At risk of stating the obvious, in this post I’d like to highlight a pernicious misunderstanding that I find to be widespread out there in the world.
This is not new thinking. You’ll find a more sophisticated historical account, stated very clearly though in somewhat different terms, in the first few pages of this PDF. Still, despite decades of debunking, this misconception remains ubiquitous. I’d like to explain it in the simplest and clearest terms I can.
Start here:
GDP = Consumption Spending + Investment Spending
Consumption Spending = Spending on goods that will be consumed within the period.
Investment Spending = Spending on goods that will endure beyond the period.
Looking back at a period, from an accounting perspective, it’s obvious that if there’s less consumption spending, there’s more investment spending. This must be true, because that’s how we tally things up, once they’ve happened. There are two types of spending; every dollar spent last year must be one or the other. If there’s less of one, there’s more of the other.
But people conclude: if there is less consumption spending, there will be more investment spending. (So we’ll increase our stock of real stuff, and we’ll all be richer!)
They’re confusing (and confuting) a backward-looking, historical, accounting statement with a forward-looking, causal, predictive statement. Because looking back, GDP is fixed. It has to be; it’s already happened! But in that very instant of thought, people abandon that fixed, historical perspective and think: if one component is smaller, the other will be larger.
This makes no sense at all. Think about it: If people spend more on consumption goods next year, that will cause more production — including production of long-lived goods to increase production capacity. Investment won’t go down because people spend more on consumption. GDP will go up. Next year’s GDP (obviously) isn’t fixed.
Likewise, people tend to think that less consumption spending means there will be a higher proportion of investment spending (so, relatively, more real-wealth production). Wrong again. The backward-looking Y = C + I accounting identity tells us exactly nothing about why people will make their spending decisions — what causes them to choose consumption vs. investment spending. They might choose to increase or decrease either or both, for myriad reasons. One doesn’t cause the other in some kind of simple arithmetic manner.
This seems very obvious. But if you hold this firmly in your head as you peruse people’s statements out there in the world, I think that you will find that many of them do not have it fixed very firmly in their heads.
Cross-posted at Angry Bear.
Comments
179 responses to “No: Less Consumption Does Not Cause More Investment”
[…] Cross-posted at Asymptosis. […]
Nice title.
Yes, it is foolish of people to think more consumption leads to less investment and so on. And the fact that such belief is held widespread is amusing.
I think rather than backward or forward looking, it is based on the silly production function approach where output is determined by a production function and so more consumption implies less investment.
What the conventional wisdom distracts from is that less consumption (because of how it’s coincides with wealth/income concentration) does lead to malinvestment and instability (resulting in further concentration), because more money is chasing fewer worthwhile investments, leading to bubble formation and the like.
So as per #2 we have less consumption causing high investment?
Excellent, excellent post. It is clear and easy to understand. I particularly like the contrast between backward- and forward-looking. And for me, it’s important that the “accounting identity tells us exactly nothing about why people will make their spending decisions…”
Sorry, I got lost when I read the words “production function”.
It’s a category error to confuse accounting with a distinction between the past and the future.
Accounting identities and logical requirements for accounting coherence hold past, present, and future. That’s the basis on which post Keynesians used sector financial balances to predict conceivable future outcomes around the time when the US government was running budget surpluses.
The point you are making is not about accounting. It’s about something else.
@JKH
It’s about using historical accounting assumptions when doing forecasting. Big mistake.
I think the effect can be generalised into those that can handle dynamic changes in all the variables and those that have to hold certain variables fixed based on their prejudices.
What I see mostly is fixed quantity, fixed amount of money, fixed exchange rate thinking.
@Neil Wilson
That’s an issue, but it’s a separate issue again, and not really about accounting.
It’s about the naïve and/or manipulative use of historic risk statistics in future projections.
i.e. including the issue of ergodicity
accounting supersedes all of these things
those who don’t acknowledge the fundamental importance of accounting in economics just don’t understand what it is they’re sneering at
Also, if you go to Krugman’s blog, and read ‘A Dark Age of Macroeconomics’ (on the side), what he’s effectively saying is that accounting identities are dynamic when used as projections into the future, something apparently not understood by the freshwater school, according to him.
Steve,
You make a good point but I think that you go too far.
Firstly, what you say about interpreting ex post identities in a causal way is true. An example of an equivalent error would be thinking that, because GDP is just the sum of various things including G, the government can raise GDP simply by raising G. Another would be thinking that, since private saving is equal to investment plus net lending to other sectors, the government can raise private saving simply by running a deficit.
That said, the fact that you can’t get these things from an identity, doesn’t mean that they’re not true in some cases. When and where they might be true is an open question, despite the fact that they aren’t *universally* true as a result of the identities in question.
So, it might well be the case that saving “causes” more investment, in some situation. It’s actually quite easy to come up with a model where it does (I leave that to the reader). The fact that “saving causes investment” is not implied by an identity (cannot be implied), doesn’t mean that it is never true.
@vimothy
Right, you have to look at what is going on or likely to go on. For instance is consumption falls below trend unexpectedly investment increases as a result of unplanned inventory growing, which is undesirable to the degree it sends a signal to firms not to produce, i.e., cut future investment. So increasing investment in the present here results in reduced investment in the future, until the inventory glut clears.
Another case is that of mercantilists countries that suppress consumption through wage suppression to increase investment through gains from exports. Firms investing gains from exports do well, while workers work for the ROW instead of themselves. This is considered ideal in many models of capitalist enterprise and national economic policy to support it.
So in the phrase “saving more than consuming” we have to look at what the “more” implies. Taking that phrase to means something good is not always justified by the facts, or it is only justified by a particular interpretation of the facts that may involved questionable tradeoffs such as are involved in mercantilism. Therefore, it constitutes a false inference when generalized.
@JKH:
“Conceivable” is the key term here. We’ve done this discussion and I think we agree. Accounting identities can demonstrate that a prediction (a conceivable future) is impossible, i.e. every country reducing its import/export ratio at once.
But they can never tell us that a prediction is right. They can only, and only sometimes, tell us if it’s wrong.
The trade balance thing is just saying: “I don’t care what you do. When we get to the end of the period and look back, you’ll never see what you’re predicting we’ll see. It’s impossible.”
As I said a year or so ago, accounting identities do not impose a constraint on economies, only on our economic reasoning.
In any case the idea that “Y = I + C means decreasing C next year will cause I to increase” is a logical error, of some undoubtedly named type.
An accounting identity doesn’t cause anything.
To rephrase Krugman: “both Fama and Cochrane are asserting that desired savings will automatically be converted into investment spending.” That is an assertion of a predicted cause and effect: more saving will cause more investment.
And he’s right that this is completely wrong. When we get to the end and look back, saving and investment for the period will be equal. Fine. But as SRW has said, that’s a trivial and tautological statement, basically just saying that our accounting construct is “complete.” Great. We knew that.
When Fama and Cochrane use it to “prove” that more saving will cause more investment, or Sumner uses it to suggest that less C will cause more I, they’re simply wrong.
@vimothy
Right. Again: accounting identities can’t prove that a prediction is right. They can only, and only sometimes, prove that it’s wrong.
Or to put it another way:
There are an infinite number of predictions and causal assertions that are in accord with, are not disproved, proved to be impossible, by accounting identities. Those identities don’t give us the slightest clue as to which of those predictions, those assertions of cause and effect, are correct.
Just because Fama and Cochrane’s assertions don’t violate accounting identities doesn’t mean they’re correct. There are many other assertions that also conform, and that directly contradict F&C. Which are right? Since they all conform to accounting identities, those identities are of no help in answering that question.
“As I said a year or so ago, accounting identities do not impose a constraint on economies, only on our economic reasoning.”
That’s not a clean dividing line. The financial system is a construction of double entry bookkeeping. The rules constrain the results.
I think SRW is overstating the general awareness about the issue of the required integration of accounting within economics.
@JKH
The fact that there’s as much continuing discussion about it as there is means its not well understood at all.
@JKH
“Those identities don’t give us the slightest clue as to which of those predictions, those assertions of cause and effect, are correct”
With all respect, that’s what the trivial point is. Nobody should be disputing that. The fundamental point is that future feasible outcomes must be stock/flow consistent. And if everybody understood that, then I suppose we’d all be post Keynesians.
One off beat example comes to mind immediately. Krugman in his debate with Keen a year ago claimed he understood T accounts. I think he exaggerated. I don’t think he’s worked them through for central banking. And that was also an element in his more recent debate with SRW and STF, which had to do with conceivable (accounting) outcomes for lifting off the zero bound. Krugman is brilliant, but somebody needs to lock him in a room for a weekend and teach him central bank T accounts.
@JKH
And tremendous confusion still prevails ubiquitously about the differences between income accounting, sources and uses of funds accounting, and balance sheet accounting. Everywhere in economics.
The phrase “stock-flow consistency” aside, this is axiomatic in the mainstream.
Sorry, what I meant to type there was,
The fundamental point is that future feasible outcomes must be stock/flow consistent.
The phrase “stock-flow consistency†aside, this is axiomatic in the mainstream.
@JKH “The financial system is a construction of double entry bookkeeping. The rules constrain the results.”
I really disagree. The financial system is a construction of agreements between people. (Mostly consensual, but even those backed by threats of [ultimately physical] coercion.) Formal and informal, written and unwritten, some (parts) of those agreements written in contracts, some in laws and regulations, some merely existing as widespread or universal social expectations.
Accounting is a description of that construction, using a particular set of methods and conceptual constructs that has proven useful. National accounts are a model of the economy. The map is not the territory. The economy would exist absent any accounting description of it.
But yes: the map does affect the way humans interact with the territory. i.e. If something is marked terra incognita or “Here be dragons,” people won’t go there. Which is why I keep saying that one’s choice of accounting constructs and labels is inevitably normative, rhetorical, and political.
