THE MODERN MONEY APPROACH TO SECTORAL BALANCES AND CAUSATION: MMP Blog #4 Responses

There were a large number of relevant comments and questions. I have done some cut and paste here and will deal with them in order.

Question: Is there any material difference between the sectoral balances in a currency and the sectoral balances issued in the national accounts for GDP purposes?

Answer: Here is my understanding: for the US there would be no (significant) difference as we use dollars in our stocks and our flows. Even if we buy foreign made output, we provide dollars that are exchanged for foreign currency. In other countries there could well be a significant portion of the economy that is denominated in a foreign (dollar) currency. Much of that could go unrecorded, of course. In that case the official accounts would be in domestic currency but if it were feasible we could also keep some accounts in dollars. All the macroidentities for this country would still apply for transactions that take place in dollars.

Q: Several comments were made about this statement: “No matter how much others might want to accumulate financial wealth, they will not be able to do so unless someone is willing to deficit spend.”

  1. So do you consider inventory run up to be in the category of ‘willing’?
  2. I’m thinking optimist makes perishable goods that in the end nobody wants to buy having somehow managed to persuade a bank to create the necessary money (possibly by having large valuable real thing to offer as collateral).
  3. I also find it very confusing. A desire to accumulate wealth is very easy to realize – do not spend your income. Whenever anybody gets a paycheck technically the whole amount is saved. So saving or accumulation is realized by definition while spending requires action.

A: If a firm is producing “widgets” it does so to “realize” them in the form of money things—it wants to sell them to get a credit to its bank account If it cannot sell them, they are added to inventory and count in the GDP accounts (technically NIPA) as investment. There will be an offsetting flow which is saving. Within the private sector, the increase to investment equals the increase to saving—this activity has no impact on the overall private sector’s balance. But let us imagine that foreigners order those widgets; in that case, the firm gets to sell them (receiving a credit to its bank account); there will be no increase to domestic investment. Instead, exports have increased—there is a positive entry to the current account balance. Ignoring all other entries, the US domestic private sector gets a surplus on its balance (saving) while the foreign sector “deficit spends”.

I know this will not answer all possible questions that follow on from this. After we look at the “circuit approach” later in the MMP we will see how the firm financed its production of widgets and what the implication is for the firm if it fails to “realize” them in the form of sales for money things. You can think of the “saving” of the household sector as the counterpart to the undesired inventory accumulation by the widget manufacturer. The manufacture of the widget produces household income that can be consumed or saved; of course the firms hope workers never save—because that means lost potential sales. If households do save, widgets go to inventory as investment. The firm can then be in trouble—not able to cover its costs. But foreigners or the government can step in to fill the demand gap.

Q: I wonder about “a) Individual spending is mostly determined by income.” Is this important/necessary/useful for you exposition?

A: Of course, it is true that wealthier people can fairly easily spend even if their flow of income is zero—they can sell off assets or borrow against them. But for many households, it is “mostly” true that income determines spending. And it is common sense to most people. My bigger point, however, is that at the aggregate level we need to think about reversing the causation. My household’s income is mostly determined by my employer’s decision to spend on my wages and salaries. So household consumption really depends to a great extent on its income (so consumption is called “induced spending) but its income in turn comes from somewhere—largely spending by firms and governments on wages, profits, and interest. At that spending by firms is undertaken on the expectation of sales (expenditures by households or other firms). We then also have government and investment and exports that are at least to some extent “autonomous” to income (don’t depend on today’s income). Yes these are important issues both for explanation and for projections of economic performance. There is also a logical angle: a society can decide to spend more but it cannot decide to have more income (unless it spends more). Spending is thus logically prior.

Q: When somebody hands you a five dollar bill, you can’t spend (create an outflow) out of that instantaneous inflow. You can only spend out of your stock — whether it’s a Swiss bank account or the buck and a quarter you have in your pocket. Flows are strings of instantaneous events; stocks have existence and duration. You can only spend out of wealth, not out of income. Obvious, but a point of confusion out there in the world.

A: When my boss pays me my $5 wages, that is indeed an income flow—ie: $5 per hour, per week, per month, or per year. Flows occur over time (even if the time is short). I can accumulate my income (wages) flow in the form of green paper dollar notes—the flows accumulate to a stock of dollar bills. (Stocks are measured at a point in time. Now!, for example.) If instead I spend the wages as I receive them, that is a consumption flow financed out of wages flow. But if I save all my wages as accumulated stacks of dollar bills for a period of a year, and then at the end of the year I choose to run down my wealth by splurging on a new BMW, then I am dissaving (reducing stock of wealth) to finance consumption.

