Some neighbours arrive

The other day I introduced a simple model of how a monetary economy works. The model was centred on the payments of my business cards to elicit labour from the kids that live in my house. All the basic national accounting results that apply in a real economy were present. The simplicity extended to considering only two sectors – the kids (private) and the “house” (public). In terms of modern monetary theory (MMT) we start by examining the broad relationships between the government and non-government sector, where the latter comprises the private domestic and foreign sector. Some readers have suggested that the results obtained would not apply if I had have explicitly modelled the cross-border flows (that is, the external sector). Well today, I have some news … some neighbours have arrived next door to my place and the kids from each house are jumping fences.

To get back intp the scheme of things here is a brief recap of where we left my simple household business card economy. As background reading I suggest the following blogs – A simple business card economy and What causes mass unemployment?.

Recap

The following briefly refreshes our memory of the model presented in this blog – Barnaby, better to walk before we run. I strongly recommend you re-read (or read) that blog to see the most simple exposition of the model. You will see that things get more complicated in the model I present today.

Recall that:

  • I devise a plan to get my children to work around the house which involves me offering them by worthless business cards each month as wages. The children are disinterested in the plan initially but soon realise they have to pay me taxes each month in business cards. The imposition of the tax creates a demand for my otherwise worthless cards.
  • All wage payments, taxes and interest payments are demoninated in cards and transacted via entries into a spreadsheet we keep on our home computer system.
  • The kids cannot pay their taxes until I spend the cards on wages. Taxes are not levied to raise revenue. I am totally free to create as many business cards as I choose.

The following Table summarises the main results of the system before trade enters the picture. For a large printable version of the 9-month sequence that is discussed click HERE. It is best viewed in a landscape format.

You will notice it is a bit more complicated than the spreadsheet tables presented in the companion blog last week. The spreadsheet we keep in the house now defines the overall spending aggregates – public spending (G) which is total wages and interest payments; exports (X) and imports (M) (more about which later). Total output in the family is equal at this stage to total public spending.

You then see the public spending and revenue accounts, the budget balance [Taxes (T) - Total Public Spending(G)] and the national debt (outstanding bonds issued).

The next set of entries relates to the kids accounts. They can earn wage and interest income but pay taxes. Total private saving (S) is the difference between total house income and taxes.

The next set of entries details the so-called sectoral flows. We have three sectors interacting: (a) public (me); (b) private domestic (kids); and (c) external (relations with our next door neighbours although in Months 1 to 4 they house next door is empty.

The national accounting rules relating to these sectoral flows ensure the balances (correctly specified) sum to zero. So S + (T – G) – (X – M) = 0. This is not an idea or theory but an accounting rule that always holds in any economy. That is, it cannot be wrong.

The final two sets of entries relate to the wealth accounts of the kids and the next door neighbours. Our kids can choose to hold their accumulated saving in the form of cash (in cards) or purchase a bond (also specified in cards).

Once trade begins you will see that the kids next door can also buy bonds that I issue as long as they have my business cards – remember I am the only person who issues these cards. The kids next door will also receive interest payments denominated in my cards for any bonds they buy off me.

Recap: Months 1 to 4

In Month 1, I run a balanced budget which is, from inception, the MINIMUM that can be spent, without a continuous deflation. That is, the kids would not be able to earn at least as much as they needed to pay taxes.

If the budget is balanced there can be no net saving or net accumulation of financial assets.

In Month 2, I agree to the kids’ desire to save some business cards so they can temporally arrange their work load and have holidays. The children’s desire for thrift forces me to run a deficit as a matter of course. They cannot save in the currency unless I am spending more than I tax them.

So the desire increases the level of activity in the economy by 200 cards per month and the extra employment generates higher incomes and permits the children to save 200 cards a month.

The principles now understood include the finding that public deficits allow the private sector to net save in the fiat currency and accumulate financial assets. In this case the saving is in the form of non-interest earning business cards.

Further, the accumulated saving of financial assets is the stock of wealth and reflects the accumulated fiscal deficits. The stock of past savings as it stands do not earn any interest. Another way of looking at this is that there is excess liquidity (spare cards) in the overall system and the rate of interest is zero.

To reward thrift, I introduce a new financial asset – a bond in Month 3 which will pay 10 per cent on all cards saved. The payments are made with respect to last period’s stock of bonds. So all accumulated cash (card) savings are converted to bonds (400 in Month 3). The bonds are recorded in the spreadsheet and have instant maturity (that is, can be converted back into cards at any time).

In Month 4, I start paying interest income on the outstanding stock of bonds so in addition to wage income (800 cards) I pay 40 cards in interest income. The payments are made in the same way as all spending – I just calculate the amount owing and enter the number in the spreadsheet. Just an accounting entry. The kids notice that their non-wage income has increased which allows them to further accumulate wealth.

Seems as though everyone is happy. I am using my fiscal capacity to deploy otherwise idle labour which created income. The income, in turn, generates the capacity to save as long as I run deficits which I am happy to do. The only cost to the household in all of this are the real resources being consumed in the the process of generating the income. The spreadsheet entries are all costless.

What we all realise in this household is that the accumulated public deficits equal the accumulated private savings, which, in turn, sums to the accumulated stock of financial assets. This stock of financial assets can be split between cards and bonds as per the preferences of the children.

It is also clear that the rate of interest would be zero unless I issue the bond or agreed to pay an interest rate on the saving balances. The bonds cannot be bought by the kids unless I have previously spent an equal sum of cards. The bonds do not “finance” my business card spending in any way at all.

Here is the spreadsheet accounts describing the first four happy months of our household. I assess the kid’s have as much work as they desire and so the household is at full employment. There is enough demand to allow them to save cards for future use (like buying some other labour to allow them a holiday in one month or more).

So far so good.

Some neighbours arrive

After lying empty for 4 months or more, the house next door suddenly becameoccupied at the beginning of Month 4. Yes, a lovely family arrived to take up occupancy.

I believe they are called the China family. Their kids are very eager to work and my kids are very eager to use some of their income (cards) to pay them to work.

Further, Dr. China (the female parent next door) has introduced a similar scheme to the one that has been successfully operating in my place for the past four months – she is paying and taxing her kids in her business cards to motivate them to work around her house.

Given the fences are easy to jump over, what emerges in Month 4 is that our kids and the China Family kids start doing deals. The work in each house is not identical. Our kids are happy to work over there and they have found the next-door neighbours kids are happy to work in our house doing things.

The work our kids do next door amounts to our house resources earning income next door which we might call Export (X) income. They are paid in China Business Cards (CBC) which they can hold in that denomination or convert at the fence into my business cards. I abstract from the inner workings of the foreign exchange market that operates on the fence perimeter. That is another story but does not undermine any of the main results here.

I am happy to allow my kids to pay the China Family kids to work in our house in my business cards that they either earn or have saved. This allows them to work less if they desire. So it is like substituting saving for leisure. The work that the China Family kids do around our house amounts to us leaking some of our domestic spending (income) over the fence and we might call this Import (M) expenditure.

The China family kids convert my cards into CBC or hold them as they see fit. I am also happy to allow the China Family Kids to buy my bonds and earn interest in the same way that my kids can if they want to hold their accumulated saving in this way. Of-course, I only accept my cards in return for a bond and all my interest payments are in my cards.

All transactions are maintained in my spreadsheet system which the kids call the “central bank” because they learned at school that they can keep their accumulated saving in a “bank”.

An exchange rate (the relative price between my cards and CBC) emerges and reflects the relative demand and supply of the two types of business cards. So if exports are less than imports (which we might call net exports (NX) < 0)) then there are more of my cards being supplied in exchange for CBC and so the price of my cards relative to CBC falls - we might call this a depreciation. The opposite holds. Initially the parity is 1 but that soon changes due to "market forces". That is, we decide not to peg our exchange rates because it would tie up our days worrying about it. Each family aims to maximise welfare using its respective card fiscal policy and to keep it free from having to worry about pegs.

I soon noted that, in general, the willingness of my kids to pay the China Family kids to do work in our house rose with total income but fell somewhat when my cards were depreciating against the CBC and vice versa. Note: the capacity to export might also rise when my cards depreciated against CBC but for simplicity I have made this sensitivity zero. It doesn't alter anything of substance.

At the outset, I notice that both sets of parents are happy that their kids are being industrious and jumping the fence to earn each other's cards. However, the China Family appears to have a curious attitude - they are happy to "export" more labour services to our house and accumulate my business cards than the labour services they get back in return.

It is clear to me that exports are costs (my kids could be working around our place instead of next door) while imports are benefits (the China Family resources improving our welfare). So it was curious that the China Family would want to give us more real resources than we had to give them just to accumulate my business cards. No telling though ... people are different.

But the China Family attitude certainly enhances our welfare - we get more net real resources and I am happy that lots of work is being done around the house and my kids are happy that someone else is doing it.

To understand the impact of the neighbour's arrival we also have to redefine total income produced in our household per month (a flow). Prior it was just my spending (on wages and interest payments). Now, we earn "export" income which has to be added to the "public" spending (G) but we lose the "import" spending to the China Family.

So we define the total household GDP to be equal to G + X - M, which is something I read in some textbooks as well!

Month 5 – trade begins

As you will see, things now get more complicated.

Given the China Family attitude to importing and exporting and my kids’ attitude to substituting leisure for work in Month 5 a trade deficit soon opens up. We export our labour worth 30 cards and they provide us with 148 cards worth of work which leads to a trade deficit of 118 in Month 5. The exchange rate depreciates as a result which has some attentuating impacts next period.

I am still paying out 800 in wages and now I am paying 64 cards in interest servicing payments (because the kids had accumulated 640 cards as bonds at the end of Month 4).

So total house income (GDP) in Month 5 = 864 + 30 – 148 = 746. So you can see that the household economy contracts because of the leakage in imports outweighing the injection from exports but my kids are working less by choice.

The public deficit rises to 264 cards (spending = 864 and taxes = 600). This deficit is now not fully added to the national debt because the kids use some of the potential saving to purchase imports. So they save 146 cards in Month 5 courtesy of my fiscal deficit (minus their import spending) and their bond holdings (wealth) rises by the same amount.

Notice also that the China Family kids have also accumulated 118 of my cards which they also convert into bonds. I create some new rows on the spreadsheet to record this and give them copies. These bonds will earn interest for them next period but all spending on this will remain in terms of my cards and inject extra cards into the household economy.

Overall, the national debt is now 904 cards (sum of my kids’ and the China Family kids’ bond holdings).

You will also clearly appreciate that the China Family kids (or their parents) have played no role in allowing me to spend my 864 and run a deficit of 264 cards in Month 5. I would have still run a deficit by choice and if they didn’t want to allow us to import as much then domestic income and saving would be higher and my deficit would be slightly lower.

Finally, the sectoral balances are more complicated than before trade was introduced. We will consider them separately in the next main section. But you can see that the sum of the balances still adds to zero, as is dictated by the national accounting framework.

Month 6 – a neo-liberal inspired fiscal austerity program begins

As we learned in the simple model without neighbours, one night I started to read about the dangers of public spending and deficits. I spend the whole night while the kids were safely sleeping on the Internet reading neo-liberal economics literature.

The literature was at odds with what I was observing. Everyone seemed to be happy and working hard and enjoying life around the house and I was certainly getting the tasks I wanted done performed by the kids.

But the economists and some Youtube videos I watched (by someone saying they were from the Austrian gold standard libertarian school of thought) were really scary.

My budget was about to blow out and become viral. The interest rates I would have to pay on the debt would sky-rocket because no-one would want to hold it at 10 per cent. Funny I thought, I don’t actually care if they hold cash balances or bonds. I thought I was doing the kids a favour offering them a interest-bearing asset. But that is not what the literature said. Viral!. Okay, that’s scary.

It was also clear from the literature that I had become hostage to the China Family who were now funding my deficits and would pull the pin on me anytime soon because they wouldn’t want to hold anymore of my bonds. Funny, I thought – my spreadsheet was encrypted so they couldn’t hack into it. I just sat there typing in numbers each month to determine by wage payments. They were my business cards after all – the China Family had their cards (CBC) but mine were mine.

