MMT 101: Response to the Critics Part 3

Adding the domestic private sector

By Eric Tymoigne and L. Randall Wray

[Part I] [Part II] [Part III] [Part IV] [Part V] [Part VI]

In the previous installment, we focused mostly on the government side of the circuit. In this piece, we study the interaction between the government and nongovernment sectors while retaining the consolidation hypothesis.

For the purposes of the analysis, we will think of the nongovernment sector as equivalent to the domestic private sector, however, the analysis could just as well include state and local (nonsovereign) levels of government as well as the foreign sector in the nongovernment sector.

We will further address the issue of potential inflationary pressures raised by Palley, the reasons behind the holding of government currency, and issues of net saving and financial instability raised by Fiebiger.

As we argued previously, we do believe that it is useful to look to our historical past to learn something about the way that the monetary system operates. While Massachusetts-Bay governments emphasized the importance of a tax system for the stability of their monetary system, they also noted that taxes tended to drain too many bills out of the economic system compared to what was desired by private economic units. This created a dilemma:

The retirement of a large proportion of the circulating medium through annual taxation, regularly produced a stringency from which the legislature sought relief through postponement of the retirements. If the bills were not called in according to the terms of the acts of issue, public faith in them would lessen, if called in there would be a disturbance of the currency. On these points there was a permanent disagreement between the governor and the representatives. (Davies 1901, 21)

Private economic agents desired to hold bills for other purposes than the payment of tax liabilities, namely daily expenses, private debt settlements, portfolio choices, and precautionary savings. However, by draining all or most of the bills via taxes, the government prevented the domestic private sector from accumulating the amount of bills it desired.

At the same time, taxes were at the foundation of the monetary system so they needed to be imposed and collected as expected. Ultimately, the governments of colonies were unsure how to proceed in terms of the amount of bills to recall.

Some knowledge of national accounting helps to solve this dilemma. Let us start with the flow of funds accounts. This accounting approach uses balance sheets to analyze the three main economic sectors of an economy: the domestic private sector (DP), the government sector (G), and the rest of the world/foreign sector (F) (Ritter 1963). For the moment, the foreign sector will be left to the side.

A balance sheet is an accounting document that records what an economic unit owns (assets) and owes (liabilities and net worth) (Figure 3).

Figure 3 A Basic Balance Sheet.

A balance sheet must balance, that is, the following equality must always hold: 

FA + RA ≡ FL + NW or NW – RA ≡ FA – FL.

Each macroeconomic sector has a balance sheet (Figure 4).

Figure 4 Balance Sheet of Each Macroeconomic Sector

Financial assets are claims on other economic sectors. Financial liabilities are claims of other economic units on an economic sector. For every lender there is a borrower, so if one adds together the claims of the lender and the borrower they must cancel out:
(FADP – FLDP) + (FAG – FLG) ≡ 0

Thus, summing across sectors, it is true that the sum of all net worth equals the sum of real assets, that is, only real assets are a source of wealth for the whole economy.
(NWDP – RADP) + (NWG – RAG) ≡ 0

Given that the previous identities hold in terms of levels, they also hold in terms of changes in levels (“flows”):
Δ(FADP – FLDP) + Δ(FAG – FLG) ≡ 0

Δ(FA – FL) is called net lending or net financial accumulation. If an economic sector accumulates more claims on the other sectors than the other sectors accumulate claims on it, that  economic sector is a net lender: Δ(FA – FL) > 0.

It is quite straightforward to conclude that not all sectors can be net lenders at the same time. That is, if one sector accumulates a net amount of financial claims, another must be accumulating a net amount of financial debts. Usually, the domestic private sector is a net “lender” (in the terminology normally adopted; i.e. it records a net accumulation of financial claims) and the government sector is a net borrower (i.e. it issues more debt than the volume of financial assets it accumulates).

This accounting framework is not theory but it provides a context to set proper policy goals. Indeed, regardless of the amount of economic adjustments—changes in the exchange rate, interest rate changes, aggregate income fluctuations, etc.—some desired financial outcomes can never be achieved and it is highly destructive to continue policies that aim at achieving incompatible desires.

The most important policy implication is that, in a closed economy, it is inconsistent for a government to put in place policies that promote thriftiness in the private sector while aiming to reach a government surplus: if the private sector runs a surplus by definition the government sector is running a deficit (in the closed economy).

