{"id":7864,"date":"2010-02-09T18:15:31","date_gmt":"2010-02-09T07:15:31","guid":{"rendered":"https:\/\/billmitchell.org\/blog\/?p=7864"},"modified":"2010-02-09T18:15:31","modified_gmt":"2010-02-09T07:15:31","slug":"barnaby-better-to-walk-before-we-run","status":"publish","type":"post","link":"https:\/\/billmitchell.org\/blog\/?p=7864","title":{"rendered":"Barnaby, better to walk before we run"},"content":{"rendered":"

\t\t\t\tToday I have been thinking about the macroeconomics textbook that Randy Wray and I are writing at present. We hope to complete it in the coming year. I also get many E-mails from readers expressing confusion with some of the basic national income concepts that underpin modern monetary theory (MMT). In recent days in the comments area, we have seen elaborate examples from utopia\/dystopia which while interesting fail the basic national income tests of stock-flow consistency. Most of the logic used by deficit terrorists to underscore their demands for fiscal austerity are also based on a failure to understand these fundamental principles. So once again I provide a simple model to help us organise our thoughts and to delve into the elemental concepts. It is clear that in order to come to terms with more complicated aspects of MMT, one has to “walk before they can run”. So its back home today.
\n
\nToday, was a classic case. The Opposition Finance spokesperson Barnaby Joyce (or B Jo as he is being called – for what reason?) who is fast becoming the “joke of the town” told ABC news<\/a> that Australia was in danger of defaulting on its sovereign debt. He was quoted as saying:<\/p>\n

\nYou’ve got to ask the question: how far into debt do you want to go? We are getting to a point where we can’t repay it. Let’s look at exactly what they’re doing now and ask this very simple question: are you paying back your money, are you even meeting your interest component, and can you keep the debt stable? Or is the debt racing ahead by more than even the interest expense? And if it is, any household budget will tell you that’s a very dangerous place to be.\n<\/p><\/blockquote>\n

So Mr. Joyce hasn’t the first clue about how the monetary system operates nor the difference between the household budget and the Australian government budget. I thought this little tutorial would help.<\/p>\n

To help Barnaby along we need to simplify things. I would refer him to this diagram, which should be in the first chapter of every macroeconomics textbook. It depicts the essential structural relations between the government and non-government sectors. You can make it bigger by clicking on it and it might help to print it for reference (to avoid scrolling up and down).<\/p>\n

\"essential_government_non_government_relations\"<\/a><\/p>\n

<\/div>\n

You can see that the diagram is arranged in a vertical manner with the government sector at the top. Most macroeconomics textbooks wait until well into the book to introduce the government sector. That lapse is telling.<\/p>\n

Further, debt-deflation theories (such as pure credit models) also abstract from the government sector. But MMT shows that a failure to understand the vertical relationship between the government and non-government sectors leads to spurious conclusions about stocks and flows.<\/p>\n

A digression: a flow variable can only be calculated with reference to a time period. So $100 of spending per quarter or year. A stock variable like the unemployment pool has no time dimension so has to be observed at a point in time. Flows feed stocks and so a valid macroeconomic model has to ensure that all the flows it specifies augment\/reduce stock variables in a consistent manner.<\/p>\n

Several points emerge from this diagram.<\/p>\n

First, while central banks appear to be independent of treasury functions, there is no gain in separating the treasury and central bank operations when seeking an understanding of how the monetary system operates. The consolidated government sector determines the flow of net financial assets (denominated in the fiat currency) in and out of the economy.<\/p>\n

Treasury operations (spending and taxing) can deliver surpluses (destruction of net financial assets) or deficits (creation of net financial assets). Most central bank operations merely shift non-government financial assets between bank reserves and government bonds (open market operations), so for all practical purposes the central bank is not involved in altering net financial assets.<\/p>\n

The exceptions include the central bank purchasing and selling foreign exchange and paying its own operating expenses. While within-government transactions occur, they are of no importance to understanding the vertical relationship between the consolidated government sector (treasury and central bank) and the non-government sector.<\/p>\n

Second, we can understand the basic vertical relationships by cutting the diagram off just below the non-government box. Extending the model to distinguish the foreign sector makes no fundamental difference to the analysis and as such the private domestic and foreign sectors can be consolidated into the non-government sector without loss of analytical insight. Foreign transactions are largely distributional in nature. We can thus operate as if the non-government sector is as one. The point here is that all (horizontal) transactions between institutions or entities within<\/strong> the non-government sector net out in an accounting sense to zero – for every asset created there is a corresponding liability.<\/p>\n

This is a crucial difference – the vertical transactions between government and non-government do not net to zero – they can create\/destroy net financial assets. Understanding that is a key step in being able to make literate and informed comments, whatever your ideological persuasion, about the monetary system and the role of government within it.<\/p>\n

Third, the results we derive below is exactly the same when expanding this example by allowing for private income generation, a banking sector and diversifying the non-government sector into a foreign and domestic sector.<\/p>\n

Apart from getting the accounting clear and allowing us to avoid making fools of ourselves by saying things like – “the taxpayers will be paying off the debt for years”; or “debt is financing government spending” and related nonsenses; this framework helps us understand that it is the use of state money that introduces the possibility of unemployment.<\/p>\n

Unemployment is always a choice of government in a modern monetary economy. It always has the capacity to maintain full employment by ensuring its net spending is sufficient to meet the desire to net save by the Non-Government sector.<\/p>\n

When I talk about a modern monetary economy I mean a system with:<\/p>\n