JKH has magisterial post up on the recent dust-up over Saving as perceived in various sectoral models — one-sector (global, for instance, or government- and trade-balanced domestic private sector); two-sector (government and private including international); the most common MMT construct, the three-sector model (government, domestic private, and international); the rather uncommon four-sector model (government, international, domestic household, and domestic business); or even a seven-billion-plus-sector model, in which each individual (and business, and government) is represented as a sector.
His key point, I think — one I agree with profoundly — is that people need to be very clear on which model they’re assuming when they use the word Saving, or the construct “S.” (People sometimes use those two differently, with different implied sectoral models, sometimes within a single discussion or even a single sentence.) In most cases the different constructs of saving and S that people throw around are absolutely valid within their (implicit) sectoral models. The problem arises when people are talking about different sectoral consolidations within the same discussion, without themselves and/or their interlocutors being (fully) aware of it.
I’ve left a few glancing comments over there, but it’s prompted me to write up some thinking here that’s conceptually related.
How do we think about the central bank, and actually the nature of money and the monetary system? I see a lot of people talking past each other because they’re talking about different levels of accounting consolidation. Here are four ways to look at the Fed:
1. It’s an independent institution, separate from Treasury and the reserve-holding banks.
2. It’s part of “government” — a consolidated entity comprised of Treasury and the Fed.
3. It’s part of the private sector monetary system — a consolidated entity consisting of the Fed and all the banks holding reserves at the Fed.
4. It’s part of a fully consolidated monetary system consisting of Treasury, the Fed, and all the reserve-holding banks.
I’m not going to explore all these fully — there’s a book (or several) there — but here are some thoughts on each that might illuminate how the thinking is very different depending on which you adopt, perhaps showing how quite a lot of unecessary confusion and cross-discussion might be avoided.
1. It’s an independent institution, separate from Treasury and the reserve-holding banks.
Even though this is the “reality” of our monetary system (as a result of legislative diktat), thinking about it this way results in an odd conceptual situation. We end up with a sovereign currency issuer (Treasury) that (like a household or business) has to borrow in order to spend, and a bank (the Fed) that can issue unlimited funds ex nihilo to purchase assets. This seems exactly the opposite of how one would imagine things would work.
2. It’s part of “government” — a consolidated entity comprised of Treasury and the Fed.
This is a preferred MMT construct, and it has much conceptual appeal. “Government” issues new money through Treasury spending, and Fed open-market and QE operations are basically fiddling around the edges of the money “supply,” largely for the purpose of interest-rate management. Yes, the Fed actually issues the money, but in this consolidated view “government” is doing the issuing through deficit spending, crediting people’s bank accounts with newly-created money.
3. It’s part of the private sector monetary system — a consolidated entity consisting of the Fed and all the banks holding reserves at the fed.
This makes conceptual sense, because all deposits ultimately resolve, consolidate, back to reserves at the Fed. In this construct, all the banks (including the Fed) are issuing private money as licensees of of the Fed, which ultimately derives its licensing authority from “government” (Treasury).
4. It’s part of a consolidated monetary system consisting of Treasury, the Fed, and all the reserve-holding banks.
Looked at this way, we could conceive of it all as a single big national bank, with deposits resolving back to reserves, which ultimately resolve back to the full faith and credit of the government (Treasury).
These are fairly sloppy characterizations. I know the JKHs and SRWs, Ramanans, Vimothys et. al could (and I hope will) express them more cogently and accurately. But I wanted to keep them brief to highlight my central point:
Different views, consolidations, of these entitites result if very different understandings of “how the monetary system works.” Each (properly presented, unlike here) is valid within its own construction, and each imparts an important understanding of how things work. The problem arises, as with Saving and “S,” when a person, or people in discussion, confute and confuse these different views, or switch among them during thinking and discussions.
Cross-posted at Angry Bear.
Comments
44 responses to “Thinking About the Fed”
Steve
(I – S) = 0, I = S, Always.
Net government spending or not. Net exports or not.
Does this affect the discussion?