{In an open economy, both the domestic private sector and the government sector could run surpluses, but that would mean that the rest of the world runs a current account deficit. Obviously, for every current account surplus there must be a current account deficit, so there is no way that all countries could be in surplus. That, in turn, means that it is not feasible for all countries to simultaneously pursue domestic private sector surpluses and government budget surpluses.}

Beyond ensuring feasibility of policy prescriptions, the accounting identities also provide a framework to set up a theory. 

First, MMT argues the fiscal position of the government sector is ultimately driven by the desired net financial accumulation of the non-government sectors. We know that budget accounting requires that the following applies to the government: G – T – ΔFAG + ΔFLG ≡ 0 so ΔFLG ≡ – (G – T) + ΔFAG; therefore, at equilibrium, the accounting identity requires that the fiscal position is:
(G – T)* = Δ(FADP – FLDP)d = Δ(FADP – FLDP)

A more familiar way to present this can be achieved by noting that

In that case we have:
(G – T)* = (SDP – IDP)d = (SDP – IDP)

Usually the domestic private sector desires to net save (i.e. to accumulate net worth beyond the accumulation of real assets) so the government sector must be in deficit (again, in the closed economy).

If the government fiscal position is in surplus, or in a deficit that is not consistent with the desired net saving of the domestic private sector, nominal national income will adjust as the domestic private sector changes its spending level. As national income changes so do automatic stabilizers, and so the fiscal position will move to be consistent with the level desired by the non-government sector. How national income will change (change in output and/or price) will depend on the state of the economy and how adjustments affect desires.

Second, going back to the Massachusetts dilemma, one can conclude that, as long as the domestic private sector desires to have a net accumulation of government currency, there is no need to retire all of the emitted currency through taxation, i.e. there is no need to have a balanced budget.

The question about what the proper federal fiscal stance is at full employment, or other economic states, cannot be determined independently of the non-federal government sectors’ desire in terms of net accumulation of federal government financial assets. 

Thus, contrary to Palley’s argument, there is no need to assume that the fiscal balance should be balanced at full employment to prevent inflation:

There is no finance constraint on G because of the capacity to issue sovereign money. However, once the economy reaches full employment output, taxes (T) must be raised to ensure a balanced budget […] This balanced budget condition must be satisfied in order to maintain the value of fiat money. In a no growth economy, having the fiscal authority run persistent money financed deficits will cause the money supply to increase relative to GDP, in turn causing inflation. (Palley 2013, 8)

The fiscal balance at full employment will depend on the desired net saving of the non-government sectors at full employment income. If the desired net saving of the domestic private sector is positive at full employment income, there is no inflationary pressures from a fiscal deficit.[1] Similarly, if the budget deficit is too high relative to the desired net saving of the domestic private sector, there will be demand-led inflationary pressures around full employment as the domestic private sector spends unwanted funds. Again the Massachusetts experiment provides some great insights about wars leading to ballooning discretionary government spending and declining tax receipts and so upward pressures on prices.

However, as national income rises non-discretionary government spending will decline and taxes will rise. This will occur without changing the tax structure and without policy decisions aimed at lowering discretionary spending, but just due to automatic stabilizers.

Thus, contrary to what Palley argues, there may not be a need to proactively raise taxes (i.e. raise tax rates or impose new taxes) and cut spending as the economy does better if strong enough automatic stabilizers are in place. But this does not mean that a surplus is needed during an expansion.

To summarize, MMT certainly does not say that at full employment the fiscal position of the government cannot be balanced; it can, but that is not up to the government sector to decide.[2]

Third, the previous discussion does not mean that MMT is for a fiscal deficit, nor is it for a fiscal surplus or a balanced budget. MMT is agnostic regarding the fiscal position of a monetarily sovereign government per se.

As Abba Lerner’s “functional finance” approach insists, the fiscal position of the government is not a relevant policy objective for a monetarily-sovereign government. Price stability, financial stability, moderate growth of living standards, and full employment are the relevant macroeconomic objectives, and the fiscal position of the government has to be judged relative to these goals instead of for itself.

If there is inflation that is demand-led, the fiscal position is too loose (surplus is too small or deficit is too large); if there is non-frictional unemployment, the fiscal position is too stringent. Also if financial fragility grows due to negative net saving by the domestic private sector, the government’s stance is probably too tight.

