Back to basics – aggregate demand drives output

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1. We call saving a leakage from aggregate demand because it is taken out of the expenditure flow. Other things equal, a rise in a leakage will reduce output and national income. So the only way this economy can remain at its previous level of activity is if there is new source of expenditure to match the withdrawal of consumption.

   And this is why Say’s law (whether in the form of Say’s equality or Say’s Identity) will not necessarily work in the short or long run?

   I have been reading Paul Davidson (Financial Markets, Money, and the Real World, Edward Elgar, Cheltenham, 2002) and he argues that yet another “leakage” is when money gets tied up through speculation on financial assets on secondary markets (in a cycle of (1) money used to buy a financial asset then (2) the money given to a new speculator who holds it ready for a new financial asset purchase, then back to (1) and so on).

   Do you think this is a fair view?

2. The one ‘good’ thing out of our government’s desire to decimate the economy is that it will provide hard evidence of the effects of the policies – mush as the 1920s and 30s did for Keynes et al.

   It may be that the UK has to go through this for the greater good.

3. Does it make any difference if a household wants to consume an extra $20 worth of local food and services by borrowing $20 from a Japan?

4. It’s much easier to understand with the diagrams.

   What are the chances of this being taught in Eton?

5. wow my attention span is far to short.

   “Mainstream macroeconomics has virtually no content that is applicable to the real world.”

   now where have i read something like that before?

   Moreover, the characteristics of the special case assumed by the classical theory happen not to be those of the economic society in which we actually live…

6. Just a minor point; I feel it’s unfair to Ricardo to call these models “Ricardian” – Ricardo himself said “but the people who paid the taxes never so estimate them, and therefore do not manage their private affairs accordingly.” he only put it forward as a thought experiment in a true gold-standard economy. These are “Barrovian” models.
   A true Ricardian would heavily tax land speculators, miners and the idle rich, seek to lower the cost of living for the poor, and believes in some version of the labour theory of value.

7. Arthur!!!

   Good to see you commenting over here!

   Stick around for a while, check out somer older posts, get familiar with the commenters and start asking some questions. You will definitely learn something.

   Theres no better place to start your day than at billy blog.

8. Thanks bill for a superbly informative blog!
   I have a simple question – if private investment is greater than private saving (I>S), is that equivalent to saying the nation has foreign debt? Or does it depend on how much of that investment is excess stock (unintended investment) as opposed to desired investment?

9. I have enjoyed reading your blog for around a month now. For an economic layman like me what you say makes sense. Just to ask is the main point in your argument not already conceptualised as the paradox of thrift?

   Equally I undertstand from reading your blog that the logical assumption for an efficient economy is full spending and no saving. This is an issue that detracts from solely economics as coming into my old area of study you can never trust all other independent actors not to save and gain themselves a competitive advantage at your loss. Hence why the best outcome for all is to save.

   Please correct me if I am wrong.

10. James: Just a minor point

    I disagree that this is a minor point, and I am happy to see the historical record set straight. There is too much misrepresentation of past thinkers owing to ignorance. As even many mainstream economists, such as Krugman and DeLong, have observed, most of the mainstream is woefully ignorant of economic history. So thanks for setting this straight and giving Ricardo his due. Please keep it up. We shouldn’t fall into their loose talk and sloppy thinking. It’s all too easy to fall prey to repeating their buzz words.

11. “Most nations run external deficits”

    But the fewer countries that have surplus must in principle have the same total amount as the deficit countries have. In pricipe that is because there are anomalies in the number countries claim to have, it doesn’t add up to zero.

12. Hi, Bill-

    “Note clearly that the printer attached to the computer is silent – there is no “money” being printed.”

    Ah- very droll! Yet above, you write:

    “The government issues the currency in this two-person economy…”

    “The government says: “I will spend $100 on private sector activity which will provide the currency…”

    There is no reason for all this currency to not be printed out and instantiated as tokens to be handed back and forth. It is simply out of post-modern convenience that you have chosen to use a spreadsheet instead, which in the event of a power outage may allow this economy to collapse ignominiously.

    So I think the point stands that the “printing money” metaphor is perfectly applicable. Not only that, but people know in their bones that the government *does* print the money, which puts the lie to all the mainstream propaganda about private industry being the source of all money/wealth and the government having to steal it from the private sector, etc.

13. Burk, two things get confused by the public in the use of the term “printing money.” In a very obvious and trivial sense, bank notes are printed pieces of paper. In the non-trivial sense, “printing money” as ordinarily used signifies the cb increasing reserves, e.g., through QE, adding to the money base.

    In the first place, reserves never enter the economy and get spent. They are just number on accounts, either in ink as previously, or digitally as now. The connection between the notes and reserves is that banks exchange reserves in their account that the cb for notes, which they hold as vault cash in anticipation of customer demand. Customers draw down their account in exchange for notes.

    Secondly, the cb is just shifting the composition of assets. Reserves are its liability, and like on other balance sheets the liabilities are offset by assets. (Unlike other liabilities, the government’s liabilities are irredeemable under a nonconvertible floating rate system.) When the cb buys bonds, it takes the bonds on its balance sheet and reserves increase in the sellers account. Since the bonds were initially exchanged for reserves, this is just a shift back in aggregate. No new financial assets created.

    The public confuses reserve operation with printing of notes for circulation. There is no intrinsic connection. As far as MMT is concerned, the term “printing money” is a canard.

14. “So I think the point stands that the “printing money” metaphor is perfectly applicable.”

    No they don’t print money. They spend it. It is that which adds benefit to the economy as long as it is not to excess.

15. “- aggregate demand drives output and national income. Cut spending and prosperity falls.”

    Aggregate demand and Government spending are not the same. Yet from one sentence to the next, you attempt a switch-a-roo on us. Cuts in *government* spending to not necessarily cause a reduction in prosperity. You are the one lying, as I doubt you are confused about this.

16. You gotta love Warren Mosler.

    “Senate Candidate Bets Congress $100 Million That the U.S. Government Cannot Run out of Money”

    http://moslereconomics.com/2010/10/22/press-release-3/

17. Dear Richard (at 2010/10/23 at 7:34)

    You noted:

    Aggregate demand and Government spending are not the same. Yet from one sentence to the next, you attempt a switch-a-roo on us. Cuts in *government* spending to not necessarily cause a reduction in prosperity. You are the one lying, as I doubt you are confused about this.

    I suggest you go back to the first few weeks of Macroeconomics 101 – Mainstream or otherwise. The fact that government spending adds to aggregate demand is not controversial in any paradigm whereas the net effects of this addition might be debatable.

    Aggregate demand is the sum of total spending – household consumption, private investment, net exports and government spending.

    The mainstream argue clearly that government spending crowds out private spending. But they acknowledge it is still aggregate demand! Your further point that “Cuts in *government* spending to not necessarily cause a reduction in prosperity” is true and I agree with you and have never said otherwise. Not necessarily is the operative qualification. The point I made in this blog which you seem to want to ignore for the sake of accusing me of lying is that cuts in government spending which are not replaced by an equal rise in private spending will cause a reduction in prosperity. Every professional economist agrees with that point if there is idle capacity. Sorry.

    I would also note that I deleted another of your comments (2010/10/23 at 7:52) where you claim I said something when in fact it was a quotation from someone else and I provided that quote in a different post to the one you attempt to comment on. Then followed a one line personal attack on me rather than my ideas without further substantiation, argument or evidence. I remind you that I have a Comments Policy and that your attack was in violation of that policy.

    I may be wrong and I welcome informed commentary pointing that out or adding other interesting points to the edification of all of us. But to accuse me of being a paranoid liar without further evidence or discussion is not edifying at all and will never be published on my blog. I don’t see the point in rehearsing unsubstantiated bile here.

    I may be a paranoid liar and would like to know how you conclude that so I can get help if you are correct. Why not provide some argument to support your view and we will see where we go with that?

    best wishes
    bill

18. “Aggregate demand is the sum of total spending – household consumption, private investment, net exports and government spending.”

    Of course. Feel free to tell your readers that if the government starts using paper currency as toilet paper, AD has increased.

    You know precisely how gov’t spending as a component of AD can be misleading, and you’ve put it to good use here. Yes, if you just want AD to increase, triple the president’s salary. Better yet, triple the military expenditures. The more tanks we have, the more prosperous we are. It’s Econ 101. Interest paid on debts increases AD.

    Tell your readers how starting a war increases AD and–this will be the best part– how that translates into prosperity. If AD causes prosperity, why has Foreign Aid failed so miserably?

    If government spending causes prosperity, why not just keep on spending indefinitely?

    Our blog author has confused actual prosperity with a number, a redistribution as an increase. If the government stops spending, yes, AD drops (as data), but there’s not a dimes worth of difference in the actual prosperity of the nation.

    Answer this: Does the U.S. have more prosperity because of the AD increases caused by wars in Iraq and Afghanistan? Keynesian economics in one simple lesson: Invade thy neighbor.

    “cuts in government spending which are not replaced by an equal rise in private spending will cause a reduction in prosperity.”–You So, if the U.S. were to stop all of it’s spending in Iraq–with no increase in consumer spending–it would be less prosperous?

19. Dear Bill,

    Thanks so much for the occasional explanation like this: God I’d love to see you on the 7:30 Report instead of ‘Mr pontification’. Cheers …

    jrbarch

20. I have refined my question, anyone help with an answer? I am refering to Bill’s diagram 2.
    Does it make any difference if a household wants to consume an extra $20 worth of local food and services by borrowing $20 from an Overseas bank? What if the $20 is used to buy a house?
    So I figured this out> the 20$ just goes round and round until its repaid to the Overseas lender. While its going round and round its getting taxed out of existence isn’t it? It keeps going round and round until one day the Overseas Lender wants its $20 back? So the 20$ firstly added to job creation then detracts from it in some future year when it is repaid?
    I only want an answer because I read that Australian Banks borrow from Overseas about 30% of every dollar they lend with a lot of it going into Residential Mortgages. I couldn’t figure out if this is good or bad for jobs long term. I don’t care how rich or crowded with stuff peoples homes get as long as everyone has a right to a job, income for a good life, shelter and health care. if MMT can deliver it I will support it.
    Richard, this site has always being very tolerant of stupid questions but it is not tolerant of rude personal attacks. Bill is equal to anything you can dish out anyway.
    Nice small waves again this morning in warm water too. ps have found spellchecker. It wont fix my grammer though.