But the liberatarian person – I actually had to turn the volume down while listening to him down because he had such an abrasively whining voice that sounded as if he knew nothing – but he had said the China Family would undermine our welfare. I didn’t want that.

The literature also said I would have to impose punitive taxation on my kids to get my budget deficits down and into surplus and pay back the national debt. Paying back the debt had to my priority it said. Further, high taxation would undermine the incentive of the kids and they would just refuse to work.

Funny, I thought, they were really happy to be working at present and using the increased income, savings and wealth to buy in real resources from elsewhere to make things even better.

They also were really pleased to buy the debt I offered them because they got a little extra reward for their saving. Also if they refused to work how would they pay the taxes anyway? The fact they had to get by cards to pay the taxes and therefore remain living in the house was the reason they offered to work in the first place.

The literature was adamant. I read newspaper columns and IMF papers. I bought Mankiw – which I learned was a famous textbook. I couldn’t believe how expensive it was but it must be worth reading at that price.

All these sources were telling me … I needed a credible exit strategy!

So in Month 6, I follow the advice and implement a fiscal austerity plan by cutting back on the amount of work I am prepared to pay for. I only offer 450 cards in that month to my kids. I note that exports (the amount of work my kids do over the fence) does not change (they can earn of my 30 cards when converted).

The dramatic decline in income plus the depreciating exchange parity between my cards and the CBC work together to reduce the trade deficit. Yes, I had also read that the trade needed to be rebalanced and I could not longer keep running a trade deficit, even though I had always thought they were delivering net real benefits. Anyway, imports (the China Family kids working here) falls to 94 and net exports falls to a deficit of 64 (down from 118).

The literature indicated that some short-term income losses would occur but in the long-run demand (fiscal) policies were not determining in terms of income growth. So I wasn’t concerned that our national GDP had fallen from 746 cards to 476 cards per month in Month 6. This was going to be a short sharp shock to get everything back on track.

But I must admit I hardly gave the other aggregates much attention because I was noticing I was back into a budget surplus. With total G = 540 and T = 600, I turned in a beautiful number – a 60 card surplus in Month 6. All other issues were rather insignificant given my goal to get back into surplus. The exit plan was working.

I call a family meeting and said:

We have had to “pull our belts in” and that it was time to be fiscally responsible. I had to set the household economy back on the path to fiscal sustainability. This surplus will underpin future growth once I get the national debt off our backs.

I quoted Mankiw about all of this but no-one knew what I was talking about.

The kids just looked on edge and said something about their savings were drying up and they couldn’t get as much work as they wanted and the China Family kids were now staying over their side of the fence a bit more. They also said that in Month 6 they had to sell 124 cards worth of bonds they were holding to meet the shortfall between income and tax obligations.

So they claimed they were not as well of as before. I told them “we all have to pull our belts in and do our bit to get this house economy back on track”.

When I examined the spreadsheet further I noticed that I had indeed retired 60 cards worth of the national debt – by buying back 124 card bonds from my kids while still selling 64 card bonds to the China Family (as a result of the on-going current account deficits).

But there was still 844 cards of debt outstanding.

I also noticed the China Family had accumulated even more debt as a result of the on-going trade deficits and this needed to be addressed. I had to get rid of the trade deficits as well as the national debt.

I also noticed my interest payments were still rising. That signalled to me that next month even tougher measures were required or I might go broke as the neo-liberal literature had been warning me.

However, if I had stayed reading billy blog I would have realised that:

  • Budget surpluses squeeze the private sector for liquidity and the private sector is forced to run down wealth through negative saving in order to meet their tax obligations.
  • Budget surpluses destroy private wealth!
  • When the government is in surplus and the external sector is in deficit, the private domestic sector must be dis-saving and running down their wealth.

Months 7 and 8 – budget surpluses grow, private (kids’) wealth falls
From the neo-liberal perspective, my strategy as the government of the household has been exemplary. I am now generating surpluses and retiring debt. I am no longer living beyond my means. I fail to notice that the kids’ (private sector’s) wealth is being destroyed and they are unable to work as much as they want.

However, I read in one of the articles that it was highly likely that the kids didn’t want to work anyway – they probably had attitudinal problems or were demanding excessive earnings. So if the rising unemployment was voluntary anyway and the kids were enjoying leisure more what is the problem?

I also fail to notice that the kids who hadn’t accumulated any wealth are facing rising debts. They seek to borrow from other kids because their work opportunities are being limited and they have to pay their taxes still.

Anyway, bouyed by all my economic reading and the events in Month 6, I decide that I should try to wipe out all the national debt. So in months 7 and 8 I extend the fiscal austerity and cut spending to 400 then 350 cards per month. I also note that my interest servicing payments on the outstanding debt are falling (84 then 73 cards per month). All this is heading in the right direction.

I thus enjoy increasing surpluses of 116 (Month 7) and then 177 (Month 8).

I also read about the twin-deficits thesis which said that budget deficits drive up current account deficits and so you have to reverse that process. I note in this regard that the trade deficit is narrowing dramatically as total house economy income (GDP) falls from 429 to 378 over the two months.

In Month 7 I retire a further 116 card bonds (national debt) – buying back 171 card bonds from my kids but selling 55 card bonds to the China Family. I note that the foreign component of this debt is falling too. Good! Even though this debt is denominated in my cards, I read that foreign debt would force me to default more quickly than locally-held debt. It didn’t make sense, but then who was I to question.

In Month 8 I retire a further 177 card bonds (national debt) – buying back 222 card bonds from my kids while selling only 45 card bonds to the China Family.

At the end of Month 8, national debt is at 55 card bonds down from the unsustainable level of 904 at the end of Month 5. My kids now hold 270 card bonds and the China Fmaily 282. More work is needed.

I don’t make the connection that the budget surpluses are forcing my kids to increasingly dis-save and run down their wealth to stay solvent. All I am motivated to do is to get the debt monkey of my back.

If I had have stayed reading billy blog I would have known that:

  • The reductions in outstanding public debt is systematically reducing the income-earning opportunities for the kids. So not only does the austerity plan reduce employment opportunities it also erodes private fixed-income capacity.
  • The budget surpluses continue to destroy wealth by squeezing the private sector of liquidity.
  • Some kids will be becoming increasingly indebted.
  • The introduction of a trade deficit doesn’t alter this result.

Month 9 – National debt falling, private (kids’) sector insolvent

In Month 9 I make further cuts in my wage spending to really drive down national debt. I want to push the net exports position into surplus and stop the foreign debt rising and I want to extinguish all locally-held public debt.

That idiot on billy blog starts accusing me of being a “deficit terrorist” – but what would he know anyway?

Anyway, the austerity plan continues and I cut my wage bill to 310 cards per month and my interest payments on outstanding public debt fall to 55 cards.

The exchange rate is starting to appreciate as the trade balance narrows and the IMF indicated this was a desirable growth strategy. Problem is that total house economy income (GDP) has fallen further to 330 cards and there is no longer much work being done around the house. The garden is in a sorry condition and rubbish is piling up. Moreover, some of my longer term projects – I called them public infrastructure development projects – like painting the house are now abandoned.

But this is all temporary – that is what the message from the mainstream economics writings is. Clearing out the debt and getting the deficits down will pave the way for growth.

My budget surplus is now a wonderful 235 cards but needs to be higher because there is still outstanding national debt.

The kids now dis-save a further 270 cards (their total income is 330 and they have to pay 600 in taxes). They get the shortfall by selling me back their bonds. It just happens that they had exactly 270 card bonds left so I have retired all locally-held national debt. That is a cause for me to call another family meeting, rather like going on national TV, and announcing that:

The household economy has now retired all its locally-held debt. We will not have to pay higher taxes to pay the interest servicing payments and now we are running surpluses, the deficits have all been paid back too.

The kids look at me with a distant gaze – they seem troubled by this news – I don’t realise they are now underemployed and insolvent.

For next period, they will default on their tax obligations given they have no sectoral wealth left and they cannot earn enough income to cover their obligations. I tell them that they will have to work for less card income if they want to get more work. They wonder how that will work when I am still only paying 310 cards per month and expecting 600 back!

I also note that the current account is heading into surplus (a small deficit remains) which will allow me to start retiring the foreign-held national debt. Before long our household economy will be debt-free, running external surpluses and will continue to run budget surpluses. Everything that the design of the credible exit plan I read in countless articles specified.

I just have to convince the kids to save more so they can pay their taxes in the coming months. I have done as much as I can to get the tax and interest payments monkey off our backs!

But more can be done and I start to read about Greece and the need to avoid sovereign default on outstanding held by the China Family. More fiscal austerity is called for.

If I had continued to read billy blog I would have realised:

  • The accumulated budget balances equal the accumulated savings in the non-government sector. The distribution of these accumulated savings between private domestic and external depends on the size of the external deficit. The prior local accumulated saving was achieved by cumulative budget deficits and the external deficits. The budget surpluses destroyed the private wealth and offset the earlier deficits (which had created private wealth).
  • Running surpluses thus forces the private sector to dis-save and private wealth holdings are destroyed as a consequence.
  • For a time the kids were able to borrow from each other to maintain their spending (and tax payments) but eventually, their saving is compromised by the falling national income (household wages plus interest payments). The fiscal austerity in each of the last 4 months causes recession and increasing unemployment and ultimately mass insolvency in the private sector.

Sectoral balances – another perspective

The following graph shows the sectoral balances from the Table to allow you to understand the relationships more clearly. You can observe the different stages of budget dynamics.

These balances are derived from the National Accounts and in summary (in our simple model without private investment) the condition that has to hold is that:

S + (T- G) – NX = 0

So private saving (kids) plus the budget surplus minus the external surplus has to sum to zero. It is easy to see that

S = -(T-G) + NX

So if the public balance is in surplus and there is an external deficit (NX < 0) then S must be negative by construction of the national accounts. You cannot escape that conclusion. In this example, we have seen how a wilfully designed fiscal austerity program in the presence of a current account deficit systematically undermines private saving.

At the outset, with a balanced budget and no trade, there is also no private saving overall. All income is being taxed away. As the business card deficits expand, the boost to total income allows the kids to save from month 2 at a steady rate. Note the graph is showing flows per month. In months 2 and 3, saving is 200 cards per month (a flow) which accumulate after month 3 to 400 cards of assets or wealth (a stock).

In Month 4, the neighbours arrive and imports rise faster than exports and so the kids are spending some of their income outside the economy which reduces their saving and the total income available. The net exports (current account deficit) rises but private saving is still strongly supported by the budget deficits.

Then the fiscal austerity program begins and the negative impact on total income is such that private saving now plummets in the negative zone. The current account deficit narrows as imports are hit hard (they are a function of total income). The kids can only meet their tax obligations now by selling up their bonds and using the liquidity to meet the shortfall.

As the fiscal surpluses continue to ravage income, the kids continue to dis-save. By Month 9, they have no wealth left and cannot pay their bills. They are broke and the system grinds to a halt with massive unemployment and poverty.

Conclusion

You can see that when the neighbours moved in certain distributional changes occured in the accounting relationships and the situation became more complicated. But the basic principles summarised by the sectoral accounts remain intact.

I could have extended the model to have a period of external surpluses. If they had have been large enough then private saving could have been supported even though the public budgets were in surplus. This is the Norwegian case. But very few nations are in this situation. Most of the nations are in the situation presented in this model. Current account deficits are the norm.

This typical model allows you to see that under these normal circumstances, budget surpluses undermine income generation, reduce the capacity of the private domestic sector to work and save, and destroy the wealth holdings of the latter. Ultimately this sort of strategy will generate insolvency and crisis.

The introduction of the next door neighbours should also dispel any notions that the “closed economy” version of this model was hiding something important. It was not. The sectoral balances are very clear when you add the external sector.

Further, you should be able to clearly understand that the China Family is not funding the public spending in this model. How can it? I issue my own business cards and they issue their cards. I spend in my cards.

Further, I don’t need to sell any bonds. All that would be different is that the bond holdings rows (local and external) would be zero and the cash holding rows would record the asset accumulation. Should either the local kids or the China Family kids not want to hold this cash then they could spend it in various ways and this would reduce my deficits anyway and help support growth and income generation.