[…] Cross-posted at Asymptosis. […]
My understanding is different from Paul’s —
Private Sector Saving (flow) = Net Investment + Fiscal Deficit + Trade Surplus
As for the Fed, it should be considered part of government since it’s a creature of government and its leaders are appointed by government…
@Dan
(S-I) = S(n) -S(n-1) where n is the total number of budget cycles over history,so
(S-I) is merely the current years ending total net savings minus the previous years ending total net savings.
It follows that:
I = the previous years ending total net savings and S = Sn. Then:
S(n-1) = I(n-1); Then:
(S – I) = S(n) – I(n-1)
S = I ; Always.
“(S-I) is merely the current years ending total net savings minus the previous years ending total net savings.”
I don’t follow this, and I don’t think that corresponds to standard accounting. But perhaps I don’t understand your basic definitions. You seem to be speaking of stocks, whereas I explicitly cited flows. What is you “total net savings”? What would it be after one budget cycle?
Thanks…
@Dan
This is arithmetic, not accounting. Accounting is a special form of arithmetic but is not needed to illustrate this problem – it would only make the problem more confusing, as most people don’t understand accounting which is a rule-based discipline. Accounting must follow the laws of arithmetic, not vice-versa.
After 1 budget cycle (1 year) “net savings” would be (S – I). “Total net savings” would be the sum of all (S – I) over all budget cycles (say 235 years, 2011 – 1776). So:
“Net savings” for 2011 is equal to the “total net savings” at the end of the 2011 budget cycle minus the “total net savings” at the end of the 2010 budget cycle.
(S – I) is a flow corresponding to the net change in savings (not money in savings accounts) meaning the net change in dollars or dollar-denominated financial assets in the non-government (NFA’s).
S and I can be flows or stocks depending on the context. In context of the sectoral balances equation they are stocks, and the difference between two stocks over some time period t is a flow.
S(n) is a stock evaluated (a snapshot) at time n. S(n-1) is a stock evaluated at time (n-1). If (n) = 2011 then (n-1)=2010.
The flow (S – I) is typically observed over a time period of 1 year ie 1 budget cycle. The flow is equal to the difference between the beginning stock I and the ending stock S (The beginning stock I is equal in magnitude to the beginning stock S, and I always equals S at any given moment in time).
(S -I) would more appropriately be shown as [S(n) – I(n-1)] but it isn’t necessary since the term (S – I) is generally assumed to represent the flow “net savings” in the S/B equation.
All I know is that when I go to visit the Fed Board of Governors website I note the URL is http://www.federalreserve.gov/
So it looks like the government to me. The fact that it is owned and run for the benefit of banksters doesn’t mean it is not part of the government. The banksters own and run the Executive Branch and the US Congress as well. And they are clearly part of the government.
I think it is misleading to view banks as “licensed” to issue money as arms of the Fed. Commercial banks don’t issue the same monetary instruments that are issued by the Fed. They issue IOU’s called “deposits”. Those IOU’s are ultimately liabilities for the money issued by the Fed, and the owner of deposits can demand payment from the bank in the form of the Fed’s money. If the bank doesn’t have enough of that form of money in its possession they have to buy it from the Fed. They can’t just print it up.
Just as in a previous era we were on the gold standard, in the current era we are on what we could call the “US base dollars standard”. Base money – Fed notes and bank reserve balances at the Fed – play a similar role in our system as was played by gold in gold standard days. However, base US dollars have no other industrial use as a commodity, so they are pure fiat money.
Commercial banks in gold standard systems aren’t licensed to produce gold; they are permitted to issue IOUs for gold. And I think that’s the same way to look at the current system. Of course banks of the past often issued, and were permitted to issue, IOU’s whose total liability far exceeded the amount of gold they had ready access to, and the same is true today of commercial banks with respect to the base US dollars they have ready access to.
The Fed currently has sole authority to issue the monetary instruments that are the legally established final means of payment in our financial system. All other financial instruments are in one form or another IOU’s for that fundamental and final means of payment. However, that issuing authority is constitutionally established as belonging to Congress, and the authority was simply delegated by the Congress to the Fed when it created the Fed with the Federal Reserve Act. So the Fed is clearly an arm of government, and the Congress can re-asset operational control over the nation’s monetary operations whenever it wants to pass the legislation to do so.
