no end of confusion…

  4. February 1st, 2012 at 12:57 | #4

    Just to add: as JKH has finally made clear to me, S in the NIPAs does not represent an actual flow (I does); it’s an accounting construct, a “temporary accounting repository” that’s necessary to resolve sources and uses of funds — basically to reconcile the NIPAs with the Fed FOFs.

    (I claim: S only exists because Kuznets and company wanted to model the real economy of goods and services as a barter economy, and ignore all those pesky financial assets.)

  5. vimothy
    February 1st, 2012 at 13:17 | #5

    @Asymptosis

    Steve,

    That seems slightly idiosyncratic.

    I think to most people, savings refers to the stock of savings, defined for whatever entity or aggregate is under consideration. The flow of saving is the sock adjustment experienced by that entity or sector over a given period of time.

    The flow of private saving in a given period corresponds in the usual GDP identity to a flow of investment expenditure and a flow of net govt expenditure. It is possible for the stock of private savings to increase (equivalently, to have a positive flow of private saving) even as the national debt is reduced or paid down.

    But if you define saving to mean “nominal saving net of private investment” and the stock of savings to mean “the nominal value of the national debt”, then you are correct by accounting identity.

  6. February 1st, 2012 at 13:35 | #6

    @vimothy: “to most people, savings refers to the stock of savings, defined for whatever entity or aggregate is under consideration. The flow of saving is the sock adjustment experienced by that entity or sector over a given period of time.”

    Absolutely right. “S” does not comport with how people think of “saving(s).” Hence all the confusion. Confusion compounded by trying to figure out how changes in financial asset prices figure in the “S” picture. They don’t. But if my portfolio goes up in value, I certainly feel that I have more “savings.”

    Hence Rowe and Sumner’s (and my) lengthy posts on what “S” is. Links on request.

    I like the understanding I’ve gotten from JKH. It really explains it best, though it might seem abstruse at first thought.

    This confusion is compounded by MMTers using the plural construction I use here (mea culpa), referring to the stock of privately held net financial assets.

  7. February 1st, 2012 at 13:40 | #7

    @vimothy: “define saving to mean “nominal saving net of private investment””

    Recursive definition. If the “saving” inside the quotes means S, then “nominal saving net of private investment” equals zero. Because S=I.

  8. Tom Hickey
    February 1st, 2012 at 14:12 | #8

    Problems typically arise when ordinary language terms (like “saving” and “savings”) get conflated with technically defined terms through use of the same sign the considerably different contexts. The simple answer is, don’t do that, but it is very difficult to correct after its been done.

    There is a similar problem in the case of “investment.” Economists under stand “investment” in terms of firm expenditure, whereas most non-economists think of it in terms of household purchase and ownership of financial assets.

  9. February 1st, 2012 at 14:29 | #9

    re: “This confusion is compounded by MMTers using the plural construction I use here (mea culpa), referring to the stock of privately held net financial assets.”

    I’m realizing that when they (I) do so, it is to some extent a rhetorical trick like SS arguers not “understanding” whether we’re talking about the consolidated or “on-budget” budget, and jumping between the two as needed (without notice) for their rhetorical purposes.

    “The only way to increase savings is to run a government deficit or a trade surplus.”

    They (I) should say “the only way to increase the stock of privately held net financial assets is to run a government deficit or a trade surplus.”

    But it’s not nearly as rhetorically catchy. So they use it even though it’s inherently confusing to anyone who knows about “S.”

  10. February 1st, 2012 at 14:33 | #10

    @Tom Hickey: “There is a similar problem in the case of “investment.”

    Absolutely! In econo-speak, “investment” is *spending* on durables (physical and otherwise). Which is exactly the opposite of how people use it in the vernacular. The part of your income that you *don’t” spend, you save or “invest.”

    S is a bigger problem, though, because economists don’t understand what it is.

  11. Dan Kervick
    February 1st, 2012 at 15:05 | #11

    What really bugs me is the economists’ use of “investment” to include stock-building or inventory accumulation, which then lets them asset that S=I. That strikes me as having nothing to do with the intuitive understanding of investment. If I receive a shipment of lumber as income, and put it into storage, I have saved it. If I use it for some productive project of capital development – like building a boat or warehouse – or lend it to someone else who uses it productively and promises me a return, then I have invested it. But the economists call both of these things “savings”. It’s an ideologically-motivated semantic scam.

    So then people then suggest that we tax away some surplus of savings, like appropriating a bunch of lumber stored up in warehouses doing nothing, and use those savings for a productive public purpose, the economist comes back and says, “Oh no. That lumber is already an investment, so all you are doing is shifting resources from one investment use to another. No benefit!”

  12. February 1st, 2012 at 16:27 | #12

    @Dan Kervick

    Well yes, the stored lumber should be treated as investment. The owner is unhappy with the prices he could get on the market. He is saving it in the hopes of getting a higher return in the future. It’s like not pumping oip until prices rise again.

  13. February 1st, 2012 at 19:25 | #13

    Steve,

    Your insistence on care that we keep our conjectures of the world logically consistent is much appreciated. And your description of the role of accounting, the insights that accounting relationships can and cannot offer is spot-on and very well put. But I really dislike your example. It contains a common bit of rhetorical overreach that unnecessarily discredits MMT-ish ideas.

    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.

  14. wh10
    February 1st, 2012 at 20:00 | #14

    @Steve Waldman

    If govt doesn’t accommodate it, does that then mean there will be deflation? If more economic value is created against a fixed supply of nominal financial assets, then won’t price have to change in nominal terms?

  15. February 1st, 2012 at 20:03 | #15

    Steve, nice to see you here, and with such good challenging thinking. On my way out the door, but one question: is that share of stock newly-issued for me? Or was it just a share of its own stock that the company was holding (a concept I have to work my brain around…)? As I write I’m thinking it doesn’t matter — dilution — but…?

  16. February 1st, 2012 at 22:20 | #16

    wh10 & Steve — Your comments dovetail very nicely. Suppose I do some work for a firm, and it increases the firm’s real economic value by 10%. (I’m too incompetent to add any value at all in real life, but we’ll pretend a huge “value add” to keep the numbers round.)

    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. 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 antideflationary 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.

    (It is perfectly fair, and quite possibly correct to argue that in the present economic environment, due to absence of demand and business-sector risk-aversion and broken household balance sheets, that household saving will not be accommodated by increased claims on expanding value in the business sector, and so the best way to repair those balance sheets is for the government sector to run a deficit. I very much support the use of government balance sheets to help the US household sector save. But that is because I think the other path will not work very well right now, not because as a matter of logic and accounting no other path is possible.)

  17. JKH
    February 2nd, 2012 at 00:32 | #17

    Steve Waldman,

    For reference only (you know this cold):

    S = I + (S – I)

    Private sector saving = investment, plus the change in private sector net financial assets.

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

    MMT is not entirely innocent of the “rhetorical overreach” you suggested, as I think you clarified in your second comment.

    MMT frequently adopts short hand mode, in which it conflates terminology, describing what is actually (S – I), as saving.

    This is unfortunate, in that the distinction is very important, not only in positive terms, but in normative terms.

    To the degree that MMT associates saving with (S – I), it leverages the message of its normative view, that the private sector is driven by the motivation to satiate its desire for net financial asset accumulation. This general view has great associated consequences for its normative view on deficit financing, etc. etc.

    This can be problematic from a logical perspective, and therefore from the perspective of normative balance.

    It is not clear at all that the desire for net financial assets is in fact the driving force, in my view.

    It is more the case I think that the true force in this Keynesian context is the desire for saving per se – i.e. for S.

    And S can be mapped into two components, as above, “I” and (S – I).

    To the degree that the “I” component is submerged in a lazy conflation of the meaning of “saving”, the (S – I) outlet for saving desires is the one that becomes accentuated in the MMT story.

    The more accurate story, in my view, is that the (S – I) outlet is a critical point of adjustment, as per MMT, but that it is VERY importantly not the only critical point of adjustment.

    So I think for the most part I may be agreeing with and reformulating your comment(s) in my own words. And you’re right – the merging of business and household sectors into the private sector is a catalyst for lazy and perhaps overly convenient interpretation. After all, should we not hesitate just for a moment before blithely ticking off corporate debt and equity as “negative financial assets” within this private sector consolidation?

    (To give MMT its due, they have published sub-sector analysis in this area, although it’s not so prominent in the inherently fast marketing world of the blogosphere.)

    “There is no “to the penny” sort of accounting relationship between household-sector financial saving and government issue of NFA.”

    Right, and again, this statement is probably implicit in MMT’s recognition of the difference between what it classifies as “horizontal” versus “vertical” financial assets. The horizontal nexus includes the financial asset interface between business and households, and there is real investment off to the left of that interface. But your point is a fundamental one that is submerged in the frequently applied MMT shorthand version of the world. MMT should be given credit for understanding this, but not for advertising it.

    Perhaps we should start to look at the problem as one of portfolio mix, and portfolio balance, where the two major categories for the application of saving are investment and net financial assets. I see MMT driving a theme of persistent marginal adjustment through net financial asset accumulation; not one of deliberate portfolio balance between investment and net financial assets. And in doing so, there is a tendency toward open ended flow arguments that facilitate persistent budget deficit rationales, rather than targeted stock balance arguments, as a matter of overarching investment and saving strategies.

    BTW, it looks to me like Steve Roth’s algebra holds up very well through his piece, with a small edit here or there. While I obviously agree with your general point on MMT communication tendencies, the accounting identities properly formulated absolutely ARE a constraint, as Steve R. has suggested. They don’t constrain behaviour, but they do constrain the aggregate structure of alternative feasible outcomes. I don’t think you’re suggesting that the important nuances of unpacking them into properly interpreted sub-sector structures is evidence they don’t do their job as formidable identities.

  18. vimothy
    February 2nd, 2012 at 03:29 | #18

    JKH,

    There’s a slight mistake there in line two of your comment, which made me reread my first comment, which also has a mistake. Your identity should read,

    S = I + (G – T)

    Which is why it is possible for the private sector to increase its saving even as the govt increases its saving (in which case, private saving is investment less govt saving), but not to to simultaneously have (correcting my own mistake),

    S – I > 0
    G – T < 0

    BTW, agree with the broad thrust of Steve W's comments here–which are very good–, especially WRT MMT's occasional conflation of saving with private nominal saving net of investment (or whatever you want to call it).

  19. vimothy
    February 2nd, 2012 at 04:59 | #19

    I’d also like to post a good comment from an old thread at LvMI where MMTers debated Austrians. The post is by the commenter “current”:

    * * * * *

    I think I’ve mostly mined out this thread. There isn’t much left to say here that can be dealt with using the medium of blog comments.

    However, I’d just like to end with a neat explanation of the problems of nominalism from Mises which he gives in “The Theory of Money and Credit” and “Nation, State and Economy”.

    During the first world war the value of German and Austrian currency lost a great deal of value. According to the Chartalists of the time this was *beneficial*. They explained that the fall of the mark versus other world currencies meant that the value of foreign investments rose. Suppose the mark goes down 5% against the pound (I don’t know the magnitude of the actual fall). In that case German businessmen who have assets in places where the pound is used find that their assets are worth more in terms of German marks. So we have:

    Nominal value of capital stock owned by Germans = Nominal value of domestic German capital stock + Nominal value of foreign capital owned by Germans

    Chartalists pointed out that the second component rises as the price of German marks falls. Mises called this “the lowest depth to which monetary theory can fall”.

    But, this analysis in terms of nominals tells us nothing about real magnitudes. The fact was that the currencies of Austria and Germany fell *because they were probably going to lose the war*. The market estimated, quite correctly, that the destruction of productive capacities brought about by the war would mean that there would be fewer German goods to buy, and hence less demand for German money. (The market may also have estimated that it was likely that the Germans would resort to large scale money creation causing inflation, which was what happened though a few years later).

    The fall in the price of the German and Austrian currencies was in fact a marking-down of the capital stock of their entire economies. That represented a market estimate of what the effects of the destruction of the war would be. Foreign investments rose when valued in marks only because they were not affected by this, as domestic investments were.

    In reality we have:

    Real value of capital stock owned by Germans = Real value of domestic German capital stock + Real value of foreign capital owned by Germans

    This total has fallen because the first component (which is of course much larger) has fallen. The second component has remained similar to before.

    That there is a nominal inward flow that will produce a higher nominal GDP is irrelevant.

    * * * *

    blog.mises.org/12576/oh-wow-it-turns-out-that-we-can-print-our-way-to-heavenly-bliss/

  20. JKH
    February 2nd, 2012 at 05:20 | #20

    Vimothy,

    S = I + (S – I) is not a mistake.

    And rather than being a small error, it’s a critical analytical decomposition of private sector saving, most particularly in the context of interpreting the (sometimes ambiguous) MMT intended meaning of saving. Not understanding it can be the source of much confusion around MMT. The fact that you thought it was an error might hint at some. Moreover, it’s the saving algebra that encapsulates what Steve W. is driving at in his comment. That’s partly why I started my opening comment with it.

    It’s an obvious identity/truth from the algebra alone, just as a self-referencing rearrangement of terms.

    But it’s much more than that in the context of deconstructing MMT’s approach to the interpretation of saving.

    Before getting to that interpretation, here is the national income accounting/algebra that gives background context:

    C + I + G + (X – M) = C + S + T

    (S – I) = (G – T) + (X – M)

    That’s one permutation of “sector financial balances”, as a derivation of national income accounting.

    That particular permutation says:

    Private sector net financial asset accumulation = the government deficit plus the current account surplus.

    This is the SFB formulation that defines NFA (actually the flow change in NFA) as the left hand side – it’s the excess of private sector saving over the amount required to fund investment.

    Private sector NFA is MORE than just the government deficit in an open economy. Only in a closed economy does it collapse to (G – T) as you suggested. The always correct definition starts with (S – I), not (G – T).

    Now, in parallel, but at the core of the relationship between private sector saving, investment, and “net financial asset” accumulation:

    S = I + (S – I)

    Just looking at the algebra, this is an obvious identity (or truth, really) just as a result of being a mere rearrangement of entirely equal terms. But it has considerable meaning in the context of how the pieces of the saving puzzle come together.

    Using the earlier definition of net financial asset accumulation from the sector balances equation above:

    Private sector saving = investment plus private sector net financial asset accumulation

    That equation is the foundation algebra for illustrating the point Steve W. was making, in my view, as per my explanation above. I agree with SW’s point, as per my comment. And I also covered this same aspect (among many others) in recent comments under previous posts here at Steve R.’s site.

  21. vimothy
    February 2nd, 2012 at 06:04 | #21

    JKH,

    That’s an unfamiliar decomposition of GDP–thanks for the clarification. Obviously it is tautological, hence correct, but analytically it seemed redundant.

    The point that I was trying to make is that, assuming a closed economy as I did in my initial comment, you can decompose private saving into the sum of private investment and “NFA”. Clearly, private saving can be positive even if net saving is negative as long as private investment compensates.

    I see now that you were driving at a measure of net saving or net acquisition of financial assets for the private sector inclusive of both “NFA” in the sense of claims on the govt and “NFA” in the sense of claims on the foreign sector.

    This seems like a very sensible way to proceed, if not typical of the MMT analysis that I am familiar with. (And I’d still be willing to defend the generic breakdown we are taught at university, which is of course totally consistent with what you write.)

    Anyway, pardon my ignorance–as you were ;-)

  22. paulie46
    February 2nd, 2012 at 06:13 | #22

    “Private sector NFA is MORE than just the government deficit in an open economy”

    How about Private sector NFA = National Debt™ + dollar assets unencumbered by an off-setting liability

  23. paulie46
    February 2nd, 2012 at 06:16 | #23

    OOPs – I should re-state the previous as…

    Private sector NFA = Treasuries held by the non-government sector + dollar assets unencumbered by an off-setting liability.

  24. vimothy
    February 2nd, 2012 at 06:27 | #24

    BTW JKH,

    A further comment re your post at 00:32. I think this,

    It is not clear at all that the desire for net financial assets is in fact the driving force, in my view.

    It is more the case I think that the true force in this Keynesian context is the desire for saving per se – i.e. for S.

    Is an important point.

  25. JKH
    February 2nd, 2012 at 06:28 | #25

    @vimothy

    “if not typical of the MMT analysis that I am familiar with”

    V, you may be thinking of the NFA position of “non-government”, which combines private and foreign sectors. THAT position is identically equal to the government deficit (or debt in stock terms). That’s both a convenient and useful consolidation, that MMT defines as a high level conceptual reference point for the communication of its core message, about government as a marginal supplier of desired saving to non government, and that is a very valid point. But it can obscure what lies beneath.