I have also conducted this in real terms. It wouldn’t make much difference if I did it in nominal terms with a price level incorporated. In the growth phase as long as capacity was growing then inflation would not have been an issue and in the recessionary phase, deflation would likely occur and make matters worse.

But the underlying sectoral relationships and the budget-driven dynamics shown here would all still occur.

Most of the so-called experts who care to wax lyrical about exit plans and national debt never reveal they understand anything about these sectoral relationships or budget dynamics. Most of what they say would never “add up” nor is it stock-flow consistent.

What this simple model allows you to do is see the basic relationships clearly and how the spending, income and saving flows in each period impact consistently on asset stocks held. You will find very few mainstream economists who will entertain that level of consistency in their analysis.

In addition to the background reading I suggested above to map this model into the real world I would recommend you read the following trilogy: Deficit spending 101 – Part 1Deficit spending 101 – Part 2Deficit spending 101 – Part 3.

That is enough for today!

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    84 Responses to Some neighbours arrive

    1. Kid Dynamite says:

      Professor –
      are you going to extend this example into the opposite scenario – where instead of trying to balance your budget you continue to spend with a growing deficit? I think that might be illustrative.

    2. Kid Dynamite says:

      I have another question/scenario – your kids, at the end of month 9, are no less solvent than they were to start with at month 1 – so you repeat the cycle all over again, except of course now you are spending a little more to pay interest on the Chinese Neighbor’s bonds… Maybe you fail to learn your lesson, and you do this exact same cycle (deficit –> surplus) (the interest component will change, though, of course)… At the end of a number of cycles, your kids will always end up with no savings, while the Chinese Neighbor’s savings grow and grow and grow until one day:

      The Chinese Neighbor’s kids, after 10 cycles of 9 months each, are starting to grow up and want some independence. Even better, they have a lot of Billy Business Cards saved up to spend. They come over to your house and say “hey bill, I hate living in close quarters with my bro, I want to rent a room in your house. I’ll pay you 650 cards a month for it”

      of course, you’re a rational person – 650 is better than the 600 your kids are paying… and then we get: INFLATION.

    3. pebird says:

      Kid Dynamite – the business cards are of little inherent value to the central bank. Remember, the CB can print them at will. The CB wishes to generate work from its internal population. Also, the next door kids need to make their deals with the other kids – private sector to private sector.

      Doesn’t mean that the CB wouldn’t accept the offer (after all he is reading Mankiw), but then we would need to introduce another element to the model – a military – to oust the kids from their bedrooms.

      I prefer that the next chapter be that an uncle come to town to stay for a while – he agrees to the business card structure on the condition that he is given a charter to act as the CB agent to facilitate lending to the kids – and of course advising the CB on monetary and fiscal matters. What would happen next?

    4. NKlein1553 says:

      Kid Dynamite,

      Inflation would only ensue if all the work done by Bill and the China family’s children over the ten cycles of nine month periods did not result in any extra production of real resources. If over that time period the child labor had been used to build say an extra room, there is no reason why inflation would be a necessary consequence of having the China family’s kids move into Bill’s house when they turn eighteen. Whether or not Bill is capable of directing his child labor force to increase productive capacity is a different story. Although, if the alternative is zero-productivity unemployment I would assume any work completed under Bill’s direction would be preferable.

    5. NKlein1553 says:

      Rereading my previous statement I find the phrase: “under Bill’s direction,” to be misleading. This implies Bill is controlling the labor force directly, which is not specified in the hypothetical scenario described in this blog. A better phrase would be “on Bill’s behalf.”

    6. Tom Hickey says:

      Interesting post by Dani Rodrik on globalization. (h/t Yves Smith here on EU/Greece)

      The inescapable trilemma of the world economy

      I have an “impossibility theorem” for the global economy…. It says that democracy, national sovereignty and global economic integration are mutually incompatible: we can combine any two of the three, but never have all three simultaneously and in full.

    7. Yossarian says:

      But why are your kids paying the same amount of tax that they were paying before their incomes fell? And what is happening to their expenses- are you charging them the same amount for food, rent, and utilities? If they are trading with each other why are the prices of trade-able goods and services not falling along with the supply of business cards? Perhaps the prices are staying high because China Family is spending the cards that they accumulated, buying up all of your kid’s Vegemite.

      You describe the economy: “there is no longer much work being done around the house. The garden is in a sorry condition and rubbish is piling up.” Why are your kids so lazy? Or is it that the Draconian Emperor (you as the govt) running the economy stubbornly refuses to bring their expenses down proportionately with income?

      What happens when we introduce Arab Family who just discovered their house sits atop a geothermal energy source. They supply both your family as well as China family with heat and electricity. The winter is particularly cold and China family desires more heat so they send more of their spare cards to Arab Family in exchange for more heat. But Arab family only has a fixed supply and tells your family that they will have to either pay more for heat or get less heat. Your family would rather forgo a snack than be cold so they pay the higher price for heat. But now they have less to pay for Vegemite and so your kids are forced to go into your pantry so they can sell more Vegemite to China family so that they won’t have to go over the fence and work.

    8. Tom Hickey says:

      Last Mile update: Meteor Blades and BarbinMD, influential bloggers at Daily Kos, have cited Randy Wray in several posts. Daily Kos is a widely read progressive Democratic site.

    9. Yossarian says:

      When prices are stable in the face of productivity enhancement that allows for the production of 3-4% more goods with the same resources/effort, that IS inflation. The hidden cost of inflation is being masked by higher productivity (or cheap labor from, say, China). So your inflationary policies are robbing some citizens of 3-4% purchasing power increase every year. Of course for every loser there is a winner and someone is benefiting from that inflation. Those someone’s are most heavily concentrated in DC and on Wall St.

    10. Detroit Dan says:

      Thanks for the alert, Tom Hickey. I’m headed over. Glad to see the modern money principles being more widely discussed…

    11. bill says:

      Dear Kid Dynamite

      Or I act as an entrepreneur anticipating they will want to live at my house and I make extensions and increase “productive capacity”. Once I cannot do that then inflation might be an issue but I can then simply put the tax rate up to choke of excess demand.

      best wishes
      bill

    12. Adam (ak) says:

      Dear Bill,
      Of course your model is valid – but it is valid because of the assumptions you made. Adam Smith defined the goal of all the economic activities as maximising consumption. Your kids are trying to do exactly that. What if in your model you have a not a Chinese but a German family believing in “Der Merkantilismus” and their children not only work on your property but also keep marching in their backyard to the sounds of Parademarsch?
      One day they will cross the fence with a tank made of cardboard and take away a piece of your backyard claiming that they need more space and they have accumulated enough of your bonds to make they claim justified – and your kids won’t be able to do anything because the German kids grew stronger. You made them stronger.
      (To all the German readers: I only refer to the stereotype valid in period circa 1860-1945).

    13. bill says:

      Dear Adam (ak)

      The model is a reflection of the way the modern monetary system operates. The assumptions are entirely applicable to the real world we live in unlike the assumptions that drive mainstream economic theory.

      On top of the monetary system, lies a political system and national agendas. Of-course, they can deliver negative consequences of the type you outline. But those considerations are beyond my professional expertise and irrelevant to the point I was making with the model – it is a learning device to allow people to resolve difficult issues in monetary economics.

      best wishes
      bill

    14. bill says:

      Dear Kid Dynamite

      You said:

      your kids, at the end of month 9, are no less solvent than they were to start with at month 1

      Yes they are. The difference is before Month 1 there was no monetary system and so need to work to pay taxes. At the end of Month 9, the monetary system is in place and they have legal obligations (600 cards per month) which I have forced them to default on by not supplying enough cards.

      best wishes
      bill

    15. Gamma says:

      This “model” is nothing close to how the modern monetary system operates Bill.

      Name one country in the world that imposes taxes first, and requires citizens to pay regardless of income. A tiny proportion of taxes operate in this way (council fees, land tax, perhaps).

    16. Burk says:

      This and its predecessor is a fantastic presentation of mmt basics. Could it be extended to the creation and resolution of inflation, the utility of interest rates in controlling inflation, worker-capital disputes leading to stagflation, politically uncuttable expenses leading to excess spending, etc., private fractional banking with credit creation, and resource shocks? Or just one of the above? Thanks!

    17. Tom Hickey says:

      Name one country in the world that imposes taxes first, and requires citizens to pay regardless of income. A tiny proportion of taxes operate in this way (council fees, land tax, perhaps).

      The colonial British actually did this in Africa to force the natives to work. Don’t have the citation off-hand. Perhaps someone else remembers.

    18. bill says:

      Dear Gamma

      I could have made taxes a function of national income and therefore introduced some automatic stabilisation into the model. But it would have been more complicated again and you would still get the same result. A lack of fiscal support undermines private saving and if carried out long enough will drive the private sector into insolvency.

      The accounting dynamics and stock-flow mechanisms in the simple model are exactly the same as those operating in modern monetary systems. Most commentators in the media fail to demonstrate an understanding of these underlying mechanics.

      We need to walk before we can run!

      best wishes
      bill

    19. bill says:

      Dear Burk

      Thanks for the comment. It could be extended in many ways but then I would be getting beyond the scope of the purpose which is to illustrate the underlying national accounting relationships and their dynamics. I will think about extensions though that don’t muddy the waters too much.

      All your suggested extensions are important considerations that overlay the basis stock-flow relationships that my little play model illustrate. Many of them are in the politicial rather than monetary sphere, which is not to say their manifestations don’t have monetary implications (they clearly do).

      best wishes
      bill

    20. bill says:

      Dear Tom and Gamma

      Imposing a poll tax was often used by colonialists to force a currency onto an otherwise “independent” nation of people. Then the complexities of the tax system that Gamma noted followed.

      best wishes
      bill

    21. Kid Dynamite says:

      bill wrote, in a comment reply:

      “Yes they are. The difference is before Month 1 there was no monetary system and so need to work to pay taxes. At the end of Month 9, the monetary system is in place and they have legal obligations (600 cards per month) which I have forced them to default on by not supplying enough cards.”

      then reduce taxes! you’ve balanced the budget after all, why continue with this surplus? better yet, why not remove your monetary system – just declare your currency worthless, end taxes and salaries, totally screw the chinese neighbors who have saved up your business cards, and let your kids go back to watching tv and eating Cheetos.

      i am eagerly looking forward to the example where you show what happens when deficits balloon and you illustrate why it’s not a problem

    22. Fed Up says:

      Kid Dynamite and bill, I think you need to distinguish between deficit spending with currency and deficit spending with gov’t debt.

    23. Fed Up says:

      At the beginning, I think you need to add some steps.

      1) An “entity” prints currency (600).

      2) The “entity” gives the currency (600) to the gov’t.

      3) The gov’t then deficit spends the currency (600).

    24. Fed Up says:

      “If the budget is balanced there can be no net saving or net accumulation of financial assets.”

      Assuming no debt, does that mean there is no private spending either?

    25. Fed Up says:

      I would like to see private spending and wealth/income inequality (possibly even including “retirement” inequality) included.

    26. Fed Up says:

      Off topic but…

      For JKH and anyone else who would like to comment.

      From:

      http://macroblog.typepad.com/macroblog/2010/02/the-punch-bowl-the-party-the-exit.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+typepad%2FRUQt+%28macroblog%29

      “Here’s the way I think about the options addressed by the Chairman in his prepared remarks. Let’s start with a well-traveled metaphor for how “policy accommodation” works:

      Step 1: The Fed fills up the punch bowl (by buying assets and lending funds to financial institutions, which corresponds to a like quantity of liabilities on the central bank’s balance sheet, which includes bank reserves).

      Step 2: Bankers spike the punch (by leveraging the quantity of bank reserves outstanding into a multiple quantity of loans to the private sector).

      Step 3: The party’s on (as businesses and individuals support production and consumption from the credit provided).”

      “By Dave Altig, senior vice president and research director at the Atlanta Fed”

    27. Tom Hickey says:

      I think you need to distinguish between deficit spending with currency and deficit spending with gov’t debt.

      The government is the issuer of the currency, which it uses for its disbursements. It does not borrow in order to spend. It does not tax in order to spend. Government spending is the way the government issues currency into the non-government economy by government purchases of goods and services and other disbursements.