21. bill, I think you need to add a medium of exchange supply. I also believe you need to add a “firm” that is bank or bank-like. That means someone saves $20 and that $20 is invested as bank capital that becomes $200 in debt (demand deposit medium of exchange).

22. Punchy said: “Does it make any difference if a household wants to consume an extra $20 worth of local food and services by borrowing $20 from an Overseas bank? What if the $20 is used to buy a house?”

    And, “I only want an answer because I read that Australian Banks borrow from Overseas about 30% of every dollar they lend with a lot of it going into Residential Mortgages.”

    Those two seem different to me. Can you expand on the second part?

23. Hi Bill
    I’ve got a mental block on ‘I’
    I can see the consequences of savings on inventories.
    Are you (or the National Accountant) saying that ‘I’ is always a balancing figure for the Sources NI equation that can be assumed to be restocking or destocking of inventories? Or is the ‘Private Investment’ coming from elsewhere?

24. After a bit more consideration..
    Is ‘I’ effectively a combination of previous period’s savings on things that don’t get consumed in the current period and the change in inventories in the current period?

25. Hi Fedup,
    your right I have confused my own question, Thanks. Is it the case that if I borrow from O/S and spend it in my country it does little or nothing for the country where the money came from but will create employment in my country. When I pay the money back to the O/S lender will it cost jobs in my country?
    As for Australian banks borrowing from O/S so we can pay more and more for Houses (shelter) I just cant see how it adds anything at the Australian end of the deal. I wanted to know what it adds as we are doing plenty of it.
    Cheers Punchy

26. I know I’m late to the party, but there is a chance someone will answer my question.
    Tom Hickey said, “reserves never enter the economy and get spent.” My question is if that means that QU isn’t being used by the big banks to raise stock prices. Also, is the Fed really allowed to spend money in the market. I asked because at some sites I visit I read all kinds of things about what is done with QU and what the Fed does.

    Also, the banks have been accused of simply buying Treasuries and getting the interest. My understanding is that the Fed buys up the excess reserves and pays the discount price for them. Is that correct and if so does that mean excess reserves can’t be used to buy Treasuries?

    I also have a question about the austerity in Britain. I know that in the US private debt to GDP is around 270% ( which I realize is unsustainable and decreasing), but I’m wondering if the Brit’s have a low enough private debt to GDP ratio to help delay the ill effects of austerity for any length of time- like maybe until more reasonable heads take control.

27. In QE, banks are selling mortgage backed securities (MBS) to the Fed in return for reserves. The excess reserves earn 0.25% from the Fed. This positive interest rate policy was originally done to ensure liquidity in the payments system, as reserves are the final accepted form of settlement.

    Banks may or may not be using those reserves to buy up Treasuries – but it is basically a swap of assets between Treasuries and reserves. Short-term treasuries (1 mo/3 mo/6 mo) are 0.15%/0.16%/0.19%, so the banks do better just leaving the reserves sit.

    This is not an injection of funds into the system, it is a swap of longer term assets (MBS) that have higher interest rates for shorter term assets (reserves) with lower interest rates. This will tend to drop the long term interest rates (by the market showing a preference for low risk, low interest assets). Because the Fed is buying up MBS assets (assume at a higher price than the market, otherwise they would let the market do it), this has the effect of raising or at least slowing the decline in these asset prices.

    The effects on income of this policy is unclear – borrowing costs should decrease long term, but interest income is also decreasing. Since the wealthy are continuing to increase their share of the current income stream, the decline in interest income is less important to them than to the fixed income folks who depend on interest payments. But, again, the future effects of this policy are unclear.

    I am not sure, but banks may be able to use their increased reserve position to increase their leverage in other markets (e.g., equities), especially since commercial and investments banks are combined into single entities. But I do not know if there are regulatory controls to manage such actions. At a minimum, the repair to their balance sheets have allowed them capacity to increase leverage in other markets, driving up asset prices.

28. @GLH
    I’ve some bad news. The UK privat sector is deep in the hole. The government is virtuous compared to it even by mainstream economic reasoning. McKinsey: Overall UK debt: 469% of GDP. Composition: Government: 52%; Nonfinancial Business: 114%; Households: 101%; Financial Institutions: 202% (reflects that London is a financial hub). Something must be wrong with British education standards? They seem to have serious trouble with arithmetics?

29. I have finally solved my ‘I’ problem.

    The problem was that the NI accounting identities were not holding true in the spreadsheet I was building because I was applying G & T transactions to firms whereas I believe they should have been confined to households.

    Anyway all the identities now match and the ‘I’ accounting adjustment seems to me to be an important concept. The direct correlation between firms and household savings is clear and I can see how ‘I’ not only holds up aggregate demand and puts money in households savings, as well as providing scope for increased future output, it is also the signal (from household savings) to firms to change their behavior with regard to jobs and output.

    The importance of the appropriate fiscal policy become even clearer to me.

    Thanks for the refresher Bill. I look forward to the textbook.

30. Thanks to both pebird and Stephan.

31. I was just over at Krugman’s blog on QE2, and perusing some of the comments, people are hopelessly confused on what reserves are. Krugman himself confuses the matter in his post by calling them short term government “borrowing.” However, reserves are neither current liabilities nor payables at all in the ordinary sense of nongovernment accounting. As I believe Stiglitz observes, reserves are not redeemable.

    Krugman correctly includes reserves and currency in the monetary base as the Fed’s liabilities. Currency is exchangeable at face value for reserves by banks belonging to the FRS. It should be obvious that currency is not redeemable either.

    Then Krugman goes even further down this hole by called these putative current liabilities “debt.” No wonder people are confused.

32. Tom,

    I think there’s more right than wrong in Krugman’s post. The main issue is that QE is a duration swap and Krugman at least got that right – which is a lot actually. Go over to the monetarist sites if you can stomach it and they’ll be talking about QE and the multiplier.

    You’re right if you want more precision than that, but the issues do become semantic. I can see where you’d be sensitive to the use of the terms “borrowing” or “debt” in the context of MMT.

    The issue of redeemability also is not immune from semantics considerations. You could always say that reserves and currency are redeemable for tax credits – i.e. the elimination of tax liabilities – an interpretation that is MMT aware as well.

33. Neil Wilson says:
    Friday, October 22, 2010 at 19:31

    Maybe some do need the UK to go through this in order to learn.

    However, those about to be thrown out into the street would disagree with the need to reinvent the wheel. It’s too cold here and those who need to learn will be warmed at home, in government offices etc!

    Billy is right to use the word ‘terrorism’. Because those inflicting this will not suffer.

34. JKH: I can see where you’d be sensitive to the use of the terms “borrowing” or “debt” in the context of MMT.

    I am not quibbling with Krugman on the correctness of what he is saying. I am just focusing on the terminology that reinforces the notion that government finance is analogous to nongovernment finance. I’m sure that Krugman is just using the terms conventionally, but reading the comments to his post is clear that ordinary people pick up the wrong idea. The reason we have operational definitions is to be precise and obviate confusion.

    You could always say that reserves and currency are redeemable for tax credits – i.e. the elimination of tax liabilities – an interpretation that is MMT aware as well.

    Yes, but if one calls reserves and currency government “debt,” then to be consistent one should say correspondingly that tax obligations are “debts” to government, and the person is the street is going to say, “But I never borrowed anything from government.” 🙂

    People who understand what going on aren’t taken in by the terminology, but ordinary people are, and it perpetuates the myths.

35. Helen @ 10:57

    In Economics as Religion, Robert Nelson calls the economic norm that suffering is good for you if you are poor, “Calvinism without God.” It’s pure ideology shaped by previous religious convention.

36. “Our blog author has confused actual prosperity with a number, a redistribution as an increase. If the government stops spending, yes, AD drops (as data), but there’s not a dimes worth of difference in the actual prosperity of the nation.”

    So exactly how do you propose to increase prosperity?

    I think we ought to pay for it. Do you know anyone who will do something worthwhile for free?

    Now, either the govt pays for it OR the private sector pays for it.

37. Richard “Answer this: Does the U.S. have more prosperity because of the AD increases caused by wars in Iraq and Afghanistan? Keynesian economics in one simple lesson: Invade thy neighbor.”-
    The Nazis were the first government to implement Keynesian economics. They turned around the economy by building autobahns and then by building weapons. Reganomics was basically MMT- the star wars project was a way to increase aggregate demand. Lets face it, if every one burnt their neighbours house to the ground every 10 years or so there would be no unemployment. All of that is why I think it is extremely dangerous to not have waste and strife as the key evils and instead have unemployment and deflation as the key evils (as MMTers seem to do).

38. Tom,

    Yeah, I re-read his post and you’re probably right.

    It takes a much longer piece to explain it properly, without confusion.

39. Richard – is it beyond you to be a little less aggressive/discourteous?

    I suggest you read more of Bill’s back blogs as you are missing a lot of the picture. It is all about deficit spending to deploy idle capacity – in particular unemployed people who want to work but which the private sector has not found jobs for. Such a person remaining unemployed for a year is a real resource which is lost to the economy – this has nothing to do with redistribution.

    It does seem as if you are wilfully misunderstanding Bill/MMT and throwing muck around. But just in case you are genuinely confused:

    * Iraq/Afghanistan:
    – military expenditure has increased AD to the extent that, at the time when it was spent, there was spare capacity (meaning it wouldn’t ‘crowding out’ private spending; it would increase the military payroll and the revenues of US mercenary firms, some of which would be spent/invested in the economy. Of course, the multiplier effect of such spending is that much less when it destroys infrastructure (even another country’s). There are obviously good non-economic reasons not to invade other countries; are you seriously suggesting that because MMT highlights the economic benefit of military action, the adoption of MMT would lead to an even more militaristic foreign policy than at present?