    EACH sector has its own NFA position. That’s important, and again goes to the crux of the potential confusion around this issue.

    Moreover, the household sector has its own NFA position, and it is VERY substantial, because it frees up the household savings analysis from the consolidated treatment of corporate liabilities and equities as negative financial assets. This is the crux of Steve Waldman’s point. And the household sector position is VERY important in the interpretation of the Fed flow of funds analysis, which in itself is an essential element in the overall coherence of the subject matter.

    Finally, you – Vimothy, as your own defined sector, have your own NFA position.

    If you just give me your numbers, I can calculate it for you.

    :)

    That’s why I think of this stuff as a massive algebra – a closed, coherent mathematical system that must serve as a consistent foundation in any rational discussion of economics. Otherwise, people are just talking about different, self-created definitions, with no possible resolution. And there’s a lot of that going on.

    P.S.

    “unfamiliar decomposition of GDP”

    huh?

    GDP = C + I + G + (X – M) last I looked.

    No?

  26. vimothy
    February 2nd, 2012 at 06:32 | #26

    Yes, sorry, I meant your decomposition of the private saving flow into,

    S = I + (S – I)

    Which I like very much, and will be adding to my bag of identities for further reference!

  27. JKH
    February 2nd, 2012 at 06:32 | #27

    @vimothy

    “Is an important point”

    very important in my view

    glad you agree

  28. JKH
    February 2nd, 2012 at 06:42 | #28

    @vimothy

    S = I + (S – I)

    Good.

    It’s an odd identity isn’t it?

    More of an abstract truth, than an identity. Almost beyond an identity. So simple.

    I think it’s the one that in my journeys I found to be the most critical in understanding the raw guts of MMT. And I only stumbled into it myself by constantly reworking this stuff.

    I’d put it on par with understanding how S must be defined – in its essential interpretation as a residual of income – as per my previous discussions here with Steve Roth.

  29. vimothy
    February 2nd, 2012 at 06:49 | #29

    JKH,

    Yes–it is odd; certainly unfamiliar, as I said. But, now I understand it, I would also describe it as elegant.

  30. JKH
    February 2nd, 2012 at 07:08 | #30

    Steve Roth,

    Here is the part of our discussion from two weeks ago that touched directly on the point that Steve Waldman makes above:

    http://www.asymptosis.com/saving-equals-inventory.html#comment-3571

    “ …..

    Steve R.,

    “How does that utility surplus turn into financial assets? (When net financial assets can only increase due to government deficit spending?)”

    I think there’s an important point to be brought out here.

    The MMT construction of “net financial assets” is a device.

    It’s a device MMT uses as an anchor in developing a general theme for an economic justification for government deficits.

    In doing so, they tend to emphasize the position of the private sector and the foreign sector relative to the government sector. “Sector financial balances” is another device.

    These are OK devices.

    But there should be a BIG CAVEAT in the interpretation of the private sector balance, and I think this has been the source of considerable confusion in outsiders trying to get inside the MMT thinking box. And wouldn’t you know it – it’s an accounting interpretation problem. I’ve alluded to this earlier.

    Here’s the issue, I think:

    MMT breaks down the world into two top tier macro sectors – government and non-government.

    It then typically breaks down non government into private and foreign sectors.

    What it has done as well, but not very often in blogosphere presentations, is break down the private sector into business and household sectors.

    Unfortunately, the private sector consolidation obscures a great dealing of the important accounting that lies beneath in the accounting interface between business and household sectors.

    If business holds investment I, and finances that with debt and equity claims held by the household sector, those financial claims are eliminated at the level of consolidated private sector accounting.

    So what that consolidation obscures is a massive net financial asset position of the household sector with the business sector. It’s a much larger position than the bilateral NFA positions that the household sector may hold with each of the government and the foreign sectors.

    So that HNFA position is fundamentally important to household economic behaviour as well.

    Household behaviour is not driven only by conventional MMT NFA interpretation, but by this interpretation as well.

    I would maintain that households do not “desire” NFA only in the MMT sense. What they desire is more saving per se, when saving is the issue. And that desire includes any of these NFA outlets described, on top of any real investment (e.g. residential real estate) they already hold.

    It just turns out that government can open its bilateral NFA effect on a dime, when aggregate demand is sagging. And that’s important. But private sector accounting consolidation obscures the total dynamic of the thing.

    ……. ”

    I think my point in all of this is that a description that is as deeply contextual and powerful as Steve Waldman’s has been here – has a definitive and simple algebraic anchor in a coherent system of accounting as represented by income statements (e.g. NIPA), balance sheets, and flow of funds.

    S = I + (S – I)

    And I think that says a lot about the power of the general accounting/economics theme that we’ve been developing here.

  31. vimothy
    February 2nd, 2012 at 07:19 | #31

    JKH and Steves W & R,

    I’d like to think more about changes to the stock of savings in terms of the underlying productive capacity of the economy and would be interested in your thoughts on the following.

    Say that we have an economy with a given aggregate production function and stock of capital (and other factors of production). Say further that there is some sudden discovery of a productive technology that multiplies output over all inputs by some common positive factor. Then the real value of the capital stock and national wealth is also increased.

    What I am getting at is that it is important to relate “saving” and “savings” to underlying real forces of future production and consumption, as well as understanding them in terms of cross-sectoral financial flows.

    The real value of national savings is going to be pinned down by real factors (to some extent, at least, and totally in a simplified model). Now, the real stock of private saving is not a function of any nominal flow of “outside” dissaving. Or is it? And if it is, how?

    So I don’t understand how MMT relates real private savings to the private sector’s acquisition of nominal “outside” financial assets. It’s clear that a sovereign currency issuer can issue as much debt as it likes in nominal terms. But it’s also clear that it cannot do this in real terms. In real terms, it faces constraints just like every other economic entity, currency issuing or otherwise. But why should we care about the govt’s ability to issue as much nominal debt as it likes?

  32. February 2nd, 2012 at 11:10 | #32

    Oh dear I did wake up to a lot of reading. What hath Roth got? Time for some JKH pushups…

    Here’s one (at least) double irony:

    1. Steve’s central point:

    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.

    Directly echoes my own mea culpa, which turned out to be a proleptic acknowledgement of Steve’s comment — proleptic even though I didn’t know he was going to post it! I guess I was thinking somebody would…

    2. Just before reading Steve’s comment, I had sent an email to an MMTer suggesting that the school should pay more attention to real-economy productivity and production issues.

    I am such a hypocrite. I used a vernacular definition of savings that’s seductive because it’s how people think about their savings — “my stock of financial assets” — and confuted it in an (unconscious?) error of composition with that favorite MMT macro construct: the total stock of net financial assets = cumulative government deficit spending.

    I shouldn’t do this any more, and neither should other MMT advocates.

    OTOH! Steve’s saying that people can “save” more by working more and smarter, and stowing away the resulting increased claims on firms’ resultant increased value. In a sense, “no duh.” If we collectively produce more lasting stuff by working more and smarter, we’re “saving.”

    But I don’t think that has anything to do with whether households spend or save (a.k.a. don’t spend). They could work more/smarter and buy stuff with all the extra income, transferring those extra “savings” right back into the firm sector.

    I don’t think this in any way validate the example Steve objects to. But…

    Some specific responses:

    @SRW: “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.”

    Right. That’s the kind of long-term-rough-equivalence story I tried to suss out recently (with questionable or negligible success) in the MMT Thought Experiment.

    @JKH: “should we not hesitate just for a moment before blithely ticking off corporate debt and equity as “negative financial assets” within this private sector consolidation?”

    Nicely summarizes my discomfort, and my penchant for Godley’s conceptual/accounting model in which 1. Household income includes capital gains, and 2. Business profits are not instantaneously transferred to households.

    “Perhaps we should start to look at the problem as one of portfolio mix, and portfolio balance, where the two major categories for the application of saving are investment and net financial assets.”

    My thinking has been moving in this direction because it jibes with the decision I face every day as a *individual* business owner: should I invest in (spend on) new computers for my employees, or leave my “savings” stored/”invested” in financial assets? The latter is damned attractive because after ten years I’ve got the earning and still have the principal. The computers, while they might have delivered greater return, are long gone.

    Could all business owners, in aggregate, choose financial assets, in which case we get no investment? I think the accounting clearly allows that possibility. IOW, its’ all about spending on real goods — velocity — and the expectations that spur that spending, not about saving/not spending.

    “BTW, it looks to me like Steve Roth’s algebra holds up very well through his piece”

    Well then. I’m in the interesting situation of having suggested that JKH is wrong in saying that I’m right.

    “net financial asset position of the household sector with the business sector”

    That little word — “with” — was a huge aha for me. In my words: financial assets are credits. Which raises the obvious question: “credits with whom?” Depends on which sector you’re looking from/at — how the equity/equity-claims are depicted.

    “S = I + (S – I)”

    This is a gem, need to internalize it further. I understand the arithmetic, but don’t yet fully grok its crystalline essence.

  33. February 2nd, 2012 at 11:26 | #33

    @vimothy: “I don’t understand how MMT relates real private savings to the private sector’s acquisition of nominal “outside” financial assets.”

    Boy can I relate.

    I’m getting there, but I haven’t achieved the clarity that would allow me to help you with that. Yet.

  34. paulie46
    February 2nd, 2012 at 11:51 | #34

    What are nominal “outside” financial assets?

  35. vimothy
    February 2nd, 2012 at 12:12 | #35

    @paulie46

    Sorry, that’s (probably unhelpful and confusing) figurative shorthand for nominal claims on other sectors, i.e. the private sector’s nominal stock of claims on the govt and the foreign sector.

    “Outside” assets is meant to suggest assets without an “inside” liability, and so which do not “net out” on aggregation. “Outside saving” would be the “(S – I)” in “S = I + (S – I)”.

  36. JKH
    February 2nd, 2012 at 14:18 | #36

    @Asymptosis

    “The only way to increase private savings (the stock of net financial assets) without changing imports is to increase exports or run government deficits.”
    ……

    “It looks to me like Steve Roth’s algebra holds up very well through his piece, with a small edit here or there.”
    ……

    “Well then. I’m in the interesting situation of having suggested that JKH is wrong in saying that I’m right.”

    - Your first statement is true, GIVEN that you’ve defined private savings as the stock of net financial assets

    - But you really should define it as an AMOUNT equal to the stock of real investment plus the stock of net financial assets: S = I + (S – I)

    - Given the outstanding progress we’re making here, I consider that a small edit

    :)

  37. JKH
    February 2nd, 2012 at 14:21 | #37

    P.S.

    And then you add “or increase investment” to your first statement, of course

  38. February 2nd, 2012 at 16:25 | #38

    Superb piece Steve. The comments are even better (no offense!).

    This all blends into a point that I have been trying to make regarding the big job guarantee debate. It sort of blends with the marginal product of labor, but more generally pertains to the value of one’s production. MMT often neglects production for consumption. Many Austrians do the opposite. I’d like the find the middle ground.

    It’s my belief that MMT has many holes in it because of this obsession with govt as the monopolist and supplier of the currency. I think the state theory is partially false as it pertains to our constitutional republic, but MMTers often use it to make extreme points. It leads to all sorts of false conclusions like the JG, an overemphasis on govt policy and ideas regarding the foreign sector. The weakness (for whatever reason) is in misunderstanding one of Steve W’s original points regarding real value. I think most MMTers would fully agree with Steve W, but that doesn’t stop them from neglecting the importance of production at times.

    The accounting is useful in defining the relationships and the operational realities of our monetary system. But the identities do not teach us how to optimize output per se. Anyhow, I haven’t fully collected my thoughts on this yet, but I thought these comments were superb in addition to Steve’s post and deserved recognition. So thanks.

    As many of you know, some of us are forming alternative thinking on all of this outside of the MMT umbrella. I think through collaboration the answers to these questions are not outside of our reach. So I hope the discussion will continue to move forward and I hope to somehow positively contribute (though, like Steve W, I maybe not have much, if anything of value to add!).

    Cullen

  39. beowulf
    February 2nd, 2012 at 17:14 | #39

    Cullen you and Steve W are being modest, you’re both chock-full of value added (and I don’t just mean your harvestable organs).
    To a point JKH made above (merging of business and household sectors into the private sector is a catalyst for lazy and perhaps overly convenient interpretation.”), see Anwar Shaikh’s paper, “Three Balances and Twin-Deficits: Godley versus Ruggles and Ruggles”.

    “In the US, a similar thread of evidence led Richard and Nancy Ruggles to conclude that on average the household savings rate was zero and that business savings was equal to business investment.
    webcache.googleusercontent.com/search?q=cache:eSis8uiSSLMJ:homepage.newschool.edu/~AShaikh/Shaikh%2520Godley%2520Conference%2520Paper.pdf

  40. February 2nd, 2012 at 17:41 | #40

    @beo: “Anwar Shaikh’s paper”

    What a wonderful opening paragraph. Godley must have been a lovely guy. Very reminiscent of Kahnemann’s latest, in which he frequently speaks so fondly of Amos Tversky — who died before they could get their Nobel together — and their decades-long friendship and collaboration.

    Oh and yeah the analytical stuff seems pretty good too.

  41. beowulf
    February 2nd, 2012 at 18:10 | #41

    @Asymptosis
    The last paragraph is pretty good too.

    it is certainly possible that the relative private sector balance will settle once again at some sustainable level. If so, we will be back to the era of sibling deficits: then liberal economic prescription for continued expansion in budget deficits to raise employment will result in larger trade deficits, while the conservative
    prescription for reduced deficits will lead to lower trade deficits but higher unemployment. These are the dilemmas of our time.”

  42. JKH
    February 2nd, 2012 at 18:20 | #42

    @beowulf

    Beo – that’s a really weird result on household saving in that paper.

    Not to get into it too deeply now, but here’s my initial take on it. The fed flow of funds report shows a net financial asset position for the US household sector exceeding $ 30 trillion. About half of that could be attributed to equities, half to credit – although much of it is buried levels down beneath claims on pension funds, etc. Real estate and durables, etc. is about $ 20 trillion rounded, and the sum of the two is how net household wealth pushes up well through $ 50 trillion.

    The weird thing about that saving result is that it seems to imply on the surface that the entire net financial asset position of the household sector has been generated internally by the corporate sector.

    E.g. increases in the value of a stock, assuming no dividends, are reflected as an increase in net financial assets of the household sector, even though it has received no direct NIPA income from stocks. And somehow that dynamic would have to spill over into the total value of net credit and equity held by the household sector. And it would have to have been that way since God created US saving, which is even weirder, assuming one takes that statement about household saving at face value.

    It makes no sense at all to me. But its my first take.

  43. vimothy
    February 2nd, 2012 at 18:27 | #43

    beowulf,

    Really great, germane link, thanks for that. Levy Institute has Shaikh’s presentation notes up as well, which are handy:

    levyinstitute.org/conferences/godley2011/presentations/Shaikh.pdf

  44. JKH
    February 3rd, 2012 at 04:47 | #44

    @beowulf/JKH

    thinking about it a bit, I can start to visualize how it might happen in theory

    just have to imagine now why it might happen in practice

  45. February 3rd, 2012 at 05:51 | #45

    @vimothy

    Welcome aboard! ;)

  46. vimothy
    February 3rd, 2012 at 07:56 | #46

    TC,

    Ha!

    Anyway, been going through that paper. Here’s a brief summary of the bits that stood out to me.

    Author describes two parallel (and I assume) PKE approaches to understanding national income and expenditure flows: Godley and Cripps (G&C) and Ruggles and Ruggles (R&R).

    G&C model starts with an equation for excess demand as a function of the three sector balances. Excess demand causes undesired changes in inventories. Their equilibrium condition is that this value is zero in the “short-run”.

    Now, you can write the private sector balance as the difference between private saving and investment, where private saving is the difference between disposable private income and consumption.

    The “Twin Balance Hypothesis of the New Cambridge Approach” is that this is zero in equilibrium, which implies that the budget deficit equals the trade deficit and that private savings equals investment.

    G&C hypothesise that the private sectors desired stock of net financial assets is proportional to private disposable income, and that this stock-flow ratio is constant. Private savings adjusts against investment to bring the two into equilibrium.

    Author of the paper makes a slight alteration to the model to ensure that the adjustment process dynamically stable.

    The result we end up with this that the proportionate growth rate of private net financial assets equals the proportionate growth rate of the economy. G&C assume that the growth rate of the economy is zero in the short run, in which case the private balance is zero.

