MMP Post #10 — Keeping Track of Stocks and Flows: The Money of Account

Stocks and flows are denominated in the national money of account. In previous weeks we examined the definitions of stocks and flows, as well as the relations between the two. (It might be helpful if you quickly review the previous discussion on stocks and flows, and the relation between the two: flows accumulate to stocks.) Financial stocks and financial flows are denominated in the national money of account. In this blog we will go through the details of keeping track of stocks and flows in the money of account. That will also lead us into a discussion of the relation between “money” and “spending”—how do we “pay for” things?
As discussed in the past two weeks, the money of account is almost always the domestic currency—the money of account chosen by the government. In some cases, however, the accounts can be kept in a foreign currency. For the purposes of this blog we will ignore that complication—all the record keeping discussed here will be presumed to take place in a single national unit of account. Let us begin with the case of an employee earning wages.
 While working, the employee earns a flow of wages denominated in a money of account accumulating a monetary claim on the employer. On payday, the employer eliminates the obligation by providing a paycheck that is a liability of the employer’s bank. Again, that is denominated in the national money of account.
If desired, the worker can cash the check at her bank, receiving the government’s currency—again an IOU, but this time a debt of the government. Alternatively, the check can be deposited in the worker’s bank, leaving the worker with an IOU of her bank, denominated in the money of account.
Wage income that is not used for consumption purchases represents a flow of saving, accumulated as a stock of wealth. The saving can be held as a bank deposit, that is, as financial wealth (the bank’s liability).
When it comes time to pay taxes, the worker writes a check to the treasury, which then debits the reserves of the worker’s bank. Reserves are just a special form of government currency used by banks to make payments to one another and to the government. Like all currency, reserves are the government’s IOU.
So, when taxes are paid, the taxpayer’s tax liability to the government is eliminated. At the same time, the government’s IOU that takes the form of bank reserves is also eliminated. The tax payment reduces the worker’s financial wealth because her bank deposit is debited by the amount of the tax payment.
We can conceive of a flow of taxes imposed on workers, for example, as an obligation to pay ten percent of hourly wages to government. A liability to government accumulates over the weeks as wages are earned, which is a claim on the worker’s wealth. The tax liability, measured in the money of account, is eliminated when taxes are paid by reducing the worker’s financial wealth (debiting deposits also measured in the money of account) and the bank’s reserves are simultaneously debited by government.
At the same time, the government’s asset (the tax liability owed by the worker) is eliminated when taxes are paid, and the government’s liability (the reserves held by private banks) is also eliminated.
Sometimes it is useful to compare these flows to water flowing in a river, that gets accumulated as a stock behind a dam. However, it is important to understand that these monetary stocks and flows are conceptually nothing more than accounting entries, measured in the money of account. Unlike water  flowing in a stream, or held in a reservoir behind a dam, the money that is flowing or accumulating does not need to have any physical presence beyond ink on paper or electrical charges on a computer hard-drive.
Indeed, in the modern economy, wages can be directly credited to a bank account, and taxes can be paid without use of checks by debiting accounts directly. We can easily imagine doing away with coins and paper notes as well as check books, with all payments made through electronic entries on computer hard-drives.
All financial wealth could similarly be accounted for without use of paper. Indeed, most payments and most financial wealth are already nothing more than electronic entries, always denominated in a national money of account. A payment leads to an electronic debit of the account of the payer, and a credit to the account of the payee—all recorded using electrical charges.
The financial system as electronic scoreboard. The modern financial system is nothing but an elaborate system of record-keeping, a sort of financial scoring of the game of life in a capitalist economy.
For those who are familiar with the sport of American football, financial scoring can be compared with the sport’s scoreboard. When a team scores a touchdown, the official scorer awards points, and electronic pulses are sent to the appropriate combination of LEDs so that the scoreboard will show the number six. As the game progresses, point totals are adjusted for each team.
The points have no real physical presence, they simply reflect a record of the performance of each team according to the rules of the game. They are not “backed” by anything, although they are valuable because the team that accumulates the most points is deemed the “winner”—perhaps rewarded with fame and fortune.
Further, sometimes points are taken away after review by officials determines that rules were broken and that penalties should be assessed. The points that are taken away don’t really go anywhere—they simply disappear as the scorekeeper deducts them from the score.
Similarly, in the game of life, earned income leads to “points” credited to the “score” that is kept by financial institutions. Unlike the game of football, in the game of life, every “point” that is awarded to one player is deducted from the “score” of another—either reducing the payer’s assets or increasing her liabilities.
Accountants in the game of life are very careful to ensure that financial accounts always balance. The payment of wages leads to a debit of the employer’s “score” at the bank, and a credit to the employee’s “score”, but at the same time, the wage payment eliminates the employer’s implicit obligation to pay accrued wages as well as the employee’s legal claim to wages.
So, while the game of life is a bit more complicated than the football game, the idea that record keeping in terms of money is a lot like record keeping in terms of points can help us to remember that money is not a “thing” but rather is a unit of account in which we keep track of all the debits and credits—or, “points”.
Your homework assignment (should you choose to accept it): Think about government spending and taxing in terms of those scoreboard electronic entries. When government “spends money”, where does it come from? When we pay taxes, where does the “money” go? In what sense does the government “spend the money it receives in tax payments?”