Fourth, to ensure stability of the economic system, it is usually important that the domestic private sector not be a net borrower. Indeed, if the domestic private sector is a net borrower, this implies that the amount of net financial assets held by the domestic private sector is declining because borrowing from other sectors grows faster than the gross accumulation of financial claims on other sectors.

As a consequence net worth declines unless the nominal value of real asset grows fast enough through asset price appreciation. This is exactly what happened during the recent housing boom when the speculative boom of housing prices was rapid enough to sustain the wealth of households in spite of unprecedented borrowing. 

Of course, all this is in line with Minsky’s Financial Instability Hypothesis (Tymoigne and Wray 2014). The implications of having a domestic private sector being a net lender is that the federal government sector has to be in deficit unless the foreign sector is willing to be in deficit.[3]

It is also consistent with the argument of Wynne Godley, who argued “Without an expansionary fiscal policy, real output cannot grow for long.” (Wynne Godley, 2000) While this will not apply to countries that can run chronic current account surpluses, this “Mercantilist” policy is a “beggar thy neighbor” policy in the absence of a sovereign currency. This is a point Wynne recognized back in 1992 when he argued against the set-up of the EMU: “[T]he power to issue its own money, to make drafts on its own central bank, is the main thing which defines national independence. If a country gives up or loses this power, it acquires the status of a local authority or colony.”

Fifth, contrary to what Palley, Rochon and Vernango, and Davidson state, MMT does not believe that the only reason for holding the government currency is because of taxes. Taxes are just a sufficient condition for acceptability of currency—not a necessary condition, however historically taxes and other obligations to authorities did play a central role in the development of modern currency going back at least to Ancient Egypt. Government currency can be held for other reasons as the Massachusetts experiment showed. This is actually why the government can run a deficit as people want to hold government financial instruments (in monetary form or not) beyond the purpose of paying taxes (Wray 2012).

It is a shame that heterodox economists do not understand the difference between necessary and sufficient conditions. They could have avoided a lot of unnecessary argument if they would notice that we argue taxes are a sufficient condition to create a demand for a government’s currency, but they might not be a necessary condition. And before we get more misguided criticism let us add that we are presuming the government that imposes the tax liability is willing and able to collect at least some taxes. If a government is not willing or able to collect any taxes, then the uncollectible tax might not be sufficient to create a demand for the currency.

Sixth, Fiebiger is perfectly correct to state that the previous accounting framework is not enough to understand how financial fragility grows within a specific subsector of the domestic private sector because financial assets and liabilities held within that subsector are eliminated from the analysis above.

However, the flow of funds identity helps greatly to conceptualize economic relationships between public and private sectors, which is one of the points of MMT.

In addition, MMT does differentiate between saving (in the flow of funds it is the change in net worth: ΔNW) and net saving (saving less investment). Net saving shows how the accumulation of net worth occurs beyond the accumulation of real assets. For the domestic private sector, this comes from a net accumulation of financial claims against the government and foreign sectors.

A central point here is that government deficits add to the saving and net saving of the private domestic sector. Lavoie notes:

While it would seem that government deficits in a growing environment are appropriate — as it provides the private sector with safe assets to grow in line with private, presumably less safe, assets — it is an entirely different matter to claim that government deficits are needed because there is a need for cash. Even if the government kept running balanced budgets, central bank money could be provided whenever the central bank makes advances to the private sector. (Lavoie 2013, 9)

This is correct but this is not the point made by MMT that relates to net saving. Providing advances does not lead to net saving of government currency as financial assets of the domestic private sector increase by the size of the increase in financial liabilities.

Stated another way, advances have to be repaid so the gain in government currency is only temporary. Only a government deficit induced by fiscal policy leads to net saving.

Monetary policy can change the composition of net saving by buying financial assets in the domestic sector in exchange for government currency, but it cannot change the size of net saving, i.e. the net accumulation of financial assets.

We can think of it this way. Normally, a central bank advances currency into existence while the Treasury spends currency into existence. The difference is important: fiscal policy creates net financial assets; monetary policy only “liquefies” financial assets. This is a normal division of responsibilities, but one can imagine a central bank that spends its notes to buy real goods and services, and a Treasury that lends. Both are branches of sovereign government and can be directed to do what the sovereign government wants them to do.