And yes: if people don’t understand the accounting constructs, if they don’t know Latin and think that “terra incognita” means “free milkshakes for all,” they may find themselves slogging through some very unpleasant territory.
@Asymptosis “The economy would exist absent any accounting description of it.”
Rethinking, I actually think that’s wrong. The accounting description is part of the construction, and it constrains where people can go, what they can do within that construction. CDOs wouldn’t exist without accounting constructs.
But accounting constructs are only part of the construction (and simultaneously a partial map/description/model/representation of that construction). I can plant a garden, harvest, and eat without accounting.
But: can I trade without accounting? Actually yes. cf Graeber on the early ubiquity of gift economies, in which no firm tallies are kept. That’s how we trade most things with our family and friends.
@vimothy
so you’re saying the post Keynesians have added nothing in that dimension?
@JKH
“That’s not a clean dividing line.”
Right!
Accounting does impose constraints because of all future paths one can think of – many of them can simply be thrown away because they won’t be obeying all the constraints.
IMO, the constraints can be quite strong – for example for policy etc.
@Asymptosis
National accounts are a model of the economy
I didn’t say the national accounts or the economy.
I said the financial system.
And I’ll stick by that – it’s a construction of double entry accounting.
People use the financial system on that basis.
@Asymptosis
the territory is double entry bookkeeping
@vimothy
“An example of an equivalent error would be thinking that, because GDP is just the sum of various things including G, the government can raise GDP simply by raising G.”
Yes but it can raise the GDP by simply raising G 😉
@JKH “somebody needs to lock him in a room for a weekend and teach him central bank T accounts.”
Me too! I think you should be the guy stalking around the room looking fierce and slapping a ruler on his palm. Care to volunteer?
Tangent: really understanding T accounts might clear up my perennial confusion about you-know-what. Here:
Business expenses ≠expenditures
A business spends $1,000 to build a drill press. That’s an expenditure. But on its books, it’s not an expense. The expense hits the books over ensuing years as it “consumes’ that drill press (estimated as depreciation). The expenditure is not deducted from income to derive profit. (Or it’s deducted as part of total expenditures then added back, as a “contribution” to profit.)
So in the national accounts, how is that consolidated for a sector? Does I equal total business expenditures (not including intermediate goods of course)?
@JKH
I wouldn’t say that they’ve added nothing, but stock-flow consistency is not unique to post Keynesians.
@vimothy I’d say, rather:
The assertion that a future outcome is feasible must be stock-flow consistent to be true.
The problem is that Cochrane et al are essentially (though unconsciously) saying, “Look, it conforms to the accounting identities. It’s feasible. That proves that it’s true!”
@vimothy
I think its ENTIRELY unique as a point of emphasis
@JKH
have a look at Godley-Lavoie and tell me if you’ve ever seen anything like it as a textbook – putting the accounting construction of the monetary system right at the center of the economy
its very unique
@JKH
Well, that seems like a matter of judgement and I won’t argue with it. At the same time, in any GE setting, stock-flow consistency is a necessary requirement.
@vimothy
Stock-flow consistency is not just accounting relationships but also how the flows and stocks move forward in time. I don’t think mainstream has anything like that. Even if there is something roughly looking in the direction, it would have errors such as the central bank fixing the stock of money.
@Ramanan
I will say again, in *any* general equilibrium setting, stock-flow consistency is assured by necessity.
@vimothy
Example?
@Asymptosis
This is a bit rough for now:
‘Expenditure’ is not a crisply defined word in accounting terms, IMO.
What is crisp is ‘expense’ – which is a deduction on the income statement.
But it occurs to me now that it is important it is to distinguish between the following three things:
a) Production of investment goods
b) Purchase of investment goods
c) ‘Investment’, whatever is intended by the meaning of that
The production of investment goods is an income statement ‘event’. It produces revenue on the income statement. E.g. Boeing produces 757s.
The purchase of investment goods is NOT an income statement ‘event’. It is NOT an expense. It is a cash outlay that is captured in the sources and uses of funds statement. The purchase of investment goods is a use of funds. Potential sources of funds include asset disposition/liability issuance and internally generated equity funds (retained earnings). So purchase of investment goods can be funded from any of those types of sources of funds. E.g. American Airlines purchases Boeing 757s.
I think this may be a big part of the problem in understanding what is meant or implied by the third term above, ‘investment’. I think it generally is used as implied in the context of the purchase of investment goods. But in fact it is captured in NIPA as the production of investment goods and in the flow of funds (but more so latterly in micro sources and uses of funds) as the acquisition of investment goods. This may be an important part of the overall discussion that we haven’t touched on much yet.
‘Expenditure’ is a bit of a loose non-accounting term, IMO. It is used often with investment type cash outlays, but I see no reason why it can’t be used for consumption outlays as well. I think ‘cash outlay’ is as good a synonym as any, that being neural with respect to a particular accounting application.
Not sure why you are uncertain regarding the aggregation issue. The drill press would be a type of investment and investment is aggregated at the macro accounting level – whether through NIPA production, or sources and uses of funds acquisition of investment goods across the sector.
@vimothy
I hear you, but I see no evidence in mainstream economics of the kind of emphasis that post Keynesian economics regularly applies with regard to stock/flow consistency. Moreover, it may be there in models, but its certainly not there in terms of understanding the basics of monetary operations, which is at the heart of financial operations, which is central to economics.
@JKH
meant neutral rather than neural
but neural works for me also
🙂
This is a great post, and I think the point is extremely important to remember in modern economies. But I wouldn’t say it’s true in all cases, which means that in rare circumstances the normally faulty conclusion is actually correct.
I’m referencing Russia in the late 19th century here. So there’s a lot of conditions that have to be in effect in order for the suppression of consumption to lead to higher investment. Basically no meaningful private capital formation (agrarian society), a resistance by the majority of the population to accept any reduction in living standards (consumption) which often resists by cheating tax collectors (converting their produce into alcohol and selling illegally), and no significant foreign investment. In this specific situation reductions to consumption (by government taxation) directly allows the creation of capital for industrial investment.
While I’m aware that this is hair-splitting and there point made in the OP is true for us today–but it’s important not to swing in the opposite direction and say that it’s true in every situation.
@JKH
Good comment. Very JKH!
I’d add that purchase/sale of investment goods will a source of funds for another firm, so macroeconomically both production and purchase affects income flows because inventories is at current costs and sale is at final price and is a source of funds (plus minus/taxes).
I think expenditure is used in national accounts for consumption and the distinction becomes important because households have consumption for which they pay but also consume what the government buys for them such as public goods, so final consumption expenditure and actual final consumption.
@JKH
Although I am not sure about this, I think the neoclassical production function cannot be made consistent with SFC. Neoclassical economics and also other variants such as NKE require a production function. Without it they are meaningless.
@Ramanan
Yeah, the use of ‘expenditure’ may be fluid across micro and macro
e.g. here in micro form, at least:
http://en.wikipedia.org/wiki/Capital_expenditure
Of course, ‘capex’ is a pretty common term
And I see no obvious impediment to using it the macro sense
While, as you say, its common to refer to consumption expenditures in macro accounting
I think the important point is that ‘expenditure’ ranks low on the necessity scale in terms of accounting definition – unlike expense on the income statement or the definition of investment goods produced and/or sold
I just cracked open my old financial accounting book for the first time in 30 years – and expenditure is not in the index – that tells us something as well
The value of planes sold by Boeing less its costs of goods sold and other expenses shows up as its micro NIPA contribution as a company – i.e. its profit, less dividends
Cost of goods sold (e.g. engines) and other expenses become revenue to other firms and income to wage recipients
The process then decomposes further starting at the level of revenue to other firms
I know what you mean, but careful with the terminology in terms of ‘sources of funds’ in the accounting sense – the cost of the engines is not a source of funds (in the sources and uses of funds accounting sense) for the manufacturer of the engines, but a source of income statement revenue – the funds terminology starts at the level of retained earnings in that context
– although one could debate this I suppose, apart from the normal financial accounting, in the sense of the comprehensive Godley/Lavoie accounting matrix (haven’t looked)
– but in terms of micro accounting coherence, you won’t see the gross revenue line in the sources and uses of funds statement
@Ramanan
BTW, whenever I hear that somebody is doing an MBA (which suggests to me obviously that they have some interest in business generally), I tell them (shout to them actually) that the most important course they will ever take for a business education is financial accounting – it used to be mandatory in first year, whatever the course stream chosen after that; I hope it still is
@JKH
I specialized in finance back then, and a lot of it was the kind of capital market/efficient market theory that is derided today; I strongly suspected that it was the product of a distinct professorial odour at the time, and was right on that, but there was a lot of good stuff as well
@JKH
Yeah I was talking in the G&L transactions flow matrix sense.
Definitely agree about MBA courses. Somewhat tangentially reminds me of Keen’s friend Graselli’s claim that he is not doing accounting. I was thinking at that point – how can he claim that? But coming back to the point, business decisions are strongly dependent on financial statements and how they may look like in the future. A lot of firms go bankrupt because of poor financial decisions even though they may have had good talent and resources to do well.
Even John Hicks – whom mainstream economists like because of IS/LM and I like because of other reasons – admitted that firms are making decisions based on such things and lot of what he and other economists say is in the air.
@Asymptosis
Back to the basics of your post:
“Think about it: If people spend more on consumption goods next year, that will cause more
production — including production of long-lived goods to increase production capacity.â€
Good.
It’s a combination of two things, IMO:
a) Basic Keynesian multiplier stuff regarding marginal propensity to consume, etc.
b) A twist on the basic multiplier that includes a knock-on ‘multiplier’ for investment as well – investment is usually treated as one-shot endogenous injections at a time, followed by consumption iterations. You’ve gone a step further, which is interesting – and believable. I’ve always been sceptical about the treatment of Keynesian injections as purely exogenous. Have you come across anybody that models it this way, or am I simply out of touch?