@ Detroit Dan and Steve
Retraction – the following is not true and I should have known better:
(I=S); Always
This is only true under special conditions – balanced budget, no external sector.
Also this:
In context of the sectoral balances equation they are stocks should read:
In context of the sectoral balances equation they are flows
and this:
The flow (S – I) is typically observed over a time period of 1 year ie 1 budget cycle. The flow is equal to the difference between the beginning stock I and the ending stock S (The beginning stock I is equal in magnitude to the beginning stock S, and I always equals S at any given moment in time).
(S -I) would more appropriately be shown as [S(n) – I(n-1)] but it isn’t necessary since the term (S – I) is generally assumed to represent the flow “net savings†in the S/B equation.
should be ignored as it makes little sense – I should have re-read and edited it before posting.
Sorry, don’t know what I was thinking.
Sorry to be slow getting back to this, folks.
@Paul “This is only true under special conditions – balanced budget, no external sector.”
Thanks, that’s exactly what I was going to say.
@Dan Kervick “f the bank doesn’t have enough of that form of money in its possession they have to buy it from the Fed. They can’t just print it up.”
Here’s what I’ve been wondering about: if the banking sector issues more credit — creates more deposits — the Fed has to provide reserves to support those deposits. So in that sense — forcing the Fed to create more reserves — aren’t banks effectively printing money (even though the Fed does the actual “printing”)?
Good post, Steve. Wading a bit into taboo territory here. This is why hierarchy is important, contrary to Cullen’s recent statements. It may not be important if you are trying really, really hard to be politically agnostic, but it needs to be addressed or those maintaining the confusion win out.
The hierarchy has to be people>government>private banks. Or at least people>government=private banks. If you maintain 1) or 3) (above) then the populace loses monetary sovereignty and transfers that sovereignty to minority private interests. It’s critically important, IMO.
Thanks Paul, for the update.
Thanks also to Dan K for clarifying the subject of the original post. You’re the best on this subject, IMO…
Well said, DaveGerlitz!
In response to Asymptosis’ wondering out loud about banks forcing the Fed to create reserves, I’ll do some wondering myself.
1. Some countries don’t have reserve requirements. Does that mean that private banks have less power in those countries? (they can’t force the government to create reserves) Does that seem upside down?
2. What would be the effect of eliminating reserve requirements in the U.S? Does that change the picture painted by Dan K?
Don’t have time to think these questions through at the moment…
@Detroit Dan “What would be the effect of eliminating reserve requirements in the U.S?”
Very good question. Just to point to a related question — IORs — that I think was well hashed-out here:
http://www.asymptosis.com/answers-taking-ior-to-zero.html
http://www.asymptosis.com/more-on-interest-on-reserves.html
@Asymptosis
SR:” Here’s what I’ve been wondering about: if the banking sector issues more credit — creates more deposits — the Fed has to provide reserves to support those deposits. So in that sense — forcing the Fed to create more reserves — aren’t banks effectively printing money (even though the Fed does the actual “printingâ€)?”
MMT economists would say that while loans create deposits and deposits create reserves, bank credit nets to zero. Net financial assets remain unchanged. According to Mosler, if one chooses to use “printing” to mean what most people assume it to mean, then it has to refer to injection of net financial assets, which results from a fiscal operation that falls under the Treasury function rather than the central bank function.
Most people are concerned about increases in reserves because they assume that these cause bank credit to increase due to the money multiplier. MMT shows how the causation runs the other way.
Scott Fullwiler has a paper on IOR, “Paying Interest on Reserve Balances: It’s More Significant Than You Think.” download link
[…] Asymptosis » Thinking About the Fed […]
@Tom Hickey “MMT economists would say that while loans create deposits and deposits create reserves, bank credit nets to zero.”
But still: if new credit issuance forces new reserve (vertical money) issuance, isn’t new credit issuance effectively creating new vertical money? Not one-for-one for each transaction, but over time?
posted this over at Mike Norman’s but wondered what you might think:
One question is whether it is wiser to stick to a standard definition of, say, accounting terms and then to try and define the world as one sees it from within that confinement. Or whether it is wiser to redefine the terms to suit one’s intended statement. The prior has the advantage of providing different ideological factions with a common linguistic ground from which to argue, but is a disadvantage for those arguing from outside standard paradigm, as the terms themselves will invariably reflect biases and blind spotsinherent in the paradigm.