10 Responses to MMP Post #10 — Keeping Track of Stocks and Flows: The Money of Account

  1. R.Just thinking about different ways of viewing this.Could it be said that the essence of the system is the banks' authority to refuse instructions from the clearing system (and have that authority backed up by the legal system)?If I initiate a transfer from my account to yours, eventually the bank will refuse the instruction – as I will hit my limits.If I initiate a transfer from your account to mine, the bank will (I hope!) refuse the instruction.A government that has abdicated its Fiat powers can have its transfer instructions refused by the bank. The treaty conditions must give the bank the authority to stop payment or the abdication is just a pretence.Yet a fiat currency issuer can issue transfer instructions at will between any sets of accounts and the banks have no legal authority to refuse them.

  2. "As discussed in the past two weeks, the money of account is almost always the domestic currency—the money of account chosen by the government."And, "So, when taxes are paid, the taxpayer’s tax liability to the government is eliminated. At the same time, the government’s IOU that takes the form of bank reserves is also eliminated. The tax payment reduces the worker’s financial wealth because her bank deposit is debited by the amount of the tax payment."It seems to me that money of account can be replaced with the medium of exchange. If the central bank reserves get replaced to maintain the fed funds rate, then the bank demand deposit has been accepted for the tax payment. IMO, that means domestic currency should be replaced with medium of exchange, currency plus demand deposits denominated in the currency."If desired, the worker can cash the check at her bank, receiving the government’s currency—again an IOU, but this time a debt of the government."I don't agree that is debt. It seems to me two definitions of debt may be needed here with one definition of debt being one way to dissave (spending more than income)."When it comes time to pay taxes, the worker writes a check to the treasury, which then debits the reserves of the worker’s bank. Reserves are just a special form of government currency used by banks to make payments to one another and to the government. Like all currency, reserves are the government’s IOU."I'm hoping JKH will talk about the differences between currency and central bank reserves (maybe even demand deposits too). Whenever I try, the first words I usually hear are that's not right. When JKH says things, that's not right are usually not the first words in a reply."Indeed, in the modern economy, wages can be directly credited to a bank account, and taxes can be paid without use of checks by debiting accounts directly. We can easily imagine doing away with coins and paper notes as well as check books, with all payments made through electronic entries on computer hard-drives."Would that make people vulnerable to a "currency tax"?

  3. My understanding is that the Treasury account at the Fed is not counted as being part of the money supply. However, it is accounted for a being a liability on the Fed's balance sheet.So when the taxes eventually get cleared into the Treasury account at the Fed, that money is no longer part of the money supply.But here is where I am unclear: If the Treasury spends is there a corresponding debit from its account at the Fed? If there is then it seems fair to say that taxes, if not 'fund' then at least act as a tally for spending.

  4. Where is our money, really?I gather that banks keep their money in the federal reserve. Where does federal reserve store them? What is the infrastructure? What kind of a computers are used? What is the storage media? Who are the manufacturers? What information is stored in the data entries? What are the datalinks between banks and the central bank? What kind of software is used? What is the history of the system?