    R&R don’t use formal modelling. Based empirical analysis of NIPA hypothesise that no sector is a net supplier or receiver of funds in equilibrium. They have a nice turn of phrase: “with respect to sector saving and capital formation the general rule is that each tub tends to stand on its own bottom.” Household saving is zero. Business saving equals business investment. Private balance is zero. Capital accumulation drives saving (i.e. saving adjusts to investment to equilibrate the system). Expected future aggregate demand drives investment.

  47. beowulf
    February 3rd, 2012 at 09:28 | #47

    @vimothy
    “This article argues that an expansionary fiscal policy is a necessary condition for growth in the long term, reasserting an old Keynesian principle that sustained expansion requires continuously growing exogenous injections to the flow of income.”
    http://findarticles.com/p/articles/mi_m1093/is_n1_v41/ai_20485331/

  48. vimothy
    February 3rd, 2012 at 11:08 | #48

    beowulf,

    I admit to finding it hard to make sense of that result, though. Why should private sector demand for saving systematically exceed investment supply? You’ll note that in Godley’s models, this comes out of behavioural assumptions and the conditions needed to solve the model for the steady state. It’s not behaviour which is generated from the (theoretically grounded) behaviour of actors within the model. It’s a top-down assumption.

  49. February 3rd, 2012 at 11:15 | #49

    @vimothy:

    “in Godley’s models, this comes out of behavioural assumptions and the conditions needed to solve the model for the steady state. It’s not behaviour which is generated from the (theoretically grounded) behaviour of actors within the model. It’s a top-down assumption.”

    Interesting. Is Godley breaking the Roth Rules of accounting and economics? Suggesting that accounting causes economic behavior?

    Or is he just choosing some behavioral assumptions that comport with the accounting, while acknowledging that very different assumptions could achieve the same?

  50. vimothy
    February 3rd, 2012 at 11:31 | #50

    @Asymptosis

    Steve,

    Is Godley breaking the Roth Rules of accounting and economics? Suggesting that accounting causes economic behavior?

    I would say no. Godley uses accounting matrices to track and relate the evolution of variables. The actual behaviour of those variables is driven by behavioural assumptions, i.e. structural-type equations, and by existence of the stock-flow steady state.

  51. Detroit Dan
    February 3rd, 2012 at 12:06 | #51

    Excellent discussion. Thanks as always to JKH for clarifying things…

  52. February 4th, 2012 at 01:49 | #52

    fyi . . .

    Jan Hatzius of Goldman Sachs wrote this article in 2003 and someone posted this on Scribd:

    http://www.scribd.com/doc/79229916/Financial-Balances-Model-of-the-US-2003

    “The Private Sector Deficit Meets The GSFCI – A Financial Balances Model Of The US Economy”

  53. JKH
    February 4th, 2012 at 07:35 | #53

    @Ramanan

    Ramanan,

    From the Goldman paper:

    “The economy will be weak if desired changes in financial balances add to a number greater than zero, and vice versa. The mechanism ensuring that, after all is said and done, the actual balances always do sum to zero, is changes in income.”

    - accounting constrains economic outcomes

    “If corporations are running a financial deficit — cash flow exceeds the sum of capital spending and inventory accumulation — …”

    - Typo? I can’t make sense of it otherwise. What am I misreading?

    “We can solve for the long-run equilibrium financial balance for the household sector. Depending on the exact assumptions that we make, this type of calculation yields an “equilibrium” household sector balance of +2% to +4% of GDP.”

    - Appears to contradict the previous previous Shaikh paper, as in my questioning of the same here:

    http://www.asymptosis.com/how-accounting-constrains-economics.html#comment-3771

    “Third, financial balances in the public sector probably depend more on political preferences than on long-run sustainability considerations”

    - not sure how to interpret that; maybe his pre-MMT version, or maybe consistent

    Apart from that, the behavioural modeling is impressive, but also pretty intuitive. At the end of the day, the accounting constrains the sum of the sector results, whatever the behaviour. The behavioral modeling must always “fit” (in the pure modeling sense of that word) the accounting outcome, not vice versa.

  54. February 4th, 2012 at 10:23 | #54

    @JKH

    “The mechanism ensuring that, ..”

    I think Hatzius is talking more of income changing rather than changes in interest rates – the latter emphasized by neoclassical economists. But yeah definitely accounting constrains economic outcomes.

    I haven’t understood Shaikh’s paper yet (though I heard it live) – the details but seems like it is saying that households in the US spend whatever they receive immediately in their bank accounts after making compulsory mortgage payments, so that all their accumulation of financial assets is via pensions which they are unable to spend immediately.

    I saw this footnote is Godley&Lavoie’s book:

    “It has been shown by Ruggles and Ruggles that once the fictitious
    real estate enterprises of NIPA that take care of households new purchases of residential
    units have been taken out, and once pension fund schemes are considered as saving by
    firms rather than that of their employees, then the change in the net financial position
    of the household sector is virtually nil, and even negative on the average in the United
    States since 1947″

    http://books.google.co.uk/books?id=YUZv_8BvlLAC&lpg=PP1&pg=PA282#v=onepage&q&f=false

    is the Ruggles and Ruggles article.

    The definitional issues and differences between authors is too confusing to me at this stage. That is, the footnote changes definition temporarily to use R&R’s definition. But the general idea seems to be revolving around households spending everything available after compulsory mortgage payments so that households increase their financial assets purely by compulsory saving plans of their employers, on an average.

    “Typo? I can’t make sense of it otherwise. What am I misreading?”

    Looks like more than a typo. Somehow reminds me of the discussions around the “paradox of profits”.

    ‘“Third, financial balances in the public sector probably depend more on political preferences than on long-run sustainability considerations”
    - not sure how to interpret that; maybe his pre-MMT version, or maybe consistent”

    Yes, I too am not sure on how to interpret his version of sectoral balances.

    Yes Hatzius seems to do some good modeling. Liked his part that when stock markets are doing well, there is more household spending since they feel richer etc.

  55. JKH
    February 4th, 2012 at 10:33 | #55

    @Ramanan

    I’m going to spend a bit more time with the numbers – later. My guess right now is that Godley and Rubbles (independently) came up with some generalizations about the expected gross distribution of sector balances, that don’t apply very well (at least in recent years) to the US. But there’s still the somewhat separate point that Rubbles made about the long term expectation for household net saving – as being zero – which I find particularly unbelievable in the case of the US, given that the household NFA position reflected in the Flow of Funds report is around $ 30 trillion. That sort of discrepancy can only be explained as differences between market value (NFA) and book value (cumulative saving), and I don’t see how 100 per cent of the NFA position can logically be attributable to that sort of differential. On the other hand, the Goldman numbers look like they work quite well. Enough for now, though. Thanks.

  56. February 4th, 2012 at 11:45 | #56

    @JKH

    Are you saying that these authors are saying that the financial balance of the household sector is zero?

    Ruggles & Ruggles changed the definitions around to reach the conclusion is what I make of it.

    Hatzius’ charts on the household sector looks very similar to Godley’s charts on the personal sector.

    Shaikh observes that Godley’s models (as opposed to his empirical work) leads to long run saving of zero. However this is for “non-growth” models not for growth models. He makes some changes to say something.

  57. JKH
    February 4th, 2012 at 13:35 | #57

    @Ramanan

    R.,

    Every so often, I see a paper that covers some very interesting subject matter, and invest some time on it, but with some puzzlement at first. After a while, it becomes painfully obvious, that the paper is so badly written, it warrants absolutely no time at all. So it is with this Shaikh piece. And it should be considered no reflection on the quality of Godley’s work, in any way. But the Goldman paper was worthwhile.

  58. February 4th, 2012 at 13:53 | #58

    @JKH

    He he. I still think there is something in Shaikh because some of expressions like alpha(1-t)g looks familiar but I can’t make more sense of it at all at this point despite many attempts to read it.

  59. February 4th, 2012 at 22:06 | #59

    @vimothy
    What exactly are you asking here?

    1. Does the math require a growing deficit to create growth? The answer to this is yes, according to Godley – it falls out of the steady state observation. If you want to avoid the steady state, you need something to “grow”

    or

    2. Why do People consistently demand more savings than investment is willing to supply?

    One game I always think about is a coin flip game. This game is easy, you win on heads, lose on tails. It’s even easier because you get to name your odds before you flip. Any odds will be taken.

    The only catch is you need to bet your entire net worth on the game. As wealth goes up, the minimum odds you need to play go up until at some point, you’ll no longer play.

    I think this thinking applies to societies as well as individuals. People in aggregate could demand higher odds than investment is perceived to supply at that time, well basically forever.

    As time goes on and society gets more wealthy, this quality spread in demand should grow. it’s late and I’ve had lots of cough medicine, so I can’t tell if this makes any sense at all.

  60. February 5th, 2012 at 08:58 | #60

    “given that the household NFA position reflected in the Flow of Funds report is around $ 30 trillion. That sort of discrepancy can only be explained as differences between market value (NFA) and book value (cumulative saving)”

    Big aha.

    Can we say that (flows): cap gains – net investment in fixed assets = the market’s best guess as to the value of newly created non-fixed real assets?

    IOW, national savings (the stock) = unconsumed fixed assets + all the other real assets that have been created and not consumed, but that aren’t explicitly accounted for in the NIPAs?

    Those other real assets would include knowledge, skills, organization capital, ideas, the population’s capacity to work in the future, etc.? (Not sure about the last on the list)

    So (again, stocks):

    Net Financial Assets = Fixed Assets + Unnacounted Real Assets (as estimated by the market)?

  61. February 5th, 2012 at 09:37 | #61

    BTW, I find the last line of Godley’s Balance Sheet Matrix to be a wonderfully succinct summation of much discussion here.

    I think it resolves down to:

    Net Worth of Firms + Government debt = Net Worth of Households

  62. vimothy
    February 6th, 2012 at 03:56 | #63

    What’s the problem with the Sheikh paper? It seemed like a fair and easily understandable representation of Godley’s model to me. But then, this might just represent my own lack of familiarity with Godley.

  63. vimothy
    February 6th, 2012 at 04:06 | #64

    TC,

    Does the math require a growing deficit to create growth? The answer to this is yes, according to Godley – it falls out of the steady state observation.

    I’m not sure that’s quite correct. Given the definition of equilibrium that Godley imposes on the model, the only stable path has NFA growing at the same rate as the economy. If on the other hand the deficit is growing, then the stock-flow “norm” will not be satisfied and the model will not be in equilibrium.

    Why do People consistently demand more savings than investment is willing to supply?

    Do people in fact demand this? If so, why?

  64. JKH
    February 6th, 2012 at 10:09 | #65

    Pulled from spam. Sorry.

    (REPEAT submission, from several hours ago)

    Steve,

    “Given that the household NFA position reflected in the Flow of Funds report is around $ 30 trillion. That sort of discrepancy can only be explained as differences between market value (NFA) and book value (cumulative saving)”

    That’s a wobbly reference from my perspective, because I was drawing a hypothetical connection between something I’m comfortable with (Fed Flow of Funds), and something that on the surface makes little sense to me (the Shaikh paper, as in my comment to Ramanan) – so my “explanation” was only hypothetical, regarding a weird and questionable discrepancy, from my perspective.

    I haven’t spent enough time on the detail of Godley models to draw connections, so let me summarize again on a stand-alone basis some aspects of the Fed flow of funds report as I think they might relate to a couple of your points.

    FED FLOW OF FUNDS HOUSEHOLD SECTOR BALANCE SHEET ASPECTS

    $ TRILLIONS – LIBERALLY ROUNDED:

    Total assets $ 71 trillion

    Physical 23

    Financial assets 48
    Ultimate* equity 16
    Ultimate* debt 32

    Liabilities 14

    NFA 34

    Net worth 57

    * By “ultimate”, I mean either directly held or indirectly held claims. An example of an indirectly held claim is the underlying equity value held by a pension fund portfolio that has a corresponding actuarial liability to a household.

    PRELMINARY OBSERVATIONS:

    The US household NFA position is about $ 34 trillion.

    Only $ 16 trillion of that represents the value of equities to which households have either direct or indirect claim.

    The remaining $ 18 trillion is attributable to net debt claims (i.e. $ 32 trillion in assets net of $ 14 trillion in liabilities (e.g. mortgages, credit cards)).

    The $ 16 trillion equity is at market value – not book value (see further explanation below).

    FURTHER OBSERVATIONS:

    a) Household NFA far exceeds the net worth of firms, as the latter is represented by the book value of equity. (This goes to one of your points.)

    b) The evidence of a) lies in the fact that households have ultimate claims in the form of all net business equity financing AND net debt financing. The latter netting includes not only elimination of intra-business held debt, but elimination of debt issued by households (mortgages, credit cards, etc.)

    c) Regarding one of your points, the connection of household NFA to government debt is tricky, because of multiple bilateral NFA interfaces among household, corporate, government, and foreign sectors. A granular, sector distribution of government debt appears as a cross current to that NFA decomposition. For example, China owns a lot of US government debt. The non-US world in total holds a net NFA position with the US. But China’s own holdings of government debt don’t necessarily match that non-US total NFA position. The rest of the publically held debt is held by the US private sector, which itself includes both corporate/institutional and household sector direct holdings of government debt. It’s complicated. It’s much easier to make a statement about the NFA of all non government (US and foreign), as a simple bilateral interface of non government with government, than it is to decompose NFA according to multiple sectors and sub-distributions of government debt holdings.

    d) US household NFA is derived from a balance sheet that includes (pre-netting) gross financial claims in both debt and equity form. Much of this is valued at market value as opposed to book value (government debt is one of the exceptions to this). This balance sheet includes gross claims against business, government, and the rest of the world. Business sector fixed assets are “downstream” from these financial claims. Business sector fixed assets are obviously not valued directly in the sum of household claims, incorporated instead through the prism of financial claims held both directly and indirectly by households. (This goes to another of your points.)

    e) Finally, it is always a challenge to relate historic saving by each of the household sector and the business sector to any of household assets, household net assets (net worth), or household net financial assets. Cumulative business saving is reflected in business retained earnings, which is a book value number. The book value of business retained earnings is one component underlying the market value of equity claims on business. The other is original paid-in capital. These two components sum to total book equity, but the relationship of total book equity obviously isn’t 1:1 to the market value of equity, since the latter is constantly fluctuating in value, notwithstanding change or no change to book value. On the other hand, to the degree that the market value of equity reflects historic business saving in its underlying retained earnings component, that value obviously is not attributable to historic household saving as defined in NIPA. Yet the net financial asset value that corresponds to it is reflected in household NFA. That’s because households have ultimate claim to the “paid-in capital” component of business equity, and those claims get augmented indirectly by business retained earnings, following which equity in its total book value (paid in capital plus retained earnings) is valued at market, and reflected in the ultimate claim that households have on it.

    As far as Godley is concerned, as I said I really haven’t had the time yet to relate his work in detail to my own interpretation of the US flow of funds. As I suggested to Ramanan, I’m not going to attempt to interpret Godley through the prism of that Shaikh paper. I just wish instead I could get the hour of my life back that I wasted trying to read it. (No disrespect to Godley’s work.)
    :)

  65. JKH
    February 6th, 2012 at 10:11 | #66

    “Godley matrix is on Page 3 here”

    Page 3 of which paper? The link is to a list of papers.

    P.S. earlier comment caught as spam, I think

  66. February 6th, 2012 at 12:19 | #67

    “I think it resolves down to:
    Net Worth of Firms + Government debt = Net Worth of Households”

    Not right.

    Bring the thing on the right hand to the left hand. Net worth of households and firms cannot have different signs.

    The correct equation is

    Net Worth of Households + Net Worth of Firms + Net Worth of Government = Nonfinancial Assets

    I think you are referring to the Table 3 which you probably referred in some different post http://www.ipc-undp.org/publications/srp/TOWARDS%20A%20RECONSTRUCTION%20OF%20MACROECONOMICS.pdf

    The whole table is a bit poorly constructed/printed. There’s no current/capital account in the balance sheet matrix. Just one column for each sector. But in the paper there are two :(

    You can see a cleaner version of this in his book with Marc Lavoie (Table 2.4).

  67. February 6th, 2012 at 12:36 | #68

    I actually like the “transactions flow matrix” because it’s in a sense more dynamic (at least in my head) and more importantly national accountants do not present it that way exactly, so its more unique.

    I have two blog posts on this on my blog

    http://www.concertedaction.com/2012/01/09/the-transactions-flow-matrix/
    http://www.concertedaction.com/2011/11/11/financial-crisis-and-flow-of-funds/

  68. February 6th, 2012 at 12:45 | #69

    @vimothy

    Yes not required. More a “long-run”/situational kind of statement.

    Growth can also be due to higher private expenditure relative to income. (And in the open economy case net exports).

