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Hi Nick,

How about another example . . . economists talk about something called "national saving" as if there is a "pool" of money that can support investment spending (or borrowing in general) using basic national income identities rearranged a particular way.

However, from basic double-entry accounting it is clear that such a "pool" of "funds" doesn't exist and in fact that the causation generally runs the opposite direction from what economists assume. For instance, bank loans create bank deposits (no prior "saving" or deposits or reserves necessary), and government deficits create net financial assets for the non-government sector. Again, we're talking about accounting of nominal transactions here (just saying that to avoid some typical criticisms that arise when we point these things out).

Best,
Scott

Hi Scott. Assume a closed economy and no government for simplicity.

The identity is Y=C+I

Define S as Y-C. We can rewrite the identity as S=I. These are just different ways of saying the same thing.

These accounting identities tell us nothing about the direction of causation. Indeed, accounting (double-entry or whatever) can never tell us anything about the direction of causation of anything.

Interpreted as an equilibrium condition, they become Y=Cd+Id, and Sd=Id, where 'd' means "desired", and Sd is defined as Y-Cd.

Notice this says nothing about the supply of output. It's only one half of a full equilibrium condition, which would read Cd+Id=Y=Ys where Ys is output supplied (i.e. the amount people/firms WANT to sell.

These equilibrium conditions don't determine the direction of causation either. They don't even say how we get to equilibrium or if we even will.

Simple Keynesian model: Assume Ys is exogenous, Id is exogenous, Cd depends on Y, and Y=min{Cd+Id,Ys} (aka the short side of the market determines quantity traded). Her, if we are at less than full employment, Id determines Y, and determines Sd too. Causation runs from Id to Sd.

Simple classical model: Assume Cd depends on Y and r plus exogenous stuff, Id depends on r and exogenous stuff, and r adjusts until Cd+Id=Y=Ys.

In this case, since both Sd and Id are endogenous, you cannot say that Id determines Sd or that Sd determines Id. Both are determined by the exogenous shocks to consumption and investment. If there are no exogenous shocks to investment (for example), then the exogenous shock to consumption and savings, plus the interest elasticity of investment and savings, determine Investment and saving.

It all depends on the model. The accounting doesn't determine anything. (Fighting words! Sorry.)

Economics is not accounting constrained.

But accounting is a necessary clearing point for robust exchanges through economics’ intellectual central bank.

Economist ... liberate thyself.

Nick,

You’re not rejecting accounting. You’re agreeing that accounting is necessary. You’re just uncomfortable with the idea of outsourcing your accounting challenge.

The problem is that if you develop your own scheme, you must demonstrate that it is logical and consistent. If anybody can identify a contradiction in your measurement system, your system will fail.

I don’t think you can develop a non-contradictory accounting system of any type that applies to economics and that does not reflect basic double entry bookkeeping.

And the whole issue of stuff demanded and stuff supplied simply requires a supplementary accounting system that deals with the contingent future. Actuaries deal with such stuff all the time. Risk analysis deals with. So deal with it. It doesn’t obviate the necessity of a decent ex post accounting system as the foundation.

JKH: "You’re not rejecting accounting. You’re agreeing that accounting is necessary. You’re just uncomfortable with the idea of outsourcing your accounting challenge."

Yep. Exactly. Very succinct.

Is double-entry bookkeeping the same as my "second fundamental principle of accounting"? (If I buy something, I am at the same time selling something else of equal value). In economics, that's where the budget constraint comes in. Walras' Law is one reflection of that, when we are talking about demands and supplies.

"And the whole issue of stuff demanded and stuff supplied simply requires a supplementary accounting system that deals with the contingent future. Actuaries deal with such stuff all the time. Risk analysis deals with."

NO, NO, NO!!

Even with no risk or future there is a fundamental distinction between quantity demanded and quantity bought (and between quantity supplied and quantity sold). This is why economists and accountants are two solitudes, speaking past each other!

Hi Nick:

In Y = C + I you assume that whatever is not consumed is invested (S = Y - C). The implicity assumption here is that all bank savings are somehow channeled back into investment (plus you ignore under the mattress money, which is fine). I don't know what operational mechanism you have in the back of your mind for how savings are channeled into investment, but it is probably some flavor of "banks lend out deposits". This is incorrect, and may be one area where economists and accountants can have a profitable exchange.

