Some neighbours arrive

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

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

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

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

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

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

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

4. Kid Dynamite,

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

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

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

   The inescapable trilemma of the world economy

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

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

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

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

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

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

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

11. Dear Kid Dynamite

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

    best wishes
    bill

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

13. Dear Adam (ak)

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

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

    best wishes
    bill

14. Dear Kid Dynamite

    You said:

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

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

    best wishes
    bill

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

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

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

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

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

18. Dear Gamma

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

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

    We need to walk before we can run!

    best wishes
    bill

19. Dear Burk

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

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

    best wishes
    bill

20. Dear Tom and Gamma

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

    best wishes
    bill

21. bill wrote, in a comment reply:

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

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

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

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

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

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

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

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

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

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

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

26. Off topic but…

    For JKH and anyone else who would like to comment.

    From:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

33. Dear Fed Up

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

    best wishes
    bill

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

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

    Thanks.

35. Tom Hickey said:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

39. Dear Kid Dynamite

    Thanks again for your comment.

    You asked:

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

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

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

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

    You then said:

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

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

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

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

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

    best wishes
    bill

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

45. Hey Kid

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

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

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

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

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

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

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

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

46. Greg –

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

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

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

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

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

48. NKlein1553,

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

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

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

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

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

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

49. “Markets create jobs.”

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

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

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

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

    http://livingnewdeal.berkeley.edu/

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

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

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

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

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

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

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

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

52. NKlein1553

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

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

    The central bank remits most profit annually to the Treasury.

53. Alright Kid

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

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

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

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

54. NKlein1553,

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

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

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

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

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

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

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

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

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

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

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

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

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

57. Dear Gamma

    You said:

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

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

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

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

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

    That is the reason it matters.

    best wishes
    bill

58. Bill,

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

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

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

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

    thanks.

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

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

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

    A simple business card economy

    Barnaby, better to walk before we run

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

    Stock-flow consistent macro models

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

    Complete billy blog on one page!

61. Kid

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

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

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

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

62. Hey Kid

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

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

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

    for now, i leave you with this from today:

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

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

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

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

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

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

    Randy Wray, Wall Street still doesn’t get it

    “Be prepared for another global crisis by summer.”

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

65. Tom:

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

66. Just my 2 cents.

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

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

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

67. Hi Kid Dynamite:

    I think you identified an important issue when you said:

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

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

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

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

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

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

68. Siiiiiiiigh

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

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

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

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

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

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

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

71. Hi Youssarian:

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

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

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

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

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

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

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

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

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

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

73. Very interesting explanation.

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

74. is there any room in this simple model for inflation?

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

76. since G – T = (S – I) – (X – M),

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

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

    100 – 100 = (0 – I) – (200 – 120)

    0 = – I – 80

    I = -80?

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

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

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

    i’m trying to think simple here;

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

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

    im really confused by this…please help!

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

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

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

    GDP = C + I + G + (X – M)

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

    So GDP = G + X – M

    So I = 0

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

    Sources of income: G + X

    Uses of income: S + T + M

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

    The sectoral balances then simplifies to:

    S = (G – T) + (X – M)

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

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

    since G – T = (S – I) – (X – M),

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

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

    Given your parameters:

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

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

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

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

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

    You then wrote:

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

    100 – 100 = (0 – I) – (200 – 120)

    0 = – I – 80

    I = -80?

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

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

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

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

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

    So S = 80

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

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

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

    Hope that helps

    best wishes
    bill

79. dear bill,

    thanks very much for your quick response!

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

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

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

    thanks very much once again!

80. dear bill/whom might be reading,

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

    in the private sector, it looks like this;

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

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

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

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

81. Bill (or others)

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

    thanks

    Mike

82. Mike,

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

83. Hi Neil,

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

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