Once again, this is not an accounting issue per se. Keynesian projections of income statements and balance sheets are consistent with projections of accounting coherence. It’s the people who don’t understand the comprehensive nature of both ex post and ex ante accounting dynamics that get it wrong. And again, it is a category error to identify accounting as purely ‘backward looking’.
@Ramanan
To deny the importance of accounting to economics is to deny the importance of mathematics to life in general.
@Ramanan
Corollary – econ should learn financial accounting prior to differential equations.
Or Lebesgue integration!
🙂
@Ramanan
Slightly more contentious, but attempting to be respectful:
Mosler’s claim to ‘insider’ fame and fortune rests very heavily on an understanding of straight forward micro and macro accounting as an input to his ‘paradigm’.
A separate problem IMO (and this is true of MMT in general, IMO) is that the MMT intellectual processing and output includes a deliberate conceptual and verbal transformation of that standard accounting input that (IMO) is unnecessary and counterproductive for educational purposes.
Of course there is a brilliance to Mosler’s understanding, as well as his method (which is separate from the understanding), and it works for him, but I think it’s problematic for wider comprehension of what really is basic accounting.
On the other side, it is clear from mainstream blogosphere posts since the financial crisis, that the economics profession has only gradually been learning and understanding central bank reserve accounting. This is obvious from the general arc of ‘discovery’, where even relatively recent posts by monetarists and others find and interpret central bank reserve accounting as if they’ve just created the wheel.
@JKH
Yeah very counterproductive especially since there is overkill.
I find it funnier when his fans start advertising the insider part.
About mainstream – I found it surprising that someone like Whelan who goes into details of the Eurosystem operations, finally ends up claiming no loss (which he later shifted).
@JKH
Lebesgue … 🙂
@JKH
“And again, it is a category error to identify accounting as purely ‘backward looking’.”
Probably not the best choice of words, but I took Steve to mean simply that accounting is an ex post record.
I think the mistake may be in the temptation to treat accounting identities in terms of functions that allow prediction, e.g., based on taking income, saving, consumption, investment as variables in a closed system, so that holding income constant and reducing consumption increases investment. The conclusion is that “more” investment is always “good” in that it leads to an increase of capital stock, and therefore reducing consumption is always desirable. But analysis shows this inference to be true only in special cases — that in fact much of the time that there is reduced consumption, unplanned inventory increases — so the general statement that less consumption leads to “more” investment (cet. par.) is taking “more” normatively to imply “good” rather than positively, simply wrt composition of changes in capital stock and inventory, planned or unplanned. This is a common error when money is considered neutral and the effects of leverage are ignored.
JKH makes the excellent point that financial accounting is integral to management even though mostly ignored by economists. Probably why economists don’t have a lot of influence in business. Contemporary business is highly competitive, where size and market share are decisive. But this makes market leaders monsters to manage. The CEO has to coordinate control of people, resources, processes, and finance, so the CFO becomes a virtual partner, managing not only “money” but also inventory control. In fact, the CFO is now generally a strategic partner and plays the role of chief operating officer, often having that title. The COO is charged with managing efficiency and effectiveness hands-on, whereas the CEO is the overall coordinator of the monster.
With business becoming more competitive in the global economy, this is also true of smaller and mid-sized companies, especially those that are experiencing rapid growth, and they are a different type of monster, adolescents, so to speak, and also difficult to manage.
Irrespective of size, management has to be pay close attention to efficiency, and while marketing and sales is regarded as the primary revenue producer, hence highly rewarded traditionally, inventory management is often the decisive factor in today’s highly competitive environment. Do these companies care much about unplanned inventory when they are on a three to four day schedule?
@Tom Hickey
“Simply that accounting is an ex post recordâ€
Steve has done about 10 posts on macro accounting, and since I’ve inserted myself promiscuously at various points in the comments, I’ll persevere more with this, or all is lost in terms of my own contribution.
So again, here’s what I mean by category error:
Let’s suppose we’re thinking about economics and what the “right way†to do economics is.
You can sub-divide that into three different pieces – thinking about the past, thinking about the present, and thinking about the future.
The past is done and the present is what it is. The future is what economics can influence.
One of the ways of thinking about the future is to imagine different scenarios or outcomes, perhaps based on different policy decisions. This is standard analysis in risk management and in financial management and business and economic management more generally. Intelligent analysts understand the wisdom of considering multiple scenarios, as opposed to the danger of hanging one’s hat on a single forecast of the future.
In order to think clearly about future scenarios, you have to be able to compare them to the present situation and what’s happened in the past.
In order to do this, you have to be able to evaluate outcomes by measuring them in some sense.
And in measuring them, you have to be able to compare measurements of possible future outcomes consistently with the same types of measures as applied to the present situation and what has happened in the past.
In economics, that measuring system has to be an accounting framework.
That’s quite separate for example from the differential equations that inhabit various models that may lead you consider various scenarios. In that sense, the differential equations found in models about hypothesized behavior are secondary to a foundation of accounting when used as a continuous measurement framework for past results and future potential results.
The basic point is that you must use the same accounting framework for the future than you do for the present and the past.
Believe me, I used scenario modeling in private sector strategic financial management for many years, and the coherence of the projected accounting framework was the most critical thing. Post Keynesian stock/flow consistency at the macro level reminds me very much of what was considered sound and essential methodology at the micro level in my own experience.
And so in that sense, it is a category error to assume that accounting only deals with ex post or the past. It doesn’t. It’s a system that must be applied consistently through past, present, and future projected time. Otherwise, your output in terms of evaluating future scenarios resulting from current policy decisions is absolutely useless.
So accounting in this sense is timeless.
And the category error includes mistaking periodic measurement for measurement of a past period. Or of mistaking a point in time measurement for measurement of a past point in time. It can be. But it doesn’t stop there. That is the category error. That measurement system must be projected into the future, in order for any economic analysis to make sense at all.
And that is what post Keynesians mean by stock/flow consistency, I think. Stock/flow consistency after all is moot when it comes to the past. Those accounting statements have already been prepared and audited. They are certainly stock/flow consistent. It’s the future that matters when it comes to meaningful statements about stock/flow consistency. And that’s why the post Keynesian approach is so meaningful.
An earlier commenter said that mainstream economics was quite aware of this and practiced it. I don’t have time now, but I can go through Godley/Lavoie and come up with many excerpts in which it’s demonstrated quite forcefully that mainstream economics is anchored only very insecurely on stock/flow consistency.
@JKH
This is definitely getting clearer. What might be helpful is a distinction among 1) accounting record, 2) the use of accounting in financial and strategic planning in business and finance, and 3) the relevance of accounting to micro and macro. It seems to me that business and finance know how to use accounting to advantage, but economists not so much, at least in the way most academics do economics and in the way the subject is generally taught in textbooks. In the mainstream, the emphasis is on econometrics rather than accounting principles and practice, so it is not surprising that most economists don’t think in terms of accounting and finance. For example, its surprising that PK is not expert in cb ops since his field is international trade and that involves central banking and balance of payment issues. If he is not up on it, why would others be?
“I can go through Godley/Lavoie and come up with many excerpts in which it’s demonstrated quite forcefully that mainstream economics is anchored only very insecurely on stock/flow consistency.”
That would be a worthwhile contribution to clarity.
@Tom Hickey
thanks, Tom
useful suggestions all around
big stuff; I’ll get to it more fundamentally at some point
@Ramanan
Ramanan,
Literally *any* GE model is stock-flow consistent. That includes all DSGE models, right down to the most basic workhorses like the Ramsey and Solow growth models. If you know anything about them, and you think about this logically, you can easily see that they have to be.
Vimothy,
I don’t know much about those models and wouldn’t foresee having to reference them in making the point at a more comprehensive level. But I’d enjoy learning a bit more about them, at a high level of course, in the context of this sort of discussion.
So I have a question:
Stock/flow consistency in the context of this discussion means macroeconomic consistency at the level of real and financial stocks and flows. That includes the monetary and financial sectors. So to demonstrate stock flow consistency, you have to demonstrate that projected balance sheets are consistent with projected income statements at the macroeconomic level, at least in some sense.
In measurement terms, at the most comprehensive level, that means things for example like the projected Fed flow of funds balance sheets being reconcilable with projected NIPA.
Godley/Lavoie certainly has the full framework for that sort of analysis.
I have no idea what the scope of these models is. But do they begin to do that sort of analysis, in part or in whole? In particular, do they project monetary system balance sheets? More particularly, do they treat the central bank and the banking sector in stock/flow consistent fashion?
To demonstrate my ignorance, I’d venture to say I’d be a bit surprised if they do this. But this sort of analysis is necessary for a demonstration of stock/flow consistency in a meaningful way. Otherwise, the macroeconomic adding up closure that is required for the meaning of consistency to hold is a bit elusive and speculative, it seems to me.
JKH,
The long answer will have to wait, but the short answer is: yes.
I think the point made here is correct, but it can be made very simply in the context of the accounting identities. Use as an example the completed calendar year 2012 and the ongoing calendar year 2013. We know:
Y(2012) = C(2012) + I(2012)
and we can predict with certainty:
Y(2013) = C(2013) + I(2013)
But what we can’t do is reason from the supposition that:
C(2013) I(2012).
And that’s because we don’t know:
Y(2013) >= Y(2012)
Here’s a similar fallacy. Suppose our initial prediction for 2013 were that GDP in 2013 will be greater than GDP of 2012 by a factor of r, and that the increase will take place in consumption and investment equally. So we have predicted:
Y(2013) = r*Y(2012)
C(2013) = r*C(2012)
I(2013) = r*I(2012)
Now suppose we have a downward revision in our consumption prediction for 2013, and the revised prediction is that:
C(2013) = q*C(2012)
where q < r. Does it follow that investment for 2013 will be higher than our original prediction? No, not at all. You might attempt to deduce that conclusion from the accounting identity by using the revised consumption prediction along with the unrevised GDP prediction. But without further evidence that GDP will equal the previously predicted number, there is no warrant for the argument.