When a bank makes a loan, it creates a receivable (asset) and a deposit (liability). It expands both sides of its balance sheet at the same time, this is the double entry bookkeeping that JKH is talking about. Notice how the act of credit extension (receivable) CREATES the matching liability (deposit). The correct causality to introduce into this accounting identity is "loans create deposits".

If the loan and deposit happen in the same bank, it is trivial to see how this works. If the loan and deposit are created in different banks, the reserve system operationally gives the lending bank access to the reserve credited by the deposit in the other bank. We can go into this later, but please trust me for now.

So what role to deposits play in enabling bank lending? None. (More precisely, very little, as they are a cheap liability and thus reduce the banks profitability slightly). Bank deposits really are "dead money" the same way cash stuffed under a mattress is "dead money".

So, Y = C + I + S, and we need to introduce the "S" term here because "S" does not flow into "investment".

I don't like introducing this concept before establishing how G-T = Y - I - C - G - T (ignoring NX) but that's been a bust, so what the heck.

Sorry, I meant that deposits slightly INCREASE bank profitability.

Winterspeak:

The accounting identity Y=C+I means "all newly produced goods are bought, and we divide all goods bought into a mutually exclusive and jointly exhaustive pair, C and I".

The real fudge has nothing to do with anything about banks and money (this holds true in a barter economy too), it's in the way we treat unsold goods. If you produce something, and don't sell it, you are deemed to have sold it to yourself. It is treated as part of I, inventory investment.

When I teach Y=C+I+G+X-M I always explain it this way to my students: "try and find a fault in it. You can't. Because whenever you find something wrong with it, I will just re-define my terms to that it stays true. The inventory investment is one fudge. Excluding used goods is another. Excluding spending on intermediaries is another. Saying that capital gains aren't included in income is another, etc.

It's like the "No true Scotsman fallacy" in philosophy. (Someone says "No true Scotsman would ever molest children". Someone gives a counter-example. He replies by re-defining what he means by a "true Scotsman".)

It's OK in accounting.

Will return to this later. Gotta teach on Bertrand vs Cournot. (Getting ready for my next post on framing monetary policy)!

RE: the accounting doesn't determine anything . . . (you knew I'd reply to that!)

I think you aren't getting the point I'm making. There are RULES of accounting that you can't violate if you want the analysis to be relevant to a world like ours in which every transaction affects financial statements of those involved. As we've agreed before, too, though, just getting the accounting right is necessary but not sufficient for having a good model.

My point was not necessarily a criticism of the model you built in this post or in response to me. It was a broader criticism of the idea that prior saving (or deposits or reserves) is necessary to finance borrowing or government deficits (even when one assumes the govt sells bonds). While these views of causation are nearly universal in the field and are at the heart of many models and policy recommendations, they are inconsistent with the actual accounting.

Best,
Scott

“NO, NO, NO!!”

YES! YES! YES!

Quantity bought is ex post.

Quantity demanded is an ex ante contingency for quantity bought – it’s a future ex post scenario for quantity bought, under a certain condition. The condition is that the quantity demanded is exactly met by the quantity supplied (which, due to mathematical continuity in supply and demand curves, has a near zero if not zero probability of happening). The accounting entry is contingent double-entry. There are a zillion such scenarios. Just because the numbers get big doesn’t mean you can’t account for them all, at least in theory.

And accounting applies as well to systems without banks or money. You proved it with the example of unsold goods. But if you’re working with economics relative to the money system we actually have, it would be helpful to work with that as well.

“Because whenever you find something wrong with it, I will just re-define my terms to that it stays true.”

You’re just changing terminology. That’s not helpful, but the accounting requirement is that the equation works.

BTW – when I suggested that economics is not accounting constrained, I meant double entry bookkeeping shouldn’t hold you back from exploring any economic problem in the system we have today. On the contrary, I think it liberates you to do so.

Didn’t Bertrand and Cournot play for the Montreal Canadians?