    * Foreign aid
    -the lack of success of foreign aid in recipient countries is likely related to mechanisms of spending aid revenues within target economies – ie weak/dysfunctional/corrupt political institutions. Not really applicable to what MMT is on about, which is how it’s unwise to cut back on spending on domestic programmes when there’s such idle capacity and willingness to save on the part of the private sector.

    * “If government spending causes prosperity, why not just keep on spending indefinitely?”
    -MMT always says that deficit spending makes more sense the more space capacity there is in the economy; as AD approaches AS, deficit spending should be curbed.

    Best wishes
    M

40. I wonder about the effectiveness of spending in the UK. Surely there has already been a pretty significant spend due to Olympics preparations which surely should have created many jobs and spurred growth.
    Perhaps this is the source of their high inflation at present.

    Would be interested to hear from a Brit about this.

41. Ray yes there has been significant public investment the London Olympics infrastructure, which must have had some positive multiplier effect; but

    Our persistent 3% CPI increases are speculated by the Bank of England to stem from energy and ccy depreciation effects; no one seems to believe this but I haven’t heard any plausible alternative explanation, when wage increases are all at 0-2% and broad money appears under control.

    Best wishes
    MMTP

42. More than a little sad when all is required is the political will to fix the homes …

    Public Housing Repairs Can’t Keep Pace With Demand
    http://www.nytimes.com/2010/10/25/nyregion/25repairs.html?pagewanted=2&partner=rss&emc=rss

43. Punchy said: “Is it the case that if I borrow from O/S and spend it in my country it does little or nothing for the country where the money came from but will create employment in my country. When I pay the money back to the O/S lender will it cost jobs in my country?”

    I think it depends.

    And, “As for Australian banks borrowing from O/S”

    I’m not getting that part.

    And, “so we can pay more and more for Houses (shelter) I just cant see how it adds anything at the Australian end of the deal. I wanted to know what it adds as we are doing plenty of it.”

    Would it allow the private sector to be able to run a deficit for the trade deficit and/or budget surplus?

    trade deficit = gov’t deficit plus private deficit

44. Typo :

    The ‘M’ in the identity for the uses of national income (Y = C + S + T + M).

45. Thanks for pointing out that typo. I was wondering…

46. “The government says: ‘I will spend $100 on private sector activity which will provide the currency…’

    How about the government says: “I will create a central bank and ‘borrow’ $200 from it and deposit that money in a private bank, which will gladly lend you $120 against $150 worth of real wealth that you have create by the sweat of your brow.” Our non-government person has no net DOLLAR savings, but he has $30 on his balance sheet if you count “inventory.” It is only the constraint of there being no third member of the economy to buy the inventory that prevents the first guy from having net savings. That third guy, of course, must also create some wealth in order to be able to borrow the $150 to buy what the first guy made, but that’s how real economies work. All the government has to do is seed the private banks with legal tender reserves; it never has to spend a nickle.

47. Lawrence J. Kramer says, “All the government has to do is seed the private banks with legal tender reserves; it never has to spend a nickle.”

    When banks lend and create deposits, money is created (the deposit) but it nets to zero as the assets and liabilities are equal. No nongovernment net financial assets are created by credit extension. Moreover, money created through credit extension involves an interest obligation on the part of the financial sector in addition to the oblibation to repay the principal.

    When government spends into the economy this increases nongovernment net financial assets with no obligation to repay on the part of the private sector or private sector interest obligation.

    If the public wishes to net save, it needs net financial assets with which to do so.

48. “If the public wishes to net save, it needs net financial assets with which to do so.”

    I’ve given an example of how an economy would work and people would accumulate wealth using only bank reserves created by Government printing (but not spending) and fractional reserve banking. If my model creates “no new net financial assets,” but does allow for the accumulation of net purchasing power by the public, perhaps the focus on net financial assets (money) simply swings at the wrong ball.

    Prof. Mitchell’s two-person economy fails as a thought experiment because it does not allow for a number of players sufficient to enable fractional reserve banking. Without that possibility, the model is too hobbled to illustrate how T-accounts summing to zero does not negate the possibiltiy of net saved purchasing power and adequate liquidity to execute it.

49. Lawrence, see Bill’s post on fractional reserve banking here and here, for example. Also see the comments, especially by JKH and Scott Fullwiler. Banks don’t lend reserves.

50. Tom – I’m not looking for a primer on MMT. Let’s stay with your comment.

    “When banks lend and create deposits, money is created (the deposit) but it nets to zero as the assets and liabilities are equal.”

    If the bank lends against an asset, the only necessary “liability” is the encumbrance on the asset. There needn’t even be recourse against the borrower. Absent recourse, there is no offsetting liability on the borrower’s balance sheet except to the extent that the loan reduces the carrying value of the asset, which may be zero if the asset itself is carried at zero. If there is recourse, the borrower’s liability is a guaranty that the collateral will be worth the balance due. Such a guaranty can be valued at less than the total loan; indeed, it can often be insured through a third party for the payment of a small premium. When that happens, the insurer’s reserve for the claim is certainly less than the amount of the loan. Meanwhile, what you call “new net financial assets” – the money borrowed against the asset – are in the borrower’s SAVINGS account. Is there a useful definition of “saving” under which the borrower has not “saved” the amount of the loan, net of the value/cost of the guaranty, if any?

    Recourse – creation of a liability – is a contractual term, not a necessary attribute of a secured loan. Unsecured loans to individuals create offsetting liabilities, but an unsecured loan to a corporationis just an encumbrance on the owner’s stockholdings. If the business can service the loan without using the proceeds, it can pay those proceeds to its owners, who can put them in the bank, again, as savings. Do you doubt that Facebook could borrow $1,000,000 tomorrow and pay it to Mark Zuckerberg as a dividend and that, if he is carrying his stock at zero on his balance sheet, he would not have net savings of $1,000,000 by virtue of the loan? Would it matter whether the bank making the loan got its deposits from the recipient of government spending or by government deposit without spending?

    It all starts with the generation of real wealth in the real economy. Someone builds a house or a web site, hangs a shingle, or writes a song. If the result can be swapped for something else, it is wealth, and a bank will lend against it, asking recourse only to the extent its bargaining position permits. Thus, the money lent may or may not be offset by an accounting liability, and the recipient, or those who enjoy his custom or largesse, will have net savings, again, without Uncle Sam having spent any money. All that’s needed is for the government to create banking reserves by depositing money. The private sector will handle the rest.

    Money is a medium of exchange. Governments create it as an accommodation; it allows people to quantify and homogenize their purchasing power. It could be created and disseminated for that purpose by a government that had no other function, i.e., that spent nothing on anything (and,therefore didn’t tax, so the idea of a model that starts with assumed taxation is really unhelpful). Net saving is simply surplus value added, i.e. purchasing power not yet exercised. It is a real phenomenon, not a monetary one.

    As for fractional reserve banking, I don’t see the difference – vis a vis the claim that private savings require a public deficit – between the standard model whereby reserves precede loans and the MMT model where loans drive reserves. Actually, I don’t see any policy implications of the difference either. Apparently, the cost of money to the bank is affected by the Fed’s degree of accommodation, so the bank’s hurdle rate (a function of the spread it charges and creditworthiness it demands) also depends on that degree of accommodation. In other words, if the Fed eases, the bank can make money on loans for which there is a greater demand than if money is expensive. Since banks create money by lending, the cost of money determines (ceteris paribus) how much lending is done, and, thereby, the money supply.

    Do you not agree that (i) real wealth can be created without money, or (ii) money can be created merely to provide a medium of exchange for real wealth, or (iii) that real private wealth can reasonably be called “net private savings”?

51. Lawrence says, “Do you not agree that (i) real wealth can be created without money, or (ii) money can be created merely to provide a medium of exchange for real wealth, or (iii) that real private wealth can reasonably be called “net private savings”?”

    (i) Difficult in a money economy, certainly on any scale that would matter much without slavery.

    (ii) The chief purpose of money is as a medium of exchange. Money is a financial asset used to facilitate transactions involving the exchange of both real assets and other financial assets.

    (iii) Depends on what you mean by “savings.” If savings = net worth, then it includes all assets, financial and real. But that does not affect the fact that net financial assets are created by government deficit expenditure, or that the national “debt” as the accumulated deficits is the total nongovernment saving of net financial assets. This is just states that the net financial assets created by deficits gets saved as tsy’s due to the politically imposed requirement of a S-4-$ deficit offset with tsy issuance.

    It is funds flowing through an economy, some of which are committed to productive investment, that results in the increase in real assets, i.e., real wealth as part of net worth. Some portion of income is not consumed and is saved as financial assets, e.g., bank accounts or bonds.

    Government inject and withdraw net financial assets, banks create debt-based funding, and productive investment creates consumable products and real assets.

52. “I’ve given an example of how an economy would work and people would accumulate wealth using only bank reserves created by Government printing (but not spending) and fractional reserve banking”

    Seeding state money into private banks is state spending. The state is getting nothing of real value in return for its scrip.

    That system is entirely consistent with MMT, although I’m sure that the theorists would suggest that there are more efficient means to fire an economy up than state spending into the private banking system.

53. Tom –

    i. “Difficult” is not “theoretically impossible,” which I understand to be the claim. I’m not advocating a money-free society, just noting that there is no theoretical obstacle.

    ii. Fine. Then there is no reason why it needs to be “spent” into existence as opposed to lent into existence.

    iii. What about non-recourse, fractional reserve bank loans against collateral carried at zero, which create no offsetting liability? Are they not net private savings?

    Neil –

    What I call “seeding” can be accomplished by the government lending to the bank, i.e., opening an interest-bearing account. That’s not what is actually happening here; the gov’t is IN FACT running a deficit. But we’re talking necessary identities here, and I’m just saying that government spending is not LOGICALLY necessary to the creation of money by the banks against real wealth without recourse.