    Assuming away the existence of the external sector, this means the private sector as a whole is increasing its indebtedness relative to income and is unsustainable leading to a crash at some point which is difficult to point.

    “Growing deficits” can also be growing deficits in $ not necessarily percentage of GDP.

  69. JKH
    February 6th, 2012 at 12:58 | #70

    R.,

    Net Worth of Households + Net Worth of Firms + Net Worth of Government = Nonfinancial Assets

    That doesn’t look right, if the definition of net worth is the usual one. You’re double counting net worth of firms. Is there an intuitive explanation for why that would be useful?

    (I’m still waiting for my (lengthy) comment from this a.m. to be posted)

  70. February 6th, 2012 at 13:40 | #71

    @JKH

    JKH,

    Yes there are definitional things here. G&L point out in their book that equities issued are valued at market prices and included in liabilities.

    The Z.1 does not include equities in liabilities and shows it as memo. For example table B.102

    So probably explains double counting going on if one uses the Z.1 definition.

    The UK Blue Book uses SNA which is somewhat different in style from Z.1 and they count equities in liabilities. Hence their definition of Net Worth is different from Z.1

    http://www.ons.gov.uk/ons/rel/naa1-rd/united-kingdom-national-accounts/2011-edition/bod—blue-book-2011.pdf

    Check Table 3.1.9.

    G&L don’t like equities excluded from Liabilities though they have a full page explaining why they do so. (Though I think the more important reason they do not mention, is the open economy case! – and I have seen a critique of the Economic Report of the President in Godley’s “Seven Unsustainable Processes” taking issues with not counting equities held by foreigners as if they don’t count as debt).

    They reasons according to them is that directors are reluctant to cut off dividends as it would send a negative signal to the markets, even though interest and principal payments are contractual obligation but dividends are not.

    They also take issue with valuing equities at historic costs. I think SNA (and Blue Book) values them at market value

    This can have counterintuitive consequences because if there is a boom in stock markets, firms net worth will be recorded as negative. For example according to them the net worth of nonfinancial firms in the US was negative in 2001 with this definition. (Tobin’s q turned greater than 1)

    However, it doesn’t matter too much from a behavioural viewpoint in their view.

    Will wait for your am comment.

  71. February 6th, 2012 at 14:22 | #72

    @JKH

    First, in case it didn’t ping you, I’ve despammed your comment.

    Ultimate* equity 16
    * By “ultimate”, I mean either directly held or indirectly held claims.

    So should this read “equity claims” to be clear, per your various previous?

    Gotta run, more anon.

  72. February 6th, 2012 at 14:29 | #73

    Ramanan :

    I think you are referring to the Table 3 which you probably referred in some different post http://www.ipc-undp.org/publications/srp/TOWARDS%20A%20RECONSTRUCTION%20OF%20MACROECONOMICS.pdf

    Yeah that’s the one.

    There’s no current/capital account in the balance sheet matrix. Just one column for each sector.

    ???

    http://www.asymptosis.com/?attachment_id=5014

  73. JKH
    February 6th, 2012 at 14:39 | #74
  74. February 6th, 2012 at 14:40 | #75

    @Asymptosis

    Sorry didn’t phrase my sentence correctly.

    As in … the current and capital accounts appear only in the transactions flow matrix in the Godleyan construction. None of his other papers (both before and after) have a current account and a capital account in the Balance Sheet matrix.

    The table in the link http://www.asymptosis.com/?attachment_id=5014 is the result of bad table creation. So is the sign next to firms’ net worth in the row “Balancing item”.

  75. February 6th, 2012 at 15:02 | #76

    Ramanan :

    The table in the link http://www.asymptosis.com/?attachment_id=5014 is the result of bad table creation. So is the sign next to firms’ net worth in the row “Balancing item”.

    I thought that sign was weird! (Been doin’ my pushups…)

    Waiting for the new edition of the book. Hopefully I’ll be able to participate better when I’ve gotten into it.

  76. JKH
    February 6th, 2012 at 15:28 | #77

    Steve/Ramanan:

    Can you please give me your best explanation of what you think Godley is doing in his page 3 table, under the lower “balance sheet matrix” section, column 7, balancing items (I), (K)

    How do you interpret those entries exactly?

  77. February 6th, 2012 at 15:40 | #78

    @Asymptosis

    “Waiting for the new edition of the book. Hopefully I’ll be able to participate better when I’ve gotten into it.”

    Got mine autographed already by Marc.

    http://www.concertedaction.com/wp-content/uploads/2012/02/Autograph.jpg

    Too bad didn’t get Wynne’s autograph on it.

  78. JKH
    February 6th, 2012 at 15:44 | #79

    @Asymptosis

    “…….

    “By “ultimate”, I mean either directly held or indirectly held claims.”

    So should this read “equity claims” to be clear, per your various previous?

    ……….”

    No.

    This can refer to either debt or equity claims.

    But the wording in my example was poor; hence some ambiguity.

    My example was:

    “An example of an indirectly held claim is the underlying equity value held by a pension fund portfolio that has a corresponding actuarial liability to a household.”

    This would better have read:

    “An example of an indirectly held claim is the underlying equity CLAIM held by a pension fund portfolio that has a corresponding actuarial liability to a household.”

    And an alternative example could have been:

    “An example of an indirectly held claim is the underlying debt CLAIM held by a pension fund portfolio that has a corresponding actuarial liability to a household.”

    Good catch on some poor wording. Thanks.

  79. JKH
    February 6th, 2012 at 15:46 | #80

    @Ramanan

    cool!

  80. February 6th, 2012 at 16:31 | #81

    @JKH

    Godley has an opening stock of balance sheet matrix to which he adds certain entries of the transactions flow matrix. Then he creates a revaluations matrix (though not shown in the paper) which records asset revaluations. Such as changes in the market values of bonds, equities etc each sector holds. After this he reaches a closing stock of balance sheet matrix which becomes the next period’s opening balance sheet matrix.

    The column 7 is actually not needed and in most of his papers, that column is not there at all. The column and the Σ column are joined into one. When joined the bottom right entry sums to non-financial assets.

    When not done so, like the paper, all rows and columns sum to zero. I think he preferred it that way but haven’t seen it in other papers. The reason for the preference is that all the rows and columns of the transactions flow matrix sums to zero so its nice if the same happens in the balance sheet matrix as well.

    So firms hold inventories which are stocks (as opposed to “change in inventories” which is a flow) and firms also have fixed capital.

    The item (Row 11, Column 7) just signifies the fact, that since assets and liabilities cancel out, the sum of financial net worth of all sectors is the sum of non-financial assets.

    If one sees it as a moving picture, then things are more easy to see. So for example, households save a part of their income and they allocate it between deposits, bills/bonds and equities. At the same time, they see a holding gains in their existing stocks of assets. These are recorded in the revaluation matrix.

    So the closing balance sheet matrix is calculated as Closing Stocks = Opening Stocks + Flows + Revaluations.

    So in every period, firms would have made products, sold them and are left with unsold inventories. This means the closing stock will be different. Firms may have also purchased fixed capital (from itself) and ignoring depreciation for the moment, this means entries in the transactions flow matrix. Record revaluations of existing assets in the revaluation matrix and add both to the closing stock.

    For financial numbers, take the opening stock (such as equities) and to this add the flows (such as new purchases of equities by households) and add revaluations of previously held equities. Do this for all assets and liabilities and you get the closing balance sheet matrix for financial assets and liabilities.

    This process can be facilitated by the creation of another matrix called the “full-integration matrix”.

    The first row of this matrix is the previous period Net Worth of each sector. Then the next few rows are transactions and after this, revaluations. The last row is the end of period net worth.

    Bit difficult to summarize the whole process but it is done very systematically in G&L’s Monetary Economics.

    Coming to the point about sum of net worths, one should be able to verify this by changing the definition of net worth to the SNA definition (ie, move memo items into liabilities etc) to find out that the net worth of all sectors of the US economy is equal to the sum of non-financial assets plus the US net international investment position.

  81. February 6th, 2012 at 16:34 | #82

    ” When joined the bottom right entry sums to non-financial assets.”

    Sorry remove that line.

  82. February 6th, 2012 at 16:50 | #83

    @JKH

    :- )

  83. JKH
    February 6th, 2012 at 16:51 | #84

    @Ramanan

    Thanks. I’ll need to absorb your comment.

    I must say, this is the second time I’ve looked at that paper in the past several weeks. And I’ve hit the same stumbling block on both occasions.

    I dare say that column 7 doesn’t look stock flow consistent to me. That alone suggests I must be wrong, given the author. And it appears to factor into his final net worth equation, so I’ll have to spend more time on it.

    Everything else with that important exception looks exactly like I interpret it from the US Fed Flow of Funds perspective.

    Thanks.

    BTW, I assume you’re being called up as a guest speaker, on international current account matters, here:

    http://www.moslereconomics.com/wp-content/powerpoints/umkc.pdf

    :)

  84. February 6th, 2012 at 17:11 | #85

    @JKH

    “should this read “equity claims” to be clear, per your various previous?
    No.
    This can refer to either debt or equity claims.”

    Right I wasn’t asking about the “ultimate” (understood), just about the bare “equity.”

    Still busy, back to this more soon.

  85. February 6th, 2012 at 20:59 | #86

    @JKH

    It is stock-flow consistent. I don’t see any reason why, perhaps the typo in firms’ net worth?

    Such things were kids’ play for Wynne!

    Here’s a much better table which I pictured from my phone from G&L’s book:

    http://www.concertedaction.com/wp-content/uploads/2012/02/Balance-Sheet-Matrix.jpg

    Note: The negative sign in the row net worth may first appear strange but the convention is left hand sides of balance sheet have positive signs and right hand sides negative.

    The table has tangible capital i.e., merges fixed capital and the stock of inventories

    ….

    Don’t think I will be called to talk on this issue by Kansas City- given I have come close to … okay let me avoid the word.

  86. February 6th, 2012 at 22:32 | #87
  87. JKH
    February 6th, 2012 at 23:06 | #88

    Steve R./Ramanan,

    OK.

    Here’s where I’m at on this now, is that the Godley matrix presented on page 3 of that paper is contaminated by utter rubbish, with respect to the logic of column 7 and the consequential footnoted definition of net worth. That makes it useless, as far as I’m concerned.

    I know you won’t like that, Ramanan. But wait. By enormous contrast, the Godley matrix presented in your linked post is perfectly clear and correct, in my view.

    At least, I can link the logic in it exactly 1:1 to my own understanding of the US Fed Flow of Funds report.

    In other words, that second Godley matrix in Ramanan’s post is PERFECTLY COMPATIBLE with the logic used in the US Fed Flow of Funds reports, by my reading of it.

    E.g. in that second version, it is very easy to develop my earlier equation:

    S = I + (S – I)

    I’ll save that development for a bit later, if necessary.

    This is the first time I’ve successfully traversed a Godley matrix of any type, anywhere, in any detail. So that’s a personal accomplishment I guess. But I’m a bit angry having to endure now TWO poorly presented papers (including the first one by Godley, in my view).

    Thanks, Ramanan – for posting the second Godley matrix (from the book, I gather?) with good accompanying explanation.

    One of my numerous problems with the first one was trying to decipher the notation in the absence of explanation or alphabetic intuition.

    I now understand that “FU” stands for undistributed business profit – i.e. retained earnings.

    That’s good, because I feel like I’ve been “FU’d” over trying to figure out this notation and others in the first paper, before Ramanan presented this stuff so clearly in his post. But maybe “FU” is standard notation everywhere, aimed at guys like me who are too lazy to work through such matrices in detail.

    How on earth that first Godley paper ever got published is beyond me. Does anybody ever proof these things before they’re published? But maybe you totally disagree with me on this, Ramanan.

    I’ll have more to say on the construction of “the good matrix” in coming days, now that I understand what they’re trying to do with it. It is in effect a particular transformation of the conventional set of financial statements (income, balance sheet, and flow of funds). It’s probably comparable to something Steve Keen tries to do, although in his case without understanding conventional accounting and what it already offers by way of insight. But this version is far superior to Keen’s, in that it accurately maps to subsets of actual accounts found in conventional financial statements, as opposed to the made up ones that Keen uses.

    I feel better now, having struggled for several days trying to make sense of these matrices.

    Thanks again, Ramanan, for your outstanding research on these matters. You deserve that autographed copy.

    (Now PLEASE don’t tell me that second Lavoie/Godley matrix is an unreliable simplification of what they’re aiming for. I wouldn’t have thought so. I also haven’t yet absorbed all your comments above.)

  88. JKH
    February 6th, 2012 at 23:14 | #89

    @Ramanan

    ?

    I don’t get the Pilk comment.

  89. JKH
    February 6th, 2012 at 23:18 | #90

    @Ramanan

    Oh. Didn’t see Wilson’s comment.

    Now I get it.

    :)

  90. February 7th, 2012 at 00:03 | #91

    “How on earth that first Godley paper ever got published is beyond me. Does anybody ever proof these things before they’re published? But maybe you totally disagree with me on this, Ramanan.”

    It’s a working paper. Don’t think it was published. My guess is someone else typed out the table for him.

    Btw, Marc Lavoie was stunned by something in one of Wynne’s 1999 paper – this was published and fairly neat with such tables. There was one expression which Marc couldn’t derive himself and he wrote to Wynne who replied back saying the reason Marc could not is that there’s a mistake in the expression. And so, according to Marc, their friendship began.

    Yes, from their book. By the way you should really get their book. It is EXACTLY what you have been talking of and it goes at amazing lengths to show how assets and liabilities are created and reduced.

    Wynne’s models are like Chess. Simple T-accounts just give one or two steps. But using such constructions, one can see 10 steps ahead – that too for the whole economy.

    Yes FU is undistributed profit for a given time period. Don’t think its a standard expression but Godley’s work is too exotic even for Post Keynesian Economics. Most of them do not even realize the importance of his work.

    About Keen Marc Lavoie had this to say: (first comment)
    http://www.progressive-economics.ca/2010/05/20/remembering-wynne-godley/

    “Also, Steve Keen did spend some time on a sabbatical at the Levy Institute, where Wynne showed him that with his clumsy DOS software he could reproduce whatever complex mathematical models Steve could produce with his fancy modern software!”

    Yes, there are more complicated ones – especially for the open economy case. And since these involve two currencies, there are too many subscripts and superscripts in the notations and these things can be highly confusing at first but then done with “loving detail” as one reviewer of his book says calling him “A Foxy Hedgehog” and that “The fox knows many things, but the hedgehog knows one big thing”.

    “Thanks again, Ramanan, for your outstanding research on these matters. You deserve that autographed copy.”

    Thanks :- )

  91. JKH
    February 7th, 2012 at 00:46 | #92

    COMPARISON OF LAVOIE/GODLEY AND US FLOW OF FUNDS ACCOUNTING

    This is a quick draft. I may fix it up later, particularly if there are some oversights or errors on this first go around. But I think it’s fairly close to right. Feel free to have at it.

    So here’s my interpretation of the second Godley matrix. I’ll describe it just the way I’d describe a comparable US Fed Flow of Funds version.

    The business balance sheet expands it assets by the amount of new business investment – both fixed and working capital investment. That is called “uses of funds” in conventional flow of funds accounting.

    The business balance sheet expansion is funded by bank loans, retained earnings, and new equity claims purchased by households. All of that is called “sources of funds” in conventional flow of funds reporting.

    The business balance sheet expansion is balanced – i.e. sources and uses of funds are matched in size.

    That accounts fully for the business balance sheet expansion.

    The bank balance sheet expansion includes new loans (entirely to business in this case) and Treasury bill purchases. That comprises uses of bank funds.

    The bank balance sheet expansion is entirely funded by deposit creation (loans create deposits, etc.). That comprises sources of bank funds.

    The household balance sheet expansion includes acquisition of new currency notes, treasury bills, bank deposits, and equity claims. That’s uses of household funds.

    The household balance sheet expansion is funded by its saving (hi Steve).

    The government balance sheet expansion includes the NEGATIVE EQUITY created by net deficit spending (This is a custom JKH feature that converts deficit spending to a balance sheet position. You can ignore it from here, but remember it a few years from now. It appears in neither Godley nor US flow of funds versions).

    This is where it starts to get interesting, because the government uses of funds is actually a hybrid combination of a conventional NIPA type treatment and a pure flow of funds reports. Government expenditures are NIPA type items as they would apply to the government sector, to be consistent with private sector NIPA reporting. The pure flow of funds use, to be consistent, would show the negative equity balance sheet position. In any event, we’ll leave it as the use of funds being government expenditure.