      Debt issuance is a monetary operation rather than a fiscal one. Debt issuance transfers the excess reserves generated by deficit spending through currency issuance into savings of non-government net financial assets when the debt is purchased by non-government entities. It is a transfer of one government liability/non-government asset into another. It’s a wash.

      Winterspeak has a short summary of MMT here that explains how it works clearly and concisely.

    28. Fed Up says:

      Would it be possible to eventually have deficit spending with currency thru the interest on the national debt?

    29. Tom Hickey says:

      At the beginning, I think you need to add some steps….

      1. The Fed credits the Treasury’s reserve account at the Fed (600).

      2. The Treasury disburses that amount through spending on goods and services and other disbursements (600).

      This occurs through writing checks, e.g., SS, and electronic transfers. No cash is involved. This is not the way that cash enters the banking system. Banks exchange reserves for cash as demand at the window.

      Through the settlement process the 600 in the Treasury’s reserve account is transferred into the reserve accounts of the commercial banks that the recipients of the Treasury disbursements use. Then these banks credit the respective deposit accounts of there customers who spend, save or invest the funds as they chose.

      Note that reserves themselves are never spent into the economy. They are for settlement purposes in the FRS only.

    30. Tom Hickey says:

      Would it be possible to eventually have deficit spending with currency thru the interest on the national debt?

      Interest payments on the national debt are made through currency issuance and increase non-government net financial assets. Interest on national debt is part of the budget, so yes, deficit spending can occur through interest payments. They are government disbursements, just like other government disbursements.

    31. Tom Hickey says:

      “Here’s the way I think about the options addressed by the Chairman in his prepared remarks. Let’s start with a well-traveled metaphor for how “policy accommodation” works:

      This conceptual model misrepresent what happens operationally. It is based on the erroneous money multiplier that presumes incorrectly that banks “lend reserves,” or lend on reserves.

    32. Fed Up says:

      Tom Hickey, I don’t know if it will work out, but I’m trying to come up with a wealth/income inequality scenario (table like here) with positive price inflation targeting where the gov’t does deficit spend with gov’t debt (the national debt).

    33. bill says:

      Dear Fed Up

      I will reply to your points later but if you want my spreadsheet to help you with your innovations send me a real E-mail and I will post it to you.

      best wishes
      bill

    34. “i am eagerly looking forward to the example where you show what happens when deficits balloon and you illustrate why it’s not a problem”

      Please define “balloon” so that there’s no misunderstanding. Do you mean a very large deficit in the pursuit of full employment? Continued deficits after full employment is reached? Something else?

      Thanks.

    35. Fed Up says:

      Tom Hickey said:

      “1. The Fed credits the Treasury’s reserve account at the Fed (600).

      2. The Treasury disburses that amount through spending on goods and services and other disbursements (600).

      This occurs through writing checks, e.g., SS, and electronic transfers. No cash is involved. This is not the way that cash enters the banking system. Banks exchange reserves for cash as demand at the window.

      Through the settlement process the 600 in the Treasury’s reserve account is transferred into the reserve accounts of the commercial banks that the recipients of the Treasury disbursements use. Then these banks credit the respective deposit accounts of there customers who spend, save or invest the funds as they chose.

      Note that reserves themselves are never spent into the economy. They are for settlement purposes in the FRS only.”

      Under that scenario, it seems to me that anything other than currency is some type of debt. Assuming that, I would say 600 of some type of debt is created and less (possibly a lot less) currency is actually printed.

    36. Fed Up says:

      Tom Hickey said: “Would it be possible to eventually have deficit spending with currency thru the interest on the national debt?

      Interest payments on the national debt are made through currency issuance and increase non-government net financial assets. Interest on national debt is part of the budget, so yes, deficit spending can occur through interest payments. They are government disbursements, just like other government disbursements.”

      Good. I’m hoping that I’m starting to get what the model looks like.

    37. Fed Up says:

      Tom Hickey said: “Here’s the way I think about the options addressed by the Chairman in his prepared remarks. Let’s start with a well-traveled metaphor for how “policy accommodation” works:

      This conceptual model misrepresent what happens operationally. It is based on the erroneous money multiplier that presumes incorrectly that banks “lend reserves,” or lend on reserves.”

      Is this possible and thoughts? Under some past scenarios and if the fed electronically “printed” excess reserves, the banks would just say give us the currency. Then the banks would use this currency as bank capital to make loans. The bank capital multiplier would look like the reserve multiplier.

    38. Tom Hickey says:

      “Excess reserves” means in excess of the reserve (liquidity) requirement. The banks still need the reserves for settlement, when they credit their customers’ deposit accounts and the customers then write checks on these accounts that are deposited in other parties accounts. The reserves are the bank’s liquid assets that it uses to meet its liabilities, like the checks drawn on customer’s deposit accounts.

      Bank assets offset bank liabilities, and bank assets are different from bank capital, which is the equity of the bank. Here is an explanation. Basically, reserve assets involve liquidity, and bank capital determines solvency.

    39. bill says:

      Dear Kid Dynamite

      Thanks again for your comment.

      You asked:

      then reduce taxes! you’ve balanced the budget after all, why continue with this surplus? better yet, why not remove your monetary system – just declare your currency worthless, end taxes and salaries, totally screw the chinese neighbors who have saved up your business cards, and let your kids go back to watching tv and eating Cheetos.

      It is not the monetary system that is the problem but the misunderstanding of it which leads to the abuse that I demonstrated. Why continue the surpluses indeed! The economy was fine running deficits which were supporting saving.

      The reason why I would not scrap the monetary system is because it is capable when properly managed create public and private wealth and advance welfare for all the citizens. When it is misused it destroys the same.

      I am not sure the neighbours were of Chinese ethnicity. Their name was Dr and Dr China!

      You then said:

      i am eagerly looking forward to the example where you show what happens when deficits balloon and you illustrate why it’s not a problem

      As Scott said we need a definition. But if I may anticipate – yes, I could have a situation where all real resources in the house were fully employed and no further output was possible in the economy. Then if I kept increasing the deficit beyond that point then I would be misusing the fiscal capacity and I would illustrate to you that it is a problem.

      But prior to that, under the circumstances I outlined (the sectoral balances) the deficits were adding wealth and income.

      Why don’t you start the discussion on those terms and let me know if you disagree with those propositions. All sorts of horror scenarios can be dreamed up where I become an idiot and misuse the monetary system I am in charge of and bad outcomes occur. Definitely – and that happens in the real world too. We can also imagine military invasions by the China Family as one comment conjectured. Sure – the US invades nations often.

      But why not start on my terms and work through the model as it is and see if we disagree on the stock-flow consistency and the national accounting. That would be a good place to start.

      best wishes
      bill

    40. Tom Hickey says:

      Under that scenario, it seems to me that anything other than currency is some type of debt. Assuming that, I would say 600 of some type of debt is created and less (possibly a lot less) currency is actually printed.

      Well, I suppose you could say that the Treasury’s being provided reserves from the Fed corresponding to its currency issuance means that the Treasury has a liability to the Fed, but the Fed as central bank and the Treasury are both the government, and the government cannot “owe” itself anything except as a fiction of accounting to satisfy accounting identities. There is nothing “real” going on though. It’s just bookkeeping that records what government does internally. It doesn’t impact the real economy other than to facilitate the flow of funds through settlement in the FRS.

      It definitely is not like the Fed lends the money to the Treasury and then the Treasury spends it into the economy, which is, I suspect, what you may be thinking. There is a widespread conspiracy theory that the Fed is a private bank that creates money and lends it to the Treasury at interest. This is completely bogus.

      I see where you are going, though. You might say, then, where does the Fed get the reserves? Does it “borrow” them from someone? If where does that someone get them, and so on ad infinitum. The government doesn’t borrow from anyone when it issues currency. The reserves provided by the Fed are simply for liquidity purposes. There aren’t two real things, reserves and currency. These are numbers in spreadsheets, reserves in the interbank system, and currency in the commercial banking system. Some of the government money in the commercial bank system is cash, but this is a very small proportionally. The banking system is essentially spreadsheet containing constantly changing numbers.

      Reserves just make the currency liquid so that it can flow. “Reserves” were physical (gold) when there was convertibility but now with a fiat currency, which is by definition non-convertible, nothing real corresponds to reserves. Nada. Zip. You can’t convert dollars into reserves. They are spreadsheet entries used only for interbank settlement. Reserves are an accounting fiction for settlement purposes only . Government issues currency through disbursements and reserves at the Fed provide the liquidity for settlement in the interbank system (FRS).

    41. Tom Hickey says:

      Fed up, when I say that “You can’t convert dollars into reserves,” I mean you as an individual, not a generic “you” that signifies that it is not possible to convert cash into reserves and vice versa. But only banks can do this, because only they have access to the interbank system, along with government.

    42. Anonymous says:

      Next time, you’ll have to introduce credit and the horizontal relationships, to give us another big piece of the puzzle!

      Is it only me that worries that we are giving China too much US treasury savings? I mean they are acquiring some serious purchasing power, that they might some day use. Hell, at the rate they’re going it won’t be long before they can live off interest alone.

      I also wonder how the rest of the world’s banking system will survive if the expansion of US debt stopped or contracted.

    43. Kid Dynamite says:

      Bill –
      thanks for the replies. look – it’s fairly simple to illustrate that you can’t have sustained surpluses in your business card economy when you start from month 1. without even bothering with the shenanigans, you can just try to tax at 600 cards and spend 400 cards in wages – then you get insolvency in month 1. I think what people like me are having a much harder time understanding is if you’re suggesting that because sustained surpluses don’t work then it implies that sustained deficits must then work. This seems clearly and obviously wrong, and I don’t even think it’s your point – but it is what “we” non-MMT’ers hear (correctly or incorrectly) when MMT practitioners argue against reducing the deficit – we hear “the US doesn’t need to balance their budget because government debts are different from household debts, the government doesn’t need to fund its spending with taxes or debt, and surpluses lead to bad things.” We turn around and reply “but that doesn’t mean we can accumulate endless debt and deficit – it has to end badly at some point” – IN THE REAL WORLD!

      I’m not sure I really want to debate this next point with you, although i don’t think it’s really true. you wrote:

      “It is not the monetary system that is the problem but the misunderstanding of it which leads to the abuse that I demonstrated. Why continue the surpluses indeed! The economy was fine running deficits which were supporting saving.

      The reason why I would not scrap the monetary system is because it is capable when properly managed create public and private wealth and advance welfare for all the citizens. When it is misused it destroys the same.”

      Things were fine in your household before you introduced an artificial currency and monetary system, weren’t they? you clearly don’t need business cards to get them to do the chores – the business card economy doesn’t create any wealth or advance welfare for your kids does it? couldn’t they just have a list of chores to do instead – and consequences if they don’t do them?

      as for your question for clarification from me: what is the definition of full employment in your house? your kids are fully employed as early as month 2 aren’t they? perhaps you can show both in your next example: how continued deficit spending WITHOUT full employment isn’t a problem, while continued deficit spending WITH full employment is a problem.

      you also made a reference earlier to “productive capacity”… i’d love a more detailed discussion of that point. Trying to bring it back to real world relevance again: i’m still confused as to what you are suggesting in terms of full employment as it relates to the USA. would it be ok if the government paid all unemployed people to dig holes and fill them in again? or do the jobs have to be “productive.” if the jobs don’t have to be productive, then instead of paying people to dig holes and fill them in, why not just pay the people to sit at home and do nothing? (and nevermind the fact that this may sound like unemployment insurance, although it may be relevant!”). Would it be ok if the government spent a billion dollars creating jobs that produced a fraction of that in “capacity” ??

    44. rvm says:

      Hi to everybody, fascinating blog indeed! Will spread the word around to everybody I know!
      Here is a question:
      What makes the Chinas’ kids eager to work for foreign currency in their neighbor’s household?
      Maybe they have some spare time which they prefer to spend working second job, and they weren’t able to find such in their own household? What makes the foreign business cards valuable for them as they don’t need them to pay their own taxes – the possibility that they can exchange it for domestic money?