Further, there is no necessary reason for a division of these responsibilities at all, and historically sovereign governments operated without central banks, with all operations consolidated in a treasury or exchequer or finance ministry.

In the next installment we will add a detailed examination of the central bank.

[1] We recognize that inflation can result before full employment, and that government’s spending (or taxing) policies can contribute to inflation through, for example, creating full employment. Here, however, we are focused on responding to Palley’s claim that at full employment government must run a balanced budget to avoid causing inflation. We note also that Keynes reserved the term “true inflation” to indicate the situation where additional spending must cause inflation because the elasticity of output has fallen to zero when all resources are fully employed. This seems to be the scenario Palley has in mind. However, his argument that if there is a budget deficit at full employment, then there must be “true inflation” in Keynes’s sense is flawed.

[2] We do not mean to imply that government decisions have no impact. For example, a “trickle up” policy to move income to the rich might increase the private sector’s net saving desire, resulting in bigger budget deficits at full employment; a policy that uses New Deal-style job creation to achieve full employment might instead be consistent with a balanced budget. In other words, government policy can affect the private sector’s behavior.

[3] Note that state and local governments—that are nonsovereign in the currency sense—strive to have budget surpluses. In the case of the US, almost all states have constitutions that forbid budgeting for deficits. In the case of the US, outside deep recessions, state and local governments run surpluses and the foreign sector runs significant surpluses against the US. For the domestic private sector to have a surplus means the federal government must run a large deficit to balance against state and local surpluses, foreign surpluses and the domestic private sector surplus. There is no reason to expect that this would be inflationary—regardless of the level of unemployment.

43 responses to “MMT 101: Response to the Critics Part 3

  1. “one can conclude that, as long as the domestic private sector desires to have a net accumulation of government currency, there is no need to retire all of the emitted currency through taxation,”

    In other words net saving can be seen as voluntary taxation. People have decided overall to check their spending themselves and therefore the government no longer has to check their spending for them.

    This leads to some interesting conclusions. For example if you limit the amount of bank lending then you can end up with quite a large space for tax cuts.

    Which means that you can say that Wall St playing casino games on margin is actually making your tax bill higher than it otherwise would be.

    • Neil: clever. Reminds me of a policy I advocated long ago (long before MMT) during the Calif Prop 13 movement: since our citizens hate taxes so much but love lotteries, I advocated we replace taxes with mandatory participation in state lotteries. Participation would be a rising percent of income (hence progressive). Rather than “saving as voluntary taxation” we’d have “mandatory gambling as saving”, combined with a random redistribution mechanism making a few of the gamblers filthy rich as an inducement to maintaining popularity. We’d probably have the voting public continually increasing the mandatory contributions to the lottery! So much so that we’d have to rapidly ramp up govt spending to close demand gaps.

  2. “In a no growth economy, having the fiscal authority run persistent money financed deficits will cause the money supply to increase relative to GDP, in turn causing inflation. (Palley 2013)”

    Again with the static (this time “no growth”) economy! Perhaps even true, but again irrelevant. Population is growing, and productivity is growing, so the economy will grow and will require deficits in the non-private sectors.

    If the no growth economy he assumes has no growth in any of the factors of GDP, perhaps Palley is assuming no growth in I, and thus (S=I) no new net saving. If Palley has assumed away any desire for new net saving, then his example could even become consistent with MMT. But still irrelevant.

  3. financial matters

    “”Monetary policy can change the composition of net saving by buying financial assets in the domestic sector in exchange for government currency, but it cannot change the size of net saving, i.e. the net accumulation of financial assets.

    We can think of it this way. Normally, a central bank advances currency into existence while the Treasury spends currency into existence. The difference is important: fiscal policy creates net financial assets; monetary policy only “liquefies” financial assets. This is a normal division of responsibilities, but one can imagine a central bank that spends its notes to buy real goods and services, and a Treasury that lends. Both are branches of sovereign government and can be directed to do what the sovereign government wants them to do.

    Further, there is no necessary reason for a division of these responsibilities at all, and historically sovereign governments operated without central banks, with all operations consolidated in a treasury or exchequer or finance ministry.””

