Archive for March, 2018

MMT and the Wealth of Nations, Revisited

March 23rd, 2018 Comments off

I just had occasion, in replying to a correspondent, to reiterate much of the thinking in my recent MMT Conference presentation. I thought it might be a useful and apprehensible form for some readers, so I’m reproducing it here.

I’ve also explained this at somewhat painful length here.

Correct me if I am wrong but what you are saying extends MMT into the private sector. The govt boosts balance sheets with stimulative fiscal policy. The private sector boosts balance sheets through asset price appreciation. Each creates “money” out of nowhere.

That’s one way of saying it. It adds a mechanism for asset (money) creation beyond “outside” (gov) and “inside” (bank) money issuance.

I’d say: MMT largely and Sectoral Balances exclusively “think inside” the incomplete flow of funds accounting matrix, which ignores cap gains (and nonfinancial assets). So it misses the biggest asset (“money”) creation mechanism there is.

To be precise:

Gov def spending adds assets to PS balance sheets. No new PS liabilities added, so +PS NW.

Bank lending (net, new) adds assets to PS balance sheets. But adds equal new PS liabilities, so no ∆NW.

Market runups (cap gains) add assets to PS balance sheets. Like gov def spending, no new PS liabilities added, so +PS NW.

Key point though: unlike gov def spending, new assets from cap gains don’t “come from” anywhere, aren’t issued by any sector. There are no new liabilities added to any other sectors’ balance sheets. That’s why cap gains aren’t included in the closed-loop, balance-to-zero flow of funds matrix.

The thing is, the economy doesn’t balance to zero. It balances to net worth. (Wealth.) That’s the bottom-line balancing item that makes balance sheets…balance. Since the flow of funds matrix is missing complete balance sheets, total assets, net worth, and cap gains, it can’t represent that.

And what is money?

People use that word in three primary ways:

1. The market-priced value of balance-sheet assets or net worth (representing the value of ownership claims), designated in a unit of account. Wealth. Ask a zillionaire, “how much money do you have?”

2. Financial instruments whose prices are institutionally pegged to the unit of account. Fixed-price instruments. (The price of a dollar bill is always $1.) eg Checking/MM-account balances and physical cash. The instruments that are tallied in monetary aggregates. Finance types often refer to this as “cash.” A subset of (1).

3. Physical currency/coins. A convenient late invention that makes it easy to transfer assets from one (implicit) balance sheet to another. A different meaning for “cash.” A subset of (2).

Note that the stock of #2 can only increase if some sector (financial or gov) issues more. Ditto its subset, #3. And, market pricing can’t affect the total stock of this subclass of money because these instruments’ prices are…fixed! The stock can only increase/decrease, these instruments can only appear/disappear, through issuance and retirement by other sectors, which post equal liabilities to their balance sheets. (That issuance/retirement is tallied in the FFA matrix — inside and outside money.)

If I have money in my pocket, I have a right to claim some portion of of the worlds’ production, be it a cup of coffee or a beach house on a tropical island.

Right. In practice, you can also claim people’s labor. Cause they need money. A balance-sheet asset is a formalized, labeled numeric representation of the value of an ownership claim (generally embodied in a financial instrument, with the claim’s asset value always designated in a unit of account), which can be exchanged for A) goods and services and B) other ownership claims.

So where does this money come from?

Ignoring #3 as a distraction, and focusing just on the two financial mechanisms that increase net worth:

A. Gov def spending. (Creates #2 hence also #1.)

B. Existing-asset market runups. (Creates #1 but not #2.)

As technological progress increases our productive capacity, so does our wealth. We become richer, so we should have more money.

Can definitely look at it that way. Wealth could be:

1. The value of our existing stock of stuff — both tangible and intangible, both consumable and productive. (To the extent that those can be distinguished; productive “capital” is “consumed” through use, decay, obsolescence…)


2. The capitalized net present value of what we will be able to produce in the future (thanks in large part to our existing stock of productive stuff).

Either way, I’d say:

We steadily increase our stock of real stuff. Surplus from production, all that. There are three financial mechanisms for creating new $-numerated claims on that new stuff, new balance-sheet assets. In terms of magnitude, cap gains is the dominant mechanism.