54. Neil – Let me clarify, that the government gets nothing for its scrip is irrelevant to the claim that deficits=savings if the loan to the bank doesn’t create a deficit. If the Treasury books an interest cost for its loan from the Fed, we can hypotheize an interest payment by the bank to the Treasury, The result: no federal debt, but money available to lend without recourse against zero-carry-value assets.

55. Lawrence, admittedly it is possible to set up a system in a variety of ways, all of which have consequence, e.g., barter system with no money permitted (yes, there are some people who use no money as a matter of principle), only state money with no bank money creation, only bank money creation with no state money creation, private banking seeded with state money as you suggest, vertical-horizontal system as at present, convertible flexible rate or nonconvertible floating rate, etc. There are a lot of proposals being floated around right now.

    MMT is a description of the operations of the existing system, what they entail, and how to improve outcomes by taking advantage of the opportunities of the current system. There are also suggestions for tweaks to the existing system by removing politically imposed restrictions in various currency zones.

56. I’m fine with what MMT purports to be. I’m just questioning one simple, apprarently fundamental tenet: an accounting identity between net private savings and net public debt. I cannot square that identity with either the theoretical possibility of (i) HPM being created by unspent government bank deposits, or (ii) bank-created money lent against previously unaccounted for value added. If the identity doesn’t hold, how much of the MMT edifice remains? If it does hold, how does it handle the two phenomena I have noted, especially the latter, which in fact takes place in our economy every day?

57. Lawrence: “real private wealth can reasonably be called “net private savings””

    You can call anything anyhow and build any theory on any basis you like but you need to be aware that your definitions can go against commonly accepted practice, rules and assumptions. But then it will be you who has to defend your definitions.

    National accounts is the system approved and recommended by United Nations for use in all countries and it defines savings in purely nominal accounting terms. Within national accounts your house is not your savings regardless of how you personally think about it.

    _http://en.wikipedia.org/wiki/National_accounts

58. Sergei – The issue isn’t nomenclature; it’s existential economics. I’m happy to use the definition you propose, but then you have to defend its relevance to economic reality. What does the identity that exists under the definition you favor betoken? I can’t see why anyone would want to measure “net private savings” under your definition except as an observable thing that has historically correlated with some less directly measurable phenomenon. Weatlh, as perceived by its holders, drives economic activity (that there being my defense of my definition). If “net private savings” doesn’t measure wealth, what does it measure that matters? And if it doesn’t measure something that matters, why do we care that it equals the net public deficit?

59. Lawrence,

    Your instincts are good but I’m afraid that you’re unlikely to get sensible answers to your questions here. There is nothing tying the flow of real saving to the flow of nominal saving net of the flow of nomnal investment (what does this value signify in any case?). Real saving and MMT net saving are not the same thing.

60. “It is funds flowing through an economy, some of which are committed to productive investment, that results in the increase in real assets, i.e., real wealth as part of net worth. Some portion of income is not consumed and is saved as financial assets, e.g., bank accounts or bonds.”

    Tom, you’ve either been mislead or you’ve somehow managed to confuse yourself. The correct version is, “some portion of output–a flow of real resources–is not consumed (i.e. is saved) and is used to finance real investment.”

    REAL saving is given, in a closed economy, by,

    S = Y – C – G

    Where S is the flow of unconsumed real resources (goods and services) available for investment.

61. Lawrence, we all live in the monetary economy. Savings in monetary economy by definition is monetary income not spent. Net private savings measure the monetary wealth of the private sector in aggregate. This wealth is not about perception or relevance but about accounting facts, where accounting was invented to reflect the monetary reality.

62. Sergei –

    What on earth are “accounting facts”? We wouldn’t need GAAP if accounting were about facts. Accounting is about homogenized reporting. Accounting is about book values; economics is about market values. Any presccriptive economic program that looks to accounting identities is doomed to fail.

    But meanwhile, I’m still waiting for SOMEONE to explain to me how non-recourse loans against unrealized gains figure into the claim that bank lending creates no new net financial assets. What are the T-accounts on the transaction? It seems to me that the bank debits loans and credits cash, but the borrower debits cash and credits equity, i.e., net financial assets. Can you plug that hole in my understanding?

63. “Savings in monetary economy by definition is monetary income not spent. Net private savings measure the monetary wealth of the private sector in aggregate.”

    I don’t think either of these statements is correct. Nominal saving (singular; flow of) is monetary income not spent on consumption. Net private saving (singluar; flow of) refers to the balance of payments between private and non-private sectors in the economy. It measures relative flows of nominal expenditure between them.

64. Lawrence,

    “It seems to me that the bank debits loans and credits cash, but the borrower debits cash and credits equity, i.e., net financial assets.”

    I think you are correct. There was quite a bit of discussion of this in the comments in the not too distant past. Anon to thread!

65. Lawrence:

    You are making some interesting points, but I am not sure about the technicalities you use:

    ”
    but an unsecured loan to a corporationis just an encumbrance on the owner’s stockholdings.
    ”

    Unsecured loan is as much of a company liability as the secured one — not clear why you apparently disagree with this. It does not matter if you call it “encumbrance” or “debenture” or whatever, the debt extraction mechanism may be different legally speaking, but an unsecured loan it is still a liability on the debtor books.

    ”
    Do you doubt that Facebook could borrow $1,000,000 tomorrow and pay it to Mark Zuckerberg as a dividend and that, if he is carrying his stock at zero on his balance sheet, he would not have net savings of $1,000,000 by virtue of the loan?
    ”
    Not sure what you are saying here.

    MZ’s stock book value being zero or any other value, as well as his balance sheet, are irrelevant to the way the company pays his dividends. If the company took a loan to pay the dividends, the loan, secured or otherwise, is the company’s liability, not MZ’s.

    ”
    Would it matter whether the bank making the loan got its deposits from the recipient of government spending or by government deposit without spending?
    ”
    The bank that made the hypothetical loan to MZ needs zero deposits (abstracting from some complications arising from interbank settlement requirements aka “liquidity” management).

    ”
    I can’t see why anyone would want to measure “net private savings”
    ”

    I share you discomfort with respect to the above.

66. Lawrence:

    “but the borrower debits cash and credits equity”

    The borrower debits cash and credits his liability (the “Loan to Repay” account).

    “Equity” is an accounting fiction being a difference between total assets and liabilities book values.

    The act of loan granting does not change either the borrower or the lender capital/equity book value at the moment the loan is granted.

67. Net “private” savings is different from “real savings” as Vimothy pointed out.

    Net private savings is a construct arising from consolidating balance sheets in which productive capacity does not contribute to savings, because the financial liabilities of firms cancels agains their real productivity capacity. Under the definition of net private savings, an economy that, due to some improvement in technology or the discovery of new resources, is no richer and has no more future consumption opportunities unless the government supplies the private sector with more deficit spending. That’s problematic.

    But “real savings” is different from actual household savings — e.g. deferral of consumption. Under this definition, if our economy consists of two people and one bank. One person bids up the price of the other’s house by $100, and pays the for house on credit. The seller of the house realizes a gain of $100 (after retiring his own debt). If he elects to not spend the $100, then he has deferred the consumption of $100. The buyer of the house has not pulled forward any consumption, because his balance sheet merely expanded to include the house and a corresponding liability. Everything else, including the nominal price of consumption, continues as before. Therefore the aggregate $100 of consumption was deferred by the economic actors, and this did not result in a $100 increase in investment, as no investment occurred.

    Therefore saying that “real savings” is what matters is also problematic. It may matter in the very long run — e.g. at some point the relationship between deferring consumption and increasing investment must be brought into balance, otherwise the economy wont be able to deliver enough consumption when those deferring stop deferring. But as long as people are willing to continue to defer consumption, then there is no reason why the paper wealth — the amount of deferred consumption, must move one-to-one with changes in the productive capacity of the economy.

    So what drives economic decision making? Why are people unemployed and what sets the price level? Net private savings, “real savings”, or actual household savings? I think its better to view the state of the economy as arising from the results of individual decision makers, so the interplay between actual household savings and real savings, among other factors, is what is most important. It all depends on your model, but I am suspicious of models that try to make a direct association between either net private savings and household wealth, or between models that assume that household wealth can only increase if the real productive capacity increases. The latter is too optimistic an assumption, and misses out on a lot of dynamics that are important for understand the trade cycle.

68. “One person bids up the price of the other’s house by $100, and pays the for house on credit. The seller of the house realizes a gain of $100 (after retiring his own debt). If he elects to not spend the $100, then he has deferred the consumption of $100.”

    I don’t get it–there is no real saving or consumption in this transaction, but nominal savings has increased.

69. By “actual household savings”, you just mean nominal savings?

70. “Net saving is simply surplus value added, i.e. purchasing power not yet exercised. It is a real phenomenon, not a monetary one.”

    You can of course define savings this way. But then the question is how to do you relate it to the consumption/saving decision faced by households, or the investment decision faced by firms? There is a logical leap — a fudge — if you assume that individual household savings are measured by some fraction of real net savings. Therefore net savings may not be the economically relevant thing to look at.

    This discussion would be really helped if people didn’t just *define* various terms that had the word “savings” in them, but if they incorporated their definitions into models of behavior. The disputes arising here are about the relevance to behavior of each definition of saving.

    I would argue that in an economy in which households are looking out for themselves, the savings/consumption trade-off is driven by the change in financial net-worth of individual households, rather than an increase in the productive capacity of the nation as a whole.

    We can debate exactly how those changes are recognized on the household balance sheet — mark to market, cash-basis, expected resale value at the time the households wish to take delivery of the deferred consumption, etc.

    But however you recognize the changes to balance sheets, it’s safe to say that a household that receives a windfall from the sale of an asset does not say to itself “the real productive capacity of the nation has not increased, and therefore I am no richer”.