    It seems that using high powered government currency to liquefy some financial assets can be problematic. If we consider that much of the MBS was fraudulently created then it would make sense that these securities should lose some of their value. It seems that in this case the government would be deciding to support their value by trading them out for government currency thus in essence using its deficits to support these misguided securities.

    This would seem to essentially be a fiscal decision to support this segment of the domestic economy.

    • The decision to support MBS was made by the Federal Reserve, however, so it was a monetary decision, was it not?

      • financial matters

        I think that the Fed’s ‘normal job’ is supplying currency into the economy. A strict monetarist would say that this is enough and the ‘free market’ can take it from there.

        When the Fed starts favoring certain aspects of the economy I think it is making fiscal decisions on how to spend the ‘people’s deficits’.

  4. This is a great article btw.

  5. “Which means that you can say that Wall St playing casino games on margin is actually making your tax bill higher than it otherwise would be.”

    Nice one. I’ll have to think about that one a bit. If you’re right, it’s a pretty big deal.

  6. Who are all these so-called “critics” you are trying to shoot down in flames? As I read the comments, it would seem most of them have already crash landed. But what have you achieved? I personally believe MMT is actually a valid blueprint for how an economy should, or could, work, but it will never get off the ground until it is addressed to the people who really matter – the general public. Stephanie’s book for Toddlers is a step in that direction, but we can’t approach the general public as children. While there might well be a few “critics” in their midst, the vast majority have no real knowledge about MMT. This current series is just preaching to the converted, to a certain extent, but will it serve to promote MMT in the arena where it really counts?
    In this current post that supposedly deals with the “private’ sector, I did not see one single reference to private banks and the fractional reserve banking system. How can you ignore that when speaking of the “private” sector?
    It is also interesting that my earlier comment about the overriding control that BIS has on the economy of 55 nations around the world did not solicit one single response. How can this be ignored? Is MMT a purely academic idea aimed at continuous discussion with no intention of ever trying to formulate a policy that can be converted into a practical system? What a waste if that is the case.

    • So far as I can tell, MMT is not against the current financial/monetary system per se, it seems to be more interested in pointing out what that system actually is, without resorting to conspiracy theories, and then using that knowledge to use that system to its fullest logical extent; that extent being beyond that which is currently envisaged by policy makers.

      • I’m not sure what “conspiracy’ you are talking about. but I presume it is the claim that BIS sets the rules for all the 55 Central Banks members. It would be great to hear another reason why no country has adopted the principles of MMT in spite of the fact many of them can claim monetary sovereign status, but refuse to go down that path.
        Is it because those governments don’t want to reduce the control the tax system gives them over their people? Why wouldn’t a nation want to shrug off the chains of ever increasing debt if there is a way to do it?
        If there is a genuine answer to that, maybe it should become the focus for achieving MMT as a practical system.

    • Guggie: you’ve probably entered MMT at the wrong point. Read the primer first. Then if you want, take a look at the critics. Certainly not necessary, since none of them has got a leg hold. If you want to skip the critics then of course you ought to skip the response to them.
      That is probably the best strategy for most. These posts are only for those who already know MMT and the critiques, and who might be interested in responses to critics.
      All the others really only need to know that Uncle Sam has not run out of money, and cannot run out of money. Your President lies to you.

      • I have read the Primer Randall, and have been following MMT for the last 2 years so, that’s why I believe it does represent a “blueprint” for what should be happening. But why isn’t it. There are plenty of countries in the world that could have monetary sovereign status and not have to suffer this ever growing debt so, why haven’t they taken up the option?
        Surely, a government that has the opportunity to rid itself of debt and do what Lincoln did back in 1861 must have some strong reasons not to follow through.
        Lincoln explained the benefits in a nutshell “”The government should create, issue and circulate all the currency and credit needed to satisfy the spending power of the government and the buying power of consumers….. The privilege of creating and issuing money is not only the supreme prerogative of Government, but it is the Government’s greatest creative opportunity. By the adoption of these principles, the long-felt want for a uniform medium will be satisfied. The taxpayers will be saved immense sums of interest, discounts and exchanges. The financing of all public enterprises, the maintenance of stable government and ordered progress, and the conduct of the Treasury will become matters of practical administration. The people can and will be furnished with a currency as safe as their own government. Money will cease to be the master and become the servant of humanity. Democracy will rise superior to the money power.”
        Isn’t this precisely what MMT is capable of achieving?