@Dan Kervick
Sorry, but one paragraph didn’t come through when I posted the above comment. The part beginning, “But what we can’t do…” should read:
But what we can’t do is reason from the supposition that:
C(2013) I (2012)
And that’s because …
“In broad terms, one can identify two schools of thought which actively developed a series of models based on the stockflow consistent approach to macroeconomic modelling, one located at Yale University and led by the Nobel Prize winner James Tobin, and the other located at the Department of Applied Economics at Cambridge University and led by one of the present authors (Wynne Godley). To a large extent, both groups worked independently, at least until a conference on Keynes that was organized in Cambridge (UK) in 1983, most of their papers and articles having
been written in the 1970s and early 1980s. The Yale group, also known as the ‘pitfalls approach’ or the New Haven school, focused its attention on portfolio and asset choice; its inspiration was essentially neo-classical and based on a practical variant of general equilibrium theory. The Cambridge UK group, which was known as the Cambridge Economic Policy Group (CEPG) or the
New Cambridge school, used the stock-flow consistent framework mainly for forecasting whether an expansion was sustainable, as Godley (1999c) still does today, and to discuss the balance of payments problems that were then plaguing the United Kingdom.
Both research groups faded in the middle of the 1980s, as their funding was cut off, and their ideas, whatever their importance or their relevance, were put on the back-burner, and overtaken by research based on the representative agent, as in New Classical and New Keynesian economics. But these new models are DEVOID of the comprehensive outlook that characterizes the approach advocated by the Yale school and the CEPG, as could be seen from a reading of Tobin (1982a) and Godley and Cripps (1983) respectively, or by the reading of other outstanding individual contributions to the stock-flow consistent approach, such as that of Turnovsky (1977) or Fair (1984).”
Godley-Lavoie
@Dan Kervick
Sorry, same problem. Don’t know why the software won’t post what I wrote. I guess it doesn’t like greater than signs Trying in English:
But what we can’t do is reason from the supposition that:
C(2013) is less than C(2012)
to the conclusion that
I(2013) is greater than I(2012).
And that’s because we don’t know:
Y(2013) >= Y(2012)
@Dan Kervick
“You might attempt to deduce that conclusion from the accounting identity by using the revised consumption prediction along with the unrevised GDP prediction. But without further evidence that GDP will equal the previously predicted number, there is no warrant for the argument.”
That is true.
And you and I and hopefully nobody else here would make such a mistake.
But I have to tell you that only a complete analytic idiot would make such an error, by leveraging off the compound idiocy of making accounting the straw man that led to such an error.
@JKH
I.e. that error has nothing to do with accounting – its about brainless forecasting
@JKH
“But I have to tell you that only a complete analytic idiot would make such an error”
I think Kervick has a point here. Neoclassical economists do make such an error.
Dan’s argument can be made more formal.
The production function of neoclassical economics is
Q(t) = F(L(t), K(t); t)
where Q is the output and L is labour and K is capital.
In any one period, Q is given by the production function, and since output is also C+I+G (closed economy), higher C than otherwise implies lower I and lower I implies lower K for the next period and hence lower output than otherwise in the next period.
Bit short due to the medium of the comment but something like that.
@JKH
Which of course is consistent with what you say, since neoclassical economists are complete analytic idiots!
@Ramanan
Right.
Maybe Dan has simplified the point effectively – so simply, that its mind boggling how anybody could take such mindless approach to dynamic forecasting.
Indeed, its roughly the same point Krugman made about Chicago in Dark Age of Macro.
But my point is that accounting is not the issue in making that sort of error. That’s a straw man.
Making an error that is observable through an accounting lens is not the same thing as accounting being the methodological culprit.
@JKH
don’t mean Dan is taking the mindless approach – rather the error in his example!
@JKH “But my point is that accounting is not the issue in making that sort of error. That’s a straw man.”
Nobody’s attacking “accounting” here; no need to defend it. It’s the widespread “idiotic” misunderstanding of accounting identities that’s the problem I’m pointing out, and that Dan explains explicitly and nicely.
It’s not straw man, not even close. That’s *exactly* the error Sumner is making when he claims that consumers/non-savers “take resources out of society.” You see it *constantly* in statements by economists and non. It’s right at the heart of much, even most, economic thinking you see out there.
“only a complete analytic idiot would make such an error”? Okay…
On looking backward/forward. Yes of course accounting can be used for projections. But I think you are completely right here:
“you have to demonstrate that projected balance sheets are consistent with projected income statements at the macroeconomic level, at least in some sense.”
Those projected, envision balance sheets and income statements will be backward looking. IOW, same thing I said: accounting lets you make a statement like this: “there is no possible way that your prediction can happen, because if it happened, the income statements and balance sheets, looking back at the end of the period, wouldn’t balance. It’s impossible. There’s something wrong in your logic.”
But I don’t think we should spend much time discussing this cause we really agree. I just think that the backward vs forward looking explanation is a very clear way for people to understand the egregious and distressingly widespread error discussed above.
@JKH:
I can understand and actually very much like your construct when you say the financial system is a “construct” of double-entry accounting. (Sorry to veer off into “the economy” etc.) It wouldn’t exist without it. But I still think it’s more a construct of human agreements, claims, rights, privileges, legal powers, and accounting is the vehicle or set of tools by which those agreements are measured effectuated. But again I don’t think we need to spend much time discussing whether it’s a blueprint, or a scaffolding or a methodology or whatever. I don’t think we need that to understand how it works or at least to understand each other’s statements.
You all may be interested in the genesis of my obsession here.
My former business partner has degrees in finance and economics from the 80s. He and I are very fond of each other, and we like to argue. He’s a big (neo)classical type, and relies mostly on econ 101 truisms. “Demand curves slope down! What else do you need to know?!”
Many years ago, before I knew/understood much of anything, he threw S=I at me, assuming that it “proves” the logical fallacy we’ve been discussing here. (And in his mind, “proving” that trickle-down Reaganomics is good.) This error is *everywhere.*
@JKH:
This is very useful. Thanks.
I think the confusion may arise because:
‘investment’ … is captured in NIPA as the production of investment goods
But the only way to measure it is by looking at expenditures on investment goods.
This seem right?
@TDF
I’d make it even simpler:
If we don’t have a financial system, we’re just talking real commodities:
If you don’t eat some of this year’s corn crop — save seed corn for planting next year — you’re both saving and “investing” in the future.
As soon as you have financial assets — credits and debts — everything changes.
If there is less consumption spending and not more investment spending, what is happening?
After discussing with Ramanan, investment spending (Spending on goods that will endure beyond the period) does not equal the I in “The backward-looking Y = C + I accounting identity”. Right?
I still need some help with this:
Let’s say I save $100,000. Someone else wants to start a new bank. They sell me a $100,000 bank bond (bank capital). The reserve requirement is 0%, and the capital requirement is 10%. Can the bank now make 10 (ten) $100,000 mortgage loans?
If so, I saved $100,000. I lent $100,000 to the bank, and the bank borrowed $100,000. The bank lent $1,000,000 to ten other people, and the ten other people borrowed $1,000,000. The bank lent $1,000,000 to ten other people, however, it only borrowed $100,000 from me.
Is that scenario correct? Thanks!
@Fed Up
“After discussing with Ramanan, investment spending (Spending on goods that will endure beyond the period) does not equal the I in “The backward-looking Y = C + I accounting identityâ€. Right?”
Huh?
I said total investment is not the same I in C+I+G because government investment is included in G.
@Asymptosis
“Those projected, envision balance sheets and income statements will be backward looking.â€
Can you give me an example of a projection that isn’t backward looking in the sense that you conceive of this? Strikes me as a very moot point. How can any projection of a future state of the world not be backward looking in the sense you claim? How can ANYTHING not be backward looking in the sense you claim? Please give me an example of something that is forward looking in some sense such that projections of future balance sheets and income results are not forward looking by comparison.
This is essential.
I claim in general that if one conceives of accounting as only backward looking, one cannot correctly grasp the nature of stock/flow consistency or the post Keynesian approach to it.
BTW, you do not have a monopoly on obsession over this or surrounding issues. Hence my strong prickliness on this point.
🙂
@Asymptosis
“But I still think it’s more a construct of…â€
Prickly me, but I think this is a category error again.
The type of agreements you refer to apply equally to the house that I own.
I do not have to have an accounting for the value of that house or of my personal balance sheet in order for those agreements to be in force.
The accounting itself is a mathematical construction that is a supplement to the fact of ownership.
As is the financial system in general.
Ownership of a real asset or financial claims is driven by those issues you list. But the financial system itself is a mathematical construction. Accounting is a type of mathematics.
@Asymptosis
“But the only way to measure it is by looking at expenditures on investment goods.â€
I wouldn’t say that.
Investment is basically what is produced that isn’t consumed in the current accounting period.
That includes inventory.
Inventory gets written up in stages as value is added in the production process.
Inventory valuation can include the capitalized cost of labor at various stages.
All of that is the value of production at various stages.
Because of this, if by “expenditure†you mean spending on investment goods produced, I’d say no. Inventory shows up as an investment component in GDP. And rightfully so.
If you divide the economy up into goods and services, and make the oversimplified assumption that only goods are inventoriable, then all goods start out as investment goods, and from there take a fork in the road to become permanent investment goods or only temporary investment goods. Consumption goods are born as investment goods. That’s very simplified, but how I look at it.
@Asymptosis
“If you don’t eat some of this year’s corn crop — save seed corn for planting next year — you’re both saving and “investing†in the future.”