It becomes a matter of framing, which itself is amatter of power. And also a matter of the logical impossibility of pinpointing the limitations of a paradigm from within itself (I’m sure Tom knows the correct philosophical term for such a problem).
Although I take it that JKH, Ramanan and others are technically very well versed in accounting (while I have no formal training in either accounting or economics), and it understandibly gives them some pleasure to be able to lecture some MMT ENTHUSIASTS on what the latter consider to be their home turf (accounting), I don’t think they always appreciate the complexities and contradictions inherent in the underlying matter. Perhaps that is a problem of being too technically versed?
I came across the ‘theory of monetary emissions’ or ‘quantum economics’ the other day. Its main representatives are Schmitt, Cencini and Sergio Rossi and probably others I don’t know of. The latter teaches here in Switzerland, btw.. I haven’t read much of their stuff yet, but it seems they are closely related to the circuitists of Lavoie’s couleur, but with a strong focus on the labour theory of value and apparently some other distinctive differences I haven’t yet understood. One thing I immediately found quite helpful though, is their very clear idea of a: the different aggregate states of money (typically referred to as stocks and flows in standard speak), and b: clear distinctions and relations between these forms of money and labour as well as the physical world. Each of these four are treated separately, while MMT would typically only distinguish between ‘real’ and ‘nominal’ and, tom me at least, standard economics only distinguished between stocks and flows, as far as I can tell (do correct me, if you fell I’m wrong here).
The essence is, that what JKH portrays as a logically consistent and seemingly complete world of ‘income, balance sheets, and flow of funds’ statements, is, accrording to the quantum economists, and quite plausible to me, in fact a philosophically impossible amalgamation of physical, temporal and ideal ‘things’ (using my own terms here). One can, indeed one should, try and put all theses things together somehow, if one wished to gain some kind of insight over the world we inhabit. But I’d posit that the quality of these insights varies and can never be complete in any way and also that there is probably a trade-off between accuracy and any breadth of meaning. A good tactiuc is probably to be versed in as many paradigms as possible.
My visual memory hook is that the financial world always NETS to 0 by simultaneously expanding in opposite directions (say, vertical or horizontal). So, financial world savings (noun) are always 0. One can then slice the world to show a purportedly meaningful ‘NET’ financial gain somewhere. But this only works if the corresponding NET loss of the mirrored sector is deemed less important or neglible in contrast. For MMT, this happens when vertical transactions take place – government deficits are the lesser evil in comparison with private sector NFA gains – at least in a demand constrained world. NFA being net of sector, not net of investment here, as both sectors can invest.
The physical world, on the other hand, doesn’t ever net out. There is no negative stone for every positive stone – except maybe in some physics lab.
And then there are ideas. Ideas are rather ethereal beings, but have the power to transform things (through labour), and thus can give them value (according to quantum economics). This value can then be expressed in the relative terms of finance.
Saving, as defined in the equation S = I + (S-I), is to me an example of the attempt to combine relative and absolute. And I think the focus of MMT on NFA is an attempt to separate those issues. Net – as in net of sector. Financial – as in not real. Assets – as apposed to liabilities and thus, thanks to double entry book keeping, always relative.
Having said all that, what I’d also like to know – now that 3 gazillion pixels have been spilt over the word saving – is how ‘investment’ is normally defined. We definitely need a new term to tart a flame war over :-).
and @ Steve Roth 8:17
The MMR position seems to be that the whole ‘netting to 0’ is not the right way to look at what hapens when loans are forwarded. Yes, balance sheets balance, that’s what they’re designed to do – but an expansion of private balance sheets provides the necessary, if possibly only temporary, means by which to create real wealth, which is always a gain – at least to those who own it. Think of a 1 company world with 0 reserve requirements (no vertical component) and no interest for a moment. Bank extendes loan to company, company pays employees (say hairdressers) to cut hair, company earns money back through the services provided and pays down loan immediately. Total private balance sheet at beginning and end of period = 0. Real wealth created during period = haircut * number of people involved = positive. I guess one could then add in interest, investment and bank and company capital somehow, but I’m too thick to even start. Does that make sense?