    Similarly, when a household’s balance sheet is priced down and it incurs a loss, or must send a check to the bank when its house is foreclosed upon, the household does not say to itself “the real productive capacity of the nation has not decreased, and therefore I am no poorer”.

    In both cases, the rational household should believe that its own budget constraint has expanded out or in, as the case may be, and that it’s own income has increased or decreased via the identity savings = change in net-worth.

    The question then becomes whether, for a fixed level of “real net” savings, one household whose net-worth increases must be matched by another household whose net-worth decreases by the same amount.

    If true, then there are no income effects at the aggregate level. But to believe that is to assume that assets are always rationally priced, so that the price of assets moves lockstep with the price of consumer goods, and therefore it is impossible for the sum total of household net-worth to go up unless there has been an exactly equal increase in real (net) investment. But that makes no sense — if, for some reason, households believe that the productive capacity that they already own will be worth more in the future — it will be “more productive” — then they will recognize this on their balance sheets today, even if interest rates are fixed. This means that they will recognize income today, and will book additional savings today. Similarly, if they believe the productive capacity is decreasing, then even if the interest rate is fixed, they book the dissavings today, and recognize the income loss today.

    And how is the individual household supposed to know what the productive capacity will be, except by looking at the market prices?

    That means that everyone’s net-worth and therefore their savings can fall or rise at the same time, even if the real productive assets are unchanged in terms of their physical characteristics. What can change is the estimated productive capacity of those assets. But all that really needs to change is the expected resale value of the asset when the household plans on taking delivery of the deferred consumption.

    Therefore everyone’s budget constraint can move out or in at the same time. In that case there will be stimulative or contractionary effects purely from this financial phenomenon, and any explanations of recessions or booms arising from this phenomena can’t be articulated in terms of “real net savings”, or “real savings”, or NIPA savings, or net financial assets of the private sector as a whole.

71. “By “actual household savings”, you just mean nominal savings?”

    No, I mean savings however valued by households.

    Savings = change in net-worth.

    In order to define In order to be more specific, you would need an accounting system for recognizing changes to balance sheets in order to determine the left hand side.

    To make the discussion more clear, just assume that households use a cash-basis, system and that they divide by the consumer price index.

    In that case, you will still have discrepancy between actual household savings and “real net” savings.

72. RSJ,

    I think I see what you’re doing here and in our other conversation. You’re saying that nominal savings increased but real investment did not, which is true. But you’re not being careful about distinguishing which flows are nominal and which are real. The LF model makes more sense if you’re consistent with this.

    Real savings certainly exist (no need for scare quotes). They are the product of previous deferred consumption of real output. They’re what we did with all those unconsumed resources, i.e. the real value of the tangible (and intangible) asset stock. As you correctly observed above, you simply can’t go from nominal saving to real investment. Real investment has to be financed by a stream of real unconsumed output (goods and services). Paper savings is not enough. Neo-Chartalists are nominalists and don’t understand this, from what I’ve seen.

73. “I don’t get it-there is no real saving or consumption in this transaction, but nominal savings has increased.”

    Try telling the household whose net-worth increased by $100 that is has no “real” savings.

    The price level has not gone up (for consumer goods).

    The household has $100 of consumption opportunities that it has selected to defer.

    Try telling the household that bought the house that it “dissaved”. Its net-worth has not decreased. All that happened was that its balance sheet expanded.

    So you are implicitly using some form of rational asset valuation if you argue that the only way “real” savings of households can go up is if investment occurs.

    The individual household doesn’t care if the economy has more investment goods or not. It cares about how much real consumption opportunities it has stockpiled for itself. It cares about its own net worth divided by the price level.

    I call that household savings.

74. “Unsecured loan is as much of a company liability as the secured one – not clear why you apparently disagree with this. It does not matter if you call it “encumbrance” or “debenture” or whatever, the debt extraction mechanism may be different legally speaking, but an unsecured loan it is still a liability on the debtor books.”

    VJK – To its owner, a corporation is a piece of property. Its liabiliities are analogous, from the owner’s perspective, to a mortgage on a piece of property; the debt can only be satisfied by the property. A corporation may or may not be able to generate new value, and it may or may not have assets that can be sold to satisfy its obligations, but one thing is clear: those obligations are not obligations of the owner. Consequently, if the corporation has sufficient creditworthiness to obtain a loan, and it distributes the cash to its owner as a dividend, the owner debits cash and credits what? He could credit the carrrying value of the stock, if he is carrying it at a value in excess of the distribution, but in the case of a company that has prospered, the distribution might well exceed the value of the company on the owner’s balance sheet. What entries then on the owner’s balance sheet? What consequence to his net savings?

    The fact that the corporation even has books is wholly fortuitous. If I own a corporation, and it takes a loan that it distributes to me, the corporation records a liability, which lowers its book value. But if I own a piece of realty, and I borrow against it without recourse, the “property” has no “books.” We would have to hypothesize a borrowing entity to be in debt (since I have no personal liability) to make the T accounts sum to zero. Is that done? And, if not, why would a corporation’s liabilities matter to the savings of an owner who receives a distribution from the corporation any more than the encumbrance on a parcel of real property with no carrying value?

    I merely offered MZ as an example of an owner receiving substantial, bank-created, financial assets by effectively borrowing against his shares, i.e., by having the corporation borrow and distribute money to him.

    “The borrower debits cash and credits his liability (the “Loan to Repay” account).

    I don’t think so, not if the loan is without recourse. But that’s sort of the point I was making before: the proper treatment of such a loan is a matter of convention, not economics. Clearly, the owner now has money and he has a smaller interest in a non-financial asset (the encumbered property). He has, in effect, sold a first claim on the value of the property to the bank in exchange for newly bank-created money. No government deficit was required.

75. Try telling the household whose net-worth increased by $100 that is has no “real” savings.

    That isn’t what “real” means. At least, in economics, “real saving” is something different.

76. “That isn’t what “real” means. At least, in economics, “real saving” is something different.”

    I’m not sure of any definition of “real” savings. As Andy Harless pointed out — what would be the GDP deflator for real savings? Savings is not a “real” concept. Investment is a real concept. Savings is a purely financial concept, at least under the standard assumption that consumption goods cannot be carried across periods.

77. In every period output is either consumed or invested. Real saving is the flow of unconsumed real output. Nominal saving is “financial”.

78. “As Andy Harless pointed out – what would be the GDP deflator for real savings?”

    Indeed. You can’t ever know the true value of real variables like GDP or savings directly. Think of them as unobservable population parameters and the various measures as your OLS estimators.

79. RSJ:

    How do you quantify/measure real savings in you household example ? Could you list nominal/real/household savings, in you $100 example, numerically ?

    I am afraid real savings are not measurable unless I do not understand your definition of real saving.

80. Ah, did not see the rest. It’s a little/a lot nonsensical to use an unmeasurable, or even undefined/undefinable entity, no ? That’s why “they” use nominals instead, apparently, for lack of a better proxy

81. Lawrence:

    ”
    those obligations are not obligations of the owner.
    ”
    Sure.

    “it distributes the cash to its owner as a dividend, the owner debits cash and credits what?”

    The owner debits cash and credits his equity (the “Investment Income” account, to be precise). Kind of silly, just to satisfy double-entry rules. It is equivalent to an increase in assets without any change in liabilities, so a single entry would be enough. There is no deep philosophical sense in double-entering investment income — just a recording rule. Likewise with interest income or salary or gifts, etc.

    ”
    We would have to hypothesize a borrowing entity to be in debt (since I have no personal liability)
    ”
    You do have a personal liability — your property will be repossessed in the case of your defaulting on your obligations thus discharging the liability, at least partially. The difference will be the lender’s loss and your respective gain.

    “I merely offered MZ as an example of an owner receiving substantial, bank-created, financial assets by effectively borrowing against his shares, i.e., by having the corporation borrow and distribute money to him.
    ”

    Well, you are deforming the reality here in more ways than one starting with the idea that the company would pay dividends without having earnings, as well as their founder forcing a fraudulent action to get a $1M loan disguised as dividends 😉 So, I wold reject your hypothetical as unlikely and unrealistic although theoretically possible.

    “”The borrower debits cash and credits his liability (the “Loan to Repay” account).

    I don’t think so, not if the loan is without recourse.
    ”

    Well, this kind of record-keeping is matter of custom unless by “no recourse” you mean something other than the default eventuality option.

    Finally, I agree of course, without resorting to contrived examples, that a banking system is quite possible without government intervention (“No government deficit was required.”). In fact, it was so in the US before 1913.

82. Vimothy,

    I don’t see the issue here.

    savings = income received – consumption expenditures.

    Economists usually identify income with production, which is problematic when there is unsold production, but let’s ignore that. So we use the version:

    savings = production – consumption

    And this must apply to the individual household. Its savings are the value of whatever it produces minus the value of whatever it consumes.

    But when you produce a capital good, how do you value it?

    The issue has nothing to do with real savings versus nominal savings, but with the embedded valuation assumptions.

    So again, assume that you have two households. The endowment of the first household is a capital good that it created in this period. The endowment of the second household is labor that can be combined to produce consumption goods with the capital good.

    The second household pledges to deliver 100,000 units of consumption in 10 periods, in exchange for ownership of the capital good today.

    Assume that neither household consumes in the current period, and nothing else is produced in the current period (other than the capital good).

    So what was real savings?

    Suppose the second household pledges to deliver 500,000 units of consumption in 5 years. Does this change the real savings of household 1 and household 2?

    Suppose the first household produced 2 identical capital goods in period 1 and nothing in period 2.

    In period 1, the first household sold one of the capital goods for a pledge of 100,000 units of consumption in 5 years.

    In period 2, prospects change, and the capital good is sold for 200,000 units of consumption in 5 years. Has the first household managed to save anything in period 2? (recall, it produced nothing in period 2).

    So while it’s all well and good to talk about “real” savings, there are a whole lot of nasty valuation problems that are the same valuation problems that give rise to swings in estimates of nominal savings.