        • Guggzie: Govt debt is Nongovt Asset; Govt interest payment is Nongovt interest income. As a reader of MMT you know many of us DO support ZIRP, which is in line with Lincoln. Govt will of course still be in debt (“greenbacks”) but won’t pay interest on currency (including reserves). Advocating an end to govt debt is equivalent to eliminating nongovt net financial assets. No good would come of that.

    • “Who are all these so-called “critics” you are trying to shoot down in flames?”

      JKH and Ramanan amongst others. Two very smart cookies.
      The word ‘Pyrrhic ‘ comes to mind when battle is joined.

      • My question was, sort of, rhetorical because, it seemed to me the discussion is reactive, and especially so, if as is implied, some of the critics don’t really understand MMT. How much authority and weight do these critics have, and who do they work for, or represent? If they represent the bankers then it is pointless arguing the point with them. If they represent the Government, it’s probably the same argument.
        MMT needs to be a lot more proactive in the general population arena and hammer the message home in a way that can show the real, practical benefits that fiat currencies and MMT can offer society. Dan Lynch made the same point in his past, what’s important to academics may not be the issues that are important to the general public.
        Probably, the single most important issue for the general public stems from the fact the vast majority of people do not distinguish any difference between household budgets and government budgets. The idea of giving the politicians /government an open cheque book fills them with horror.
        Until MMT gets the general public on side it will remain a very interesting academic discourse.

        • “the single most important issue for the general public stems from the fact the vast majority of people do not distinguish any difference between household budgets and government budgets. The idea of giving the politicians /government an open cheque book fills them with horror.
          Until MMT gets the general public on side it will remain a very interesting academic discourse.”

          Exactly right. The first problem that needs to be addressed is that the general public is completely unaware of MMT, as it gets next to no coverage in the mainstream media. Once Warren or Stephanie make their first appearance on This Week, though, you can bet the critics will be out in full force, so this series is a worthwhile exercise.

          The first reaction to awareness will be, as you say, horror. It will take lots of exposure to change so many minds. There needs to be lots of preparation, so that the first exposure is not the last.

          • Thanks for the endorsement Golfer, but I’m not too sure about the value of the current series – as far as the general public are concerned. Academically, it is probably valuable, but if the critics are on the MSM, they will be talking to the general public. MMT’s response has to be designed for that level if it is to have any chance of success.

            • Right, and if these criticisms represent the critics’ position, it is good for MMT to formulate its response prior to appearing with them on the MSM. Have a playbook, and everyone on the same page.

            • Unless you mean it’s too “wonky” for the MSM, which is true, and both sides will have to condense things into shorter sound bites.

              • Yeah – and you are into the “attention span” problem when you talk of shorter sound bites – and guess who is going to win in that arena?

                • I think there could be lots of convincing short sound bites for MMT. This blog collected a bunch of 25-words-or-less MMT a while back.

                  There’s no reason to think that neoliberal economists are better at PR than MMTers.

                  • Apart from the fact they have a lot more practice – MMTers haven’t bee too prominent in this field to date, but there’s no reason they can’t be effective.

  7. I have no significant disagreement with this section on fiat currency and sectoral balances. It seems like you are addressing criticisms from economists who either don’t “get it” or who pick nits over minor details and semantics. Those details are important to academics but not so much the general public.

    My beefs with MMT are with inflation (what causes it, and the claim that a JG would control inflation), trade policy, the notorious JG, the definition of “full employment,” and the generally pro-capitalist slant of MMT. I’m waiting to see what this series has to say about those things. :~/

    • “generally pro-capitalist slant of MMT”

      Why do you think that?

      I think MMT is agnostic about political systems. It works for Socialist and Communist systems as well as for capitalist ones. There is much discussion of China, including praise of their economic policy when they have done it “right”. And even more about Europe, though they have done little “right” since the Euro.

  8. “Stated another way, advances have to be repaid so the gain in government currency is only temporary.”

    This sounds to me like saying that government debt is only temporary, because it has to be repaid eventually.

    • In the case of the advance by the Fed, it’s one lender and multiple borrowers, so it depends on the intentions of the lender to roll it over or not. With one borrower and multiple lenders, it depends on the intentions of the borrower. So it could be different.