    The government source of funds is the combination of taxes, high powered money, and treasury bills. Again, taxes are a NIPA type item as it would apply to the government sector. The balance sheet entries of high power money and treasury bills are pure flow of funds type entries. But, we’ll just say that the source of funds in this case cuts across these categories.

    So all of that described so far might be described as a “Conventional Flow of Funds Extraction or nearly so” from the Lavoie/Godley matrix as presented.

    You won’t see such things as wages in a conventional flow of funds report. Those things are found in detail in the income statement (NIPA at macro).

    Conventional flow of funds uses a number of starting points. One of them amounts to saving as defined in NIPA. To the degree that saving is a netted item (netted from such things as wages), you won’t find the gross, pre-netted income statement items in a conventional flow of funds report.

    So the Godley matrix expands conventional flow of funds (which is a connector of balance sheets over time) to the income statement detail that is compiled into the saving categories that plug into the conventional flow of funds report. So what you have in a Godley matrix is a combination of more detailed income statement transactions along with conventional flow of funds transactions. Once that is understood, the presentation becomes entirely compatible with the US Fed Flow of Funds reports, perhaps with what I might consider to be minor conceptual tweaking, if at all.

    Returning now to that same Godley matrix, the following becomes apparent, in that particular matrix, putting all of the balance sheet changes together:

    Firm saving consists of its retained earnings, the famous FU.

    Household saving BY MATRIX CONSTRUCTION (and NIPA type item derivation) is a source of funds that equals the use of funds as applied across currency notes, treasury bills, bank deposits, and new equity claims.

    Again, by matrix construction, the application of a part of household saving to currency notes and treasury bills accounts for part of the net financial assets issued by government during this accounting period. The remaining part is accounted for by treasury bills issued to banks. But households are the exclusive acquirer of the deposits that serve as the source of funds for the banks’ acquisition of the rest of the treasury bills issued by government. So directly and indirectly, household saving fully accounts for the entire NFA issued by government to the private sector. The full NFA position is embedded in household net worth as a result.

    Moreover, the rest of the bank deposits are still sourced exclusively from households, while being the exclusive source of funds for all bank lending, which in turn is directed exclusively to firms. So the result of all that is that the entire loan liability of firms is embedded directly within the amount of household saving as well.

    Finally, the last use of household saving is the purchase of new equity claims. When that’s done, ALL of the other sources of funds for firm investment have been FULLY accounted for ultimately as a source of funds originating from the household balance sheet saving position, plus the firm’s own retained earnings saving position.

    So when you combined that household balance sheet saving as a source of funds with the retained earnings of firms, which are also saving as a source of investment, you get the sum of all private sector saving as the source of funds for investment, as well as the source of funds for the change in NFA.

    Finally, when you incorporate the stock market value translation of the newly retained earnings of firms plus all other valuation effects, you get the retained earnings savings of firms fully reflected through their stock market value in the NFA position of the HOUSEHOLD balance sheet (i.e. as opposed to the private sector balance sheet).

    And all of that is exactly what is done in the US Fed Flow of Funds reports.

    Here’s the Lavoie/Godley matrix at Ramanan’s post. It’s table 2 there:

    http://www.concertedaction.com/2012/01/09/the-transactions-flow-matrix/

    Note: I’ve skipped an explanation of a lot of the NIPA like logic in that matrix, to get more quickly to the core flow of funds perspective that is comparable to Fed FF.

    E.g. NIPA business profit (and saving) is:

    C + G + I – WB = F

    Etc.

    Time for some shut-eye.

    :)

  92. JKH
    February 7th, 2012 at 01:06 | #93

    @JKH

    wouldn’t you know it – very last point in error:

    “E.g. NIPA business profit (and saving) is:

    C + G + I – WB = F”

    That’s profit, but not business saving, because its before dividends (FD)

  93. February 7th, 2012 at 01:34 | #94

    @JKH

    Excellent.

    In fact from G&L Page 40:

    “…The best way to take it in is by first running down each column to ascertain that it is a comprehensive account of the sources and uses of all flows to and from the sector and then reading across each row to find the counterpart of each transaction by one sector in that of another. Note that all sources of funds in a sectoral account take a plus sign, while the uses of these funds take a minus sign. Any transaction involving an incoming flow, the proceeds of a sale or the receipts of some monetary flow, thus takes a positive sign; a transaction involving an outgoing flow must take a negative sign. Uses of funds, outlays, can be either the purchase of consumption goods or the purchase (or acquisition) of a financial asset. The signs attached to the ‘flow of funds’ entries which appear below the horizontal bold line are strongly counter-intuitive since the acquisition of a financial asset that would add to the existing stock of asset, say, money, by the household sector, is described with a negative sign. But all is made clear so soon as one recalls that this acquisition of money balances constitutes an outgoing transaction flow, that is, a use of funds.”

    Also how the flows feed into the stocks via the “full integration matrix” in G&L’s book:

    Pic from my cam:

    http://www.concertedaction.com/wp-content/uploads/2012/02/Full-Integration-Matrix.jpg

  94. vimothy
    February 7th, 2012 at 03:42 | #95

    JKH @ 10:09,

    LOL, reading economics papers is nearly always a mistake. A few honourable exceptions like Krugman aside, most economists simply cannot write. The abstract + the major equations of the model is usually all that I can take. Assuming that Shaikh has reproduced these faithfully then, and they seem consistent with what I’ve read in “Monetary Economics” and other papers by Godley, then that seems useful to me in the sense of highlighting a particular facet of Godley’s approach. At any rate, it spoke directly to some questions I had regarding the underlying model of the economy that MMT draws on to get some of its more “iconic” results.

  95. JKH
    February 7th, 2012 at 05:33 | #96

    Ramanan,

    “In fact from G&L Page 40:

    … Uses of funds, outlays, can be either the purchase of consumption goods or the purchase (or acquisition) of a financial asset.”

    That’s the key right there to understanding the definitional and conceptual relationship between the Lavoie/Godley matrices, and conventional financial statements.

    The conventional flow of funds (sources and uses of funds) statement would describe only the acquisition of assets (real, including inventories, or financial) as a use of funds. Sources and uses of funds is a flow measurement that connects outstanding stocks at different points in time.

    The conventional flow of funds statement would never describe the acquisition of consumption goods as a use of funds, unless considered as an inventory stock.

    Conversely, the acquisition of consumption goods would be covered by the conventional income statement. This is obviously a “use of funds” in the informal use of that phrase, but it shouldn’t be confused with the formal sources and uses of funds (flow of funds) statement, in the context of the usual set of financial accounting statements.

    Put another way, both the income statement and the flow of funds statement intersect with the balance sheet statement. The income statement intersects with balance sheet net worth or equity, through the derivative level of net income or profit or saving, depending on the presentation across firms and households. The flow of funds statement intersects across all balance categories, of which equity or net worth is one, which is where the income statement intersection also occurs.

    ………….

    Lavoie says in his comment about writing the book:

    “As far as I can remember, most of our differences turned around the definition of profits, found in chapter 8.”

    That’s illuminating. It could account at least obliquely for some of the confusion in looking at some of these matrices.

    …………

    BTW, there’s still a problem with that full integration matrix you photographed.

    This net worth stuff should NOT be additive in that way.

    It wasn’t formally presented that way in the second Godley/Lavoie matrix, which I mapped directly to flow of funds treatment.

    ALL net worth should collapse as embedded into the household sector balance sheet, when stock market valuations are consolidated properly. It cannot be otherwise. EVERYTHING telescopes into the household sector, as per the US flow of funds and the way I described it in my comparison above.

    Moreover, the only way in which that total net worth can equal total fixed assets plus NFA is if the stock market valuation of total fixed assets equals their book value, which is extremely unlikely. It is better to ignore corporate fixed assets entirely when looking at net worth, and focus on the prism of the financial claims representation of them, as reflected in the household sector balance sheet. Household fixed assets are fine, to the degree they’re valued at market more directly.

  96. vimothy
    February 7th, 2012 at 07:33 | #97

    Ramanan @ 12:45,

    Yes, should have made the fact that I’m talking about shares of output explicit.

    I’m not sure to what extent I see expenditure as a key determinant of long run growth. It seems like something else (technology, capital accumulation, etc) should be pinning that down.

  97. February 7th, 2012 at 09:18 | #98

    @JKH

    “That’s the key right there to understanding the definitional and conceptual relationship between the Lavoie/Godley matrices, and conventional financial statements.”

    Yeah a very nice construction.

    “Put another way, both the income statement and the flow of funds statement intersect with the balance sheet statement.”

    Yeah plus the advantage that all rows and columns sum to zero in the transactions flow matrix.

    “EVERYTHING telescopes into the household sector, as per the US flow of funds and the way I described it in my comparison above.”

    Don’t know why you say so. The full integration matrix looks very natural to me.

  98. February 7th, 2012 at 09:30 | #99

    @vimothy

    My answer to that is that Post Keynesians are very serious about the Keynesian principle of effective demand even in the long run.

    I am more of a “demand creates its own supply” kind of person.

  99. vimothy
    February 7th, 2012 at 12:00 | #100

    @Ramanan

    It’s hard to see what would prevent the economy from adjusting in the long run to changes in nominal expenditure.

    What we tend to see empirically is fluctuations around a long run trend growth rate. And this holds across different policy regimes, etc. So there again, it’s hard to see a role for demand.

    There are models of the short run in which demand plays a role, but these explain fluctuations in output, i.e. the business cycle, and don’t have very much explanatory power over the long run, as far as I can see.

  100. JKH
    February 7th, 2012 at 12:56 | #101

    Ramanan,

    “Don’t know why you say so. The full integration matrix looks very natural to me.”

    If you look at it from a saving (flow) perspective, then the household sector can save and the corporate sector can save, and its additive in terms of total saving.

    If the corporate sector has 100 per cent dividend payout, all profit gets reflected in dividends and household saving. If the corporate sector has 0 per cent dividend payout, all profit gets reflected in retained earnings and corporate saving.

    But if you look at it from a net worth (stock) perspective, it is impossible for corporate sector net worth not to be reflected in household net worth. That’s because all corporate saving gets reflected in retained earnings, which is a stock account on which households have the ultimate claim. The value of that account is marked to market in flow of funds analysis, as an embedded component of the value of the full equity claim (i.e. the common stock).

    Flow of funds analysis connects balance sheets at two different points of time.

    Therefore, the appropriate analysis is in terms of the flow of funds is the change in balance sheet stocks, not the Lavoie/Godley “flow” as reflected in income and saving measures.

  101. February 7th, 2012 at 13:36 | #102

    @JKH

    Yes, I partly guessed your point after writing my comment – a bit like households finally are owners of the corporations.

    I think G&L’s point indirectly is that it is impossible to difficult a system of accounts which maintains their level of consistency – although their construction is close to the Blue Book but much better presented and transparent.

    “Therefore, the appropriate analysis is in terms of the flow of funds is the change in balance sheet stocks, not the Lavoie/Godley “flow” as reflected in income and saving measures.”

    They also call “change in stocks of …” as “flows”.

    It also helps for modeling behaviour – in which income/expenditure is more important. Once these decisions are taken, there is an allocation decision and so on.

    So the difference is only between the way national accounts is done in the United States and the rest of the world (which uses SNA) and not really so significant in my view. However, G&L surprisingly connects the two.

    This distinction however becomes important if foreigners are involved. Because foreigners also hold significant amounts of equities. To me the G&L way of doing it is the most general.

    Back to net worth and Z.1, recording equities at historic cost makes the whole accounting incoherent. So it records it at market value in memo. However for net worth calculation, it excludes equities. So firms have much higher net worth in Z.1

    But then one loses the “good” identity that sum of left and right (defined with a negative sign) sums to zero (in a closed economy and assuming no nonfinancial assets).

  102. February 7th, 2012 at 13:40 | #103

    @vimothy

    Forget models for a model, but that is the notion that demand has no role to play in the long run. Post Keynesians see the long run as a series of short runs and since economies are demand-led in the short run, they are demand-led in the long run as well.

    Such notions have actually led to the “consensus” that fiscal policy should be downgraded – precisely creating more shortage in demand!

  103. February 7th, 2012 at 14:19 | #104

    “Forget models for a model”

    Sorry meant forget models for a moment.

  104. February 7th, 2012 at 17:59 | #105

    @JKH

    But if you look at it from a net worth (stock) perspective, it is impossible for corporate sector net worth not to be reflected in household net worth. That’s because all corporate saving gets reflected in retained earnings, which is a stock account on which households have the ultimate claim. The value of that account is marked to market in flow of funds analysis, as an embedded component of the value of the full equity claim (i.e. the common stock).

    Makes sense. Let’s see if I’ve got this right:

    If a company makes $100K profits, that’s reflected in its LHS cash assets (say) and balanced in RHS shareholder’s equity.

    But: The firm’s net worth goes up (RHS equity “liability” is not subtracted from assets along with other liabilities to arrive at net worth).

    And: That RHS equity increase is *also* reflected as an increase in households’ LHS assets, under equity claims, so their net worth increases by the same amount.

    So Firms’ net worth + Households’ net worth in Godley is double-counting retained earnings/undistributed profits?

  105. February 7th, 2012 at 18:24 | #106

    I can kind of see the virtue of the balancing item.

    Does the K (capital) balancing item basically say here:

    Firms save by investing in fixed assets and not consuming them.

    Households save by acquiring financial assets.

    ??

    If that’s what’s being imparted, it’s kind of a nice clear, simple conceptual representation of things, since (in both Godley and NIPA) only firms invest and only households consume…

    So:

    Firm saving = investment (increase in the capital stock)

    Household saving equals change in net financial assets, or … drum roll please… S – I

    Subtract firms’ investment from total savings (S-I), and you’ve got…increase in net financial assets. household savings!!

    You can get to that through NIPAs, but look how hard it’s been for really smart people to wrap their brains around it. Even though the balancing item is weird, that actually makes it more transparent as a pure accounting entity, may make it easier for people to understand things.

    Easy to explain that:

    + Households’ net worth
    + Firms’ net worth (less retained earnings [or all SHE including initial investments?])
    + Banks’ net worth
    + Government debt
    ==============
    = National Savings/Wealth

    ??

    Seeing government debt in there would be a big aha for textbook readers etc. (I’d maybe prefer “Cumulative deficits” or “Deficit spending to date” cause it’s more general; they didn’t *have* to issue those stupid bonds/bills, could have just issued dollar bills, maybe they’ll stop eventually.)

  106. February 7th, 2012 at 18:33 | #107

    @Asymptosis

    Kill the SHE part here:

    “+ Firms’ net worth (less retained earnings [or all SHE including initial investments?])”

    FNW-SHE=0

    But does this leave initial investments (stock purchases) double counted in total net worth?

    Shoot.

  107. JKH
    February 8th, 2012 at 09:41 | #108

    @Asymptosis

    “So Firms’ net worth + Households’ net worth in Godley is double-counting retained earnings/undistributed profits?”

    Yes – at least, that’s the result using the standard interpretation of what net worth means – such as in the Fed Flow of Funds analysis.

    I’m not really sure what Lavoie/Godley mean when they start summing these things or how they use their matrices in this way. This is why I had strong preference for that single example of a matrix where they did no such summation. Where they do sum, it could be that they’re doing so across measures of saving, which does work. In your example, the increase in household net worth ends up being the sum of household saving (zero) and corporate saving (retained earnings). The two saving flows are bifurcated in NIPA, but the net worth result is integrated entirely within the household balance sheet through equity claim valuation. However, here is no automatic correspondence between the sum of book value saving and the follow up marked to market valuation of that sum, which is net worth. If market value was equal to book value in all cases, net worth would end up being the cumulative sum of saving on each balance sheet (but not the sum of net worth on each balance sheet, because household net worth already includes corporate net worth as a subset.)

    ………

    One way to tackle this aspect more cleanly is to run scenarios holding the government budget and the current account in balance, so as to focus on the stock/flow characteristics of the private sector, and then on the relationship between the business sector and the household sector within the private sector. (Once those constrained scenarios are understood, it becomes easier to analyze other permutations that include additional effects from net government or foreign sector activity.)

    So:

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

    And let’s assume they’re both cumulatively in balance from a stock perspective as well.

    So they’re eliminated as a net effect from both a flow and stock perspective.

    (G – T) = 0, flow and stock

    (X – M) = 0, flow and stock

    That forces:

    (S – I) = 0, flow and stock

    S = I, flow and stock

    S is private sector saving

    (S – I) is private sector net financial saving

    So private sector NFA is zero, flow and stock

    The question now is – what sort of permutations are possible for the relationship between the business sector and the household sector, given the saving/investment relationship that must result from such a closed, balanced budget economy?