"Ultimately, we economists have to be our own accountants."

Therein lies the problem, because that's largely what they've tried to do, not recognizing that a model inconsistent with REAL WORLD conventions and rules for financial record keeping of transactions is inapplicable to the real world.

Let's go a different direction. The model you have built thus far in this thread is utilizing only income accounting identities. But the points raised by myself, JKH, and Winterspeak refer to balance sheets. So, let's assume a model of someone taking out a loan to finance an increase in expenditure. What are the balance sheet effects for those involved of this action? Feel free to include any agents you think ought to be in the model . . . banks, investors, savers, borrowers, etc. (I do realize this is your blog, so you may not want to go in this direction which is of course entirely your choice . . . just putting the suggestion out there since it seems to be the sort of direction the commenters thus far in this thread are interested in.)

"BTW – when I suggested that economics is not accounting constrained, I meant double entry bookkeeping shouldn’t hold you back from exploring any economic problem in the system we have today. On the contrary, I think it liberates you to do so."

Right. It's kind of like a musician or writer thinking learning to read music or learning grammar will constrain his/her creativity. But it's even more fundamental than that, of course.

"But it's even more fundamental than that, of course"

Good analogy, and quite so.

There's something in higher mathematics called "measure theory", which is based in large part on Boolean logic. Attempting to do economics while rejecting (double entry) accounting is almost like rejecting mathematics itself at that level. Accounting is measurement.

Also, measurement includes the delineation of composition and aggregation. And so much of what is poorly understood about economics and our monetary system relates to the fallacy of composition.

"The real fudge has nothing to do with anything about banks and money (this holds true in a barter economy too), it's in the way we treat unsold goods. If you produce something, and don't sell it, you are deemed to have sold it to yourself. It is treated as part of I, inventory investment."

right, because excess inventory does not produce income. And where is the money that could have bought this inventory? It's dead money, sitting in a bank. So, the most elementary part of accounting, or heck, plain old measurement, namely "is there a transaction" is hopelessly muddled right from the get go.

This is exactly the sort of thing that accountants get right

"When I teach Y=C+I+G+X-M I always explain it this way to my students: "try and find a fault in it. You can't. Because whenever you find something wrong with it, I will just re-define my terms to that it stays true. The inventory investment is one fudge. Excluding used goods is another. Excluding spending on intermediaries is another. Saying that capital gains aren't included in income is another, etc."

None of those things are "fudges". Inventories are viewed correctly as short term investment from both an accounting and an economic perspective. And everything else you note is consistent with current period (income statement) accounting and prior period (balance sheet) accounting, and with the distinction/connection between book value accrual accounting and marked to market accounting. You’re not the one making those "fudges", Nick. It's an accounting system thats designed to be internally consistent. If you want to invent your own fudges - well then you've gone rogue - but nobody's going to pay much attention.

Scott: "There are RULES of accounting that you can't violate if you want the analysis to be relevant to a world like ours in which every transaction affects financial statements of those involved." Agreed. But there is more than one set of logically consistent accounting definitions, and economists need to find the set that is most useful for them, and that depends on their behavioural theories. And if you violate ALL possible sets of internally consistent rules, then the problem is not that the analysis is not relevant; rather, the analysis is logically inconsistent, or self-contradictory.

And there is absolutely nothing in accounting, and there cannot be anything in accounting, that tells me either that investment causes savings, or that savings causes investment. That's a behavioural statement. Take my earlier classical model, let savings be independent of the rate of interest, and investment depend on the rate of interest, and that's exactly what we get. I.e.

Assume Ys exogenous, Id(r), Cd(Y,exogenous shock to time preference), and let r adjust until Cd+Id=Y=Ys, then savings (or, more exactly, the exogenous shock to the willingness to postpone consumption), DOES determine investment. And if the accountants say that that violates accounting principles, then those accounting principles are wrong!

"Therein lies the problem, because that's largely what they've tried to do, not recognizing that a model inconsistent with REAL WORLD conventions and rules for financial record keeping of transactions is inapplicable to the real world."