    45. Greg says:

      Hey Kid

      I remember you commenting on an article of Randall Wrays and I’m glad you are over here participating in this discussion. It shows you think what these guys are saying is worth exploring otherwise you would just ignore it. This is the first step to understanding.

      I’d like to comment on your discussion with Bill but correct me if I put views into your head which you dont have.

      You commented that Bill didnt need the business cards to get the work done all he needed was the authority to punish them if they didnt do the chores.This is absolutely correct and Im sure Bill would not disagree but I think its kind of a weak point. Here is why. You are essentially saying that a simple economy doesnt need money. Nothing earth shattering there. All of us who have considered economics in any depth know that to be true. One could even argue that it is technically not even true in our real world economy that we need money but no one would argue that our modern system of money has not made our world much better (efficient?) at getting things done. But without credit that is measured in some “unit of account” that we all adhere to our world would be a vastly different place (maybe better I dont know) but I hope you are not arguing to do away with it completely. I think its also safe to say that a system without monetary authorities capable of enforcing use of a currency we would have a system more likely to be anarchic and unstable. The real question is how can monetary authorities behave responsibly or maybe what is the responsibility of monetary authorities?

      Bills simple example demonstrates the operational realities of our current monetary system, thats all. It shows what “deficits” measure. It shows how taxation, trade and savings function and how they are accounted for . Thats all it does. However, this model can also be expanded and lose none of its usefulness because the principles apply no matter how big the economy is and how many people are participating. There is no “fallacy of composition”. What holds in the simple example also holds at the larger level.

      Your criticism does suffer from the fallacy of composition however because while true his little economy doesnt need a monetary authority or money at all, OUR real world economy does need it or in the very least DOES HAVE IT. SO again the only question is how should a monetary authority behave?

      Many are uncomfortable with the idea of authorities issuing money and enforcing taxation AT ALL, while ALL OF US agree that there is a limit to how much authority we wish the authorities to use, these are political differences. I’m putting you in the former category so I would ask you ; What do you propose? A return to the gold standard? 100% reserve banking? Do you have a coherent idea of what changes these would lead to in the real world?

      You seem to think that our monetary authorities dont do enough to control inflation whereas I would argue jut the opposite, they do waaaaay too much. Not only that they go about the wrong way by forcing unemployment on the system to keep aggregate demand down. They have a predominate view of inflation and they use a socially dislocating tool to enforce it.

      I would argue that the answer to your question about digging/filling holes is yes. Not because its “productive” (is a Wal Mart greeter productive by your definition) but because occupied working people are less likely to engage in anti social behavior which could COST us real resources in building jails and staffing it with more “security” types. However if digging/filling is all we can think of to use our unemployed for I’d say our problems are different, like a LACK OF IMAGINATION. I trust we could “imagine” a whole lot of socially useful things for them to do.

    46. Kid Dynamite says:

      Greg –

      “What do you propose?” again – i think the problem with MMT that non-MMT’ers have is that what we hear (even if it’s not what you’re saying) is that “Deficits don’t matter.” Now, i do NOT think this is the view of MMT. It’s quite clear to me that it is impossible to run ever increasing debt and deficits beyond your economic capacity – even if you’re the immortal USA. MMT is arguing that deficits are not themselves the problem – but i feel it’s semantics – they certainly are the problem AT SOME POINT – right? What is that point? that’s the money question. Again, the concern is that we’re much nearer to that point than we’ve ever been (we = USA). And this business card economy example is not showing how deficits are not the problem. it’s showing how constant surpluses ARE a problem.

      i think your final paragraph is way off base – i don’t think your MMT economic model, or any economic model, contains variables for anti-social behavior. That’s a qualitative argument, not an economic one. I think the problem of productive jobs is EXACTLY the issue, and every time the president talks about job creation i almost have to laugh and think of no-show jobs on The Sopranos. After all – how can you CREATE jobs?!?! Markets create jobs. Governments don’t create jobs – at least not PRODUCTIVE ones. I don’t think it’s a lack of imagination – it’s a lack of capacity – by definition, doesn’t technology increase efficiency and decrease the need for employment? Combine that with immigration, and the concept of full employment makes no intuitive sense to me. Also, note that past bubbles created FALSE demand, and jobs that were clearly NOT economically productive – that’s why they no longer exist! Did we need mortgage brokers? or real estate brokers? or home builders? CERTAINLY not in the numbers that we had them – we were staffed to bubble demand also!

      Now, can governments foster demand by giving out money? Yes – Bernanke’s helicopter could drop kajillions of dollars all over our country, and that might increase market demand for goods and services – and new price bubbles and new asset bubbles – it’s no solution. Inflation is clearly the result there – it doesn’t matter that “governments don’t need to fund their debt” or that they can just create money – sure – i agree – that doesn’t mean there are no consequences.

      Note, by the way, that in both the real world and the business card economy, the people who are hurt by inflation are the SAVERS – the value of their savings (in terms of purchasing power) decreases with inflation.

    47. NKlein1553 says:

      The other day I was having a discussion over at the baseline scenario about how government deficits provide the financial assets the private sector uses to conduct its day to day affairs and that if deficits are continuously cut the private sector will have fewer and fewer assets when someone brought up the example of Andrew Jackson retiring the national debt in the 1830’s. I was thinking about this and am somewhat confused. Presumably there was still currency floating around after Jackson retired the national debt. How is this possible if government deficits equal private sector surpluses $-4-$? I assume it has to do with the fact that the U.S. was on a gold standard at the time, but still I am a little confused. Can someone clear this up for me?

    48. JKH says:

      NKlein1553,

      The cumulative government deficit equals the net financial assets of non government. After consolidating the balance sheets of the government treasury and the central bank, total non government net financial assets equate to central bank reserves (liability), central bank currency (liability), plus the public float of government bonds.

      The normal assets of the central bank are government bonds, and don’t affect the relationships in the equation above, because these bonds consolidate to zero when the central bank is consolidated with the government treasury.

      If the cumulative government deficit is zero, then the contribution to non government NFA of reserves, currency, and bonds must be zero. Furthermore, if there is no outstanding public float of government bonds, then the contribution to NFA of reserves and currency must be zero. That can only occur if the central bank’s assets are liabilities of non government, rather than the usual Treasury bonds. That means that in the sectoral credit interface between government and non government, gross financial liabilities offset gross financial assets for a net position of zero.

      You see some of this today, at the margin, in the sense that the Fed has acquired private sector assets in its credit easing balance sheet expansion.

      (The current MBS portfolio is quasi government risk, but its original funding is not captured in the cumulative budget deficit, and so it is a non government item for purposes here. Some of the other Fed programs are unambiguously private sector oriented.)

      (Unfortunately, there is some unrelated budget accounting ambiguity on Treasury’s books, because TARP should never have been treated as a deficit expenditure item. It’s a financial investment in the private sector, offset by government bond liabilities.)

    49. NKlein1553 says:

      “Markets create jobs.”

      Really? Seems like the markets have been falling down on the job for the past ten years or so:

      http://www.businessweek.com/the_thread/economicsunbound/archives/2009/06/a_lost_decade_f.html

      “Governments don’t create jobs – at least not PRODUCTIVE ones.”

      Whose making qualitative arguments now? Like Greg said, is working at Walmart more productive than this?:

      http://livingnewdeal.berkeley.edu/

      “they (deficits) certainly are the problem AT SOME POINT – right? What is that point? that’s the money question. Again, the concern is that we’re much nearer to that point than we’ve ever been (we = USA).”

      The point at which deficits become a problem is when the economy has little to no under utilization of resources. That is certainly not the case at present. I am reminded of the quote by the British Secretary of the Treasury during the Great Depression, Ralph M. Hawtrey:

      “Fantastic fears of inflation were expressed. That was to cry, Fire, Fire in Noah’s Flood … It is after depression and unemployment have subsided that inflation becomes dangerous.”

      Modern Money Theorists actually write quite a bit about the threat of inflation. If you’re interested in some of their academic work you could try looking through the publications section of the Centre of Full Employment and Equity website:

      http://e1.newcastle.edu.au/coffee/

      I’m just beginning to look through some of these resources myself. For a less semantic version of these same arguments I suggest starting with Professor Mitchell’s three blogs, Fiscal Sustainability 101.

    50. JKH says:

      I’ll just add that if the cumulative government position is actually in surplus, then the balance sheet structure described above is extended to the stage where the government treasury (and the consolidated government sector) has a net financial asset position in the liabilities of the non government sector.

    51. NKlein1553 says:

      Thanks for the explanation JHK. I’m pretty sure I understand your explanation here of how the central bank’s liabilities (reserves + currency) and treasury bonds equals the non-government sector’s financial assets. You haven’t mentioned any money the central bank uses to pay its own expenses, but I assume that money also counts toward the liability side (or maybe it’s part of currency, I’m not sure). I’m still a little shaky on the history part though. Are you saying that at the time Jackson retired the public debt the assets of the central bank ceased to be part of the liabilities of the private sector? I’m unsure about the exact dates, but at the time didn’t Jackson also abolish the central bank. My question is if assets and liabilities net to zero what were private citizens using as money at that point?

    52. JKH says:

      NKlein1553

      Sorry, I’m no good on that sort of history. Only describing how it works today.

      When the central bank receives revenue, it debits commercial banks reserves and credits its own profit/capital account. When it pays expenses, it credits commercial bank reserves and debits its profit/capital account. (The commercial bank of the payer or payee makes a corresponding entry to the customer account.)

      The central bank remits most profit annually to the Treasury.

    53. Greg says:

      Alright Kid

      Let me ask you this. If we were to have some amazing technological breakthrough and every job currently done by man was done by robots where would we be? You seem to think that would be horrible because NOW no one could do anything productive anymore. We’d just sit around reading, playing golf, playing tennis, screwing, arguing….. you get the picture. IOW all the things we want to do NOW when we dont have to work. The only question at that time would be; How do we distribute the leisure activities? Does the guy who lives closest to the tennis court ALWAYS get it first, and if he wishes does he get to keep it all day?

      Back to the real world now. Are only those who farm, mine or manufacture productive? As an anesthetist I am a service provider, I am totally unproductive, I only consume and destroy resources while aiming to keep people pain free during surgery. What about restaurants? They just distribute a transformed agricultural product, thats not productive. Wal Mart productive??? Give me a frikken break! See I can define productive my way and demean a large portion of the private sector as well, but I dont find any of those endeavors as unnecessary or worthless. Maybe I’m more interested in a citizen being “useful” or “helpful” rather than productive. A person can “add value” while not being technically productive.

      Note….. I’m not advocating that the govt should employ everyone in any way shape or form nor that they are equivalent to the private sector as a productivity engine. I DO think that the private sector is where most of our imaginative people want to, should and WILL work in a healthy society but a healthy society requires a smart govt, cognizant of what it means and how to be responsible as a currency issuer.

      You are just WRONG when you say MMTers (if you mean Bill, Warren, Randall, Marshall, Scott or Winterspeak) claim that deficits dont matter. That is plainly false. What they do say (I believe, they will correct me if I’m wrong) is that the deficit is only relevant as it relates to private savings desires, trade gaps and employment levels. Whatever the deficit needs to be to provide the savings desire of the private sector (including foreigners) and keep employment at the full level is the “right” level. Going above that is inflationary. So the focus on deficit levels them selves while ignoring those other metrics is bad policy. Which is what we have now. In fact when you hear people say they want ” A stronger currency, more exports (as an engine for American jobs), low taxes, a balanced budget, a reduced debt and increased private savings and low unemployment” That is an IMPOSSIBLE combination of wishes if you understand how the monetary system ACTUALLY functions. You might as well wish for robots to do every job currently done by humans or wish for a trillion dollar helicopter drop at your house.

    54. JKH says:

      NKlein1553,

      If that wasn’t clear on the expense side, the central bank just creates the money by writing a cheque, etc. It’s similar to the case of a commercial bank. Both types of bank create money “from nothing”. The commercial bank creates new deposits in doing so. The central bank creates new reserves (and commercial bank deposits).

      What some people don’t realize, in addition to the fact that the process is analogous for the two types of bank, is that it works not only in the case of new loans (balance sheet transactions), but also in the case of new expenditures (income statement transactions).