    Here are THREE different examples of some possible outcomes:

    a) IF business invests in I, and finances it by issuing NEW equity claims (i.e. issuing common stock), that forces business saving to zero by construction, and household saving to S = I. End of period net worth has changed by S = I for business. End of period net worth has changed by S = I for households. Households hold a total equity claim that has increased in book value by S = I, by virtue of the new book value equity injection. In both cases, this state of affairs is a book value representation, prior to any equity market valuation effect. But even at this book value stage, there is no way that total net worth in the economy has increased by 2S = 2I. It is not additive. The net worth of business is already captured in the net worth of households.

    Flow of funds analysis will mark the full household equity position to market. End of period household net worth has increased by S = I, marked to market. And again, at this second stage of marking household net worth to market, business and household net worth positions are NOT additive – end of period accounting for household net worth includes business net worth as an embedded subset, in this case through an incremental book equity claim, with the total result being transformed by equity market valuation.

    I’ve used the term “net worth” so far. I haven’t mentioned “NFA”. The NFA algebra is effectively a sub-algebra of the net worth algebra. The net worth algebra has to relate book values to market values in a coherent fashion. That challenge is mirrored in the case of the NFA sub-algebra.

    Corporate net worth is typically defined as the book value of corporate RHS equity. In this example, the book value increment is S = I. Household net worth is typically defined as the market value of household RHS equity. Corporate RHS equity is an EMBEDDED component of household RHS equity, but ONLY after market valuation adjustment. The book value of equity won’t necessarily match the market value of equity, obviously. For most purposes, the fact that RHS equity for business is typically a book value calculation and that RHS equity for households reflects the market valuation of that book value, is not a major issue. That’s because these two net worth calculations should not be added together. One is the market value transform of the other.

    A similar challenge of consistency holds in the case of “NFA”. MMT would hold that the private sector NFA position in total would be zero in the above presentation, simply because of the way I’ve constrained the government budget and the current account. That’s a correct premise. So in dealing with the issue of sub-sector NFA, you want to be consistent with that premise. So in the above example, we should ensure that the business sector NFA is the same as household NFA, with the signs reversed. The ONLY way you can do that is to ensure that the valuation basis is the same. That would mean either representing the household NFA position as the “underlying book value” according to corporate RHS equity book value, or alternatively representing the corporate NFA position at market value. The latter treatment would reflect the corporate (NFA) position in this example as the conceptual “liability” of the corporation having issued equity claims outstanding in an amount with a market value of MV, for example. This consistent mapping between corresponding NFA inverses can be done either way, but the second way keeps the valuation basis on par with the usual net worth valuation basis of household RHS equity.

    b) IF business invests in I, and finances it with retained earnings, that forces business saving to S = I by construction, and household saving to zero. End of period net worth has changed by S = I for business. End of period net worth has changed by S = I for households. Households hold an equity claim that now includes claim to an increase in the underlying business book value of equity by S = I, because business book value of equity has increased due to retained earnings in that amount. The S = I representation is a “reflected book value” representation, prior to any subsequent equity market valuation effect. Once again, even at this book value stage, there is no way that total net worth in the economy has increased by 2S = 2I. It is not additive. The net worth of business is already reflected in the net worth of households.

    Flow of funds analysis will mark the full household equity position to market, meaning that the household claim on increased business book value of equity will have a market value interpretation. End of period business net worth has increased due to an increased in retained earnings, and end of period household net worth has increased because its equity claim is on a book value that has increased, and that effect will be reflected through market value accounting for the equity claim.

    Again, these business and household net worth positions are NOT additive at this stage of market valuation either. End of period market value accounting for household net worth includes business net worth as an embedded subset of value. That embedded value is transformed through incremental market valuation of the underlying business book value of equity increase due to retained earnings.

    c) Finally, here’s a third scenario. It’s simple but somewhat more difficult:

    IF households invest in I (e.g. new residential real estate) and finance it with bank borrowing, that forces business saving to S = I by construction, and household saving to zero. Business has increased retained earnings by S = I. Before going further, we need to reference NFA in order to understand this example.

    The default use of funds flowing from business saving is a bank deposit – the same bank deposit originally created by household borrowing. Therefore, business has increased its gross financial assets by S = I. Therefore, the business NFA position is zero, valued according to book value.

    Households hold a pre-existing equity claim on business that has increased in underlying book value by S = I, because business book value of equity itself has increased in value due to retained earnings. Flow of funds analysis will mark the full household equity position to market, meaning that its claim on increased business book value of equity will have a market value translation. That translation becomes the effect on household net worth.

    For a moment, we’ll interpret the household NFA effect according to book value interpretation. So the increase in the value of its equity claim is presumed temporarily to be the same as the increase in the underlying book value of business RHS equity. But in this example, the household has added a financial liability in the same amount of S = I. Therefore, the change in the household NFA position is zero, the same as the change in the business NFA position.

    Now we move on to market valuation. Assume the market valuation of the household equity claim on business departs from the above assumption of book value. Then both household net worth AND household NFA will adjust according. They will both increase by the amount of the difference between the change in market value of the equity claim and the change in the underlying business book value of RHS equity. But further to our note under a) above, IF NFA is (conceptually) valued at market, it should be valued at market for both business and households, which preserves the equal but opposite equivalence, and preserves the integrity of the original condition that the NFA of the private sector as a whole is zero.

    In summary, for this example, end of period NFA is unchanged for each of business and households, ASSUMING that the market value of equity claims ends up reflecting underlying book value 1:1. IF the market value deviates from book value (normally the case), then end of period NFA changes by an equal amount for each of business and households (an amount that also adjusts household net worth), but the original equal but opposite equivalence of the two interfacing NFA positions is still preserved in such a way that NFA of the private sector remains at zero.

    There are a few more interesting things about this example: Return to the case where the market valuation of equity claims on business remains the same as the underlying book value of business equity. The reason that NFA for business is unchanged is that its increase in retained earnings is offset by the bank deposit that was created by the original household borrowing to finance household investment. The reason that NFA for households is unchanged is that their increase in the value of equity claims on business (via underlying business retained earnings) is offset by an increase in financial liabilities in the form of the original bank borrowing.

    It is very interesting to note that the original real investment of the household sector is NOT at all direct factor in the final reconciliation of NFA positions. NFA positions are defined exclusively on the basis of algebraic manipulation of FINANCIAL ASSETS. Real investment is not a financial asset, obviously. And neither is RHS household equity. There is no financial claim issued against RHS household equity.

    (That’s an important fact in the process of reconciling net worth for the economy back down to the household level. “The buck stops here” for financial assets and liabilities)

    And it is also interesting that household net worth has increased in this example only indirectly because of a bottom line increase in “net real assets”. The route to get there was circuitous, since it required an increase in equity claim valuation to ensure that it happened that way.

    In summary, I can’t relate all this coherently, in the most general sense, to Lavoie/Godley. I know that their presentation in that one specific matrix I referenced above is consistent with my general explanation according to US flow of funds type interpretation. This is so mostly because Lavoie/Godley didn’t complicate that particular matrix example with overall residual net worth summations, etc. around the perimeter of the matrix – summations that appear to me on the surface to be double counting in the case of some of their other matrices. I.e. it’s when they start adding “net worth” of business and households in other matrix versions that they lose me. It’s quite possible that all of their work is fully coherent, but I can’t reconcile their use of the term “net worth” to what I consider to be a standard meaning of that term in an economy that values household equity claims on business at market value. I believe what they may be doing in some of their work is decomposing market value equity claims into “constituent pieces of underlying book value” and redefining some notion of net worth according to that book value composition. What I know for sure you can’t possibly reconcile the market value of household equity claims on business by doing a book value summation of EITHER OR BOTH past household saving or past corporate saving ALONE, because that fails to delineate two different sources of business book equity – new “paid in” book value equity injections, and corporate retained earnings – and fails to reconcile that total book equity composition with a subsequent market valuation adjustment that must apply to both pieces in an integrated way, in order to come to a rational and complete expression for household net worth.

  108. February 8th, 2012 at 11:34 | #109

    JKH,

    “It’s quite possible that all of their work is fully coherent, but I can’t reconcile their use of the term “net worth” to what I consider to be a standard meaning of that term in an economy that values household equity claims on business at market value. ”

    The usage is as per SNA2008. So one can verify this via UK Blue Book.

  109. vimothy
    February 8th, 2012 at 12:03 | #110

    JKH,

    Great comment.

    The transactions matrix is strange. I notice that the sum of all sector net worths is K, so it seems to be saying S = I (total stock of saving equals total stock of investment)–or perhaps 2S = I–, but I don’t understand the logic of adding the net worth of firms to the net worth of the owners of those firms.

    Not sure if this will help, but, flicking through the textbook itself, in hte same chapter there is a brief discussion of the balance sheet of production firms, where the authors state that they are undecided about whether business sector equities ought to be treated as a liability of firms–but that this is the approach that they will nevertheless opt for. They then define business sector net worth as the difference between firm physical and financial assets and its liabilities inclusive of the market value of equities held by the household sector. In other words, they seem to have some component of business saving not fully reflected in household saving / the saving of the owners of firms.

  110. February 8th, 2012 at 12:41 | #111

    @vimothy

    “The transactions matrix is strange. I notice that the sum of all sector net worths is K, so it seems to be saying S = I (total stock of saving equals total stock of investment)–or perhaps 2S = I–, but I don’t understand the logic of adding the net worth of firms to the net worth of the owners of those firms.”

    Yes sum of net worths is K but neither net worth nor K appears in the transactions flow matrix.

    No they do not add net worth of firms to the net worth of households.

    The paper referred has a typo or uses the “own funds” concept which is an alternative in SNA.

    Neither S=I nor 2S=I (which is wrong) appears in the balance sheet matrix. In the transactions flow matrix S=I depending on how you define it.

    “They then define business sector net worth as the difference between firm physical and financial assets and its liabilities inclusive of the market value of equities held by the household sector. In other words, they seem to have some component of business saving not fully reflected in household saving / the saving of the owners of firms.”

    Saving is a flow and assets and liabilities are stocks. Yes net worth of firms can be positive or negative and is not reflected in the sense that prices of equities can rise or fall.

    Guys, everything is consistent to SNA2008 – to the penny ;-)

  111. vimothy
    February 8th, 2012 at 13:00 | #112

    R.,

    Sorry, I meant the “full integration matrix” (table 2.7 in Monetary Economics). In that matrix you can interpret the bottom row as saying that the capital stock equals total savings or national net wealth (which also implies that dS = dK, i.e. identically equal flows). But the household sector supplies and owns all the factors of production, so adding firm and household net worth could be double counting.

  112. JKH
    February 8th, 2012 at 13:02 | #113

    Vimothy,

    Thanks.

    “They then define business sector net worth as the difference between firm physical and financial assets and its liabilities inclusive of the market value of equities held by the household sector.”

    Not sure that works. Liabilities inclusive of equities cover the entire right hand side of the balance sheet, and physical and financial assets cover the entire left hand side. So the difference between the two would appear to be identically zero.

    But something just occurred to me, as a result of your comment.

    I think I may know what they’re doing now.

    Back later.

    P.S.

    Ramanan,

    What I’ve described is how the Fed Flow of Funds would represent it.

    It would appear that “SNA2008”, with which I’m not familiar, does it differently.

    Lacking a coherent explanation of SNA2008, I’m forced to infer it by trying to guess what the Lavoie/Godley methodology is. The fact that apparently there are errors or typos in some of the references doesn’t help. And it can’t be the same as the Fed Flow of Funds methodology. So I’ll guess I’ll have to take your word for it, that it all works according to Hoyle. But Hoyle in this case is a completely different methodology than the one I’m familiar with – and which happens to be the one that measures the biggest economy in the world, and the one that aligns with normal corporate financial accounting – including definitions of corporate net worth.

    Back later.

  113. February 8th, 2012 at 13:13 | #114

    Net worth is the difference between the value of all financial and non-financial assets and all liabilities at a particular point in time. For this calculation, each asset and each liability is to be identified and valued separately. As the balancing item, net worth is calculated for institutional units and sectors and for the total economy.

    For government, households and NPISHs, the value of net worth is clearly the worth of the unit to its owners. In the case of quasi-corporations, net worth is zero, because the value of the owners’ equity is assumed to be equal to its assets less its liabilities. For other corporations, the situation is less clear-cut.

    In the SNA, net worth of corporations is calculated in exactly the same way as for other sectors, as the sum of all assets less the sum of all liabilities. In doing so, the value of shares and other equity, which are liabilities of corporations, are included in the value of liabilities. Shares are included at their market price on the balance sheet date. Thus, even though a corporation is wholly owned by its shareholders collectively, it is seen to have a net worth (which could be positive or negative) in addition to the value of the shareholders’ equity.

    - from SNA2008, section 13.85 onward

    http://unstats.un.org/unsd/nationalaccount/docs/SNA2008.pdf

    So notice market value for shares and also the non-zero net worths for corporations.

    13.88 says alternatively you can give a treatment so that net worth of firms is zero such as for quasi-corporations. In that case, net worth of firms can in a sense be “added” (in sense indirectly meant in some of the comments here).

  114. vimothy
    February 8th, 2012 at 13:18 | #115

    JKH,

    So the difference between the two would appear to be identically zero.

    Yeah, that’s what I thought–I guess it doesn’t really make much sense to me either.

    BTW, R. & JKH, apropos nothing in particular, this is a very enlightening discussion–and it’s especially interesting to compare Godley & Lavaoie’s method to mainstream treatments. I’d like to try to find a link to a quick introduction to the consistency accounting framework, which is the analogous accounting framework (or one of them) used institutions like the IMF when they do macroeconomic modelling…

  115. February 8th, 2012 at 13:49 | #116

    @vimothy

    Yeah very nice discussion. Highly enjoyable – compare it to the infinite political discussions happening at heteconomist.

    My general point is convincing that the SNA way is the most right way of doing it. For example when foreigners hold large amount of equities. One is forced to do it that way – with net worths.

    SNA was prepared under the auspices of the IMF among others.

    The transactions matrix flow takes it one step ahead – it’s not there in such a transparent manner in SNA. It was invented by James Tobin (discovered?) though not with the full features.

  116. JKH
    February 8th, 2012 at 14:29 | #117

    Ramanan,

    That looks like a perfectly standard definition to me.

    So what was your interpretation of the following equation on page 3 of the Godley reconstruction paper?

    V (wealth) = NW+DG+I+K

    NW=net worth of firms, DG=government debt, I=inventories, K=fixed capital stock

    (V is household wealth, since it’s the sum of the household column)

  117. JKH
    February 8th, 2012 at 14:40 | #118

    Wait a second:

    “In the SNA, net worth of corporations is calculated in exactly the same way as for other sectors, as the sum of all assets less the sum of all liabilities. In doing so, the value of shares and other equity, which are liabilities of corporations, are included in the value of liabilities. Shares are included at their market price on the balance sheet date. Thus, even though a corporation is wholly owned by its shareholders collectively, it is seen to have a net worth (which could be positive or negative) in addition to the value of the shareholders’ equity.”

    I can’t parse that. It’s totally confusing. Particularly the last sentence.

    Does that mean they’re defining the net worth of corporations as IDENTICALLY ZERO? (i.e. as Vimothy suggested?)

    But they’re valuing the equity claim on a corporation (e.g. held by a household) at market value?

    So the net worth of corporations is zero but the net worth of households that own them includes the value of their equities?

  118. JKH
    February 8th, 2012 at 14:44 | #119

    Ramanan,

    You seem to understand the SNA, and the Lavoie/Godley adherence to it.

    Maybe you could do an example or two like the ones I did, illustrating the difference between the SNA treatment and the Fed Flow of Funds definitions and treatment that I described.

  119. February 8th, 2012 at 15:52 | #120

    JKH,

    Yes will try to do an example.

    However, there is nothing much in my opinion. This is because national accountants have differences with business accountants.

    Since the market value of equities fluctuates everyday, the net worth is a balancing item. It’s a residual.

    Even in the case of the US, the Z.1 uses market value of equities as in B.102

    For firms it displays equities as liabilities (but at market value) in memo.

    However it’s Net Worth is defined as Assets minus Liabilities excluding equities from liabilities altogether. Line 32 in B.102 of Z.1

    So even though the market value of equities appears as assets in households’ balance sheet, it does not appear in corporates’ balance sheet.

    Hence adding households’ net worth to corporates’ net worth by taking numbers from Z.1 will produce a huge number. (Because there is no cancellation).

    SNA includes market value of equities in corporates’ liabilities. The residual then is the net worth. Hence one can add the net worth of households and corporates. Because equities issued by firms and held by households cancel out.