Interesting. So you are putting forward a theory where "framing" has real effects? In other words, one set of accounting conventions (one language for describing the world) will results in a different real equilibrium from a different set of accounting conventions, even when those equilibria are described by an outside accountant using the same set of accounting conventions? We need to distinguish between the accounting conventions used by economic agents, and the accounting conventions used by economists to describe and explain the behaviour of economic agents. In other words, even if tastes, technology and everything physical were the same across two countries, if those two countries had different accounting languages, the real equilibrium would be different. Of course, at one level one hopes that would be true, because otherwise the whole accounting profession would be a total waste of resources. But does that mean that economists have to use the same accounting conventions as the people they study? What happens if we want an economic theory of a country where people get the accounting wrong?

JKH: "You’re just changing terminology. That’s not helpful, but the accounting requirement is that the equation works."

But I was just trying to explain to my students how accounting works!

"The condition is that the quantity demanded is exactly met by the quantity supplied (which, due to mathematical continuity in supply and demand curves, has a near zero if not zero probability of happening). The accounting entry is contingent double-entry. There are a zillion such scenarios."

OK, so you're a disequilibrium theorist. OK. But if Qd is less than Qs, Qd determines Q. If Qd is greater than Qs, Qs determines Q. If you believe markets are competitive, then roughly half the time it's the first, and half the time it's the other (under New Keynesian monopolistic competition, it's mostly demand-determined, unless there's a very big shock). But to say "quantity bought=quantity sold, which is all accountants ever say (sorry, it's half of what accountants ever say, I had forgotten the second fundamental principle) tells you absolutely nothing about what determines quantity transacted. That's true in Canada (where most quantities are demand-determined), Cuba (where most quantities are supply-determined), and even true on Mars!

Pheeew! I should have left you accountants fighting among yourselves! Now you're all fighting me. HELP! Where are the economists?

I must return to Winterspeak's point on savings. Because that is a point on which economists DO get confused. But later.

JKH: My point in responding to Nick was that he insists on treating things that produce income the same as things that don't. I think this is (at least one of) the core problems with how economics has chosen to do it's "accounting", ie. not account very much at all.

As you and I have discussed, inventories are properly accounted as investment, but it may be good or bad!

Just a sanity check making sure we're on the same page.

BTW w, inventory does produce income. The firm borrows from the bank to make the inventory investment, which results in income payments to the factors of production of that inventory, which becomes money and income saved in the bank because that money hasn’t yet been used to buy the inventory as product. The end result is that the bank loan has created the deposit, and inventory investment has created income and saving. That’s in accordance with PK monetary causality. (Martha says thats a good thing.)

Referring to C+I+G+(X-M): "we divide the stuff up according to who does the buying: households, firms, government, or foreigners".

Actually, we don't. To be more precise, this breakdown divides stuff up according to how it is used......except G, which is about who uses it. This has always struck me as inconsistent.

I sometimes wonder if Americans in particular might take a more positive view of government economic activity if G was not specifically identified in macroeconomic discussion, but rather allocated between C and I. It might help to make the point that, in a democracy, governments are effectively a tool of the people, which they can use to provide services and investment that are best organised collectively, such as defence and building flood protection levees, for example. Reading some comments on US economics blogs like econbrowser, one could get the impression that G is synomymous with "misappropriation" or "waste". In my view, this attitude to government activity contributed to the financial crisis, but that is another story.

And reallocating G would drive the MMT followers nuts.

But what I just wrote is entirely consistent with the importance of accounting as a foundation for the correct logic in economic relationships.

Good point, Rebel. That's why we need to know how the accounting works to get the intended classification right. Then you can work on changing the classification if its improvable, but it must end up being accounting consistent.

Wow! Consider this question: "does inventory produce income?"

An economist would address that question by trying to talk about the role of inventories in making production easier, so that more goods can be produced with the same amount of resources. (OK, a Keynesian might address it by trying to talk about the role of inventories in aggregate demand, and distinguish between desired and undesired inventory investment).

It's NOT an accounting question! It's got absolutely nothing to do with accounting! To try to answer a question like that by resort to mere accounting conventions is like some form of scholasticism! Can accounting tell us how many teeth a horse has? You can *define* income so that it does or doesn't include inventories. But that's irrelevant to the causal effect of inventories.