      Both types of money creation are reversible. Commercial bank loan pay downs destroy deposits. Central bank loan pay downs destroy reserves and deposits. Commercial bank revenues destroy deposits. Central bank revenues destroy reserves and deposits.

    55. Kid Dynamite says:

      greg, just for the record – you wrote; “You are just WRONG when you say MMTers (if you mean Bill, Warren, Randall, Marshall, Scott or Winterspeak) claim that deficits dont matter.”

      i absolutely did not say that. what i said was “i think the problem with MMT that non-MMT’ers have is that what we hear (even if it’s not what you’re saying) is that “Deficits don’t matter.” Now, i do NOT think this is the view of MMT”

      and as for jobs, Nklein & Greg: Nklein wrote “Really? Seems like the markets have been falling down on the job for the past ten years or so.” Read what I wrote, Nklein. Have the markets been falling down? maybe we don’t need that many jobs because there isn’t that much work to do! is that really a crazy thought? how can anyone reasonably expect full employment when we have productivity increases and immigration?

      Greg: when technology advances, and a robot takes your job, you don’t still get paid and get to go golfing and sit at the beach – you lose your income. I’m not arguing that technology is bad – far from it – i’m all in favor of technological and productivity improvements – but they come with a cost: loss of “productive” jobs. it’s not a problem in my model – it’s a problem in your model because you think full employment is realistic. (i phrase it like that because i’m not against full employment – i’d love it if there was enough work for everyone to do something of value, but i just don’t think there is – and i certainly don’t think people should be paid to dig holes and fill them in)

      “As an anesthetist I am a service provider, I am totally unproductive” – how are you unproductive? you get paid to eliminate pain. IF the government hired 10 people to stand behind you and cheer you on, saying “Greg, you’re doing a great job, keep up the good work,” then THEY would be unproductive.

      the “productivity” argument is a sticky subjective one. my point in mentioning is was only to try to understand if your model is advocating work that produces something? or merely that work produces a paycheck? we don’t need to “Create jobs” in order for the government to pay people – they could just send out checks. obviously, I don’t like this idea. could we pay people to stand 100 feet in front of traffic lights with signs that say “SLOW DOWN” when the light is red? sure. we could pay people to do billions of things that would clearly be a waste of money – that is what i think of everytime i hear the phrase “CREATE JOBS.”

      which leads me back to Nklein’s snipe: yes, Nklein – free, competitive markets produce jobs. governments looking to create paychecks do not create worthwhile jobs. but that is indeed subjective, and if you disagree with it, so be it – i cannot prove it to you.

    56. Gamma says:

      “If the budget is balanced there can be no net saving or net accumulation of financial assets.”

      I disagree. In the real economy, there can be saving in the form of real assets.

      Why is a net accumulation of financial assets necessarily a good thing for the non-goverment sector?

    57. bill says:

      Dear Gamma

      You said:

      “If the budget is balanced there can be no net saving or net accumulation of financial assets.”

      I disagree. In the real economy, there can be saving in the form of real assets.

      No you are agreeing. I explicitly said financial assets not real assets. Of-course, we can convert our financial wealth into real wealth – cars, houses etc. No one is disputing that.

      Why is a net accumulation of financial assets necessarily a good thing for the non-goverment sector?

      And now we reach the point! Come the day that your nominal commitments in the currency of issue exceed your financial means, then you have to liquidate some of those real assets (perhaps at loss-making prices) to stay solvent. The more real wealth you have the longer you can stay solvent in such a situation. But eventually the sort of policy I modelled will drive out all nominal and real wealth from the private domestic sector.

      That is the reason it matters.

      best wishes
      bill

    58. Gamma says:

      Bill,

      Sorry I misinterpreted your statement to be “net saving” or “net accumulation of financial assets”.

      Under what situation would everyone’s nominal commitments exceed their financial means? As we agreed yesterday, no modern government uses a poll tax system.

      (Aside – was Thatcher’s disasterous attempt to introduce a “Community Charge” in 1989 the last time a government tried a poll tax?).

    59. Kid Dynamite says:

      anyway, i don’t want to hijack this thread (anymore than i have already) so let me just say that I think it would be incredibly illustrative to the non-believers (myself included) if Bill would extend his example of the business card economy in the future to show 1) how he can run a deficit with constant and increasing debt and it not be a problem (i guess in this scenario “problem” means inflation or when Chinese neighbors take over with their own currency when Bill creates so many business cards that his kids no longer value them) and more importantly, to illustrate 2) WHEN debt/deficit grows becomes a problem – at what level.

      thanks.

    60. Tom Hickey says:

      Kid dynamite, settle down. Your fuse is too short. This is the third post in this series that is meant to illustrate the fundamental operational principles of MMT and how it differs from mainstream economics. It’s not meant to solve all the problems in the world, It is a step-by-step learning aid. Re-read the first sentence of the post. Bill is presenting “a simple model.” He is building on what went before in the development of the business card model in earlier posts, and you are anticipating what is ahead.

      Good to have questions, though. Eventually they will be answered, but you are jumping ahead. Better to master the foundations first.

      The first two posts in the business card model series are:

      A simple business card economy

      Barnaby, better to walk before we run

      You may also want to consult a related post, which is at a higher level:

      Stock-flow consistent macro models

      Here is a link to the complete archive. Explore a bit. In addition, in each post Bill links to previous posts that are relevant to that subject.

      Complete billy blog on one page!

    61. Greg says:

      Kid

      I’m still not sure of your EXACT point. You seem to be saying that we dont NEED as many jobs as we once did and the market is simply telling us that. Okay so are those without jobs (certainly many are not jobless because they lack useful skills) just SOL for now and resigned to just a completely minimal existence?

      You ask “how can anyone reasonably expect full employment when we have productivity increases and immigration?” So we know there is nothing more to be done because no one in the private sector is asking us to do it? Is that your stance? You seem on one hand to think that those with the entrepeneurial spirit will always know a productive venture when they see on and right now we are just maxed out. While on the other hand you rightly acknowledge the gross misallocation of assets during the housing boom which was driven largely by ENTRPENEURS. Are all the necessary jobs are being done and the rest of the folks are just superfluous ………… for now?. Its not possible that there is a lot of latent productive capacity that is being underutilized by the private sector because they have created their own downward spiral of layoffs—— decreased agg demand——-more layoffs———-more increased agg demand and that they are incapable by themselves to reverse it because first off they need customers.

      There is only one entity that can create a customer from whole cloth………..the currency issuer. Fears that just making work would be inflationary are ridiculous. If we went back to pre crisis ’07, we were not in inflationary times (housing bubble yes) were we? At least not badly inflationary. SO if we were to tell everyone to return to their old jobs and the govt were to fully fund everyones salary at their old level there is no way it would be worse, inflation wise than before, right? Now Im not recommending this but simply illustrating that a return to precrisis spending levels could easily be absorbed without inflation. An ELR program that paid 8-10$/hr for digging/filling would not be inflationary right? So the only opposition could be ideological, not economical/financial.

      Decisions that certain jobs dont count as work are purely ideological and have no basis in fact.

    62. Greg says:

      Hey Kid

      Dont run away from here mad or anything. You have some good questions but I think you might expect too much from ANY economic paradigm. The purpose of MMT as Tom said is not to solve the worlds problems it is to illustrate what are the REAL constraints of currency issuance. Virtually all our constraints are unnecessary and are not helping us at all. Talk about running out of money and borrowing form foreigners is nonsense and it needs to be exposed as such. Talk about what are the limits of spending and how the govt/private sector should work to enhance one another are how we should be discussing things.

      Painting certain peoples’ jobs as unproductive or useless or not real work are mostly driven by ideology. You even admitted as much in your response to NKlein. Why do you hold to an idea that you cannot prove? I’m not saying I CAN “prove” that a govt can provide a worthwhile job but thats ONLY because the defnition of worthwhile is not universally clear. I will say that the govt can make a customer, give someone a place to go for 8 hrs a day ( and stay out of trouble), provide a service that someone (not everyone) will value and keep a person “in the game” so they might find a better job in the private sector. It has been shown that private sector people do not hire the long term unemployed simply because their skills have eroded or they have developed social problems during their hiatus.

    63. Kid Dynamite says:

      Greg, Tom – relax – i’m not “running away mad.” I don’t want to hijack this thread with a debate about what constitutes a “good” or “Real” job – i don’t think it will add any value. I do indeed look forward to Bill’s future extensions of this example, which I hope will address “ok” and “not ok” deficits.

      for now, i leave you with this from today:

      http://www.kc.frb.org/speechbio/hoenigpdf/Washington.DC.Fiscal.02.16.10.pdf

      “I ask your indulgence in reminding all that the unthinkable becomes possible when the economy is under severe stress”

      If hoenig is being an idiot, please don’t hesitate to explain why – as i think his paper sums up my fears (for the future of the US economy/fiscal situation) nicely.

    64. Tom Hickey says:

      Hoenig is being an idiot. The threat is debt-deflation, not inflation. We are now in the Ponzi finance stage of the financial cycle that Hyman Minsky sets forth in his financial instability hypothesis. The next step is the implosion described in Irving Fisher’s debt-deflation theory of depressions.

      Hoenig and the bankers are presupposing that debt is going to be paid off and debt that can’t will be inflated away. There is another, more likely, scenario. Debt that can’t be paid, won’t. The day of reckoning is arriving, and all the fear of inflation is speeding it up by encouraging deflationary policy, while politics stalls real reform. Meanwhile the house of cards is collapsing.

      Paul B. Farrell, How to invest for a global-debt-bomb explosion

      Randy Wray, Wall Street still doesn’t get it

      “Be prepared for another global crisis by summer.”

      Oh, and then there’s Marshall Auerback, Will We Have to Blow Up A Continent (Again) Before We Stop Wall Street?

    65. Kid Dynamite says:

      Tom:

      you wrote “Debt that can’t be paid, won’t.” are you talking about Government debt? that is not a popular view. I think there is little to no chance that the US defaults on its debt, and I don’t think I’m stepping out on a limb by saying that. I’m especially surprised to hear you say that, considering that one point MMT’ers keep hammering on is that the government can ALWAYS pay back its debts because it owns the printing press!

    66. Sergei says:

      Just my 2 cents.

      USSR definitely had no private economy and yet for a significant period of time was able to successfully challenge another super-power. The fact that USSR failed still leaves the question of USA livability open. Only time can tell. (I mean it is a different issue that is of pyramid building in the USSR)

      Public (! and not private) spending on primary research is what is driving technological progress. Think DoD, NASA, etc. if you live in the USA

      Another point. Cumulative federal budgets deficits in the US until today sum to 6.5 $trln. Federal debt in public amounts to about 7.8 trln and total public debt is about 12.4 trln. Does it mean that federal government today already has “borrowed” about 1.3 trln more from the public and about 6 trln in total? So why do we cry about current deficits if government has 6 trln of spare spending capacity? Or maybe government debt serves another purpose?

    67. AndyfromTucson says:

      Hi Kid Dynamite:

      I think you identified an important issue when you said:

      “maybe we don’t need that many jobs because there isn’t that much work to do! is that really a crazy thought? how can anyone reasonably expect full employment when we have productivity increases and immigration?”

      If you go back in time 100 years and did a pie chart of what specific tasks consumed what percentage of the total work hours, and then fast forward to the present and look at what percentage of labor hours those exact same tasks consume today, I think you would find that that work that consumed 100% of working hours 100 years ago consumes maybe 20-30% of working hours today. In other words, there hasn’t been that much work to do for a long time.

      So why isn’t unemployment at 70-80%? My personal theory is that the growth of big government is part of what has allowed the economy to keep growing, and unemployment to stay low, despite relentless productivity increases that have reduced the labor required for survival to tiny fraction of what it once was. As the labor hours necessary to produce the necessities of life have fallen, government has stepped in to keep everyone employed by creating new jobs (soaks up excess labor supply) and imposing new taxes (forces people to work more than they would have to in order to produce the necessities).