@Oliver
Oliver, great stuff. I’m just going to take a brief stab at some of your points, tangenting off into some of my understandings and confusions.
Investment in the national accounting framework means buying fixed assets (structures, equipment, software) plus inventory (that stays on the books until it’s sold in a future period) — which are the only real long-term assets counted in that framework. It’s just an accounting definition: these goods are produced but not consumed within the given period. If they are, they’re “consumption goods.”
This is slightly problematic because investment should really mean *creating* fixed assets and inventory; we use sale of fixed assets because it allows us to measure that creation. Likewise consumption spending does not measure all consumption; consumption of fixed assets (estimated through depreciation methods) needs to be added to show total consumption within a period. But while that might create some confusion I don’t think it’s conceptually crippling.
So, ideas. Those are real assets. So are business processes, “organizational capital,” skills, even the population’s ability to work. But they go unaccounted in national accounting. I understand why: how do you measure them? But does it mean that the accounting is ignoring perhaps the biggest stock and flow of assets that exists?
I think you’re totally right that most confusion arises where financial meets real (by real I mean the production, sale, and consumption of real goods and services — things that deliver actual human utility [or produce other goods that will deliver human utility] through their consumption). It’s certainly where I get confused. (Per JKH, households, after firm value is telescoped onto their balance sheets via equity claims, have ca. $50 trillion in real assets and $10 trillion in [net] financial assets. What does that *mean*? What do those financial assets represent?)
I’m not convinced that the current national accounting framework precludes us from understanding the intersection of financial and real. But it might make it harder than it needs to be. I haven’t found an explanation of that intersection that is (for me) clear, coherent, and intuitively (easily) apprehensible. (This requires an equally clear, coherent, and intuitive explanation of what “money” is, plus some theory of value.) This might just be because the intersection is inevitably conceptually difficult (and some people actually do understand it), or it might be because it hasn’t been properly theorized yet. I tend toward the latter, but that may just be me thinking I’m gonna be the one that cracks it. (Yeah: right.)
I’ve been working on a post for quite a while on supply and demand for real vs. financial assets, but haven’t gotten clear enough to be willing to post it. Central ideas: increased transaction volume for real goods — increased “demand” — reduces inventories, so it drives supply pretty much 1:1. More sales = more production. Increased transaction volume for financial assets (so-called “demand”) does not reduce inventories — the assets just travel in circles. Higher volume can, often do, go with *lower* prices, which is not true with real goods. Because: financial assets are not, cannot be, consumed. So do supply and demand even have the same meanings in these two markets? I think not, but I’m struggling to understand the differences.
I think I’ll stop here, sorry for the random thoughts, hope you find them useful.
@Asymptosis
Oh just to add: thinking of the market for real goods as a treadmill driving a generator (or a production line), while the market for financial assets is a freewheeling squirrel cage.
@Oliver
“One question is whether it is wiser to stick to a standard definition of, say, accounting terms and then to try and define the world as one sees it from within that confinement. Or whether it is wiser to redefine the terms to suit one’s intended statement. The prior has the advantage of providing different ideological factions with a common linguistic ground from which to argue, but is a disadvantage for those arguing from outside standard paradigm, as the terms themselves will invariably reflect biases and blind spotsinherent in the paradigm.”
This would have been worth arguing had MMT’s definition of saving been different from those of national accountants. However it is not.
The debate arose because there are temporarily shifts to suit convenience.
“I don’t think they always appreciate the complexities and contradictions inherent in the underlying matter. Perhaps that is a problem of being too technically versed?”
I do think I appreciate the complexities and JKH has made so much effort since the past 1-2 months in getting some points across. Although you can see this effort since a long time.
“The essence is, that what JKH portrays as a logically consistent and seemingly complete world of ‘income, balance sheets, and flow of funds’ statements, is, accrording to the quantum economists, and quite plausible to me, in fact a philosophically impossible amalgamation of physical, temporal and ideal ‘things’ (using my own terms here).”