Nick,

You’re making the mistake of talking about accountants, which is a deflection from the issue, which is the value of accounting in an economic context. If I took the same approach to the value of economics by associating it with economists, I wouldn’t be writing this (sorry ... I mean that in general economist sort of way, Nick.)

A proper ex post accounting framework is the sine qua non of an economic theory that can even be decent at the most minimal of standards.

What you must understand also that the ex post dimension is required not just for ex post measurement. It is also a constraint on CONCEIVBLE outcomes for ex ante theorizing. If I was making a nasty statement about economists at this juncture, it would have something to do with their propensity for ex ante theorizing without a safety net – i.e. without a robust accounting framework.

"It's NOT an accounting question!"

You're "F****N" right it's an accounting question!!! I just did the entries for you @ 5:30!!!!

Rebel: "Referring to C+I+G+(X-M): "we divide the stuff up according to who does the buying: households, firms, government, or foreigners".

Actually, we don't. To be more precise, this breakdown divides stuff up according to how it is used......except G, which is about who uses it. This has always struck me as inconsistent."

Rebel: you are right. Except we are even more inconsistent than that. Sometimes we distinguish C and I according to who buys it (e.g. cars), sometimes we don't (new houses are I, even if households buy them). If we were really strict, almost everything we buy should be I, not C. Even a restaurant meal is an investment in keeping me happy for a few hours.

“But to say "quantity bought=quantity sold, which is all accountants ever say (sorry, it's half of what accountants ever say, I had forgotten the second fundamental principle) tells you absolutely nothing about what determines quantity transacted.”

Nick, this strikes me as some sort of corollary to the hammer and nail problem. You’re rejecting accounting on the basis that it doesn’t address all the problems in economics. That’s silly. I’m rejecting your rejection of accounting on the basis that it is a necessary part of economic analysis. It’s not a sufficient part, or economics would only be accounting, which is equally silly, but is what you are suggesting should be the burden of proof.

NICK: "And there is absolutely nothing in accounting, and there cannot be anything in accounting, that tells me either that investment causes savings, or that savings causes investment."

See JKH at 530. Others are saying essentially what I would say, so I'll stay out for now instead of muddying things further.

Thanks for engaging on this issue, Nick!

JKH: Excellent point -- I had not considered that treatment. Makes sense though.

JKH: And gosh-darn it, moved to obscenities! You are usually so unflappable ; )

winterspeak: I did attempt self-censorship, however feebly. Nevertheless, a slightly too heated response. Sorry, Nick. Perhaps the following soothing interlude will patch things over - a rather nifty example of the power of accounting in understanding the monetary system and government deficits:

http://neweconomicperspectives.blogspot.com/2009/11/memo-to-congress-dont-increase.html

Nick has been an absolute champ, and shown us to be the uncouth ruffians that we are. At least someone on the internet has some grace!

Simpleton questions.

On part 5. Sum of excess demands = 0. The values of excess demands = 0. I'm not getting this.
If everyone wants more. How does it equal 0?

And then n+1 is goods + money.
And there is n-1 markets. Shouldn't there be n markets. What is the -1 and -2?

Thnks.

edeast: well-spotted. The n+1 should read n-1. Typo. I've fixed it.

I've also added an update for clarity. "excess demand" means "demand minus supply". So an equivalent but clearer definition of Walras Law is: the sume of the values of goods demanded must equal the sum of the values of goods supplied.

You guys are fine! I figured this would be a LOUD argument!

OK. Time to tackle the "Savings Problem".

Warning: my views are perhaps weird from the perspective of most economists. Even weirder, I might actually line up with Winterspeak on this one: the only type of "savings" that does the damage (in the paradox of thrift/recession sense of damage) is savings in the form of money (the medium of exchange). Think stuffing cash under the mattress!

Lets start with a very simple model. No foreigners, no government. No investment. The only two goods are haircuts and money. There are no inventories of haircuts. They get produced and sold at the same time. You can't cut your own hair, and there's a tabu on cutting the hair of someone who has cut your hair recently, so you must use money as a medium of exchange. Money is a fixed stock of currency. No banks.