That’s correct. That’s the only way that saving equals investment in substance.
(Just construct national income accounting for barter)
But my whole involvement in this discussion as I’ve said before is because of an interest in real world monetary systems, not barter systems that are not only counterfactual but imaginary.
Here’s an OT break:
From Krugman today (“Fear of Ghosts):
“Remember, Britain has its own currency, which means that it can’t run out of cash. Furthermore, the short-term interest rate is set by the Bank of England. And the long-term rate, to a first approximation, is a weighted average of expected future short-term rates. Unless markets believe that Britain is going to default — which it isn’t, and they won’t — this is more or less an arbitrage condition that ties down the long run rate no matter what happens to confidence. Or to be a bit more precise, it’s hard to see what would drive up long rates except a belief that the BoE will raise short rates; and why would it do that unless it sees economic recovery in prospect?â€
This sort of thing was apparent to some of us in markets before we ever heard of MMT.
Nevertheless, I’d be all over it if I were those guys.
It seems he’s only been learning this line lately – from somewhere?
I suppose if I were an MMTer, I might be a bit miffed at the lack of attribution.
That said, he expresses the idea quite well – he is a very good writer, usually.
@Ramanan
“I said total investment is not the same I in C+I+G because government investment is included in G.”
I got that part.
Let’s assume G = 0 and NX = 0.
S= I
S = Y – C
Can I = investment spending (allocation) plus allocation in financial assets plus allocation in MOE/MOA?
For example, we had monthy budgets. Y = $100, C= $55, investment spending = $20, buy $15 of existing stock on a stock exchange, and put $10 “under the mattress”. I changed it slightly from before.
$25 ($15 plus $10) has “leaked” out of the real economy.
@JKH
But there are several errors in Krugman.
The arbitrage condition is between forwards and bonds and futures and bonds. There isn’t an arbitrage condition between long term yields and short term rates in a straightforward way. For suppose, the 10y yield moves to 2.00% from 1.74%. Forwards and futures will also move in the same direction. Would bond buyers make an arbitrage? No because it can fall to 2.20% or even 3.00%.
There will be some sort of floor because more investors will rush in at some point even if some higher technical levels are broken but there isn’t any arbitrage.
Also, although there is some sort of truth to expected short-term rates and this was used by Kaldor as early as 1939 and also by John Hicks in 1946, Joan Robinson took them to task on this. There is a long discussion by her on this in her essay “The rate of interest” which I cannot do justice to by summarizing.
@Fed Up
The leakage is not really $25 because your investment expenditure is income for someone else.
@Ramanan
“can fall to 2.20%”
sorry meant rise to …
@Ramanan
you’re right, Ramanan
arbitrage is too precise a word to use accurately in this case
but it is anticipatory in the sense of long rates attempting to anticipate policy in a general sense
that’s actually the true meaning of bond vigilante-ism as it occurred in the 80’s – nothing to do with solvency, as bonds were signalling a desire/expectation for tighter policy during that period – the term is being applied incorrectly these days, or being denied incorrectly to be more specific
@Ramanan
What about the $10?
@JKH “But my whole involvement in this discussion as I’ve said before is because of an interest in real world monetary systems, not barter systems that are not only counterfactual but imaginary.”
Ditto moi.
Hence all my confusion, and also my sense that the national accounts don’t present the goods/money conjunction in a widely understandable way, and my intuition that there might be a more understandable way (could well be wrong). How do you *think about* saving real goods when you can only measure that saving via dollars transfered, and where money “saved” is not goods “saved”? When real goods meet money, for some reason it gets damned confusing.
The fact that economists don’t have a definition of “money” — or rather, they have three non-definitions (exchange, account, storage), plus all the Ms, supplies, bases, divisias, etc. — I think goes a long way to explaining this difficulty.
Like physics without an agreed-upon definition/understanding of energy.
On that topic: in the phrase “flow of funds,” how would you define the word “funds”?
@Fed Up “$25 ($15 plus $10) has “leaked†out of the real economy.”
Or to put it another way:
$25 has not been recirculated into the purchase of real goods. It’s been held in storage.
I italicize that because it hasn’t beenput in storage. It was already in storage. That’s what a money holding is.
It just hasn’t been transferred from A to B in return for real goods.
Did someone mention velocity?
@Fed Up
Sorry, I confused numbers in your example.
@JKH
I see. Didn’t know the history of the terminology.
@Asymptosis
“in the phrase “flow of funds,†how would you define the word “fundsâ€?”
I don’t mean to be cute about this, but exactly as its defined in the Fed Flow of Funds report, whether explicitly or implicitly. And exactly as its defined in the corresponding corporate financial statement, “sources and uses of funds”.
I’m not ducking the question or wiggling around the angles of explicit or implicit. This is complex stuff. There is no short cut to learning it. You just have to wade in.
In the same way:
“my sense that the national accounts don’t present the goods/money conjunction in a widely understandable way”
It is telling that I’ve NEVER seen anybody on any blog comment page react in any way to my eternally repeated point that there are three essential types of financial statements:
income micro // NIPA macro
balance sheet micro and macro
sources and uses of funds micro // flow of funds macro
The logic of financial accounting and stock/flow consistency REQUIRES these three statements be interpreted as a coherent set. There is no other way of doing it. It must be learned. And economists must learn it in order to assess the financial sector properly as part of their overall subject matter.
@Asymptosis
The genius of Godley and Lavoie is that they actually understand that you can’t do economics properly without integrating accounting into it – micro and macro.
@Asymptosis
Exactly! That is why I tried this example here:
http://www.asymptosis.com/do-savers-take-resources-out-of-society.html
“John works for Debbie (Deb), and Deb works for John.
Deb starts out with $200 in dollar bills, $200 total.
They pay each other in dollar bills: $200 a year, each direction. Velocity = 2.
Between them, through their labor, each year they produce $200 in real resources ($100 each)– things that humans can consume to derive human utility (or to produce more consumables in the future). They both charge $2.
MV = PY ; $200 times 2 = $2 times 200
Neither save or dissave, balanced budgets.
But: This year Deb decides to save money, so she doesn’t hire John for as many hours, and only pays him $180 instead of $200. She leaves $20 sitting in her drawer; she doesn’t circulate it this year.
John still balances his budget. He spends $180.
Deb has produced $90 worth of real resources at $2, and John has produced $90 worth at $2. $360 total, instead of $400 the year before.
MV = PY ; ($180 times 2) plus ($20 times 0) = $2 times 180
Deb saved $20. John still has a balanced budget (no dissaving, $0).
Saving in the MOE/MOA caused a “recessionâ€.”
Is that correct?
Ramanan,
Well, that didn’t take long.
But the gotcha is actually based on a different post:
http://economistsview.typepad.com/economistsview/2013/05/fed-watch-when-deficits-become-a-problem.html
@JKH
oops – it is the post I referenced
@Ramanan “The leakage is not really $25 because your investment expenditure is income for someone else.”
I’m pretty sure that’s an error. Confusing inflow with income.
If I sell you a share of stock for $25, that’s not income to me. It’s just an asset swap.
@Asymptosis
Let’s expand my example. Y = $100, C= $55, investment spending = $20, buy $15 of existing stock on a stock exchange, and put $10 “under the mattressâ€. The next day I sell the stock for $18 and put that “under the mattress”. At the end of the month, I have $28 “under the mattress”. How is the $3 capital gain classified? And, the $28 could cause a recession?
“How is the $3 capital gain classified?”
In the NIPAs, I think it’s ignored. ??
@JKH “And economists must learn it in order to assess the financial sector properly as part of their overall subject matter.”
Don’t have to convince me. If they were properly trained in, and speaking in terms of, those accounting constructs, I don’t think I would have spent years trying to un-confuse their statements relative to those constructs (or extracting so much of your time trying to figure it out).
@Fed Up
Let’s put slightly more specific meat on the bones.
Suppose I = 20 refers to a new house constructed by an incorporated home builder and sold to a household for that amount.
Household income = 100
Household saving = 45
The household uses its saving as follows:
20 house
15 common stock
10 currency hoard
Let’s write this as a micro household equation:
S = I + (S – I)
I = 20 (referring to acquisition of I)
(S – I) = 25
For the economy as a whole, including government and foreign sectors, the rest of the economy must run offsetting (S –I) = (25).
That’s because S = I under fully closed or fully global conditions where all saving in respect of the economy in question is accounted for.
So where does the other (S – I) = (25) come from?
We don’t know, given the information given.
But one way it could happen is if home builder incurs a loss of 25.
The home builder’s S = (25) by definition.
And the home builder’s I = 0.
This last part may be a bit confusing. I’ve constructed the micro meaning of (S – I) here such that the ‘I’ is accounted for when the household acquires newly produced I. So the corresponding interpretation (in terms of acquisition of I) is 0 in the case of the home builder. The home builder produces the I; it doesn’t acquire it.
(I’m only using this for micro (S – I). NIPA accounts for ‘I’ as production of ‘I’ – not acquisition of ‘I’. I’m just doing a consistent transformation (from production to acquisition) to show what is happening at the micro level in this case. In effect, I’m showing a flow of funds result rather than an income statement result.)
That’s why, with the loss, (S – I) ends up being (25) with respect to the corporate result.
The capital gain of 3 will not show up on NIPA. It will show up on a flow of funds balance sheet report covering the 1 day period, as a revaluation of an asset (the stock) and a corresponding increase in net worth.
At the margin, any drop in aggregate demand relative to a counterfactual can increase the risk of a recession. In this case, the fact that the $ 28 isn’t spent on some ADDITIONAL newly produced good (that doesn’t already appear in the actual NIPA) just means NIPA is $ 28 less than what it would have been in a counterfactual where that was the case. You basically have to specify the counterfactual to correspond exactly to your desired hypothesis.