I don’t think it is really impossible. For example the Federal Reserve regularly report *detailed* statistics such as here: http://www.federalreserve.gov/releases/z1/current/z1.pdf
It’s a huge achievement.
“My visual memory hook is that the financial world always NETS to 0 by simultaneously expanding in opposite directions (say, vertical or horizontal). So, financial world savings (noun) are always 0.”
It is true that assets and liabilities of the world as a whole or changes in one period nets to zero but this two-sector focus misses out crucial things. Plus your definition whether you meant saving or savings is not the standard definition even in MMT’s case.
The point is MMT’s underlying definition is indeed the same as national accountants. And some commenters are not yet clear on this and this is surprising. There were some commenters who kept telling me it is otherwise but NO – MMT’s definition of saving is the same as national accountants. It is only in many cases that the mix these things up and do not change in spite of being pointed out – which JKH thought was flabbergasting 🙂
@Asymptosis
Think of it in terms of nominal value determined by price as a claim on actual or use value, the value being in utility. Nominal value is determined by marginal price, whereas actual value is determined by use and the utility is provides. Does money bring happiness? Only as as claim on actual value, unless one is a miser that delights in counting one’s money, or a numismatist that loves notes and coins for their own sake. Nominal value (price) fluctuates widely in financial markets. Does this affect actual value determined by use-utility?
MMT economists emphasize that the introduction of nominal value is in the interest of increasing actual value through production, distribution and consumption of goods that have use-utility. Barter never existed as the means of exchange in economies because it is highly inefficient and ineffective in achieving individual and social goals.
Some form of unit of account and medium of exchange is needed, and the original store of value seems to be been in credit-based relationships, where a person could draw on past contributions by calling obligations they created in the future. This is the basis of the credit theory of money, which seems to precede the introduction of state money and coinage historically. So the distinction of nominal (financial) and actual (goods, use, utility) seems to go back to the beginning of society in pre-history. This appears necessary for production of goods not for immediate consumption by the producer, i.e., commodity markets. Capital goods became increasingly important subsequently with the development of technology. But the outline remains the same.
Production is one purpose of an economy as the material life-support system of a society. The overall purpose of an economy is the sustenance and maximization of prosperity in a society for survival and progress, which is dependent materially on availability of real resources and the use to which these resources are put wrt effectiveness and efficiency.
@Asymptosis
See Winterspeak, The Myth of High Powered Money for a drill down.
You’re right, Ramanan, my argument was inconsistent. MMT does work with standard definitions, but the focus is often such, that in feeble minds like my own, accumulation of net financial assets is quickly equated with saving, which is technically wrong – which is what JKH was trying to say. The rest of my rant then went into why such a focus might be the right way to go – and may thus be a reason to redefine terms. Something that hasn’t actually happened. Oh well…
Tom,
I don’t who this “nominal” thing has crept in. This terminology is used when discussion inflation accounting. E.g., one can talk of nominal wealth versus real wealth using a base period.
@Oliver
Yes there is a useful analysis that can be carried out but not by mixing terminologies but by unmixing terminology. So for example one can say just by looking household saving an analyst cannot conclude if something can go wrong or has gone wrong so one needs other measures such as the household sector deficit, composition of balance sheet etc. But for doing that, one first needs to get these points clear instead of conflating them.
@Ramanan
Ramanan, I agree. There is a confusion between the use of nominal (value expressed in unit of account) and real (inflation adjusted), and monetary (unit of account and accounting) and actual (goods), that is, measures of value and what is valued. I would prefer to see separate terminology used here to keep the distinction clear. I think that the problem arises from calling inflation adjusted “real.” That is not the way “real” is used ordinarily.
@Oliver
Oliver, bean counters have their own terminology and jargon. That is why people pay them good money to do their taxes, for example. It’s the old “specialist” game for extracting rent that goes back to the early priesthoods. 😮
@Tom Hickey
There’s a real (!) reason for the usage real. So one uses real gdp grew by 2% or whatever. The reason is one needs a price adjusted measure because gdp can be growing simply because prices rose. So the usage real.
That is standard usage.
Now, and I see Winterspeak using this often but also perhaps MMTers and I don’t understand why this terminology has to be used – i.e., to call financial assets – perhaps in the net sense – “nominal wealth” or “nominal savings”.