Start in equilibrium: demand for haircuts=haircuts produced=haircuts supplied. Desired saving=0

Suddenly everyone wants to save more. The only form of saving is money. Each individual can get more money by buying less harcuts, but this is impossible in aggregate, since the stock of money is fixed. (Fallacy of composition, etc.) At the initial equilibrium, there suddenly appears an excess supply of haircuts matched by an equal excess demand for money. (Each person wants to buy \$1 less haircuts than he produces per month, and grow his stock of money by \$1 per month. Production of haircuts (=income) falls, and as it falls demand for haircuts falls further, as people try to save. Assume the price level is fixed.

Eventually income falls so much that people decide the stock of money they hold is what they want to hold, at the lower level of income. Each person operates in 2 markets (barbershops): one where he sells haircuts and one where he buys haircuts. At this unemployment equilibrium, there is an excess supply of haircuts matched by an excess demand for money for people trying to sell haircuts to other people. But no excess demand for haircuts and no excess supply of money for people buying haircuts from other people.

Now let's add one more good: antiques. Antiques are not produced. Fixed stock of antiques.

Start in the original equilibrium, then suppose people want to save more. They can either save in antiques, or in money. Suppose they want to save in the form of antiques. Excess supply of haircuts matched by an excess demand for antiques. People TRY to buy antiques, but fail, because nobody wants to sell. They re-evaluate their demands for haircuts and money in the light of this quantity constraint in the market for antiques. If they decide they still want to save, but save in the form of money instead, we go back to my earlier example, with no antiques. If they decide they have enough savings in the form of money, they MUST decide to buy haircuts instead of buying antiques, and there is no recession. Excess demand for antiques, matched by an excess supply of money in the antique market. But it has zero consequences elsewhere.

For antiques, substitute bonds, bank loans, whatever. It doesn't matter, unless it's the medium of exchange.

The only form of excess desired savings that does the damage is an excess desire to save in the form of the medium of exchange.

Is that what you were trying to say Winterspeak? If so, you were absolutely right!

More accurately, I should have said: "The only form of excess desired savings that does the damage is an excess desire to save in the form of the medium of exchange, or one that spills over into an excess desire to save in the form of the medium of exchange."

Quite right Nick... and this is one reason that paradox of thrift is an extremely dated concept. People don't hold money, they hold demand deposits... but even better they hold claims on productive assets (stocks). This is far cry from the 30s where savings really did predominately mean stockpiling money away at home.

NICK: I think so, but I need to think through your antique example further.

In your haircut example, we are on the same page. You have prices fixed, so eventually, people just become satisfied with their lower level of income. The model shows that this can be at any level, so you can have any level of employment in the economy of AD to stabilize. All of this is true.

As we have no Govt able to deficit spend, and no private credit extension, the stock of money remains fixed and it can either be transacting, or it can be out of circulation. Note that, in our real economy, putting money in a bank account and/or buying a Treasury bills takes money out of circulation just as effectively as putting it under a mattress. If you put your money in a bank, it gets taken out of circulation, and if the bank buys a Treasury bill with its reserves, it changes the term structure of that out-of-circulation money, but nothing more.

Nick,

I recognize your antique example from a previous post. I have no idea how your 7:55 comment relates to anything that I’ve seen from Winterspeak here, but I’ll leave that up to the two of you. And I also have no idea what point you’re making. It’s simply a collapse in demand and income due to hoarding of money. What’s that got to do with the topic of your post?

JKH: Yes, I'm going back to stuff I was arguing months ago, about the role of the medium of exchange in allowing the possibility of a general glut. In some weird way, I have a hunch that many arguments over accounting for savings and investment are tied in with what I was arguing back then.

And I'm also following a hunch about what I thought Winterspeak was maybe saying in some comments on the "deflationary spirals" post, and in his 1.49 post here. Just a hunch. But if I can re-interpret what someone might be saying into something that sounds right to me, I try it out and see if they bite.

Sorry. Not a very clear answer to your question, JKH. That's because my mind's not as clear as it should be.