    So the simple difference is that Z.1 excludes equities in liabilities and SNA includes it. That is the only difference. Both use “net worth”

    If I use numbers from Z.1 and do it the SNA way, net worth of corporations in the US will be much lower. Z.1 shows a very high net worth for corporations.

    So according to Z.1 the net worth of Nonfarm Nonfinancial Corporate Business at the end of Q3 2011 is $13,160.6bn but from an SNA viewpoint it is minus $1,329.8bn (Line 32 minus 34).

    This is because Tobin’s q is greater than 1 (line 38)

    Only when Tobin’s q = 1 can one get “intuitive” results.

  120. February 8th, 2012 at 15:54 | #121

    “For firms it displays equities as liabilities (but at market value) in memo.”

    Yikes

    should be:

    For firms it displays equities (but at market value) in memo.

  121. February 8th, 2012 at 16:01 | #122

    I could get double counting is when I use Net worth of households and Net worth of firms as per B.102. But the error I make there is that I use a different definition of net worth than what I began with.

    However if I define Net worth as per SNA, I can add them easily and there’s is no double counting.

  122. vimothy
    February 9th, 2012 at 02:52 | #123

    Ramanan,

    That’s helpful, thanks.

  123. JKH
    February 9th, 2012 at 04:57 | #124

    Ramanan,

    You say:

    “SNA includes market value of equities in corporate liabilities. The residual then is the net worth. Hence one can add the net worth of households and corporates. Because equities issued by firms and held by households cancel out.

    So the simple difference is that Z.1 excludes equities in liabilities and SNA includes it. That is the only difference. Both use “net worth””

    I’m not sure I follow this.

    First, let me do an example using the Fed Flow of Funds methodology. I’ll then try to compare your methodology using the same example.

    Fed methodology:

    Suppose business invests “I”, funded entirely with an equity claim EC.

    Then conventionally calculated corporate net worth = “I”, where “I” is valued on some basis – historic cost, market value, whatever. That doesn’t matter for the purpose here. Just assign it some value “I”. That’s conventionally calculated corporate net worth in this case, given the simplicity of the balance sheet example.

    Suppose the only asset held on household balance sheets is the equity claim EC.

    The Fed Flow of Funds calculates the net worth of the household sector:

    First, it observes the market value of EC (not the value of “I”).

    Call that MVEC.

    Then the net worth of households, in this example, = MVEC.

    Whatever the direct valuation basis of I is, there is no reason why MVEC is the same value.

    MVEC is what it is, calculated by the market.

    The net worth of the household sector so calculated as MVEC is then a comprehensive picture of net worth across both the household and corporate sectors. Corporate sector net worth, translated at market value, is a subset of household net worth (in this simple example, the entire value; other non-equity claim financial assets and direct residential real estate etc. could be added at this point).

    This is all consistent with what I’ve been describing generally.

    Your methodology:

    To repeat your statement from above:

    “SNA includes market value of equities in corporates’ liabilities. The residual then is the net worth. Hence one can add the net worth of households and corporates. Because equities issued by firms and held by households cancel out.

    So the simple difference is that Z.1 excludes equities in liabilities and SNA includes it. That is the only difference. Both use “net worth””

    I’ll use the same example, and you can tell me if I’ve got it right:

    As above, the conventionally calculated net worth of corporate balance sheets is “I”.

    But modified, SNA corporate net worth, I think according to the above, would be (I – MVEC).

    Household net worth would still be MVEC.

    And the sum of the two would be “I”.

    Is that right?

    If so, it is critically NOT the case that the “only difference” between Fed and SNA treatments is that “Z.1 excludes equities in liabilities and SNA includes it”.

    The full difference is that Z.1 excludes BOTH the asset value I of corporations AND the so-called liability value of the market value of equity from the calculation, meaning that the Fed calculation excludes direct reference to corporate balance sheets ENTIRELY. Indeed, this is an obvious fact with regard to Z.1. But saying it this way may be how to compare it to the SNA calculation.

    I think this is why I was having so much trouble understanding your earlier explanations.

    Again, the Fed calculation ends up at MVEC.

    Your calculation ends up at “I”, which is an entirely different number.

    And “I” is derived as the sum of two “net worth” calculations, one of which is in my view an artificial construction designed to eliminate partially the effect of the other (i.e. eliminate the direct effect of equity claim ownership per se). The rationale for this presumably is to smooth out the effects of stock market volatility from the total net worth calculation. But given the utility of tracking stock market value from a purely economic perspective, I vastly prefer the Fed approach on this. For example, stock market value has obviously been of great importance in explaining the nature of the recession, and there’s no way that households view their own portfolios and factor that view into their behavioral decisions as if it directly reflected the value of physical corporates assets instead of stock market value. And the underlying corporate asset valuations that are tracked by your approach can always be backed out through supplementary analysis. Assuming my interpretation is correct I think it’s a bad idea for the main net worth calculation event.

    So “SNA net worth” of corporations is, effectively:

    “Conventionally calculated corporate net asset value, additionally net of stock market value”

    Correct?

  124. JKH
    February 9th, 2012 at 05:05 | #125

    P.S.

    I’ve got some other observations regarding some of the numbers you referenced at your # 20 above, but would like to clarify the point in my # 24 first.

  125. February 9th, 2012 at 08:30 | #126

    Hey just to say that I’m following this carefully, but not contributing because you guys are moving way faster than me.

    I got an aha from this:

    This is because Tobin’s q is greater than 1 (line 38)
    Only when Tobin’s q = 1 can one get “intuitive” results.

    Understanding (changes in) book/historical/replacement/market value — and representing their relationships clearly — is obviously crucial to this project.

    What’s driving me is the wish to give a presentation of national net worth (and flows that drive that), broken down into household, firms, govt, (banks), that a reasonably savvy businessperson/financier could understand quickly and fairly intuitively. With very few (one or two?) assumptions/caveats/footnotes attached. (i.e. “Note that firms’ net worth does not include retained earnings.” Or similar.)

    In that “intuitive” view, firms have to have net worth — because they seem to, so apparently.

    This may be a fool’s errand, because it’s equally obvious that shareholders have an equity claim on that net worth, so you can’t depict both — and add them — without double-counting. (Right?)

    Also would like to see (as in Godley) cap gains treated as household income and retained earnings not treated as such — because that’s how people think about their income.

    Also retained earnings increasing a firm’s net worth, because again, that’s how people think about it intuitively.

    Again, perhaps a fool’s errand.

    I came across the following, btw, which seems illuminating:

    The long-term average value of q is below 1 because the replacement cost of company assets is overstated. This is because the long-term real return on corporate equity, according to the published data, is only 4.8%, while the long-term real return to investors is around 6.0%. Over the long-term and in equilibrium, the two must be the same.

    The major cause of over-valuation of assets is almost certainly due to their economic rate of depreciation being underestimated.

    http://www.smithers.co.uk/faqs.php

  126. February 9th, 2012 at 08:34 | #127

    Semi-aside: That last suggests that Tyler Cowen is right — we’re not as rich as we thought we were — and the markets have been wrong for a very long time.

  127. February 9th, 2012 at 08:43 | #128

    Here’s a stab I took at it. It’s totally wrong (just where I left it hanging when I gave up) so ignore the details, so I’m only showing it to make clear the kind of presentation I’d like to be able to create.

    Basically, translating the accounts into the terms of vernacular usage. Yet again, probably a fool’s errand.

    Godley (still assumes that ony households consume and only firms invest, but FIRMS CAN SAVE)

    Household Income = Earned Income + Cap Gains – (Profits – Dividends)
    Household Saving = Earned Income + Cap Gains – Profits + Dividends – C

    Firm Income = C + I
    Firm Saving = C + I – Earned Income – Dividends = Cap Gains

    NIPA
    Household Income = Earned Income – Cap Gains + Corp Profits (attributed)
    IOW:
    Household Income = Earned Income + Undistributed Corporate Profits

    Household Saving = Earned Income – Cap Gains + Corp Profits – C

    Firm Income = C + I – Earned Income (wages/compensation) – Profits (attributed as income to households) = 0
    Firm Saving = C + I – I – Earned Income – Profits (attributed to households) = 0

  128. February 9th, 2012 at 08:53 | #129

    @JKH:

    Again, the Fed calculation ends up at MVEC.

    Your calculation ends up at “I”, which is an entirely different number.

    This is how I ended up with one bit of the preceding, Firm’s Net Worth = Cap Gains

    Dammitall, you just can’t not call household’s equity claims an asset.

  129. February 9th, 2012 at 09:00 | #130

    Aha: How about a single footnote:

    Household Net Worth (not including Equity Ownership of Firms’ Net Worth)

  130. February 9th, 2012 at 12:52 | #131

    JKH,

    I don’t get it actually.

    Suppose a firm invests I and finances the purchase by issuing equities. Households fund this. The firm pays another firm. Household net worth does not change because it is holding equities instead of deposits.

    Firms have an additional asset I and a deposit I – because another firm is holding it and the full firm sector has these two assets. There is no change in firms’ liabilities because equities are excluded from the liabilities.

    So the Z.1 net worth of firms changes by 2I!

    In the SNA it changes by I because equities issued are counted in liabilities. Because firms have a nonfinancial asset I and a deposit I now and a new liability I.

    Hence the net worth of the whole nation changes by I – exactly how it should be!

    Now it is not necessary to say to it doesn’t matter behaviourally. Because firms will give dividends and hire more etc and this increases the demand in the whole economy.

    Suppose the stock price starts rallying. Households’ net worth increases and that of corporations decreases but the latter isn’t an issue really.

    And if there is a stock market rally, households feel richer and consume more as many behavioural economists say.

    So in the SNA stock market rally or a dip does lead to behavioral changes because households’ net worth is changed as a result of the market value of equities held as assets in their balance sheet.

    Now of course, the catch here is that in Z.1 one can say it one shouldn’t blindly go around adding the net worth of households and corporates.

    But here’s the trouble with Z.1 – it treats foreigners’ holdings of equities as if it is not a liability of the corporation. Well firms can liquidate their equity assets and purchase the corporation’s bonds. Suddenly, the nation become more indebted? But lets just keep that discussion for another day.

    “The full difference is that Z.1 excludes BOTH the asset value I of corporations AND the so-called liability value of the market value of equity from the calculation, meaning that the Fed calculation excludes direct reference to corporate balance sheets ENTIRELY.”

    Sorry I did not get this. Are you talking of households’ balance sheet?

    SNA doesn’t add households’ net worth to corporates’ net worth. These two are separate items.

    But the accounting identity derived is that the sum of net worths is equal to the tangible capital. An identity and nothing more. Just a statement of the whole nation. Neither do G&L.

    I think you should simply ignore everything said in Table 3 of the paper referred. It doesn’t appear anywhere before or after.

    Btw, column 7 is right. Just change the sign of NW in firms in Table 3 and the equation below.

    So Households’ Weath + NW (=firms’ net worth) = GD + K + I

    bring GD to the left

    Households’ Net Worth + NW (firms) + Govt Net Worth = K + I.

    (which is different I from the same comment above)

    which is the same as in G&L.

  131. February 9th, 2012 at 12:58 | #132

    @Ramanan

    Of course assuming I at the start of the comment is instantaneously created.

    Else one has to bring in how firms create this and what it hires etc.

  132. February 9th, 2012 at 13:13 | #133

    “SNA doesn’t add households’ net worth to corporates’ net worth. These two are separate items.”

    Sorry should be:

    SNA doesn’t add corporates’ net worth to households’ balance sheet. These two are separate.

  133. JKH
    February 9th, 2012 at 17:44 | #134

    Ramanan,

    “I don’t get it actually.”

    It’s the SNA interpretation of my example a) from # 8 above.

    The example is quite feasible in terms of entries, along with the other two.

    I was hoping we were past that stage.

  134. JKH
    February 9th, 2012 at 18:02 | #135

    Steve,

    “This may be a fool’s errand, because it’s equally obvious that shareholders have an equity claim on that net worth, so you can’t depict both — and add them — without double-counting. (Right?)”

    Right – that’s why the Fed Flow of Funds doesn’t do it.

    Q is a red herring from the Fed Flow of Funds perspective. It incorporates equity claims on household balance sheets at market value, which means it incorporates Q in doing that.

    And it has all the information on historic cost and replacement value (from corporate balance sheets) that you could want otherwise.

    My guess remains that LG/SNC substitutes the book value of equity claims for the market value of equity claims, IN EFFECT, compared to the Fed calculation …

    … BUT, they/it go through a torturous manipulation whereby they define “net worth” of corporations as the book value of equity minus the market value of equity. They then define “net worth” of households to include market value of equity, which is the same treatment that the Fed report does directly. LG/SNA then adds those two to arrive a result which is what you’d get with the Fed report IF it used book value instead of market value. This is a very artificial construction and an equally artificial result.

    That’s the only way I can reverse-engineer this whole discussion to some seemingly likely interpretation of what’s going on with LG/SNA.

    But I’m getting tired of the guessing game, given that I know how the Fed report does it, and it serves the overall purpose very well.

  135. JKH
    February 9th, 2012 at 18:15 | #136

    If household net worth and corporate net worth are defined as I guessed they were above, and if government net worth is defined as (NFA), then I can see this equation holding:

    Household Net Worth + NW (firms) + Govt Net Worth = K + I.

    The difference from Fed Flow of Funds is that (K + I) is effectively valued to include corporate book value instead of market value.

    The Fed shows corporate equity claims directly on the household balance sheet, which is why it doesn’t add a corporate net worth item to household net worth.

    The only reason LG/SNA gets away with adding the first two items is because of the artificial definition of corporate net worth to mean book value minus market value. Add that to a household balance sheet that includes market value, and you net to book value of corporate equity.

    This is an artificial construction of corporate net worth to facilitate adding the 4 sectors together. That’s what it’s all about. LG/SNA wants to show additivity.

    The other difference is that the Fed report doesn’t subtract (NFA) as negative government net worth.

    It’s also possible LG/SNA includes a value for real assets held separately by the government. I wouldn’t know. That would obviously not be included in the Fed report.

  136. JKH
    February 9th, 2012 at 18:23 | #137

    Steve,

    Not sure I can work through your equations above.

    But NIPA does not include cap gains. Everything is done at book value, in effect.

    Looks like SNA tries to fit itself to NIPA results as much as possible, which is why it would effectively strip out market values.

    Fed Flow of Funds incorporates cap gains on the household balance sheet. So the end result is a net worth position that reflects the market value translation of corporate equity book values, as I’ve said before. It’s intended to represent what people (households) see in their portfolios, including real estate and financial assets in total. The entire corporate sector is seen through the prism of how the household views it and values it, and everything is intended to be represented that way.

  137. February 9th, 2012 at 21:44 | #138

    @JKH

    “Add that to a household balance sheet that includes market value, and you net to book value of corporate equity.”

    There’s no stock version of bonus households “get” from the net worth of firms.

    The equation is a simple addition of net worths across sectors – a simple mathematical addition for the whole economy or a subgroup of an economy. Because an economy is bigger than “households”.

    Households do NOT behave as if equity is valued at book value. Neither G&L nor SNA claims so. Equities in households’ assets is the *market value*. So if there is a boom in the stock market, households would tend to spend more.

    “The difference from Fed Flow of Funds is that (K + I) is effectively valued to include corporate book value instead of market value.”

    The K+I is valued according to market price as a general rule – i.e., current/replacement cost. So real estate is valued at market price. Capital goods at their current replacement price. And inventories at current cost of production (not at the price at which firms are expected to sell them).

    Equities are treated as if they are equivalent to debt securities. Even for debt securities, if the market value of bonds rise to $103 or fall to $97 – having initially priced at $100, corporates liabilities increase or decrease respectively.

    So there is absolutely no reference to historical costs whatsoever. Nothing called book value appears anywhere.

    If I add net worths of sectors as per Z.1, I get a huge value – simply because of the fact that equities exist as assets in households’ balance sheets and do not appear as liabilities in corporates’ balance sheet.

    But why would I do that? In order to do so, I have to change the definition of numbers obtained from Z.1 so that it is more SNA consistent. Fortunately, it is easy. Just move the item “market value of equities” in Z.1 above “net worth” to get the SNA definition of net worth.

    What is the purpose of addition? Not to “add anything to the household balance sheet” but to confirm that the sum of net worths of an economy (in the case of a closed economy, at any rate) is equal to the value of tangible capital. i.e., financial assets cancel out with counterpart liabilities. To double check.

    I do not know what the issue is really.

  138. JKH
    February 10th, 2012 at 03:34 | #139

    Steve,

    I’m done.

    Best of luck.

  139. JKH
    February 10th, 2012 at 07:06 | #140

    P.S.