@Asymptosis
“I’m pretty sure that’s an error. Confusing inflow with income.
If I sell you a share of stock for $25, that’s not income to me. It’s just an asset swap.”
Yes I know.
As per #91, I did say I confused the numbers.
@JKH
What about the post?
Wray has been going “Krugman does MMT” since many posts now.
@Asymptosis
Btw, I used “investment expenditure” so the error was mixing numbers. Investment expenditure is not buying stocks.
@JKH
“And the home builder’s I = 0.”
The NIPA has some strange way of doing things. The way SNA does it is by valuing inventories at current costs, so both production and the sale will be a source of funds for the builder.
There is also a use of funds which appears with an opposite sign in the capital account.
Of course there are costs but consolidating the firm sector as a whole, the costs are wages (plus interest payments).
[The SNA is more G/L so income flows also appear in sources/uses. ]
@JKH
The discussions around Tim Duy’s posts always miss a few things. Strangely economists worry too much about inflation when the problem with the world is something more deep (debt) and has been like that since ages.
So one typically sees one side saying a country has “run out of money” and the others vehemently denying it “cannot run out of money”.
I suppose the argument is that if the nation cannot borrow from foreigners in its own currency, that isn’t bad.
Running out of money – although vague – has some meaning to it. Running out of foreign exchange or running out of the ability to borrow from foreigners in both domestic and foreign currency.
It matters foreigners lend resident sectors in the domestic currency because it provides foreign exchange in return.
I suppose, the ones saying “nation cannot run” out of money seem to think that nations are self-sufficient and don’t need foreigners and its citizens are okay with this. Third way economics?
So obviously Britain can run out of money even if domestic production is doing well because the assumption that there is always a price at which foreign exchange markets clear without the central bank intervening, whatever the position of claims vis-a-vis foreigners is chimerical. Some nations are ahead in the game of international competition and hence their currencies are more acceptable but by no means it is true of all nations and no means true for the advanced nations at all times. Nations regularly struggle to have their currencies acceptable and hence struggle to truly float and hence their governments are forced to borrow in foreign currencies.
But Wray and Co’s position is … eff you .. why did you (govt) borrow in foreign currency. To exaggerate a little his position is as vacuous as “Warren Buffet cannot default”.
@Ramanan
I’m aware of Wray’s campaign to smear Krugman as an MMT follower.
My point is here:
http://economistsview.typepad.com/economistsview/2013/05/fed-watch-when-deficits-become-a-problem.html#comment-6a00d83451b33869e2019101d8583f970c
@Ramanan
I haven’t look at inventory valuation methodologies in a long time.
Just assumed that NIPA reflects the accretion of inventory value through the production process, somehow, until the final step is the addition of profit generated by the actual sale.
My point on I = 0 in the example is a different issue. That just reflects the fact that I included the value of final I goods produced as a flow of funds expended in buying those goods at the household sector level. So there is no corresponding remaining I value for the business sector in that presentation.
E.g. if the new house hadn’t been sold but was still on the builder’s books, that inventory I value would show up on the builder’s (S – I) calculation in my example. So the household would have a larger positive (S – I) and the builder’s would be even more negative.
@Ramanan
“Running out of money – although vague – has some meaning to it. Running out of foreign exchange or running out of the ability to borrow from foreigners in both domestic and foreign currency.â€
Absolutely – in the case of the government running out of FX reserves and the private sector being unable to borrow from foreigners even in the home currency (although that’s a more general private sector credit risk issue across the board.)
Dare I say it – the government is in the position of being a ‘user’ of FX as opposed to an issuer?
With no contingency for the home production of FX.
🙂
There’s other stuff wrong with the MMT approach – most egregiously the fall back to the option of setting rates at zero permanently, which Wray uses here as well.
That’s assumption is what’s REALLY wrong with MMT when you get to the bare bones, but Wray’s relying on it. Delong did a pretty good take down of that assumption a week ago or so, I thought.
@JKH
Oh I think you are trying to build all the flows using Fed Up’s “data”, right?
@Ramanan
right
@JKH
Oh should have added – is there a unique way to fill in the blanks or are there more ways?
@Ramanan
not exactly sure quite what you have in mind, but I think the key in explaining something like this is:
“So where does the other (S – I) = (25) come from?”
That’s the type of constraint that usually determines how you can explain micro saving in a general way
@JKH
Yeah understood.
@JKH
Earlier post said: “Can I = investment spending (allocation) plus allocation in financial assets plus allocation in MOE/MOA?
For example, we had monthy budgets. Y = $100, C= $55, investment spending = $20, buy $15 of existing stock on a stock exchange, and put $10 “under the mattressâ€. I changed it slightly from before.”
So allocation in financial assets plus allocation in MOE/MOA needs to be “deallocated” somewhere, meaning “So where does the other (S – I) = (25) come from?â€
Let’s try this scenario. The person I bought the stock from gets $15. This person decides to stop saving in the financial asset of stock and spends the $15 in the real economy. This person dissaves by $15. $15 has been “deallocated”. That leaves $10 of MOE/MOA to be deallocated (the currency in this case). (S – I) = (10) now.
Can the $10 of deallocation come from reducing national income (GDP) by $10, most likely creating a recession?
See my Deb and John comment above: @Fed Up
@Fed Up
“This person dissaves by $15. $15 has been “deallocatedâ€. That leaves $10 of MOE/MOA to be deallocated (the currency in this case). (S – I) = (10) now.â€
This is one additional iteration beyond your first specified state as I analyzed it.
That new 15 in spending creates (15) in dissaving for the spender, but an additional 15 in GDP and forced saving for somebody else.
(The 15 is paid as income to the factors of production for the new 15 in additional GDP, and that income must be saved because the product to which it corresponds has already been purchased)
So just add those two components, which net to zero for 2 additional ‘actors’, onto my previous analysis.
@Asymptosis
Just want to clarify something I said earlier.
It’s a straw man to set up accounting as failing to explain economic behavior.
It’s a straw man compounded to set up accounting as failing to explain economic behavior on the basis that accounting is ‘backward looking.’
Accounting is not exclusively backward looking.
And accounting is not intended to explain economic behavior.
But accounting is definitely a constraint on what the set of feasible possible economic futures looks like.
When feasible possible economic futures are measured in accounting terms, the future must adhere to accounting logic.
Accounting is a constraint on the subject of economics in that sense.
It is a part of economics.
Too bad nobody teaches (or learns) it that way.
@JKH
“This is one additional iteration beyond your first specified state as I analyzed it.
That new 15 in spending creates (15) in dissaving for the spender, but an additional 15 in GDP”
OK.
“forced saving for somebody else.
(The 15 is paid as income to the factors of production for the new 15 in additional GDP, and that income must be saved because the product to which it corresponds has already been purchased)”
Sorry, I am not getting that part.
@Fed Up
15 = new GDP = new income
The spender has spent from his medium of exchange hoard (or he can swap stock for medium of exchange)
So he hasn’t needed to earn any new income from which to buy the 15 in new GDP
But his expenditure flows through to the factors of production for the new GDP
The factors get the income
But they have nothing new to spend it on
Because what they produced has already been bought
So they have to save their 15 in income
(or, same thing, somebody is forced to save the 15 at the macro level after netting everything)
@Fed Up
BTW, its a good example of the point in # 118
accounting constrains feasible economic outcomes that are measured in accounting terms
(and all economic outcomes are measured in accounting terms)
@JKH
I’ll think about that.
Let me ask this. Is the real economy short $25 of MOE/MOA or short $10 of MOE/MOA?
Let’s change the assumptions a little.
Y = $100, C= $55, investment spending = $20, put $25 “under the mattressâ€.
Somewhere else (S – I) = (25). Can that come from national income falling (I assume it is nominal national income)?
@JKH
Really like that comment #118
As Ive said before, “You cant get the economics right if you dont get the accounting right.” This is not to say that I am an accountant or can get all accounting right but I do ( I think) understand the nature and usefulness of accounting. It simply puts numbers to the events that economics is attempting to describe and manipulate. But the math of accounting is a real constraint there are certain things economists talk about that just cant happen because of accounting constraints. To relate it to what I do, its like trying to keep cardiac output constant and simply change heart rate alone. That is impossible due to the constraint of Cardiac output = heart rate x stroke volume. If you change heart rate the stroke volume must change to keep cardiac output constant….TINA.
@JKH
Here is where I was going with this.
Scenario #1, Y = $100, C = $55, investment spending = $45, financial assets = $0, MOE/MOA = $0. No recession.
Scenario #2, Y = $100, C = $55, investment spending = $0, financial assets = $45, MOE/MOA = $0. No recession.
Scenario #3, Y = $100, C = $55, investment spending = $0, financial assets = $0, MOE/MOA = 45. Recession.
Now I’m not sure about scenario #2.
@Greg
right – and it IS constantly being set up as a straw man by the economics profession – by those who would resist the idea that it is important to economics, and should be central as a measurement constraint for future projections of any kind
which is why post Keynesian economics developed the way it did, IMO
Galileo: By denying scientific principles one may maintain any paradox.
Me: By denying accounting principles, economists may maintain any paradox.
@JKH
I saved $15 and $10. I bought $15 of existing stock. The seller of the stock dissaves by $15. The factors of production save $15 (I’m still thinking about that part). Does that mean the real economy is short by $25 of MOE/MOA?
@Fed Up
Important point: the seller of the stock dissaves – not because he sells the stock – but because he spends without earning additional income to fund the spending.
The factors of production save as the converse of that – they save from additional income that they cannot spend because the product they produced has already been purchased.
(At least that’s how it all nets out at the macro level – lots of asset swaps may be involved that aren’t necessarily specified or constrained by the information supplied for your scenario)
The sale of the stock is just a stock/MOE swap.