83. “You do have a personal liability – your property will be repossessed in the case of your defaulting on your obligations thus discharging the liability, at least partially. The difference will be the lender’s loss and your respective gain.”

    That is a not an accounting liability, nor is it a personal legal obligation. It’s really a senior property right in the lender that I have an option to buy by repaying the loan. It would not appear on my balance sheet. What I’m interested in, however, is simply how such a transaction affects net financial assets and net national savings.

84. All balance sheets sum to zero Lawrence. Therefore all of them together must.

85. Lawrence,

    The accounting for loans is always the same regardless of the loan type:

    Lender: DR Loans made, CR deposits
    Borrower: DR deposits, CR Loans received

    The type of security is irrelevant to the accounting. That just affects the way the loan is written off if it becomes bad.

    A loan cannot be an asset in the hands of the lender unless the borrower has a liability to repay if he has the means.

86. Lawrence, as I understand it, if both the accounting liability and the asset are accounted for within the private sector, private books net out to 0, making it a gross financial asset, whereas if the liability is on consolidated government books, MMT considers it a net financial asset. As far as I know, this is in compliance with standard accounting terminology, but there are other economists, such as Steve Keen (?), who do not explicitly make the net / gross distinction but rather look at balance sheets across all sectors. The reason Chartalists insist on the distinction lies in their analysis of a: the hierarchy of money, it being considered a ‘creature of the state’, b: its potential within that analytical framework, or what Professor Fullwiler calls the ‘general case’ and, once all criteria for a free-floating, non-convertible fiat currency have been met c: the fundamental differences in debt dynamics between net and gross asset/liability pairs. You will agree that taking up a mortgage to buy a house is not quite the same thing as going by the real estate agent and paying for your new crib in cash. The real benefits are the same (you live in a new house) but the financial implications are very different, no matter what the contract says. MMT is about describing these differences and optimizing their respective potentials and limitations.

87. Optimizing limitations… Well done, Oliver! 😀

88. “But meanwhile, I’m still waiting for SOMEONE to explain to me how non-recourse loans against unrealized gains figure into the claim that bank lending creates no new net financial assets. What are the T-accounts on the transaction? It seems to me that the bank debits loans and credits cash, but the borrower debits cash and credits equity, i.e., net financial assets. Can you plug that hole in my understanding?”

    Borrower debits cash and credits loan liability.

    Unrealized gains are already marked up along with equity, if you are presenting marked to market accounting. Whether you present book or MTM is an accounting choice.

    The loan and the asset/equity marking methodology are separate accounting issues.

    NFA is also a separate issue.

    First, it applies only to financial assets and liabilities.

    Second, if you use MTM, you should use it consistently. E.g., if a household financial asset is marked up, you should mark up the same asset as somebody else’s liability. If it’s not a government liability, NFA doesn’t change.

89. Thanks, anon. With your answer, I now understand Lawrence’s question.

90. RSJ: savings = production – consumption
    And this must apply to the individual household. Its savings are the value of whatever it produces minus the value of whatever it consumes.

    Savings = Income – Spending

    What you call savings is wealth. Your definition of savings is inoperable in any sense because, as you said yourself, it relies on valuation methodology. A by-product of this is that you can not aggregate “savings as deferred consumption” over periods of time.

    Moreover, there is no basis to claim that a personal view on wealth based on a personal valuation process shall be validated by other households. You may claim and I agree that households form consumption decisions based on their personal views of their wealth. But if a household is wrong in valuation methodology vis-a-vis “market” then at some point of time “equity” part of financial balance sheet will be adjusted via nominal financial p&l effect.

    So yes, it is personal perception of personal wealth that matters for decisions but wealth is not savings. In a monetary economy savings are nominal and correspond by aggregated (over time, macro sector) monetary income which is not spend.

91. Sergei,

    If you are following the line of reasoning put forward by the Neo Chartalists here and elsewhere, you should know that they have totally mangled elementary economic theory.

    A nation’s wealth is defined as the value of all resources that contribute to the production of goods and services. It is a real value, the product of previous real saving. Obviously there are valuation issues here. Human wealth is not traded in a market in the same way, say, property is. See Jorgenson and Fraumeni (1989) for a well known study of human wealth, if you are interested.

    Agents in the economy form beliefs on the basis of nominal values. But a belief held by households that savings have increased based on nominal increases to net worth does not imply that real savings have increased. People might think that they are wealthier than they actually are. In fact, I think there is a good example of this. You may recall a significant economic event in the last few years involving vast increases in paper wealth not backed by an increase in the real productive capacity of the economy. I believe there were a few articles written about it in the newspapers. I would supply more details, but unfortunately I cannot remember it, because I was born yesterday.

92. Thanks for the help. I still can’t see the difference between a system in which the government runs no deficit buy puts HPM on deposit in banks and one in which it does run one and its customers do so. But it may involve notions that I don’t have the background to grasp.

93. Let me try that again.’

    I still can’t see the difference between a system in which the government runs no deficit BUT puts HPM on deposit in banks and one in which it does run one and its customers do so. But it may involve notions that I don’t have the background to grasp. (I do see how the creation of NFA as defined can require a deficit, but as so defined, NFA seems to me not a particularly useful metric. It makes me think of Flatland.

94. )

    Adios.

95. RSJ,

    “So what was real savings?”

    Real saving in this example is real investment, i.e. output flows that are not consumed, but are inputs for production of the new capital good. Assuming that the capital good was made in this period, real saving in this period is the capital good. Assuming that its the only productive asset in the economy, real savings is also the capital good.

    You are not wrong in suggesting that valuation of real activity is hard. Also, your observations at Tuesday, January 11, 2011 at 12:42 are very good (IMO, though really, I don’t know much about anything), and I agree with many of them (e.g., households act on the basis of values given in nominal terms). If you just update your understanding to include basic theory, a lot of what mainstream economists say will become intelligible.

96. ” you should know that they have totally mangled elementary economic theory.”

    You have no evidence for that assertion.

    Here is a monetary model that is consistent with standard accounting rules. Which is the mechanism by which monetary things are measured in the real world. You seem to be constantly missing entries in the accounting – primarily missing the double entry. It’s hardly surprising that things don’t add up for you if you keep doing that.

    And then we go off on the ‘its not about money’ again. Yes it is. That’s why its called Modern Monetary Theory.

    “You may recall a significant economic event in the last few years involving vast increases in paper wealth not backed by an increase in the real productive capacity of the economy.”

    Yes, and there is an accounting mechanism to deal with that. It’s called a write down. It corrects estimates in the reporting currency that turn out to be inaccurate.

    If you’ve got a situation that the system fails to model then lets see the evidence. Right at the moment all I see is “How dare you equate economics with accounting”.

97. “You are not wrong in suggesting that valuation of real activity is hard”

    The valuation of anything is always a matter of opinion (or accounting policy if you prefer), and it always has to be relative to something else.

98. “You have no evidence for that assertion.”

    There is plenty of prima facie evidence right here on this thread. Where did you study economics? If you don’t understand my criticism, you should give back you degree and start over. This time, smoke fewer bongs and pay more attention.

    “Here is a monetary model that is consistent with standard accounting rules.”

    Accounting identities are true in every state of the world. They are not theory. You need something else as well as the identities (which, incidentally, are not necessarily well understood here–e.g. public saving).

    “Yes, and there is an accounting mechanism to deal with that. It’s called a write down. It corrects estimates in the reporting currency that turn out to be inaccurate.”

    I don’t think you’re follwing my argument.

99. “It’s hardly surprising that things don’t add up for you if you keep doing that.”

    I never said that and I don’t understand how you’ve read that into what I did say. Everything adds up just fine, because I am properly accounting for nominal and real activity. Real investment doesn’t arise out of a series of nominal saving flows like Athena leaping fully formed from Zeus’ head.

100. “And then we go off on the ‘its not about money’ again.”

     Where did I write this?

     “Right at the moment all I see is “How dare you equate economics with accounting”.”

     Er, no, that isn’t what I’m saying at all.

101. a system in which the government runs no deficit BUT puts HPM on deposit

     By definition, a system with no deficit can not have HPM. What you may be looking for (?) is a pure credit economy. You can look up Steve Keene’s site for more discussions on that. I recall there was a debate there between Chartalists and some of his followers about a year ago that touched on what such an economy would look like and whether it says anything about reality. One argument in favour of concentrating more on gross than net financial assets is the fact that credit is much larger in volume and that the government / private distinction is secondary. There is no fundamental disagreement between the two schools though, but the focus is slightly different. What the horizontalists are missing are the monopolist, i.e. price setting, powers inherent in fiat.

     Or are you asking what happens when government always runs a balanced budget? In that case you are confusing stocks and flows. A deficit is a flow, in that it measures the differences in stocks from one point in time to another. A balanced budget only means that the amount of outstanding HPM is equal at both points. It says nothing about the amount (stock) of money (neither HPM, nor other) in circulation at either point.

102. “You need something else as well as the identities”

     As in “aggregate demand drives output and national income”. Isn’t that what this blog post is about.

103. Lawrence:

     ”
     That is a not an accounting liability, nor is it a personal legal obligation. It’s really a senior property right in the lender that I have an option to buy by repaying the loan. It would not appear on my balance sheet. What I’m interested in, however, is simply how such a transaction affects net financial assets and net national savings.
     ”
     You may call the relationship between the lender and the borrower by any number of different names of your choosing using a professional jargon to your taste, you may choose to record the relationship on either set of books or not at all. That won’t change the substantial debt/credit relationship and the consequences of honoring or dishonoring the contract the relationship implies it in any substantial economic way. The legal peculiarities and consequences of such peculiarities are irrelevant and uninteresting in the economic context (except of course to the parties involved).

     NFA, as defined in the way you don’t accept as useful, won’t change as the result of private parties transactions as long as the government is not involved.

     You don’t like the definition, I do not fancy it much either, but that’s what the majority of folks here consider as an important economic metric.

104. “Isn’t that what this blog post is about.”

     We haven’t discussed the blog post.