      Sure you can mock the utility of some government job that didn’t exist 100 years ago as not being truly productive or necessary. But so what if it isn’t? Is the goal to live in world where the only work that gets done is the truly necessary (food, shelter), but 80% of the population sits around all day bored out of their minds and watching cable TV? We all like some leisure, but in general humans don’t do well with vast amounts of leisure time. We like to be busy with stuff.

      To tie all this back to MMT, for me the most useful insight of MMT is that the goal of public policy should be to keep people employed and engaged in life. If the private sector is doing it, then great. But if the private sector is not providing jobs for 10% of the people who want jobs then the government needs to step in and create some jobs by increased spending. If and when the private sector comes up with jobs for those people you will see it in wage and price increases, at which point the government can reduce the spending (and thus government sponsored jobs) until wages and prices stabilize.

      By the way, I see no problem with perpetual deficits and debt. Think of government debt as simply a government benefit program (think social security, medicare, and welfare) that pays benefits based on people’s saving behavior rather than age or health status. What is not to like about a government program that rewards savers (lets call it saver’s security)? And why is ever growing debt unsustainable? The economy grows perpetually (as evidenced by the fact that we no longer live in caves) so why can’t the debt grow perpetually? Why can’t the percentage of GDP that goes to govt debt interest payments (sorry, meant to say the saver’s security benefits) grow to a large percentage as long as we regulate government spending along the way as needed to have full employment and reasonable inflation?

    68. Greg says:

      Siiiiiiiigh

      Kid, you are right the government debts will be paid off (at least the ones that are owed in their own currency) but the problem is the private debts, the CDS bets made on these debts, the currency market bets………. These are ALL private activity debts and bets and they are substantial in size globally (trillions). You are getting confused. When the deficit terrorists place sovereign govt debt in the same boat as private debts they are MISTAKEN. This “finance” problem is all private in creation Goldman Sachs, JP Morgan and the others are driving this thing off a cliff. Yes they have used govt largesse to keep it going, yes they are playing the currency markets and trying to benefit off someone elses (Greece and the other PIIGS) misery but this is not, contrary to what many want you to believe a problem STARTED by GOVT profligacy

    69. Tom Hickey says:

      ou wrote “Debt that can’t be paid, won’t.” are you talking about Government debt? that is not a popular view.

      The government issues currency so it cannot default except voluntarily. I’m talking about the folks that made all the dodgy loans and then built a derivative house of cards on tip of it. That house began to fall in 2008 and the governments propped it up for awhile. Now that action is turning out to not enough and the people are rising up against the injustice of it all. Another crisis is highly probable for financial reasons, and another bailout is of low probability for political reasons. This could get ugly.

    70. Yossarian says:

      My challenge to the model were not addressed so I will post again below. Kid Dynamite: you are exactly right: the issue of the goal of full employment comes down to your view of what govts role should be. I agree with you in that I don’t think the govt should be deciding how to keep the economy at full capacity. The Soviet Union operated at full capacity for a long time but they eventually discovered that the capacity was poor, the product poorer, and the people impoverished. If someone is out of work because of productivity- i.e., our economy produces what we need with less labor- then he needs to either figure out how to create a new need (wash and fold laundry?), improve existing products, or re-enter the work force at a reduced rate (since he can still keep the same standard of living since productivity rose). Our disagreement with many on this board will not be resolved as we view governments role and ability in a completely different light. Perhaps this question regarding the model can be addressed this time:

      But why are your kids paying the same amount of tax that they were paying before their incomes fell? And what is happening to their expenses- are you charging them the same amount for food, rent, and utilities? If they are trading with each other why are the prices of trade-able goods and services not falling along with the supply of business cards? Perhaps the prices are staying high because China Family is spending the cards that they accumulated, buying up all of your kid’s Vegemite.

      You describe the economy: “there is no longer much work being done around the house. The garden is in a sorry condition and rubbish is piling up.” Why are your kids so lazy? Or is it that the Draconian Emperor (you as the govt) running the economy stubbornly refuses to bring their expenses down proportionately with income?

      What happens when we introduce Arab Family who just discovered their house sits atop a geothermal energy source. They supply both your family as well as China family with heat and electricity. The winter is particularly cold and China family desires more heat so they send more of their spare cards to Arab Family in exchange for more heat. But Arab family only has a fixed supply and tells your family that they will have to either pay more for heat or get less heat. Your family would rather forgo a snack than be cold so they pay the higher price for heat. But now they have less to pay for Vegemite and so your kids are forced to go into your pantry so they can sell more Vegemite to China family so that they won’t have to go over the fence and work.

    71. AndyfromTucson says:

      Hi Youssarian:

      I am no Billy, but I will throw out some possible answers to your questions:

      “But why are your kids paying the same amount of tax that they were paying before their incomes fell? And what is happening to their expenses- are you charging them the same amount for food, rent, and utilities?”

      I think you are also asking why the tax isn’t an income tax. I assume Billy used a simple fixed tax just to keep the model simple. I haven’t taken the time to do the math, but I would think that making it an income tax would not change the dynamic that trying to balance the budget results in a downturn in GDP. If taxes fell as income fell in Billy’s model, he would just have to cut spending faster to balance the budget, and income would drop even faster.

      Maybe I am not smart enough, but I can’t follow your point about adding an Arab Family next door. How does it relate to MMT as versus conventional monetary theory?

    72. haris07 says:

      My 2 cents is that the assumption in this model is that the kids actually work and work productively. Alas, in the real world, some kids don’r work, but rather blow the business cards on building asset bubbles i.e. they take the cards and bid up prices of assets under the mistaken assumption that the “return” on these assets will allow them to lead an easy life and not work. This leads to asset inflation and bubbles, and eventually the bubble bursts.

      Under the MMT scenario, the govt just steps in, issues more business cards to prop up malinvestment and dis-savers and rescues them and then again the bubble starts anew.

      Another impact, it calused INFLATION (putting aside technical differences of what exactly inflation is and difference between core and real inflation, printing more $ when the real economy is not producing enough will cause inflation).

      Bottom line, the accounting flows described by MMT are accurate and the singular focus on fiscal deficits in a country which has its own fiat currency is indeed a problem created by deficit hawks and scaremongers. HOWEVER, their prescribed policy to deficit spend and print $ (electronically credit) won’t work, economically speaking, it will result in inflation and the social consequences will be a society that will learn to depend on “free money” and govt rescue and not be productive economically.

      IF the deficit spending can be channeled effectively towards productive economic work and wealth creation, then printing $ to support it in and of itself will cause no problems. But in an economy as big as US (or any other country for that matter) and in bureaucratic govt which cannot function efficiently and where a significant number of “kids” just want to live an easy life dependant on asset bubbles, this won’t work.

      Good theory, elegant and explains modern money well, but the policy solutions won’t work.

    73. dagman says:

      Very interesting explanation.

      However I have a question about the model. Let´s say things continued on as per month 4 with constant budget deficits and the same spending and taxes until the kids had adquired 6000 business cards worth of bonds. Now at 10% interest they would have enough interest payments to afford to live in the house without working. What measures would be required to get the kids to work again? Would you raise public spending and taxes at the same time? I guess it´s like a pension scheme where you would bring in new kids to do the work and the older kids get to enjoy their retirement? So it really depends on there being enough resources to feed the new kids + the older kids. Is this correct?

    74. okl says:

      is there any room in this simple model for inflation?

    75. okl says:

      can i ask what is the money supply in this example?

    76. okl says:

      since G – T = (S – I) – (X – M),

      where
      g = govt spending, 100
      t = tax revenue, 100
      s = private sector savings (GDP – T), 0
      I = investment, unknown
      X = exports, 200
      M = imports, 100

      what i’m struggling to reconcile is how investment translates into this… for example, using the above equation;

      100 – 100 = (0 – I) – (200 – 120)

      0 = – I – 80

      I = -80?

      is it possible to have “negative investment”? i mean i understand that it is exogenous, but it does sound/look odd.

      another thing is that while i can understand “canceling out” consumption- if the locals buy local produce, an expense on the household sector becomes a revenue in the corporate sector- i can’t understand how “investment” works.

      specifically, where does the money for investment come from and where does it go?

      i’m trying to think simple here;

      in the business card economy, if a kid wanted to buy a shovel (capital equipment) from his brother, he would pay 50cards to his brother. if we do not count this as consumption, but as an investment, then how does the equation add up?

      and if we do count it as an investment, then how do we differentiate between a consumption and an investment when both seems to have the same “transfer of payments” within the private sector?

      im really confused by this…please help!

    77. Sergei says:

      okl, in the national accounts it is savings which is unknown while investment can be perfectly well measured.

    78. bill says:

      Dear okl (at 2011/01/23 at 21:33)

      In the standard model of aggregate income generation we write the aggregate demand equals GDP identity as:

      GDP = C + I + G + (X – M)

      In the blog – Some neighbours arrive – which you are commenting on there is no private consumption or investment by assumption.

      So GDP = G + X – M

      So I = 0

      The resulting sectoral balances in this model is derived as follows:

      Sources of income: G + X

      Uses of income: S + T + M

      G is government spending, X is exports, S is saving, T is taxes and M is imports

      The sectoral balances then simplifies to:

      S = (G – T) + (X – M)

      So private domestic saving will equal the sum of the budget deficit and net exports.

      In your example, there are errors which is the reason you are confused. You wrote:

      since G – T = (S – I) – (X – M),

      where
      g = govt spending, 100
      t = tax revenue, 100
      s = private sector savings (GDP – T), 0
      I = investment, unknown
      X = exports, 200
      M = imports, 100

      You can derive saving (S) as (GDP – T) given there is no consumption. All income is derived by the kids and their disposable income is GDP minus their tax payments.

      Given your parameters:

      GDP = G + X – M = 100 + 200 – 100 = 200
      T = 100

      So S = 200 – 100 = 100 rather than your assumed 0. That is your first error which led you astray.

      You can check the saving via the sectoral balances framework derived above.

      S = (G – T) + (X – M) = (100 – 100) + (200 – 100) = 0 + 100 = 100

      So private saving is driven purely in this example by positive net exports of 100 with a balanced budget.

      You then wrote:

      what i’m struggling to reconcile is how investment translates into this… for example, using the above equation;

      100 – 100 = (0 – I) – (200 – 120)

      0 = – I – 80

      I = -80?

      is it possible to have “negative investment”? i mean i understand that it is exogenous, but it does sound/look odd.

      First, you can have negative investment if depreciation/write-offs outstrip new investment. For example, Haiti will probably have negative investment in the year following the disaster.

      Second, once you assume I = 0 then your example is:

      So the right-hand side as you have written it is:

      0 = (S – 0) – (200 – 120) = S – 80

      So S = 80

      Double check: GDP = G + X – M = 100 + 200 – 120 = 180. S = GDP – T = 180 – 100 = 80.

      As to your other questions (kids trading with each other etc) they can be easily incorporated into a more elaborate model of the household. Consumption would be spending that exhausts within the current year (as per National Accounts conventions) and Investment is spending that provides services beyond the current year.

      I suggest you go to a national statistics site – for example http://www.abs.gov.au – and search for the handbook of national accounts to learn how all these concepts (Investment, Consumption etc) are defined and made operational.

      Hope that helps

      best wishes
      bill

    79. okl says:

      dear bill,

      thanks very much for your quick response!

      i’ll try to digest and work my questions out.

      if i have any other questions i’ll just post them here =)

      and a quick word on the teaching models; if you could build them up slowly to something closely resembling today’s economy, it would be really great! i’m looking forward to that.

      thanks very much once again!

    80. okl says:

      dear bill/whom might be reading,

      here’s another question about the above example (up to period 6);

      in the private sector, it looks like this;

      wage income: 386
      interest income: 79
      taxes: 600
      savings (GDP-T): -124

      why can’t i just take “(386+79)-600 = -135″ as private sector savings?

      it’s a little odd for me to consider the additional -11 interest payment to the foreign sector as private sector savings.

      if that is the case, then when it comes to “savings”, then it really should read “private + foreign sector savings” or “non-govt sector savings”?