Finally, to expound on the implications of fixed-price vs variable-priced instruments/claims/assets:

When government deficit-spends, it delivers new fixed-price assets (checking/MM deposits) onto private-sector balance sheets. Assuming portfolio preferences are unchanged, the private sector is overweight “cash.”

Collectively, wealthholders can’t get rid of that cash by spending; they can only trade/swap that money around. The total stock only changes via issuance/retirement (caveat below). So they do a bunch swapping/trading of existing assets, driving up the prices of variable-priced instruments (mainly bonds, equities, and titles to real estate), with everybody marking their balance-sheet assets to market, until the market achieves its preferred portfolio balance.

The relatively fixed stock of fixed-price “money” is sort of a fulcrum around which portfolio rebalancing pivots.

So there’s some portfolio “multiplier” to government def spending. It immediately adds assets (cash) to private-sector balance sheets, but it also causes price increases in variable-priced instruments through portfolio rebalancing. Voila: even more assets.

This, by the way, is exactly how the portfolio mechanism works in the more advanced Godley-Lavoie-style models (which do encompass complete balance sheets, and include holding gains in “income.” See Haig-Simons.) Though I would suggest that the precise portfolio reaction-functions in these models might be improved.

The caveat: wealthholders can remove cash from their asset portfolios and from the private-sector balance sheet by paying down bank debt — shrinking their balance sheets, and the banks’. Likewise they can create cash by borrowing. (Again: private-sector assets and liabilities change, but net worth doesn’t.) They’re instigating the retirement/issuance of those fixed-price assets and associated bank liabilities. Think: reflux.

I hope folks find all this useful, or at least interesting.

Wealth and the National Accounts: Response to Matthew Klein

March 8th, 2018 Comments off

I’m both abashed and delighted that the truly stand-out econ writer Matthew Klein has offered wonderfully fulsome praise of one of my pieces, Why Economists Don’t Know How to Think about Wealth, and some very interesting discussion as well. Some responses here. Please excuse me if I repeat some of the points from the first article.

>His key point is that changes in net worth caused by asset prices fluctuations are just as important as standard measures of income and saving.

That’s important, but there are really three key points I’d really like to come through:

1. Wealth matters. Net worth and total assets. Those are absent from the Flow of Funds matrix, because it ignores: A. Nonfinancial assets — the (L)evels tables aren’t balance sheets — and B. Holding gains. Yes: changes in wealth measures also matter a lot (see below), and they’re of course also invisible and largely unexplained in the FFA matrix.

2. Accounting statements are economic models, based on deeply-embedded assumptions that are largely invisible except to accounting-theory adepts. The FFAs’ closed-loop construct depicts, promulgates, and validates the whole factors-of-production worldview (each according to its contribution…) which underpins travesties like Greg Mankiw’s “just deserts” claptrap. See in particular national-accounting-sage Robert Hall’s discussion of the accounts’ implicit “zero-rent economy.”

3. The dumpster fire (@noahpinion) of terminology that economists rely on to communicate — and really to think (together) — is (or should be) rigorously defined based on accounting identities. But that requires deeply understanding #2 above: what those measures and identities mean. To repeat: accounting classes don’t even count as electives for econ degrees at Harvard and U Chicago. (Really, the situation is more like the sub-basement of Fukushima Three. One word: “saving.” Many economists vaguely think that more individual saving results in some larger stock of monetary “savings.” Sheesh.)

>Roth’s presentation…is not new. Alan Greenspan wrote about these ideas back in the 1950s

Johnny-come-lately. Haig-Simons, who I refer to repeatedly, bruited their comprehensive accounting definition of income in the 20s and 30s. (Dead-cat bounce. I’m thinking the rich hate this idea. The political implications of fully revealing wealth and wealth accumulation could be…revolutionary?)

Wikipedia informs me that a German legal scholar named Georg von Schanz was on it somewhat earlier. (Modern Money Network, are you listening?)

>Roth ends up downplaying the importance of the liability side of the balance sheet.

Perhaps. At least three reasons:

1.The FFA matrix does an excellent job of accounting for (inevitably “financial”) liabilities. Nothing to complain about there. That’s where the IMAs get most or all of their liability accounting from. And economists have made very good use of that data.