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  6. I was all ready to take up the homework challenge when I realized that in light of all I was trying to digest from this site and others about MMT, a gap was developing in my understanding about gov't spending. I was going to wallow quietly in my ignorance till the answer came Wednesday,but I've been emboldened to speak up since James V above expresses part of my disconnect.The way I've understood it (on one hand) is that when the gov't spends, it does so in a convoluted process which sees Treasury deposits acquired through the private issue of treasuries transferred to the Treasury's account at the Fed. I may stand corrected on this, but if the Fed then turns around and buys these Treasuries from the initial purchasing institution, this results in a net add to private sector reserves. My gap in understanding is this: the initial money used to buy the bonds (say) from the Treasury is already accounted for in the money supply. It has already been "spent into existence". However, is the money that the Fed conjures up to buy the Treasuries back that of the "clicking up the score" variety?? Seems to me it must be. The Fed doesn't buy back those treasuries with money from the Treasury account at the Fed, it merely credits the necessary reserves… right? I guess we'll find out tomorrow. Really enjoying the series. Thanks!

  7. As interesting as the current discussions are on how the Fed/Treasury work, I'm going to try and attack the challenge from a generic point of view.From first principles of MMT (as I understand them so far), money is simply an IOU from the government to the private sector. In the scoreboard analogy, these are negative points to the government, positive points to the private sector. When the government spends money, what is doing on the scoreboard is assigning itself negative points, and giving positive points to the private sector. Money, in this sense, comes from the government itself.The reverse happens when the private sector pays its imposed government liabilites (such as taxes). Points are subtracted from the private sector in our scoreboard, and added to the government's score. This is just the government's IOU coming back to its source (as has been explained in prior posts).Now, if the government spends the money it receives in taxes, what happens is that the points on our scoreboard don't change. For every liability that comes in, a new IOU is created. If the government maintains a balanced budget, for every unit of imposed private-sector liability that the government receives (which is defined as currency), a new government IOU (currency) is created.Here's where I had an epiphany: What if the budget is not in balance – i.e. the amount of imposed liabilities received do not equal the amount of new IOUs created? If the government made too many currency IOUs and doesn't want the scores on the scoreboard to change, it has to convince the private sector to hand over its currency IOUs voluntarily. Only the truly altruistic will do this in exchange for nothing. So what does the government do? Promise to give those original currency IOUs back sometime in the future, plus a few additional currency units for their trouble. That promise, I believe, is the government bond, and those extra currency units are – voila – the interest rate.Why would a private individual want to have bonds? Just as currency holders want currency in order to pay government liabilities in the present, bond holders expect to have government liabilities in the future. By handing over currency in exchange for a bond, the bond-holder is in effect pre-paying its liabilities, and in terms of absolute units is paying less currency now to satisfy a larger liability in the future. So fundamentally currency and bonds are simply different means of satisfying the same thing – imposed government liabilities. The distinction is that currency is for present liabilities, whereas bonds are used to pre-pay future liabilities.Now, this whole exercise leaves me with a few burning questions. In keeping with the scoreboard analogy, why would a government want to keep the scores on the scoreboard the same? What are the consequences of letting the scores change? I hope these will be discussed in future posts – I am looking forward to them!

  8. So I read on something that L.Randall Wray wrote, that a government deficit is a net add of reserves to the banking system to the exact amount of the deficit (1.4 trillion deficit= 1.4 trillion net add of reserves to the banking system). I also read the natural rate of interest is zero, and so I understand what the interbank market is, and how spending and taxation affect interest rates and the purpose of bond sales. If the employer's account is debited by say 100$, and the employee receives 100$, would the employer's bank have to give 100$ of reserves to the employee's bank, somewhat in the way that the government takes a banks reserves when it collects taxes from the employee? Also, if the employee deposits 100$ in their bank, does the bank keep part of that money as reserves in its account with the FED, and loan the rest, to consumers, firms etc.(thats what I've understood from reading about our banking system, and that is what a bank does to fulfill its reserve requirement)? Does the government actually use revenue from taxation and borrowing when its spending, because it is only a scorkeeper, and the scorekeeper cannot run out of points. I look forward to hearing back, and on more posts!

    • Ankur,

      “would the employer’s bank have to give 100$ of reserves to the employee’s bank”
      Yes. The reserves are transferred electronically via the Federal Reserve.

      “if the employee deposits 100$ in their bank, does the bank keep part of that money as reserves in its account with the FED, and loan the rest, to consumers, firms etc.”
      NO. First, $100 would be added to the employee’s bank reserves by the Federal Reserve. To answer the second part of your question, please familiarize yourself with how banks work http://www.positivemoney.org/how-banks-create-money/ . This site is from the UK, but the concepts are the same. Reserve balances do not enable nor hinder lending.

      “Does the government actually use revenue from taxation and borrowing”
      Read the next blog.