Note that if I accumulated BMWs as my wealth (rather than dollar notes) then I would first have to sell the BMWs before I could finance consumption. That is of course the advantage of accumulating “cash”—I don’t have to sell it before spending. So my exposition was not confused. You could say that it is rather arbitrary whether to count hoarding of $5 notes as a saving flow into my stock of wealth, that I then run down to finance consumption versus spending the $5 income flow to finance consumption. That is to say, as we collapse the time period toward an “instant” then the distinction between flows and stocks disappears. That seems to be what you are saying. An instantaneous flow reduces to a stock as time approaches zero. And that of course is correct, too.

Note that income can be received as a flow of claims (rather than green paper). I work all month long, accumulating wage claims on my employer. (Legally enforceable in court.) Then I finally get my paycheck and deposit it in my bank account. Now I spend down my deposit until my next paycheck. If we want to be technically wonky we would say you are receiving an income flow every day of the month that finances a consumption flow every day of the month. But as you say, the “payment” of the wage actually takes place on a single day as a credit to your bank account (increasing your stock of wealth). (Technically, the claim on your employer is converted to a bank deposit—usually a debit to your employer’s account and a credit to yours.) You could not “really” spend your wages (claims on your employer) until you got your paycheck—except by borrowing against the claims.

Q: My understanding of domestic government budget surpluses is that they merely destroy the dollars that earlier spending created. Isn’t it meaningless to suggest that a sovereign government “saves” its own fiat currency?

A: In practical terms, yes. In the US during the Clinton boom there was a projection that all outstanding US Treasury debt would be retired. This led to a mad rush at the Fed to figure out how the federal government could continue to run surpluses if there were no government IOUs out there to “destroy”. If we ever did get to that point, the only way the private sector could continue to run deficits against the government would be to surrender assets (not government IOUs) in payment. You’d have to turn over your car, house, bank account, and children to the government to pay taxes!! That is the logical result of a government surplus carried to infinity—government would accumulate infinite claims on you. And yes you are correct that sovereign government does not—cannot—“save” its own currency!

Q: “It is impossible for every individual in the private domestic sector to net save at the same time if that sector’s aggregate balance is zero” Sure, but the logic is not the one you and this post claim. It is savers who force deficit spending and not the other way. This is the reason why.

A: Takes two to tango, of course. I think I made that clear. But carrying on from above, at the aggregate level (at least) it makes more sense to say that spending “causes” income which in turn “causes” saving. Here is why. If I am credit worthy I can always decide to spend more (the bank takes my IOU, gives me its IOU, and I deficit spend). I cannot (easily) decide to have more income. I need income to save more. Still, it takes two to tango. Yes, if I have income I can decide to consume less and save more. That will have an implication on someone else’s income flow (since I am not buying her widgets). And that means undesired deficit spending (and perhaps inventory accumulation—as above).

Q: Could you provide an algebraic description of MMT and its prescriptions as part of the MMP?

A: I did.

Domestic Private Balance + Domestic Government Balance + Foreign Balance = 0

That is pretty much all the math(s) you need to become a good macroeconomist! If you understand that, you are way ahead of most Nobel winners. (More seriously, where math helps, we will use it.)

12 Responses to THE MODERN MONEY APPROACH TO SECTORAL BALANCES AND CAUSATION: MMP Blog #4 Responses

  1. Thanks again for this response.What is good news is that even if the nuances of MMT aren't in people's minds yet, the sectoral balances are beginning to be discussed more and more.Who are these mystical people who are going to start spending when the government stops, and why aren't they spending at the moment which would then increase taxes anyway?You can almost hear the cogs whirring as thousands of minds try and reconcile that paradox with their preconceived ideas of how the world works.

  2. "If we ever did get to that point, the only way the private sector could continue to run deficits against the government would be to surrender assets (not government IOUs) in payment. You’d have to turn over your car, house, bank account, and children to the government to pay taxes!! That is the logical result of a government surplus carried to infinity—government would accumulate infinite claims on you. And yes you are correct that sovereign government does not—cannot—“save” its own currency! "This is a little mindbending so could you outline how this would come about in a practical sense? What would actually be happening to the finances of people and corporations.

  3. Is it possible to say that, given that government and investment and exports are autonomous, it is impossible to create savings out of the external sector balance? I mean, is it complete wrong to call "external savings" as true savings, since "true" savings can only be created through investment? An old post-keynesian professor used to teach me this (repeatedly).

  4. Thankfully, the Kansas City school of economists are challenging the failed orthodoxy of the economic profession. The change represents a paradigm shift in economic thinking and places the center of analysis on the accounting relationship between the issuer and user. Just as every asset has a liability, the issuer's debt is dollar for dollar equal to the currency users' savings.