2. Looking at households as the “buck stops here” balance sheet, liabilities are surprisingly (to me) small percentage of assets. Yes, a long secular trend with one big spike (not much for sample size…). Click for Fred.

3. For the economic import of (change in) assets versus liabilites, I’ll just point to one economic factoid which I find darned significant:

Post-1960s (post Bretton-Woods?), every time you see year-over-year decline in real household net worth or assets, you’re just into or about to be in a recession. (There are two bare false positives, just after the ’99 and ’08-’09 market dives; they look to me like blowback, residual turbulence, if that suffices as cogent economic terminology…)

Notice: The two measures are equally predictive; including liabilities (in net worth) adds no predictive power. These two measures move closely together. This especially makes sense for declines; asset markets dive, while liabilities are much more sticky downward. (They tend to climb together over time.)

So yeah, I’m with Roger Farmer about stock-market declines “Granger-causing” recessions, though 1. I cringe at that faux-statistical usage, and 2. at least for the GFC, I’d say the real-estate crash caused the stock-market crash. In any case, overall, it sure looks to me like wealth (asset) declines (proximate?) cause recessions. I’d say high debt levels amplify the effects when that does happen.

So yeah of course, net worth is not some kind of tell-all economic measure. You gotta deconstruct it. But it’s a bloody-well-necessary measure that economists (and national accountants) have largely ignored, like forever.

>defining “saving” as the “change in net worth”, as Roth does, is that this obscures as much as it clarifies

Note that I use a particular term for that, Comprehensive Saving, while leaving what I call Primary Saving (largely) intact. (The IMAs’ measure of primary income hence saving is after “Uses of property income (interest paid)” are deducted, which seems crazy (and politically pernicious) to me. I’ve moved it from it’s sort-of-hidden position in Sources, to appear explicitly in Uses, so my Primary Income and Primary Saving measures are a bit higher than the IMAs’.)


Now it’s true that I relegate Primary Saving to an addendum, favoring Comprehensive Saving as the more important measure. This imparts how deeply rhetorical all accounting presentations are. But I think this privileging makes sense give the relative magnitudes we see. (Net Lending + Capital Formation here is traditional primary “saving”).

This is J.W. Mason’s recent graph, which I was delighted to see, showing the same measures (the IMAs’ ∆NW decomposition) that I’ve also graphed in the past.

>asset price appreciation generally leads to proportionally tiny increases in spending.

The linked study, like others of its kind, in my opinion gives too much weight to marginal propensities, based on one-time changes. So I question how good a guide they are to determining economic reaction functions. This is too much of a subject to address here, so I’ll only suggest that more straightforward, long-term propensity-to-consume measures by wealth/income classes might be more illuminating. Also velocity of wealth. (I’m a monetarist! As long as “money” means “wealth”…)

Whether or not you consider these figures illuminating, they are the kind of figures you can derive from a complete accounting construct that tallies total assets and net worth. Note that both are also dependent on data from Zucman/Saez/Pikkety’s magisterial Distributional National Accounts (DINAs). What I’d really like to see is Distributional IMAs (DIMAs). I corresponded with Gabriel Zucman on this a bit; he’s given me permission to quote him:

You are correct that there can be pure asset valuation effects in the long run (i.e., capital gains in excess of those mechanically caused by retained earnings). These pure valuation effects are not part of national income, hence not included in our measure of income and our distributional series. However, they could be included down the road by computing income as delta wealth + consumption (i.e., Haig-Simon income). We have wealth in our database so we’re not far from being able to do this.

To conclude on a decidedly accounting-dweeby note, here’s the key accounting identity for Haig-Simons (which I call Comprehensive) Income:

∆ Net Worth + Consumption = Primary (traditional) Income + Holding Gains (+ Other Changes in Volume)

Subtract taxes, and you’ve got Comprehensive Disposable Income. Subtract Consumption, and you’ve got Comprehensive Saving. Equals…change in Net Worth.

Accounting identi-tists, have fun!

(For those who prefer this kind of thing in slide-deck form, here’s a PDF of my presentation from the recent Modern Monetary Theory conference.)