    “I do not know what the issue is really.”

    So unlike me, Steve, you should have no problem following the explanation of the reconciliation.

    “Nothing called book value appears anywhere”

    Here’s the Canadian version of SNA.

    The first 56 pages of tables from a 76 page report have the qualifier “book value” in the title of EVERY single table.

    http://www.statcan.gc.ca/pub/13-214-x/13-214-x2009001-eng.pdf

    Finally:

    “There are two sets of nominal NBSA data – a set at book values and a set at market values. Nonfinancial assets are at current values, in both sets. In the market value NBSA, tradable securities are estimated at market values.”

    I.e. there’s a DISTINCTION between the valuation of RHS equity at book value, versus the valuation of balance sheet assets that contribute to the determination of that book value. That’s a basic distinction and definition in corporate financial reporting. Don’t confuse book value of RHS equity with the particular method implemented to value assets in determining that book value. I’ve noted this before.

    I’m going to spend some time looking at the Canadian SNA numbers over the next while (I generally ignore them), so I don’t have to knock myself out trying to translate SNA/Fed reconciliation second hand in future. Particularly when my real interest is the Fed format, through which all of the same stock and flow issues can be interpreted more effectively, in my view at least.

    P.P.S.

    The Fed Flow of Funds calculation for net worth does NOT use the B.102 lines. It uses equity market values directly stated in B.100 and B.100e, which are quite different. See the footnote to B.100e.

  140. February 10th, 2012 at 08:03 | #141

    “The Fed Flow of Funds calculation for net worth does NOT use the B.102 lines. It uses equity market values directly stated in B.100 and B.100e, which are quite different. See the footnote to B.100e.”

    Well that’s the point. Nobody is adding net worth INTO households’ to arrive at households’ net worth. Continues forever!

    “The first 56 pages of tables from a 76 page report have the qualifier “book value” in the title of EVERY single table.”

    Yes, they are free to use book value but also report market value balance sheets.

    “Don’t confuse book value of RHS equity with the particular method implemented to value assets in determining that book value. I’ve noted this before.”

    In everything I HAVE described so far nothing called book value appears.

    That is NOT to say that NOBODY reports it. One can report these.

    So …

    As far as the Canadian system goes:

    “Consideration of the above factors has generally ledto a preference for current values rather than book values or acquisition costs. There is substantial agreement that current valuation has more meaning than values which may reflect prices spread over the past twenty or thirty years, perhaps even longer in the case of particularly durable assets. Aggregates based on historical costs or book values are neither comparable over time nor between firms or sectors.

    In defense of book values it has been stated that they are, in fact, used by most reporting units as their valuation basis and therefore are more easily collectible. More than that however, they do have some influence on firms’ decisions concerning rates of return, tax liabilities and, in the case of certain utilities, on rate regulation. In addition, analytical
    financial ratios frequently employ published net earnings which in general still reflect book values.

    However, current or market valuation has the advantage of being consistent, comparable between sectors, readily understandable and relatable to current income flows. In economic terms the relative market valuations of capital goods reflect the market’s assessment of relative present values of future net income streams. Its implementation does, however,
    present some formidable challenges.”

    http://www.statcan.gc.ca/nea-cen/pub/guide/4221065-eng.pdf

    National accounts IS different from business accounts.

  141. February 10th, 2012 at 08:13 | #142

    JKH :

    P.S.

    “I do not know what the issue is really.”

    So unlike me, Steve, you should have no problem following the explanation of the reconciliation.

    That was Ramanan, not me.

    I’ve pretty much thrown up my hands on my pipe dream in the last several comments. Can’t be done.

    If you want sectors’ net worth to add up correctly:

    Either firms’ net worth is zero, or you misrepresent households’ net worth by not including their equity claims.

    You can do some kind of split based on market vs. replacement value (footnoting it in Household net worth), but then if Tobin’s Q < 1, either firms have a negative net worth or households have negative equity claims — neither of which comports with the way people think about net worth.

    And that’s before you even touch on govt net worth, which can’t be calculated in the same way because there’s no market value (and government’s ability to print money seems to make any valuation very dicey).

    And speaking of being able to print money: banks’ net worth. I just won’t even go there.

    Yes you can value each sector individually; there’s just no way to combine those values with simple addition in any way that 1. uses the same definitions of net worth, and 2. is arithmetically correct.

    Hey! Has anyone done a Godley-style matrix for NIPAs[SNAs]/FOFs? I’ve never seen one.

    That might be my pipe dream, embodied. Could preclude future JKHs from having to go through all the hell that he’s gone through here, explaining things quickly to others like me who really want to understand, but get lost in the thickets.

  142. vimothy
    February 10th, 2012 at 08:23 | #143

    Steve,

    Has anyone done a Godley-style matrix for NIPAs[SNAs]/FOFs? I’ve never seen one.

    Yes! This is standard in mainstream large-scale macro modelling. I’d like to post a link to a paper that introduces the consistency framework and SAMs, but it’s a case of finding something suitable, and I don’t have a lot of free time…

  143. JKH
    February 10th, 2012 at 09:24 | #144

    “That was Ramanan, not me”

    I knew that

    “Could preclude future JKHs”

    probably not this one

    :)

    I’ll return to it at some point, maybe relatively soon

    Just a matter of reconciling the two different approaches in my own words, comparable to how I did Flow of Funds

    But I’ll have to spend some time on SNA to do that, get my arms around it more, as opposed to picking away at it in pieces

    Shouldn’t be that hard really

    It’s a lot tougher when you’re trying to reconcile your own description of X with somebody else’s description of Y, when you’re much more familiar yourself with X than Y

  144. JKH
    February 10th, 2012 at 09:30 | #145

    P.S.

    Actually, I have to do that

    I need to confirm whether or not my tentative stabs and jabs and guesses at characterizing the difference between SNA and Flow of Funds were as wrong as Ramanan has suggested; that will be interesting to find out

  145. February 10th, 2012 at 10:10 | #146

    National accountants would get data from various sources and databases which may use different principles (business accounting) in getting their numbers. Once they do that the have the task of converting them to national accounting principles. So they may have an internal dictionary.

    However, once these numbers – as per national accountants’ language – are available, one can start describing a macroeconomic system theoretically which doesn’t talk of how the numbers were originally recorded in the sources. So no need to address the internal dictionary.

    For the case at hand, the only difference (except the presentation of data in the final form) I can tell is that the Fed’s definition of net worth is different from SNA because the Fed does not include equities in corporations’ liabilities.

  146. JKH
    February 10th, 2012 at 10:33 | #147

    Ramanan,

    Did it occur to you that it’s quite possible for two people with good intentions not to be communicating very well at a particular point in time?

    Did it occur to you that I may have as much confidence in your explanation of this comparison as you probably have in mine at this point?

    For example, I know right now I wouldn’t characterize the difference at all in the way you just did at # 46. I think it’s quite misleading.

    The situation calls for a different approach, at least on my part.

    As I say, if there’s “no problem” on your end, then proceed to declare clarity.

    For my part, I’ll be revisiting the subject to try and fathom a more sober comparison of the two different approaches.

    And then I’ll be checking that back against my more rapid-fire assessments here.

    But I really should buy that book now.

    I suspect that’s at least one thing you’d agree with.

    :)

  147. February 10th, 2012 at 12:10 | #148

    vimothy :

    Has anyone done a Godley-style matrix for NIPAs[SNAs]/FOFs? I’ve never seen one.

    Yes! This is standard in mainstream large-scale macro modelling.

    Any pointers much appreciated. Googling:

    “balance sheet matrix” -godley

    In “Everything” or “Books” yields less-than-useful results. (Yes, tried various other searches.)

  148. February 10th, 2012 at 12:12 | #149

    @JKH

    “I suspect that’s at least one thing you’d agree with.”

    He he.

    I agree with most of #47

    The point which I am unable to get is why there is any disagreement at all. Because while I agree with most of what you say, there’s some particular point we are unable to pinpoint which leads us to different conclusions.

    Here’s from G&L’s text: (pages 26-27)


    We start with the balance sheet of households, since it is the most intuitive as shown in Table 2.1. Households hold tangible assets (their tangible capital Kh). This tangible capital mainly consists of the dwellings that households own – real estate – but it also includes consumer durable goods, such as cars, dishwashing machines or ovens. An individual may also consider that the jewellery (gold, diamonds) being kept at home or in a safe is part of tangible assets. But in financial flow accounts, jewellery is not included among the tangible assets. Households also hold several kinds of financial assets, for instance bills Bh, money deposits Mh, cash Hh and a number e of equities, the market price of which is pe. Households also hold liabilities: they take loans Lh to finance some of their purchases. For instance households would take mortgages to purchase their house, and hence the remaining balance of the mortgage would appear as a liability.

    The difference between the assets and the liabilities of households constitutes their net worth, that is, their net wealth NWh. The net worth of households is a residual, which is usually positive and relatively substantial. This is because households usually spend much less than they receive as income, and as a result they accumulate net financial assets and tangible (or real) assets. Note, however, that if equity prices (or housing prices) were to fall below the value at which they were purchased with the help of loans taken for pure speculative purposes – as would happen during a stock market crash that would have followed a stock market boom – the net worth of households taken overall could become negative. This is because household assets, in particular real estate and shares on the stock market, are valued at their market value in the balance sheet accounts.

    In the case of American households, this is not likely to happen, based on the figures presented in Table 2.1, which arise from the balance sheet of households and nonprofit organizations, as assessed by the Z.1 statistics of the Federal Reserve for the last quarter of 2005. Loans represent less than 20% of net worth. Tangible assets – real estate and consumer durable goods – plus deposits account for nearly 50% of total assets. The other financial assets are not so easy to assign, since a substantial portion of these other assets,including equities and securities, are held indirectly, by pension funds, trust funds and mutual funds.

    I don’t think you will disagree with anything said above.

    In the same page the Table 2.1 says as per March 2006 release and refers to B.100:

    Households tangible capital value is 25,000 bn and in right hand side there is loans of 11,900 and below that net worth of 52,100

    Just to verify this:

    The number as per data from the Fed shows $59tn at the end of 2005 as per http://www.federalreserve.gov/releases/z1/current/annuals/a2005-2010.pdf

    But this would be the result of corrections to the data later as confirmed by

    http://www.marketwatch.com/story/us-household-debt-up-the-most-in-20-years shows the preliminary data to be $52.1 trillion at the end of 2005.

    (that’s my Google search skills at work!)

    I of course agree with the above.

    Now after this discussion, they move to corporations’ balance sheet in the US and how it looks as per Z.1 and as per SNA’s way of doing it. However this does not affect the household’s balance sheet.

    Now, if you agree the argument shifts to which definition of net worth of corporates is more right, if at all this concept makes sense.

    Is that the case? Or perhaps it’s more complicated than that.

  149. Tom Hickey
    February 10th, 2012 at 12:14 | #150

    @JKH

    Second edition of G&L announced but not yet published

    http://www.palgrave.com/products/title.aspx?pid=512989

  150. JKH
    February 10th, 2012 at 12:33 | #151

    @Tom Hickey

    Thanks, Tom.

    Ramanan already has an early autographed copy, a fact that is causing me additional heartburn.

    :)

  151. February 10th, 2012 at 12:36 | #152

    @Tom Hickey “Second edition of G&L announced but not yet published”

    Yeah mine’s on Amazon pre-order, they say it’ll ship March 27.

    But Ramanan already has his!

  152. JKH
    February 10th, 2012 at 12:37 | #153

    @Ramanan

    That’s in the right direction.

    It’s just that I’d frame the comparison top-down from quite a different starting point, which I’m now quite intent on doing.

  153. JKH
    February 10th, 2012 at 12:55 | #154

    @Ramanan

    “they move to corporations’ balance sheet in the US and how it looks as per Z.1 and as per SNA’s way of doing it”

    Do they have a paragraph or two describing that comparison?

    If so, can you paste it here as you did with the previous pages? Or is that too much work?

  154. February 10th, 2012 at 12:55 | #155

    @Ramanan

    “which definition of net worth of corporates is more right, if at all this concept makes sense.

    Is that the case? ”

    That’s the conclusion I came to, though I haven’t grasped their different representations (much less them vis a vis godley). Looking forward to doing so…

  155. JKH
    February 10th, 2012 at 13:39 | #156

    Steve,

    I think what I’d like to do for my part is write up a comparison of the two methods. From my perspective, I can’t do it justice through piecemeal give and take discussion like this. I’ll use the Canadian SNA as a reference. I’m familiar enough with the overall SNA approach to know the approach I’d like to take in the comparison, but I need some time to ponder it a bit and write it up.

    I’ll post something here on or before Monday February 20th (in 10 days), if that’s OK. Anybody who might be interested can read it then.

  156. February 10th, 2012 at 13:47 | #157

    @JKH

    3 and half pages!

    but this I can type:

    “As a result, we shall stick to balance sheets inspired by Table 2.2, 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.”

    2.3 is the Table as per B.102 and 2.2 is the modified one as above.

  157. February 10th, 2012 at 14:03 | #158

    @JKH “I’ll post something here on or before Monday February 20th (in 10 days)”

    Why don’t we make it a real post. (I’ll ask Dan at Angry Bear if I can cross-post it as per usual.)

    No necessary deadline in that case. People who want to see it will see it.

    Better than burying all this great stuff down here where only a select elite of true illuminati ever sees it. ;-)

  158. February 10th, 2012 at 14:04 | #159

    @Asymptosis
    Oh and I don’t suppose you’d be inclined to include cross-comparison with Godley….?

    Or maybe a later post?

  159. JKH
    February 10th, 2012 at 15:33 | #160

    @Asymptosis

    Thanks. I’ll let you decide if you’d like to post it for real. I could let you know when it’s ready, or how it’s going, through other comment, and maybe post it here anyway for your preliminary perusal.

    Make contingencies though. It might be crap, and/or excruciatingly boring.

    :)

    At probable best, it would intersect with Godley indirectly via the general SNA model. I wouldn’t cite Godley too directly, because I’m not confident I know his work well enough yet. But maybe I’ll check out a few papers again.

    I’m going to try and make it pretty top down and not super detailed, and hopefully connect it back to some of your early questions on this topic.

    I’ll keep you posted (cheap, unavoidable pun).

  160. JKH
    February 10th, 2012 at 15:43 | #161

    @JKH / Steve

    Also, I can’t predict, but it might end up too long for a real post.

    I want to write something I’m satisfied with myself, whatever that means.

    So I’ll do that, and you can decide, and we can chop it if necessary for post version if you think it works at all.

    On the other hand, it could end up as a couple of lines if I think reconciliation is hopeless.

    :)

  161. February 10th, 2012 at 17:55 | #162

    @JKH: Lemme know. my first name at this domain.

  162. JKH
    February 20th, 2012 at 11:24 | #163

    @Asymptosis

    Steve,

    I’m going to defer this.

    It’s been a long time since I looked very closely at the overall system of national accounts, and I want to take this “at a measured pace”, as Greenspan used to say about monetary policy. I’ve got the general idea OK, I think, but now that I’m into it, I want to spend some more time on the details of the accounts, in bite sized pieces.

    I’ve become so used to and comfortable with the Fed Flow of Funds tables in recent years that I’ve not had a reason to go back into the national accounts top-down for some time, until now. Also, I see there are some difference between the Canadian implementation of SNA and the global document provided by Ramanan, and I’d like to get comfortable with those approaches compared to each other and with both compared to what’s available in the Fed reports.

    I think at least several of my instincts on the overall structure of the thing will turn out to be right as a statement of broad comparison. But I think all three of us are probably right with respect to different pieces of the puzzle, at least. Ramanan probably has a pretty close finger on it all, but I want to be able to put this into my own words and way of looking at it.

    So I’ll let you know if and when I have something that I think you might have an interest in seeing, for whatever reason, posting or otherwise.

    Cheers.

  163. February 20th, 2012 at 20:11 | #164

    JKH :

    Sounds good. If whatever you come up with, whenever, includes Godley-style matrixes, I will be an especially happy guy.

  1. February 2nd, 2012 at 11:39 | #1
  2. February 2nd, 2012 at 12:05 | #2
  3. February 2nd, 2012 at 12:37 | #3
  4. February 3rd, 2012 at 02:10 | #4
  5. February 5th, 2012 at 07:58 | #5
  6. February 16th, 2012 at 05:17 | #6
  7. February 21st, 2012 at 16:30 | #7
  8. March 1st, 2012 at 00:03 | #8
  9. March 19th, 2012 at 21:31 | #9
  10. February 27th, 2013 at 13:59 | #10
  11. March 1st, 2013 at 06:19 | #11