      • Yes, it could be different. But I presume the concern here is not about a risk that the Fed might decide not to re-advance currency.

        • No, the concern was that taking out a loan doesn’t increase one’s net savings, whereas earning a wage or selling a product does.

    • Eric Tymoigne

      The repayment of public debt would involve giving non-interest paying IOUs (“greenbacks”) for interest-paying IOUs (“bonds”). It would be an exchange of Fed IOUs for Treasury IOUs. Won’t change the level of financial assets of the non-gov, just the composition.

      • Or, as is more usual, maturing debt is paid off by the issue of new debt. Which is fine. An ever increasing amount of government debt is not in itself an unsustainable process. But I don’t think there’s anything inherently unsustainable about an ever increasing amount of “borrowed” currency either.

        When you talk about the gain in currency being only temporary, are you envisaging some point at which the advances have to be repaid, but for some reason the Fed can’t or won’t re-advance?

        • There is a difference. For the monetarily sovereign government, there is no constraint. For the private sector, the constraint is the ability to service the debt. So, while an ever-increasing dollar-denominated level of debt is not inherently unsustainable, an increasing level of debt relative to income is unsustainable for monetarily non-sovereign entities.

          Funding increased private sector demand by borrowing from the Fed is no better than borrowing from private banks, which we’ve tried twice recently, and the end result would be the same.

          • We’re talking about borrowing the currency (i.e. HPM) here, which means that: a) the amount of borrowing involved is quite small compared with gross private sector borrowing; and b) it would only end up in an ever-increasing ratio to income if for some reason the private sector decided to hold currency in an ever increasing ratio to income.

            • We’re getting far afield, but if the original question is whether adding money to the economy by CB lending is equivalent to doing it by fiscal deficits, I think it is not. If it had been done that way all along, then instead of having a “national debt” of about 100% of GDP and rising (which is to say accumulated private/foreign sector dollar savings of that amount), the private sector would have a debt to the Fed of 100% of GDP and rising – assuming GDP would have been unaffected by the difference. I don’t know how that could be equivalent.

              • I don’t think that is the question. Lavoie’s point is that although deficits do make a difference, they are not necessary for the supply of HPM to the private sector. I think everyone here is on the same page in relation to the question of whether deficits matter. I initially thought, reading this post, that in fact there was no disagreement at all and maybe just a misunderstanding about what MMT’s point was. But then I read the statement ” advances have to be repaid so the gain in government currency is only temporary”. Assuming that currency here means HPM, then this suggests that maybe the authors are saying that the supply of HPM must eventually fall again (when the advances are repaid). I don’t think that’s right and I think Lavoie’s point is that it is not right. (I’m still not sure, though, that that is what the authors are in fact saying – see ET’s comment at 12/5 4.54pm.)

                • Eric Tymoigne

                  The point here is that net saving is S – I which is equal to varFA – var FL. An advance by the fed leads to an increase in both varFA (fed currency held goes up) and varFL (debt to fed goes up). Thus net saving does not change.

                  • I don’t think anyone would dispute that, so if that is all the point is then I don’t think there is any issue. The bit that troubles me is the suggestion that this must necessarily be a temporary change – that varFA must at some point go negative. If FA and FL both increase, there is no net saving. But why should the increase in gross positions be temporary? But maybe I’m reading more into this than was intended.

        • Eric Tymoigne

          Regarding the fed, the choice to advance or not is not based on the Fed’s discretion but more on the demand of banks. So the question if the Fed can’t or won’t is not relevant; it will always provide and remove as needed. It will re-advance if bank needs, it won’t if banks don’t want.

  9. To the authors:

    I have enjoyed the series so far, but I have a problem with your derivation of some of the simple equations in the middle section. If Δ(FADP – FLDP) + Δ(FAG – FLG) ≡ 0 (makes perfect sense so far), then
    Δ(FADP – FLDP) = -Δ(FAG – FLG), ie, they are sign inverse.

    So when you state, G – T – ΔFAG + ΔFLG ≡ 0, that is equivalent to G – T – (ΔFAG – ΔFLG) ≡ 0 and also to
    G – T – Δ(FAG – FLG) ≡ 0. So G – T = Δ(FAG – FLG).

    If Δ(FADP – FLDP) = -Δ(FAG – FLG) (they are sign inverse) how do you get to (G – T)* = Δ(FADP – FLDP)d = Δ(FADP – FLDP)? Am I missing something? Sign errors can be one’s undoing in even simple math.