105. Lawrence: “I still can’t see the difference between a system in which the government runs no deficit BUT puts HPM on deposit in banks and one in which it does run one and its customers do so.”

     The only way that net financial assets increase is if government either spends into the economy for goods and services, or just creates bank accounts as it does in the case of transfer payments like SS, both of which inject reserves into the interbank system without creating reciprocity of financial obligation. In these cases, there is a financial asset added to nongovernment with the injection of government liability without any corresponding liability created in nongovernment. Conversely, if there is reciprocity, then the net is zero.

106. “We haven’t discussed the blog post.”

     Strange. That’s generally what you do in the comments section of a, erm, blog post.

     Might want to try reading it. It’s good stuff.

107. Vimothy,

     My point is that whether you want to talk about “real savings”, or whether you want to talk about nominal savings, you have the same valuation problem in both cases, and the argument about the sum of real savings exceeding real investment still applies.

     This valuation problem arises because people do not only exchange goods for goods, they exchange goods for promises of future payment of goods. The purchase of capital goods is typically funded by promises of future payment. There is no a priori constraint on the sum total of promises in an economy, nor is there a constraint that capital goods have constant value across time.

     Any consistent definition of savings must have the property that the savings over a period are equal to the change in net-worth in that period.

     That means if my net worth consists of one capital good, then even though I produce nothing and consume nothing in the current period, if the capital good is revalued upwards, then I must have saved in that period. We can debate about how to recognize the gain, but it’s not important. It could be justified — i.e. labor becomes more productive so that my capital good can generate more consumption, or some new techniques of using my capital good are discovered, or oil is discovered under land that I own, etc.

     If in the previous period they estimated that they could sell the capital good for a promise to deliver 1 consumption good when they retire, and then during the current period they manage to sell it for a promise to deliver 2 consumption goods when they retire, then the household whose savings was 1 unit of consumption for retirement (in future value) now has savings of 2 units in future consumption value. Therefore they must have saved 1 unit of consumption in future value in the present period, even though they produced nothing, and even though “national” savings are zero. The household that purchased the capital good did not dissave, as its net-worth did not decrease by the increase in net-worth of the household that saved.

     This is a basic accounting consistency constraint that must hold for any consistent definition of savings, whether real or nominal.

     To *define* savings as equal to production – consumption assumes that the already produced capital goods have constant value across time periods.

     It’s not a definition that you can use in the general case. Well, you can of course use whatever definition you want, but then this definition of “savings” wont be applicable to the household’s inter-temporal substitution problem, because it matters a great deal whether the household is planning on taking delivery of 2 units of consumption or 1 unit of consumption.

     I hope all of the above was intelligible 🙂

108. RSJ,

     Everything you write is intelligible. But here it is just a bit confused.

     This valuation problem arises because people do not only exchange goods for goods, they exchange goods for promises of future payment of goods. The purchase of capital goods is typically funded by promises of future payment. There is no a priori constraint on the sum total of promises in an economy, nor is there a constraint that capital goods have constant value across time.

     And so nominals and reals do not equate. They’re not even tied together by some stable, easy to understand function. That is the point I am making, over and over. But for some reason, you don’t recognise it. Maybe when I say “real savings”, you are thinking of a stock of financial assets, adjusted for inflation…?

     That means if my net worth consists of one capital good, then even though I produce nothing and consume nothing in the current period, if the capital good is revalued upwards, then I must have saved in that period

     You have saved in nominal terms, but if the real productive capacity of the economy did not increase, there was no real saving. This result follows logically from the assumptions we have made.

     If in the previous period they estimated that they could sell the capital good for a promise to deliver 1 consumption good when they retire, and then during the current period they manage to sell it for a promise to deliver 2 consumption goods when they retire, then the household whose savings was 1 unit of consumption for retirement (in future value) now has savings of 2 units in future consumption value. Therefore they must have saved 1 unit of consumption in future value in the present period, even though they produced nothing, and even though “national” savings are zero. The household that purchased the capital good did not dissave, as its net-worth did not decrease by the increase in net-worth of the household that saved.

     More confusion. If households really did save “1 unit of consumption” (if their saving produced 1 unit of additional output), then there was real saving. If they did not, there was not. If, for whatever reason, they end up with two units of output, real saving has not increased unless the real productive capacity of the economy increased, in which case their saving was made whenever the investment was made (and real resources were not consumed) that generated the extra real output.

109. Vimothy,

     I think we are using different definitions. I don’t think I am “confused”, but rather that your definition is less useful than mine. 🙂

     Here are my definitions:

     When a household saves, it purchases a claim on future output.

     If you want to think in “real” terms, then “real savings” is the exchange of real goods for IOUs that promise to deliver other real goods.

     If you want to think in terms of “nominal” savings, then nominal savings would be the purchase of IOUs with the medium of exchange, and the terms of the IOUs are denominated in the medium of exchange.

     The person buying the IOUs is saving. The person selling the IOU can use the goods to smooth their own consumption, or to invest, or even to re-sell the goods to someone else. You can’t rule any of this out in an economy.

     This definition of savings is the only definition consistent with the intertemporal consumption problem of the household.

     If you want to call the above “nominal” savings, under a classification that exchange of present goods for present goods is real, but exchange of present goods for future goods is nominal, then fine.

     I don’t particularly care, as long we agree that only nominal savings are relevant for the individual household’s consumption/savings problem.

     But when you aggregate *all* households, then those who sell IOUs in order to buy other IOUs cancel out with some households that buy IOUs. And those who sell IOUs in order to smooth consumption cancel out with some other households that sell IOUs, and what you have left is a *smaller* figure, that we can call “consolidated” savings, or “aggregate” savings, or “national savings”.

     Then, national savings, as a result of the cancellation, only consists of those who sell IOUs in order to invest.

     Therefore national savings = national investment.

     And investment can be described purely in terms of “real goods”, at least in theory. Therefore we can define “real savings” as being equal to real investment.

     But this definition of “real savings” is not applicable to anyone’s intertemporal optimization problem.

     Even if you assume that households have identical preferences, it will not be the case that national savings divided by the number of households is what the representative household uses in its intertemporal consumption problem.

     The households, even with identical preferences, will be in different states. Some will be younger and others will be older. Some will be borrowing to smooth consumption and others will be re-paying consumption. So the “average” savings will, even in perfect equilibrium, be larger than the national savings divided by the number of households.

     Now if you want to define savings as something completely different, then you need to think carefully about how useful or relevant that definition would be the decision-maker’s problem. This has nothing to do with “nominal illusion”, but with the fact that results of economy-wide variables are driven by distributed decision-making rather than by a social planner.

110. The more I think about it, the whole concept of “nominal” vs. “real” has to do with the individual’s attempts to time shift.

     Even apart from the coincidence of wants, selling a good for money allows the seller to defer purchases across time — if only enough time to walk over to the next market and buy something else. But he doesn’t need to buy something else. He can go home and then buy something later.

     Perhaps a better way to think about it is that every time someone buys a consumption good with money, they are realizing previously deferred consumption, and every time they sell a good for money, they are deferring consumption.

     Nominal transactions are transactions across time. The real versus nominal distinction is not an either/or issue, but a complementary issue. A “barter” transaction, in which a good is exchanged for another good, requires that both goods exist at the same point in time, whereas a nominal transaction contains only one good, being bought or sold in exchange for an IOU.

     That is a fundamentally different model of behavior — to look at things in “real terms” is not to view the essential nature of the economy, but to look at a completely different economy. One in which no resources can be expended for production unless those resources instantaneously give fruit to output that can be used to pay the factors of production.

     A barter economy is an economy without production, which is why there are no barter economies. All economies have IOUs, even if this is just to help your neighbor harvest crops, with the expectation that they will help you at a later time. The speculative nature of the IOUs is inextricably linked to the speculative nature of production. You don’t know if you will succeed in producing, or how much you will be able to produce, but you need to commit resources today.

     The time requirements of production, the uncertainty of production, the false price signals and coordination failures arising from too many or too few people investing at the same time — none of that is possible in a pure barter economy, and all of that is missing from a purely “real” model of the economy. Similarly once you incorporate uncertainty, the efficiency and optimality results are much weaker. You no longer get pareto optimality, you only get probabilistic optimality ex-ante. But the actual (ex-post) configuration of prices when the state of the world is revealed can turn out to be inefficient and suboptimal. No wonder economists prefer to view the world in “real” terms. That is a necessary illusion to impose a false simplicity, fairness and certainty on the economy that no actual economy has.

111. RSJ,

     Glad somebody finally said something like you did here. I really don’t “believe in” inflation, maybe I’m the only one, but I do believe in the instability of nominal prices, mostly due to government involvement in the markets/policy, and speculation. This instability is more important to follow and be aware of than so-called “inflation” imo.

     Thanks for this I think you make some good points here. Resp,

112. Ludwig von Mises, The Causes of Economic Crisis (1931), p. 162

     Credit expansion cannot increase the supply of real goods. It merely brings about a rearrangement. It diverts capital investment away from the course prescribed by the state of economic wealth and market conditions. It causes production to pursue paths which it would not follow unless the economy were to acquire an increase in material goods. As a result, the upswing lacks a solid base. It is not a real prosperity. It is illusory prosperity. It did not develop from an increase in economic wealth [i.e. the accumulation of savings made available for productive investment]. Rather, it arose because the credit expansion created the illusion of such an increase. Sooner or later, it must become apparent that this economic situation is built on sand.

113. See Tom,

     I dont get this. “diverts capital away”, “lacks a solid base”, “illusory”, “built on sand” ….WTF?

     Does this mean if a municipality issues bonds (expands credit) to extend sewer and water systems to a new service area, that is not a real thing?

     Or is he saying the prices paid will go up and you would have paid less if you spent it out of the cash account? Or are the contractors supposed to assemble all the precast concrete/pipes, fill dirt, excavators, cement, etc on spec just in case the govt wants to build a new sewer?