@Ramanan
Yes, it seems to me that using “nominal” is different contexts is confusing and “nominal” v. “real” as inflation adjusted is standard. But “real wealth” is also used, as in “real estate.” So there is confusion already introduced.
Then there is the financial value of “real assets,” e.g., book value, and there is also the nominal value determined by market (marginal) price. Then there is current actual value determined by appraisal and analysis (appraised value, fundamental value) Then there is the adjustment of these wrt the nominal v. real in adjusting for inflation. No wonder some people get confused.
Tom,
My point is that due to historic reasons or due to shortage of words there are some terminologies but it doesn’t help to add in the mess.
Real estate is okay because it is estate and still not wealth. I haven’t come across standard references using “real wealth” for fixed capital and those things. Real wealth is used in the inflation accounted sense.
Book value is different and I don’t know how it is relevant here.
So when the standard terminology for real and nominal exists why bring in “nominal savings”?
Yeah people confuse the two “real”s: nonfinancial, and inflation-adjusted.
Amazingly, this is one confusion I never had any troubles with.
But it would be nice to have a different, immediately understandable word for “non-financial.”
“Real-world”?
There’s a real (!) reason for the usage real. So one uses real gdp grew by 2% or whatever. The reason is one needs a price adjusted measure because gdp can be growing simply because prices rose. So the usage real.
The reason that is used is probably because it is considered a reasonable proxy and a very simple way describe what goes on in the physical world. 2% real growth is a simple way of saying there were 2% more things produced without having to describe them (2 more chickens, 3 more cows etc.). But to apply the term ‘real’ to the monetary measure of that real thing is inaccurate, imo. Not to mention that one then has to come up with other terms to describe the real things. Capital, for example – another often confused term. Money should admit to the fact that it isn’t real (even if prices don’t rise) but merely an accounting fiction. Fiction is not real. The real world was there before the accountants and it wants its words back!
@Oliver
Well yeah but that’s what I said.
In other words
“There’s a real (!) reason for the usage real. So one uses real gdp grew by 2% or whatever.”
&
“The reason is one needs a price adjusted measure because gdp can be growing simply because prices rose. So the usage real.” are slightly unrelated.
The second statement gives the reason for the usage of the word real and the first quote is an example of the usage of real.
If gdp grew simply because of price rise, it is not growth so real growth = 0, hence the usage of the word real.
@Asymptosis
Steve, I get what you are saying, but I’m not sure new reserves can necessarily be considered new vertical money. If the bank needs reserves because they issued credit and that deposit got transferred or spent elsewhere, it may be that the Fed performs an OMO, i.e an asset swap and not a “vertical” transaction. Or, the bank buys the reserves at the discount window at a penalty rate & have to pay for them until they are returned; so it is either an asset swap or a loan. That said, I agree with your point: the private sector directly influences the creation of reserves by the amount of credit they extend. However, I don’t think its true that reserves automatically equate to “vertical” money.
@DaveGerlitz
Sorry, that was supposed to be in reply to Asymptosis of 3/21 @ 8:05 and Tom Hickey’s reply.
@DaveGerlitz
Right. It’s not direct or 1:1. But in a sense aggregate credit issuance, and the optimism that drives it, do result in the creation of vertical money — just one step (and an indefinite and variable time period) removed.
@Asymptosis
“… if new credit issuance forces new reserve (vertical money) issuance…”
I’m curious. How is new reserves construed as vertical money? How does that add NFA to the non-government?
@Paul
OK, forget I asked – I think I see what you are getting at.
The government must follow through at some point in the future to monetize gains is what I take you to mean;
although the government isn’t “forced” by any means. That’s a political decision – it could just let the economy tank.
@Paul
Vertical money is that which is used in transactions between govt (consolidating cb and Treasury for simplicity) and non-govt. Reserves are at the apex of the hierarchy of money since banks must exchange bank reserves to get cash for their vaults to meet customer demand, and the Treasury has to get reserves from the cb in order for its credits to non-government accounts to clear, reserves being used for settlement purposes alone. Reserves always reside only on the cb spreadsheet as the final settlement vehicle for non-cash transactions that are not netted out horizontally.