    I also do not see any explanation of the * following (G-T). Was that explanation accidentally omitted? And it is not clear, at least not to me, what the subscript “d” means.

    If your target audience is an intelligent, motivated reader who may not have scholarly education in economics, I present myself as a test case. Examples (ie, actual numbers) help elucidate the equations, especially when there may be +/- sign problems. Definitions also help. It was not immediately obvious to me that I is investment. Perhaps you should define “investment” and “savings” with concrete examples for both the individual and the firm in the DP sector. Is investment the purchase of any real asset? Normally, I think of buying a bond as an investment, but in this case maybe it is “savings.” I also do not think of buying a car as an investment, but since it is a tangible asset, perhaps it is an “investment.” I may be completely wrong in both these examples. That is why I would like some clarification.

    • The audience is probably mostly people with formal training in economics, many of them with a lot of it, but only a grasp of the basics is necessary to understand most of it. If you really are fascinated by this (&deity help you) there may be something on the web, or you could audit the ECON101 course at your local community college.

      More specifically, (it’s been a long time), the basic equation of macroeconomics is


      Y is GDP – what is produced this year
      C is what is consumed by the domestic private sector
      G is what is consumed by government – doesn’t count transfer payments, because they’re mostly counted in C
      X is exports, M is imports, X-M is the net of what is produced and consumed by the foreign sector

      I is what was produced but not consumed. It could be things like cars and factories that will last for more than one period, and only the depreciation counts in C, not the whole cost. And it also includes the change in business inventories, which is literally stuff produced for sale but not sold yet. It’s not the same definition your financial advisor uses.

      So, what the equation says is that everything that is produced is either consumed by someone, or is not consumed. It’s easier to measure spending, stuff consumed, than production, so Y is always calculated, and the rest are measured. All the other equations you see here are derived from this one. There’s a good deal of math on various posts on this web site showing the derivations.

      Beyond that, there is some lingo to learn – the use of “investment” is a good example, where economists have a different definition than the general public. And there is a good deal of common sense, and understanding of how things changed in 1971 when we went off the gold standard, and what money really is and isn’t. All that you can handle, I think, without being an economics major. Actually they didn’t teach a whole lot of that when I was taking economics, so it’s kind of new even if you were an economics major a long time ago.

      Actually, the equation is about real stuff – things produced and consumed, just measured by the unit of account, the local currency. MMT is more about that currency itself, where it comes from and how it flows, and how it influences the amount of stuff produced and sold, and its price; and the proper way for government to manage it.

  10. Thanks, Golfer for the explanation. Investment does, in this context, mean what I thought. Even without any formal education in economics, I have read enough of these pages and books by Warren Mosler’s to help me understand the basic concepts.

    My questions remain about the equations as presented. I do have formal education in math so, unless I missed something, the derivation of those equations are not quite right.

    I posed my “definition” questions to the authors to suggest that they could, with a little more exposition, reach a wider audience.

    • Eric Tymoigne

      Nice catch Steve. The end result is actually correct but the typo came here: G – T – ΔFAG + ΔFLG ≡ 0. This is incorrect. It should be G – T + ΔFAG – ΔFLG ≡ 0.
      It is easy to see if one works in reverse. We know that national accounts tells use that:
      (G – T) ≡ (S – I)
      We know that the balance sheet of the DP is such that RADP + FADP ≡ FLDP + NWDP so ΔRADP + ΔFADP ≡ ΔFLDP + ΔNWDP so I + ΔFADP ≡ ΔFLDP + S so ΔFADP – ΔFLDP ≡ S – I. Thus:
      (G – T) ≡ ΔFADP – ΔFLDP
      Given that Δ(FADP – FLDP) ≡ -Δ(FAG – FLG) then
      (G – T) ≡ -Δ(FAG – FLG)

      Regarding the notations. Sorry that we went too quickly. * is a notation used for an equilibrium value and d is the subscript for desired. Translated in English: the equilibrium fiscal position is the one that will be equal to the desired net saving of the DP because it is that fiscal position that allows desired and actual net saving to be equal.

      • Thanks, Eric. I really appreciate the extra explanation. I look forward to reading the last 2 parts this weekend.