One possibility here is that the factors of production are the counterparty for this swap – they swap the MOE they’ve earned and saved by buying the stock – ultimately use their saving in the form of stock rather than MOE.
The real economy is not short MOE – but it’s an interesting question.
The reason it’s not short is that the sale of the stock by attracting MOE in exchange has actually enable an facilitating increase in the velocity of the MOE as used in the purchase of additional GDP – compared to the counterfactual in which your additional GDP increase/stock sale scenario does not occur.
@JKH
Is it fair to say every sale of anything is just an asset swap?
@Greg
Interesting question.
At the macro level, the exchange of GDP for GDI is a swap of current period product for income.
I’d distinguish ‘product’ as current period output – as opposed to prior period output that now exists as an ‘asset’.
E.g. housing produced in period periods when sold for MOE is an asset swap in that sense.
On the monetary side, the exchange of QE reserves for bonds is an asset swap, without involving a direct and immediate effect on current period income.
I think I see the point in your question though – if income is paid in the MOE, and if current period product is defined more loosely as an asset, then the result is an asset swap
The ‘asset swap’ terminology is a bit loose and perhaps could be improved at some point; I’m beginning not to like it so much myself
@JKH
in a way, its short cut terminology to refer to transactions that don’t hit current period NIPA – whether real assets or financial assets
@JKH
Looks like I said that wrong.
I saved $15 and $10. I bought $15 of existing stock. The seller of the stock receives $15 and then decides to dissave by $15. The factors of production save $15 (I’m still thinking about that part). So it sounds like the real economy is only short $10 of MOE/MOA, not $25, right?
If the seller of the stock decides to save the $15 by putting “under the mattress”, then the real economy is short $25 of MOE/MOA, right?
@Greg @JKH
Is it easier to ask what is not an asset swap in the economy?
@JKH
Greg and I are discussing borrowing and lending here:
http://www.asymptosis.com/scott-sumner-goes-marxist-proposes-targeting-labors-share-of-income.html
Is there any accounting identity that says for every $1 borrowed there’s $1 lent?
@Fed Up
“If the seller of the stock decides to save the $15 by putting “under the mattressâ€, then the real economy is short $25 of MOE/MOA, right?”
OK, it sounds like you’re just asking if putting currency “under the mattress” is equivalent to a shortage of MOE.
I think that’s a matter of interpretation. It just means that the holder of currency has no immediate intention of using it to spend. So it’s a comparative decline in the velocity of that amount of currency. You can’t say much in absolute terms about that sort of situation unless you put it in the context of a particular comparison of two different scenarios for spending or not spending that currency, etc.
@Fed Up
“Is there any accounting identity that says for every $1 borrowed there’s $1 lent?”
Off hand, I can’t think of why that just isn’t always the case in terms of identifying the role of the two counterparties to any borrowing/lending transaction.
@JKH
Let me try this scenario.
Let’s say I save $100,000. Someone else wants to start a new bank. They sell me a $100,000 bank bond (bank capital). The reserve requirement is 0%, and the capital requirement is 10%. Can the new bank now make 10 (ten) $100,000 mortgage loans?
If so, I saved $100,000. I lent $100,000 to the bank, and the bank borrowed $100,000. The bank lent $1,000,000 to ten other people, and the ten other people borrowed $1,000,000. The bank lent $1,000,000 to ten other people, however, it only borrowed $100,000 from me.
Is that scenario correct?
Some accounting:
Bank bond sale:
Assets: $100,000 of MOE/MOA (currency plus demand deposits)
Equity : $100,000 bond
Mortgages:
Assets : $1,000,000 loan
Liabilities: $1,000,000 MOE/MOA (demand deposits only)
Think of the bank as a firm. It takes in MOE/MOA (currency plus demand deposits) as capital (specifically bank capital) and usually produces more MOE/MOA (demand deposits only) than it takes in.
From above there is MOE/MOA liabilities of $1,000,000 but only assets of $100,000 of MOE/MOA.
@JKH
“OK, it sounds like you’re just asking if putting currency “under the mattress†is equivalent to a shortage of MOE.”
Yes, under most conditions.
Scenario from my comment at: http://www.asymptosis.com/do-savers-take-resources-out-of-society.html
John works for Debbie (Deb), and Deb works for John.
Deb starts out with $200 in dollar bills, $200 total.
They pay each other in dollar bills: $200 a year, each direction. Velocity = 2.
Between them, through their labor, each year they produce $200 in real resources ($100 each)– [things that humans can consume to derive human utility (or to produce more consumables in the future)]. They both charge $2.
{Scratch the part in brackets}
MV = PY ; $200 times 2 = $2 times 200
Neither save or dissave, balanced budgets.
But: This year Deb decides to save money, so she doesn’t hire John for as many hours, and only pays him $180 instead of $200. She leaves $20 sitting in her drawer; she doesn’t circulate it this year.
John still balances his budget. He spends $180.
Deb has produced $90 worth of real resources at $2, and John has produced $90 worth at $2. $360 total, instead of $400 the year before.
MV = PY ; ($180 times 2) plus ($20 times 0) = $2 times 180
Deb saved $20. John still has a balanced budget (no dissaving, $0).
Saving in the MOE/MOA caused a “recessionâ€.
@Fed Up
“Is there any accounting identity that says for every $1 borrowed there’s $1 lent?”
Yes it is “for every $1 borrowed there’s $1 lent”
@Ramanan
How about my scenario at @Fed Up #137 ?
@Fed Up
Don’t know Fed Up. I would describe situations of bank lending differently. That description looks a bit like the money multiplier description.
@Ramanan
“for every $1 borrowed there’s $1 lent”
1) where did that come from?
2) is it only true if the capital requirement is 100%
3) I’m pretty sure JKH would agree with me that my scenario isn’t the money multiplier
@Fed Up
I’m going to redo your example a bit to answer your question at least partially.
Suppose a brand new bank with no initial balance sheet issues $ 100,000 in common stock in order to get started in the banking business.
Suppose households buy that $ 100,000 in common stock.
To do that, they write cheques on their deposits with already existing banks.
That transaction is what I colloquially refer to as an “asset swap†– deposits for stock.
It has nothing necessarily to do with current period NIPA or saving.
The households are simply swapping deposits for common stock.
And the new bank ends up with a reserve balance of $ 100,000.
The required capital ratio is 10 per cent.
The new bank makes $ 1,000,000 in loans, creating 1,000,000 in new deposits.
The balance sheet is $ 1,100,000. Asset include the reserves plus the loans.
But at this point, other things equal, the bank has excess reserves that it doesn’t need (assume zero reserve requirement like Canada for simplicity).
To “get rid†of its excess reserves, the new bank (for example) buys $ 100,000 in treasury bills, either from another bank, or the public.
That restores equilibrium in reserve distribution across the banking system. The effect of buying bills from somebody other than a depositor with that bank is to move those reserves back to the other banks. These are the same reserves that the bank originally attracted from other banks with its equity issue.
The balance sheet is still $ 1,100,000 at this point.
But the capital requirement for treasury bills is zero.
So the bank is “loaned up†on the basis of having “used up†its capital.
Following that, the new $ 1,000,000 in deposits will start moving around the banking system, with chequing transactions typical of normal commercial activity, and the clearing system and competitive banking actions will resolve any subsequent distribution effect, as usual and as required after that.
@Fed Up
Second example – some of your numbers seem inconsistent through the example, but:
It sound like you have a 2 person economy with a $ 400 GDP in the first case and a $ 360 GDP in the second case.
Important that there is an opening assumption of a pre-existing cash balance – i.e. prior to the start of any GDP activity.
Then, it looks to me simply like a case of reduced velocity of money showing up as a reduction in aggregate demand and a contraction in GDP.
If the activity were pure services, without any inventory effect, then this indeed is how the recession dynamic works in the service sector part of the economy, IMO.
@JKH
The other thing I dont like about the asset swap terminology is it sort of reduces everything to barter……. which sounds too much like Rowe and Sumner. To them money is just another good which is swapped and is like a hot potatoe…… cant be held for long.
@Greg
That’s an interesting take on it. Given the references you point to, I feel your pain.
🙂
I could be delusional on this, but my memory is that I introduced the phrase “asset swap” myself when first starting to comment on MMT blogs about 5 years ago. In any event, I do remember why I used the term.
It was to distinguish between the direct effects of fiscal and monetary policy, obviously important to the MMT message at the time.
Fiscal policy creates additional income for the non-government sector. That translates to an increase in its net financial asset position – net being the important idea – as an addition to wealth which supposedly satisfies a desire to save (from income) and then spend, increasing aggregate demand.
In contrast, the balance sheet dimension of monetary policy works over time by exchanging bank reserves and currency for bonds. This is true whether its regular monetary policy or QE. (This is separate from the pricing dimension, and the setting of the policy rate). So this balance sheet process works through ‘asset swaps’ (from the perspective of the central bank’s books alone, it’s an asset-liability swap of course). The point being that there is no net financial asset or additional income delivered to non-government – at least not directly in the initial transaction. Income effects are secondary and come later through different interest rates on the various asset forms, etc.
Anyway, ‘asset swap’ was a way of making the distinction crudely by comparison with net financial asset creation – which is a swap of an asset for income instead of an asset for an asset.
@Greg
“Is it fair to say every sale of anything is just an asset swap?”
Sale of anything as an asset swap?
Nope. The clothes you buy are not assets for you. Consumption goods and services are not assets.
@Ramanan
Although inventories appear in firms’ assets. So can we say sale of consumption goods and services are destruction of assets 🙂
LOL. Obsolete dogma alert:
http://blogs.worldbank.org/africacan/saving-key-future-growth-kenya
“Now zoom forward several thousand years: saving has become central to individual and collective prosperity. As a rule of thumb those who save more become wealthier because foregoing consumption today allows one to invest in the future (e.g. you can save to buy a bicycle, a car, or a house). Businesses can invest in new equipment and governments in new roads, schools and health facilities. All of these investments are associated with better economic futures.”