Reserves enter non-govt through Treasury disbursement that injects net financial assets into nongovernment. These reserves are then “stored” as govt secdurities, e.g., in the US deficits must be offset with security issuance. If the cb doesn’t set the overnight rate to zero or pay IOR, then it uses OMO to regulate the amount of reserves in the overnight market so as to hit its parget rate.
Banks create horizontal money by extending loans and crediting deposit accounts. What is not netted intra-bank or among banks is settled in the reserves in the settlement system, in the US, the FRS. The cb as lender of last resort always ensures that reserves are available to members to settle accounts. For example, the Fed will provide loans through the discount window at the penalty rate if a bank is short at the end of a period. This is not the usual procedure, however. Banks manage reserves to ensure sufficient reserves to clear after meeting resevers requirements.
While reserves are that the apex of the hierarchy, they never enter the economy as reserves, which reside only on the cb’s spreadsheet as entries in accounts used to settle accounts with govt and interbank. Banks get cash be exchanging reserves, and govt securities owned by non-government are “stored reserves” corresponding to the settlement of accounts after Treasury disbursements. Non-banks hold cash and tsys, for example, but not reserves, since they do not have access to the FRS.
So the bank reserves, cash and tsys that are held by non-govt that result from “vertical transactions” of govt with non-govt — less obligations to govt on them — are non-government NFA. Thus, purchase and sale of tsys just change composition of non-govt NFA between govt and non-govt and within non-govt, whereas fines, fees and and taxes withdraw non-government NFA.
All transactions that are among non-government entities are horizontal, Having both assets and liabilities in non-govt they net to zero. The key feature of NFA is that they are non-govt assets without a corresponding liability in non-govt. So they don’t net to zero. The only way for non-govt NFA to be zero would be to have no public debt and a balanced budget, unless there are net exports. Then, while individual entities may net save, non-government as a whole cannot net save (hold NFA in aggregate) other than through net exports, where assets are domestic and liabilities foreign.
Think of the horizontal aspect as a closed system. Double entry accounting ensures that all accounts net to zero, that is, RHS and LHS balance. Although equity can increase on the LHS, which accounts for actual growth of the economy, there is always a corresponding entry on the balance sheet to account for it. So if there are net financial assets, then they have to come from outside the closed system. This can be either from govt net injection or the net external balance. In this way, the domestic economy becomes an open system wrt financial assets. Govt deficits increase domestic private sector NFA as does net exports since the domestic private sector gains assets without corresponding liabilities within it, and govt surpluses and net imports decrease domestic NFA as the domestic private sector gains assets without corresponding liabilities within it. MMT consolidates the domestic private sector and eternal sector as non-govt. Then the govt deficit (surplus) must equal the consolidated non-govt surplus (deficit) as an accounting identity, since there are no other flows in or out of the national economy.
Tom
Thanks for the well thought out response. Our thinking is for all intents and purposes identical.
At first I thought Steve’s statement implied that credit issuance forces the government to eventually net-spend, which maybe has the causality wrong. I mis-interpreted his statement.
Then I realized that reserve balances increase as credit increases as they must. I don’t think of reserve balances as a “money thing” such as something one can spend in the non-government but I do realize reserves are part of the “money supply”.
I see in this vein all vertical money is not NFA’s, only the portion that gets spent into the economy.
This is a subject that is opaque to most people and I expect it always will be. Another example of the recent discussions over terminolgy and semantic understandings.
@Paul
Right, it in the nuance. That’s why it is often confusing to speak of “money.” Too ambiguous. One needs to specify exactly what one means and that involves both parties understanding how the monetary system actually operates, and few do. That’s why the conversation we are having here are important. The nuance is not trivial.
[…] In my ongoing efforts to clarify national-accounting-speak (for myself and others), I’d like to take a stab at some language that is often used ambiguously: the notion of “public” debt. (See also Thinking About the Fed.) […]
[…] In my ongoing efforts to clarify national-accounting-speak (for myself and others), I’d like to take a stab at some language that is often used ambiguously: the notion of “public” debt. (See also Thinking About the Fed.) […]