     I’m having a hard time understanding this. Resp,

114. RSJ,

     Very pushed for time, but I have a spare couple of minutes while I eat my coup and drink my whiskey, so, trying to be quick,

     I think we are using different definitions. I don’t think I am “confused”, but rather that your definition is less useful than mine.

     Ha! ;-P

     I suspect we are talking past each other to some extent. Remember that I’m referring to the macroeconomy here. On aggregate, real savings is national net wealth–the productive capacity of an economy; its stock of tangible and intangible human, and tangible and intangible non-human capital. It’s definitely not a stock of IOUs or a residual stock of IOUs after netting between govt and non-govt sectors.

     To really save output, the economy needs some way to transform it into extra output in the future. Otherwise, what it thought it was saving was actually consumed, or it was wasted. A real saving would be a way to defer consumption now for increased output in the future. Agreed?

     If no *extra* output was produced, we’re just redistributing across time. Say that consumption in period 1 was lower than production, because . But if none of the saving increased the productive capacity of the economy, consumption in period 2 cannot possibly be higher than production in period 1. So there was no saving.

     If you want to think in “real” terms, then “real savings” is the exchange of real goods for IOUs that promise to deliver other real goods.

     I don’t think it is. What if the IOUs turn out to actually deliver no real goods at all? Then there was no real saving. Real savings are capital: real wealth. You can’t eat an IOU, nor can you bake bread with it.

     If you want to call the above “nominal” savings, under a classification that exchange of present goods for present goods is real, but exchange of present goods for future goods is nominal, then fine.

     Damn. Being quick is hard. I’ll try to come back to this soon.

115. LOL,

     No problem, Vimothy. I understand exactly what you are saying.

     You are saying that if productive capital does not go up, then there wont be more stuff next period for “the economy” to consume.

     Agreed.

     Similarly, I think you understand what I am saying.

     For the household, savings is time-shifting consumption. That means that you produce without consuming in one period, and consume without producing in the next period. To save is to exchange a good in the present for an IOU in the present.

     Whether in a barter economy, or a monetary economy, the individual household generally does not have the option of increasing the nation-wide capital stock.

     Their only option is to exchange present goods for IOUs (in a barter economy) or money for IOUs (in a monetary economy).

     Now perhaps the sellers of the IOUs *will* increase the nation’s capital stock. But perhaps not — you don’t know. The sellers of the IOUs may just be buying other IOUs, or they may be buying consumption goods, or non-produced goods such as land.

     This creates the possibility of a divergence between the sum of household savings and “national” savings. This divergence may or may not be justified — i.e. it doesn’t necessarily follow that the IOUs will fail to deliver the promised consumption just because there is a divergence.

     OK, what is the substantive point here? In an RA model, with labor normalized to 1, you cannot argue that y(t) – c(t) = i(t), where i(t) is the growth rate of the capital stock, and y(t) is the representative agent’s income.

     You can only argue that y(t) – c(t) = s(t), where s is the representative household’s savings.

     And then you must allow for an excess (or deficiency) of savings based on the divergence between the growth in IOUs and investment. I.e. s(t) = i(t) + d(t) where d(t) refers to growth in the IOUs not arising from an increase in investment. In this sense, we can talk about savings gluts.

     This makes things more complicated, because you cannot then rely on the interest as being pinned down by whatever preferences are necessary so that i(t) = s(t), because i(t) is not equal to s(t). You have an additional degree of freedom, measured by d(t).

     That additional degree of freedom means that the interest rate is no longer determined by a loanable funds argument, and it can no longer be counted on to clear savings demands with investment demands, even apart from zero bound issues.

     The MMT’ers would say that it is exogenous, whereas I would say that the interest rate is still pinned down by an arbitrage argument or an expectations argument, but not a loanable funds (e.g. quantity-clearing) argument. You can have an increase in the demand to borrow without rising rates, and a decrease in the demand to borrow without falling rates.

     OK, that leaves open how you would close the model. Clearly we do live in an economy prone to bubbles in which households do constantly re-value their existing savings, so what would be the parameter that would account for this?

     That’s a whole separate debate, but at least we should recognize that the debate needs to occur.

     Just because you believe households “should” only care about increases to the nation-wide capital stock does not mean that they can or do. It’s not possible for individual households to know whether their savings are too large or too small, because that is an aggregate problem. All they can try to determine is the expected return of the IOU. But because debtors can roll IOUs over, the expected return of the IOU is not pinned down to any productive characteristics.

     Now it would be great if Blankenfein and Rubin stepped up to the plate and said “My savings are not real. I’m going to forgive these debts because they were not matched by a corresponding increase in productive capital. I will not suffer from ‘nominal illusion’ that tells me I have deferred this much consumption. When I know, deep down, that I am a poor man.”

     But it’s one thing to wish that households behaved this way and another to have the model *assume* that they behave this way.

116. Matt, relative to the discussion going on here, the position of Mises is that the MMT idea that government debt is equivalent to nongovernment savings cannot be “correct economics.” This is what vimothy is arguing, at least as as I understand it.

117. RSJ,

     Similarly, I think you understand what I am saying.

     Yes. They are two sides of the same coin.

     Cheers for the nice post. I would try to respond in more detail, but I’m busy failing my exams. Salut!

118. Now it would be great if Blankenfein and Rubin stepped up to the plate and said “My savings are not real. I’m going to forgive these debts because they were not matched by a corresponding increase in productive capital. I will not suffer from ‘nominal illusion’ that tells me I have deferred this much consumption. When I know, deep down, that I am a poor man.”
     But it’s one thing to wish that households behaved this way and another to have the model *assume* that they behave this way.
     

     Right, and that portion of savings is due to economic rent, which is defined as resulting from nonproductive gains. This is what people like Michael Hudson say that it should be taxed away and recycled toward productive investment.

119. Please excuse the comment necromancy…

     I don’t agree with this analysis at all. When a consumer forgoes $20 of consumption, it does not send the economy into recession. It is a signal that the consumer is currently preferring future consumption of some type over current consumption. The consumers will naturally select the least-preferred types of current consumption to cut back on. This will accelerate the winnowing of obsolete and otherwise too-expensive products. This is a good thing, as the business class will now search for new ways to satisfy the consumer demand that the consumers are saving for in the first place. The resources consumed by the unwanted business will be freed to satisfy evolving consumer preferences.

     Government spending through direct investment counteracts the natural consumer preferences. Unwanted firms may stay in business. The important signals created by consumer saving is lost. This is the folly of central planning – the government cannot know who ought to be allowed to succeed and who ought to be allowed to fail. Unwanted business models persist and innovation stagnates.

120. Ben, what about U3 + U6 + no longer looking greater than 20%? How do you propose dealing with this?

121. My response would be the same as the 1920-1921 recession – do not intervene in the economy with emergency lending and stimulus. Let the zombie firms that are not providing consumers with value fail so that entrepreneurs may rearrange those resources into patterns that satisfy consumer demand. Through that process employment will rise again. I suppose that a government intervention could get lucky and accelerate something consumers actually want, but in practice government tends to satisfy the needs of the politically well-connected, not the average citizen.

     Ultimately it is not a “aggregate demand” problem. Unless human beings somehow stop being selfish creatures, they will always want more more more. It is the function of the entrepreneur to satisfy this demand. Underemployment or unemployment could mean either we live in a Star Trek-like world with no scarcity (not the case), or there are other barriers to the utilization of human capital (definitely the case). So my argument to solving the unemployment problem is to remove these government-imposed restrictions

122. OK, you agree with Andrew Mellon, who advised Hoover to “liquidate, liquidate, liquidate.” Hoover didn’t take the advice because he knew he would have no chance of reelection if he did. I doubt we will ever known if your view would work out as you say, Ben, because no politician that cares about being reelected (they all do) will ever take it.

123. The US public was against bailouts, TARP, etc. Every person I have ever talked to about the financial crisis is completely outraged that the same people who were responsible for the mess were never really held accountable. There is also a very strong anti-stimulus out there. I personally think that a politician who ran on a “no stimulus, no bailouts” platform would do rather well

124. The previous election was supposedly all about jobs, jobs, jobs. We’ll have to wait and see about the next one. Unemployment still seems to be intractable.

125. Ben, you might want to look at http://socialdemocracy21stcentury.blogspot.com/2010/10/us-recession-of-19201921-some.html for an alternative take on the 1920-21 recession.

126. Interesting article, but I think it ignores the broader picture that during a time of very high unemployment (avg 11.7 percent in 1921) the federal reserve kept interest rates at a record high, only cutting by a single point toward the end of the recession. Also unmentioned is the drastic reductions government spending and taxation. This is if course the opposite of what people advocate today. While the GNP numbers seem to be in dispute, as far as I can tell the unemployment numbers are not

127. I read the post and can make no sense of it. I read Ben Kennedy’s comments, which make perfect sense to me.

     Here’s an example of a non-economic portion of the post that mystifies me: “Terrorism is the use of coercive means aimed at civilian populations in an effort to achieve political, religious, or other aims.” By that broad definition, everything that has ever been accomplished by any legislature is terrorism to the extent that the legislature expects its laws to be enforced. It would include, for instance, all tax policy, especially the use of the income tax to effect income redistribution. That makes the term so broad as to be meaningless.

     A more useful definition of terrorism would be the use of force, not primarily for immediate material or coercive gain, but to generate fear among civilians (for political, religious, etc., purposes), especially when employed by an organization that doesn’t stick around for a stand-up fight but melts away into the shadows, threatening to strike again unpredictably. That definition would distinguish terrorism from conventional warfare and conventional legislative action. That’s not to say that any one of those three categories is pursuing goals that are morally superior to the others, but it at least keeps us from applying the word “terrorism” indiscriminately to any use of force we happen to deplore at any given moment. A Mafia thug who occasionally roughs up a randomly selected shop owner “pour encourager les autres” would be engaging in something like terrorism. A repressive state that more or less consistently enforces even very bad laws would be doing something we deplore, but would not be engaged in “terrorism.”