@Ramanan
“destruction”
careful
SK may be reading this
@JKH
Oh why would he have an issue with it?
@Ramanan
as in loan repayments don’t destroy deposits
🙂
@JKH
oh that anti-money stuff?
@Ramanan
you know – the model that doesn’t allow destruction of loans or cash
the thing with the ‘vault’ or whatever
@JKH
Yeah yeah remember and it had something anti-money in it.
http://www.debtdeflation.com/blogs/2007/03/30/dynamics-of-endogenous-money/
“Now consider repayment of debt. When a capitalist makes a payment intended to reduce debt, the bank is obliged to record that the debt has been reduced by that amount–but what does it do with the money? As I emphasised above, it doesn’t “mix it with anti-moneyâ€, thus destroying both money and debt in the process: instead it records that the money has been given to it in order to reduce the recorded level of debt, adjusts the debt account accordingly, but now has money that it must also do something with.”
@Ramanan
Just googled it, and got this – which I scanned quickly – and which appears to be Mr. Wilson’s effort to refine the earlier approach where money wasn’t destroyed:
“So as you can see the balance sheets that ‘create’ and ‘destroy’ horizontal money are consistent with the one where horizontal money merely changes state to dormant, and the difference is simply to introduce an accounting policy requiring an intangible asset to represent potential loan capacity that currently isn’t in circulation.”
No inclination to spend time on it. But it was evident that SK was confusing all of bank reserves, bank loans, and bank capital in some strange way. Could still be the case although less so with NW modification.
http://www.debtdeflation.com/blogs/2012/01/11/guest-post-a-double-entry-view-on-the-keen-circuit-model/
The bottom line is that normal accounting can explain all of these issues.
@Ramanan
“for every $1 borrowed there’s $1 lent†Is that wrong?
Is there something wrong with my example at @Fed Up #137 other than I used a bank bond instead of bank stock?
Does there need to be some kind of adjustment?
I think it comes down to do “banks” create new demand deposits (increasing the number of them) or not.
@JKH
Yeah. I also remember your long comment from 2010(?) which had “alarm bells start to ring” … 🙂
Yes Keen was mixing everything up. I don’t understand the modification because it sort of requires some “bank license value” which doesn’t make any sense at all.
Plus language such as “grant value”, “lend money” is strange mix of English grammar and national accounts.
@JKH
“To do that, they write cheques on their deposits with already existing banks.
That transaction is what I colloquially refer to as an “asset swap†– deposits for stock.
It has nothing necessarily to do with current period NIPA or saving.
The households are simply swapping deposits for common stock.
And the new bank ends up with a reserve balance of $ 100,000.”
Let’s say it was one household, me. Didn’t I need to save $100,000 in deposits (not spend on C goods and not spend on I goods) to obtain those deposits and then do the asset swap?
“for every $1 borrowed there’s $1 lent”
What is the definition here? For example, I consider buying a bank bond lending. I don’t consider buying bank stock lending. I think some people consider both of those lending. Does that matter?
I still see $100,000 in deposits becoming $1,000,000 in deposits. There is some kind of multiplier there unless the capital requirement went to 100%. If the capital requirement is 100%, there is no multiplier, and it looks like loanable funds then?
Can the new bank use central bank reserves as capital? If so, it could send them to the fed and earn .25% today. I want to do this so that the $100,000 in deposits is held in the bank’s checking account with a velocity of zero.
@JKH
Can the inconsistencies be fixed? I am probably going to combine the 2 examples at some point?
“Important that there is an opening assumption of a pre-existing cash balance – i.e. prior to the start of any GDP activity.”
I’ll keep that in mind, but I had to start somewhere.
“Then, it looks to me simply like a case of reduced velocity of money showing up as a reduction in aggregate demand and a contraction in GDP.”
Saving in the MOE/MOA means that amount of MOE/MOA has a velocity of zero, affecting overall velocity.
@Fed Up
Fed Up,
After having some conversations with you, I think you believe in the “old view” referred by James Tobin.
http://cowles.econ.yale.edu/P/cm/m21/m21-01.pdf
It helps migrating to the “new view”.
Tobin himself couldn’t escape from many confusions but made every attempt to do so. But he was a genius – like Keynes.
@Ramanan
i.e.,
the new view is:
“A more recent development in monetary economics tends to blur the distinction between money and other assets …”
@Ramanan
One could contrast his intended treatment with what banks actually do in the management of excess capital positions. Allocated capital does get freed up for other uses when a risk loan is repaid. But that’s got nothing to do with the strange money accounting approach he’s put together. Capital allocation can be inserted seamlessly as an internal management accounting framework within an externally oriented financial accounting framework. It’s also ironic that his approach arguably is a sort of variation on the money multiplier – which he’s quite aware is wrong.
This is the graph you are looking for: http://research.stlouisfed.org/fredgraph.png?g=ijR
When consumption goes down a bit, investment goes down a lot.
@JKH
Yes remember you pointing that out at the time too. Quite right in pointing out that it is ironically a variation of the multiplier!!
Finally getting back to this.
I totally get this. But really: we’ve got the NIPAs, which attribute corp profits to households and have have no household capital accounts, and the FOFAs, which don’t and do. And you’re saying “just collate all that in your head.” I’m suggesting that it could be better designed.
Try this imperfect analogy:
Your assignment is to siphon gas between two cars. One has no gas tank; it can only receive gas while it’s moving.
While this does not make the job impossible, it does make it a hell of a lot harder (and more dangerous!). A lot of people are gonna mess up this assignment, and innocent bystanders are gonna be hurt or killed.
I suggest we add a gas tank.
[grin]
@Asymptosis
But what would I do for fun without the zest of intra-cranial collation?
BTW, stay tuned for my upcoming post:
“Shumpeter Transformed – the Creative Destruction of Debits and Creditsâ€
🙂
Everybody has a gas tank – it’s the capital account (positive equity for business, negative equity for government, net worth for households).
I can work that analogy, albeit torturously perhaps:
The gas tank is the capital account – not the reserve account – there – we’ve just disproven the money multiplier!
And everybody has a siphon – income/revenue.
And everybody is moving.
The starting line is balance sheet # 1.
The finish line is balance sheet # 2.
The journey is the siphoning of income/revenue (NIPA).
But it includes vehicle parts swaps along the way (flow of funds).
“Your assignment is to siphon gas between two cars. One has no gas tank; it can only receive gas while it’s moving.
While this does not make the job impossible, it does make it a hell of a lot harder (and more dangerous!). A lot of people are gonna mess up this assignment, and innocent bystanders are gonna be hurt or killed.
I suggest we add a gas tank.”
Well done. Very apt analogy
JKH;
Will your post be on Monetary Realism site?
@Greg
was tongue-in-cheek, Greg
although credits and debits do work as a process of creative destruction in money terms
maybe a less cheeky post on that subject, sometime in the future
@JKH “But what would I do for fun without the zest of intra-cranial collation?”
Hey, as long as you keep letting us watch you do it…
@JKH “Shumpeter Transformed – the Creative Destruction of Debits and Creditsâ€
Not completely crazy. Quoting myself from memory:
“Inflation is to financial assets what depreciation is to real assets. If it weren’t for inflation, the rich really would own everything (instead of almost everything).”
I don’t tend to adjust my priors much based on hold-up-your-thumb-and-squint correlation analysis. I assume you’re talking about the big move at right. Like the accounting identities, this tells us pretty much exactly nothing about the cause-and-effect dynamics of what we’re looking at here (though like the identities, it might rule out some causal assertions).
This depends entirely on the period length you’re looking at. Lunch is an investment in the afternoon’s work, and I buy a car for consumption over a decade or two…
@Asymptosis
“Lunch is an investment in the afternoon’s work”
I think you’ve had one tax deduction too many.
🙂
@Asymptosis
“This depends entirely on the period length you’re looking at. Lunch is an investment in the afternoon’s work, and I buy a car for consumption over a decade or two…”
Lunch is not investment. No. No No.
I like the phrase fixed capital formation. Lunch = fixed capital formation?
Car is also not investment if owned by a household. If held by a production unit, it is investment.
@Ramanan
#1 I scanned it quickly. I didn’t see anything about bank capital or capital requirement(s) there.
#2 When losses on assets get big enough, people find out what is guaranteed convertible 1 to 1 to MOA/MOE (“moneyâ€).
@JKH
“It’s also ironic that his approach arguably is a sort of variation on the money multiplier – which he’s quite aware is wrong.”
I meant the “standard” money multiplier version is wrong. I normally see someone deposits $100 into a bank then … . First and from what I can tell, there is no mention of capital/capital requirements in the “standard” money multiplier version. Second, the $100 is not specified if it is $100 in currency or $100 in demand deposits. I don’t see how demand deposits can be “deposited” in a bank. They (and the central bank reserves) just move around so for the banking system as a whole, there is no change in central bank reserves. Now if currency is deposited in a bank, the central bank overnight rate could start falling to zero if the central bank allows it. If there is enough capital, creditworthy borrowers who want to borrow, and a 10% reserve requirement, then the $100 in currency would lead to $1,000 in demand deposits and $1,000 in loans at the same bank. Lastly, the “standard” money multiplier version does not specify how the $100 is deposited at the bank.
My example ($100,000 in currency plus demand deposits leads to $1,000,000 in demand deposits) makes me think that the capital requirement is a capital multipier is a currency/demand deposit to demand deposit multiplier. “Banks” create new MOA/MOE.
For reference:
http://www.asymptosis.com/medium-of-account-vs-unit-of-account-brazil-anyone.html
http://jpkoning.blogspot.com/2012/11/discussions-of-medium-of-account-could.html