  5. "Domestic Private Balance + Domestic Government Balance + Foreign Balance = 0"I believe that assumes the currency printing entity is not allowed to create currency/demand deposits with no loan/bond/IOU attached.IMO, it should be rich private balance + lower and middle class private balance = domestic gov't balance (which should be 0, as in a balanced budget) plus the currency printing entity balance (with a deficit run with currency/demand deposits with no loan/bond/IOU attached)

  6. Eventually, I believe you will need to address the medium of exchange issue. If the economy needs more medium of exchange, how should that happen, and should it be currency/demand deposits with a loan/bond/IOU attached or currency/demand deposits with no loan/bond/IOU attached.

  7. "Domestic Private Balance + Domestic Government Balance + Foreign Balance = 0"I believe that assumes the currency printing entity is not allowed to create currency/demand deposits with no loan/bond/IOU attached.No, the word "balance" here should be interpreted as a flow, not a stock. (Otherwise, you'd be right though.)To emphasize that this is flows being talked about, the phrase could have been written like this:"Domestic Private Net Inflow + Domestic Government Net Inflow + Foreign Net Inflow = 0"(where "Net Inflow" refers to financial assets)This should make it clear that not all sectors can have a positive net inflow ("balance") of financial assets.

  8. Great responses as usual Dr. Wray.

  9. Hugo Heden, the way I interpret the above:"Flows occur over time (even if the time is short). I can accumulate my income (wages) flow in the form of green paper dollar notes—the flows accumulate to a stock of dollar bills."is that the balance is a stock.For example, I earn $500 currency in a week and spend $400 currency in a week. I saved $100 currency (balance). The next week I earn $500 currency in that week and spend $350 currency in that week. I saved $150 currency (balance). At the end of week 2, I have a stock of $250 currency.

  10. Thx for comments. Ok 5 main issues:1. Mindbending continuous government surpluses: yes govt accumulates claims on private sector. We owe the govt its own IOUs but cannot get them except through borrowing. We can try selling the kids, etc. But govt wants to run a surplus so will not buy them. We fall further and further into debt.We can only get the govt IOUs we owe by borrowing them from govt.2. Is external saving true saving? Is investment the only source of true saving? Look in real terms both govt and private sector can create real savings (think real capital equipment and public infrastructure and educated population). In financial terms, domestic private sector can accumulate dollar claims on rest of world (or US govt) and that is certainly "true saving" albeit in financial form. Your PK teacher might have been confused. Send her to MMP.3. Divide private sector into rich, middle, lower. Fine. We can divide it into blondes and redheads, etc. Any which way you choose, as Clint would say. True: the rich save, the middle spends all its income (at least) and the poor spends more than its income. In the aggregate, the sum across all income levels leads to positive saving (usually) except over the past decade. Your point is what?????4. Medium of exchange: not a problem. Banks offer various kinds of liabilities convertible to MOE very quickly, some with small penalties.While orthodox focuses on MOE they never tell you where it comes from except from black helicopter drops of money bags. Not true. Stay tuned.5. Balances: flows or stocks? Yes to both. The sectors sum to zero in terms of either flows or stocks, so far as financial flows and stocks go. Flows accumulate to stocks. The flows balance. So the stocks balance too. If i spend $10 more than my income every day, and you spend $10 less than yours, at the end of the week my debt stock is $70 and your wealth stock is $70; we balance.More next week. LRWray

  11. @Anonymous July 1, 2011 2:16 PMYes, the word "balance" can be either flow or stock depending on context. In the context you first quoted, balance is a flow — like a "balanced budget" where the inflow equals the outflow."Balance" can also refer to a stock, like the somewhat depressing balance of my bank account.This is discussed at some length in one of the earlier MMP (Modern Money Primer) articles in this series (can't remember which one).

  12. About 1. and gov't surpluses from the 1990's:I'm thinking that some of the private sector was dissaving with stock/business profits from new computer, cell phone, and internet companies. Assumptions for 3.:1) amount of medium of exchange is a "commodity" that trades relative to goods/services2) if the amount of medium of exchange is about right and the amount of goods/services goes up, then the amount of medium of exchange needs to go up too3) all new medium of exchange has to be the demand deposit(s) from a loan/bond/IOU making it/them debtIf the lower and middle class are the ones dissaving with debt, then the amount of medium of exchange can rise and fall depending on what they do/what happens to them. Other entities that can go into debt may be reacting to them.4) I'm of the opinion the economy has a medium of exchange problem, but I'll stay tuned to this "Banks offer various kinds of liabilities convertible to MOE very quickly" idea.5) "at the end of the week my debt stock is $70 and your wealth stock is $70; we balance."What is the capital requirement on the $70?