    81. Mike says:

      Bill (or others)

      Do you have an analogous model to show how a gold standard works. I’m thinking I’d like to compare two models side by side. It wouldn’t necessarily need to be a gold standard but some other monetary model (widely used?) that is quite different to the floating sovereign fiat currency. It might make it easier to newbies to identify the points of difference — particularly when in the media all we ever read is pundits and economists who think we are still on a gold standard (in terms of policy prescription).

      thanks

      Mike

    82. Neil Wilson says:

      Mike,

      Just look at the countries in the Euro. That’s what happens when you peg a currency to something, don’t have offsetting fiscal transfers and yet still have banks that can create credit at will.

    83. Mike says:

      Hi Neil,

      Yes I understand which countries don’t have the model described by Bill but I was wanting to know is a similar model (of the type described in these series of articles) has been written to characterize that functionality. I think I (and maybe others new to this) might be able to get a better handle on it by comparing two “toy” models.

    84. Alex Seferian says:

      Reviewing this model made me better understand MMT. There are some additional conclusions that I think one can draw, in addition to the important ones outlined already, and I was hoping someone could take a few minutes to read my post and kindly confirm whether what follows is theoretically coherent.
      First, a clarification: I noticed that in the model Private Sector Savings = GDP – Taxes. Starting with the formula GDP = C+S+T, this implies that GDP-T = C+S. But since the Private Sector Balance formula is (S – I) = (G – T) + (X – M), then one has to infer that S-I = C+S, or what is the same: C+I=0. In other words, in the simple model, the Kids are not consuming, nor investing… all they are doing is saving, which is fine because the exercise is not meant to produce a perfect model of the world. Rather, it is a simplification to help people reach useful conclusions, including regarding deficits and savings.
      Now, I’d like to add a few layers of complexity to see if further conclusions can be drawn. Since the Kids just save, I’d like to assume for the time being that there are other people living in the house that consume and invest. Lets call these the “Others”. The “Others” own and manage the Garden that produces vegetables (this society is vegetarian and has zero additional needs). The “Others” depend on Father’s house not having leaks and being well maintained, but it turns out that this House has been in reasonable shape for the past years without any work being done on it, so the “Others” have generally forgotten about the need for regular maintenance (I’ll come back to this point later). Overall, the “Others” live in harmony, exchanging vegetables and related services amongst themselves, and are peaceful… they are content.
      Father, or the Government, is not interfering with the “Others”. There is a link in that the “Others” use one of the rooms of the House. Father is OK with this because he is generous, and because it is his way of compensating the “Others” for the fact that they take care of the Garden. Another link is that the “Others” have some old business cards that they use to facilitate exchange amongst themselves, and given how relatively cumbersome bartering would be. To keep things simple, at least in this next step, it turns out that the “Others” are not being taxed (we can change this assumption later).
      The Kids co-exist with the “Others”, and partly depend on them to supply a few vegetables from time to time. However, the Kids are so frugal that for all intents and purposes their consumption is negligible. I say this, for now, only to be coherent with the model that assumes that the Kids only save, and as per the formula C+I=0 above.
      Now, we go to Month 1 of the model. Assume some G is deemed “necessary” to get the house in proper shape. Assume that the G needed is 600 and that the Kids can do the work (they can because we assume that they have “idle” time… some argue they are a bit lazy… but OK).
      Because G=T, the Kids would NOT end up with extra business cards. This case is akin to them just doing the work because Father insists… Father is the boss. The tax is a coercive measure to ensure the actual activity gets done and to eradicate some of the laziness. After all, the Kids will in the end be better off because the house will not have leaks… Father knows best.
      In this case too, the “Others” will be better off, because although they did not notice at first, the house was indeed beginning to show some wear and tear.
      What if G were “useless” (e.g. instead of maintenance work, Father insisted that the Kids dig holes in the front lawn and refill them)? Then the entire Household (or Economy) would be neither better, nor worse off (as long as the Kids really did have “idle” time). Month 1 would be like a “zero sum game”.
      What about if G were “destructive”? Unrealistic but for arguments sake lets assume that Father instructs the Kids to start changing the heating system, and because of his inexperience and hardheadedness, they end up installing a system that does not work and has to be totally replaced. Then, all would be worse off. Government intervention and taxes would have made the house a slightly less comfortable place to live in.
      Conclusion #1: The nature of G is key. If G serves to advance the public purpose, then the society should be in favor of it. MMT helps focus the debate around the quality and quantity of G; it rightfully makes a case against imaginary or self-imposed constraints that only serve to fudge the real issues.
      Now, lets move on to Month 2. Let’s assume that the correct amount that must be spent in order to keep the house in good shape is 800. People had forgotten about the need for regular maintenance, but now all are suddenly “wiser” and convinced, including the “Others”. If the correct amount of spending is 800 then everybody should be better off in a scenario where G=800, versus one where G=0, or even G=600.
      Now we assume that in Month 2 Father is debating whether T=800, or 600. This is an important question. If T=800, then the Kids will not generate extra savings. Do the Kids need those extra savings? If one ignores the China family, and also ignores that in a future the Kids may become less frugal, then the answer should be no. Reminder that according to the model the Kids do not consume, nor invest; if T=800, therefore, the Kids should be indifferent, at least initially. The “Others”, on the other hand, would be really better off… they would be getting a free ride given the maintenance. Kids are indifferent, “Others” are really happy… Conclusion: the “system” is OK.
      Now lets add some further complexity. It turns out that just as the “Others” have become wiser, so have the Kids, and they start thinking that their frugality is excessive. Why should their consumption be so low that it effectively does not leave a dent on the system? To consume more they need business cards. Under this scenario, if T=600 then the Kids would be better off; therefore, they campaign for Taxes to be 600, and not 800.
      What about the “Others”? To the extent the Kids start holding business cards that can effectively be used to compete for the goods that the “Others” had been happily exchanging amongst themselves, then to a minimum the “Others” will have to get together and assess the negative impact that those extra business cards may have on their daily lives, and then see how that impact compares to the benefit they are getting by having the Kids maintain the house.
      This is a complex analysis, because the impact of the extra business cards is not clear, so overall, the “Others” tend to gravitate towards a G=T stance; the “Others” will campaign for T = 800. In fact, they will be a bit coy and argue that the maintenance is not that useful, and they will bring into the debate arguments about tradition, and how for years they have co-existed amongst themselves peacefully, efficiently, and without interference from neither Father nor the Kids. Reminder: the “Others” do not pay taxes (not yet) and they only use the business cards because they choose to do so… they are not forced by taxes.
      So what should Father do? Go for T=600, or T=800? Both sides are making what seem to be valid arguments. Father decides that it is important to first understand the impact of those extra business cards.
      The first thing that Father does is to analyze whether there is extra capacity in the Garden. He clearly realizes that the effect the Kids will have will depend on what impact the newly created currency will have on the prices of the goods that the “Others” produce and consume. Suppose there is no extra capacity, then as the Kids come into the market, prices will be driven up as there will be more competition for those same goods. The net effect is that, all other things equal, the “Others” will end up consuming less. How much less will depend on how much money the Kids have, but Father realizes that there has to be some point of equilibrium because the “Others” are indeed getting a free ride with the maintenance if T=800.
      Fortunately, the debate is somewhat facilitated because it turns out that there is indeed extra capacity in the garden. Father concludes that prices will not rise given the extra demand from the Kids (Q will adjust but not P). So Father is inclined to swing the balance in favor of the Kids. What will happen when Father announces this suggestion in an “Open House” meeting? Father is not so much a dictator, as he is a democratic consensus builder.
      The “Others” will take the news in and debate amongst themselves. OK they will conclude at first, lets allow the Kids to take in some extra veggies. Their reasoning: our loss in terms of quantity of will be zero, and yet we will benefit from the maintenance. However, suddenly one of the “Others” makes a persuasive point: with the Kids coming on board as consumers, the Garden will just reach full capacity, and whilst prices will not have increased, our ability to have a “buffer” of land to cultivate in case one area goes bad one day will be curtailed. Everybody agrees that this is an issue. Furthermore, another “Other” argues an additional point and asks: who is going to do all the extra gardening work? Not the Kids… they will be tied up with maintenance work. Now suddenly the workers amongst the “Others” realize that there will be an additional “cost” for them, even if consumer prices do not rise: this segment of the “Others” will have less vacation time.
      Ultimately, the “Others” weigh the losses (less buffer land and less vacations) against the gains (less leaks in the house) and reach a compromise. They return to the meeting and try to strike a deal, overall arguing against “excessive” deficit spending, but agreeing to some. Throughout the negotiation, the “Others” are considering that the G is meaningful and helpful. Otherwise, they will argue (quite persuasively) that the new class of consumers (the Kids) will be getting “something from nothing”.
      Father agrees that the difference between G and T cannot be too wide. His concern is that if the Kids generate too much savings over the coming months, there may come a point where the coercive nature of the taxes will not be enough, and the Kids will decide to pay their taxes through their savings, and not work and help maintain the house. At some point Father would catch on and simply raise taxes if this occurred, but he generally agrees with the notion of not letting the G and T gap become too high persistently.
      Conclusion #2: T and G have ultimately a lot to do with how a society decides to allocate resources and “divide up the cake”. Technically speaking T does not fund G in terms of the money, but T is nonetheless an instrument to effectively re-allocate real resources away from the private sector and towards the public sector, and therefore T helps implement G programs. The more G exceeds T, the more publicly orchestrated re-allocation of resources will take place, or what is the same, the more savings one segment of the society will generate relative to another. Keeping a balance is key and is a political question.
      Even if G helps advance the public purpose, the interests and philosophical beliefs of the different groups will always result in a debate in terms of who gets what, and what is appropriate for G. Those who believe that Father is “inefficient” and that the Kids are “lazy” will tend to favor low G levels. They will also want to minimize the gaps between G and T as a general rule. This is neo-liberalism in some respects. The neo-liberals will use arguments about running out of money, or about sovereign governments going bankrupt either out of “ignorance”, or “on purpose” and in order to generally keep “Father” and the “Kids” in check. For these people, whether there is or not excess capacity in the economy will be less relevant than it should be, because even if inflation is not generated as a result of G, they will find other costs that are generated if the G-T gap is high (e.g. less buffer land and less vacation time).
      Is running a budget surplus a bad thing? This question again has everything to do with the allocation of resources and the debate as to how to divide up the cake. In one extreme Father could just tax the Kids, and not generate any G. This could work as long as the Kids had accumulated savings, ie. there was National Debt. Would reducing this Debt be good? No if you ask the Kids. Yes if you ask the “Others” (to the extent that debt reflects savings of the Kids that could be one day used to compete for vegetables). Arguing in favor of one position or the other is a political question.
      What about the China Family? The simple model considers that G and the issuance of extra cards is a benefit for the Kids, and the system as a whole. The Kids get even more free time. The House gets maintained. Everybody is happy. However, there could be other repercussions from this policy of letting the China family do the maintenance work.
      In the simple model, the Kids just save. However, in the more elaborate model the Kids want to increase their consumption. To the extent they earned less savings by letting the China family do some of the work, they would have less ability to buy vegetables in the future. Lets take the example to an extreme. The Kids just become very astute traders, and in month 5 when the neighbors arrive they just decide to channel all their wages to the China family, such that the Kids end up doing nothing (they just spend time with their Play Stations), and the house gets fully maintained. Who will have bargaining power vis-à-vis the “Others” and their vegetables in the future? … clearly, not the Kids.
      Do the Kids care? Maybe not today because they just prefer to save, but to the extent they are kept idle for too long, they may loose their “edge”, or competitiveness. Then, in a future they may regret the decision of having allowed the China family to do all the work and become very efficient at it (I am thinking about Germany and the periphery).
      Be that all as it may, in the short term, to the extent G did indeed help further the public purpose of the Household, then the China family will have increased the Households welfare, as they helped maintain it and all they received in exchange were some business cards. But to the extent these business cards can chase the goods that the “Others” produce then we come back to the “Open House” debate we had before. Instead of the Kids, it is now the China Family who competes for the goods that the “Others” produce, but insofar as the Others are concerned, this makes no difference. To the extent G was to fund “destructive” expenditures (the case where the heating system stopped working) then the debate will be even more heated. Again, this is a political question.
      Is there anything above that is incorrect or does not make sense. Sorry for the long post but feedback would be much appreciated.

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