If he bites, I might try to build investment into my little model, to see in what sense increased desired saving does or does not lead to increased actual investment. But that means adding loans, plus a durable good.

"Last week, Harry supplied 40 hours of labour, but sold none; he was unemployed."

Sounds weird, doesn't it?

There would perhaps be less confusion between acountants and economists if Anglophone economists were more like Francophones.

"Last week, Harry offered 40 hours of labour, but sold none; he was unemployed."

Nick,
I think your intuition is in part right about clearing up this confusion. Namely, that Winterspeakian Savings is more akin to conventional Demand for Money to a monetary disequilibrium theorist than the more common definition of Savings. In fact, someone could come on this board with very plain-vanilla ideas about monetary disequilibrium as encapsulated by your simple model and use the same kind of accounting-based logic to argue that Savings should be defined as "saving in money" as opposed to S=I. For that person, you would have fully closed the gap, but I don't think you have here.
Because my sense is that Winterspeak cares about demand for money plus government liabilities as opposed to merely demand for money. This is why I think his definition of "Savings" would more helpfully described as the Net External Investment Position of the private sector with respect to the public sector, to borrow an idea from international trade accounting. Of course, the difference between the demand for money and the demand for "net external investments" becomes blurred in a liquidity trap even to traditional monetary disequilibrium folks, so there will inevitably be common ground. By I think there will be more uncommon ground, and I think it will be hard to draw out unless you talk about a model with a fiat currency and government deficit spending – though I also think it is possible for you to get there (maybe slightly more circuitously) by adding investment to your model as you suggested.

Nick,

I thought we were talking about accounting and economics.

Here’s the accounting for your haircut economy (I’ll keep the recession theme you carried over from your earlier post):

The national income equals the national output, which is the value of total haircuts sold.

I have no idea where your money came from, because it’s your example, but that fixed money supply constitutes the only asset and therefore the only wealth in this economy. It is representable on a national balance sheet as nominal money on the asset side and net wealth (or equity) on the other side. It doesn’t matter whether this money is gold bars or some “net financial asset” manna from heaven (or from some previous but now non-existent government).

Suppose person X sells one haircut and that is his total income. A recession starts when X sells a haircut as a producer, but doesn’t buy a haircut as a consumer. He saves that money from his income. This automatically forces another person Y to have bought a haircut as a consumer but not to have sold a haircut as a producer. Think about it. It is logically impossible otherwise.

Suppose Y has no other income. Then Y’s total income is negative. This means that Y has dissaved – i.e. Y has negative saving. (The proper definition of saving is income that is not used for consumption; i.e. saving = income - consumption.) Furthermore, Y had to have had that same amount of money as pre-existing wealth, or he would never have been able to buy the haircut, because he had no income. Y spent that pre-existing money on his haircut. So Y’s dissaving is reflected by a reduction in his money wealth – i.e. a reduction in a balance sheet asset.

Suppose everybody else in the economy still buys and sells one haircut.

Then the economy shrinks from the case where X would have bought a haircut. The economy shrinks by one haircut. Saving at the micro level has caused dissaving at the micro level. Aggregate saving is still zero, and of course aggregate investment is zero. This is the mechanism for a recession in an economy that cannot experience an inventory recession because there is no investment.

So the net result of this recession is that the economy shrinks by one haircut, and the distribution of wealth has shifted by the nominal amount of money corresponding to that one haircut. X has become wealthier by the same amount of money that Y has become poorer.

Let's talk about the ability of the lower/middle class and the gov't to make the interest payments on all the currency denominated debt to the rich domestics and the rich foreigners.

Let's talk about the ability of the lower/middle class and the gov't to make the interest payments on all the currency denominated debt to the rich domestics and the rich foreigners.

Sorry if this is a repeat.

Nick said: "OK. Time to tackle the "Savings Problem".

Warning: my views are perhaps weird from the perspective of most economists. Even weirder, I might actually line up with Winterspeak on this one: the only type of "savings" that does the damage (in the paradox of thrift/recession sense of damage) is savings in the form of money (the medium of exchange). Think stuffing cash under the mattress!"

What about excess corporate profits in a demand constrained economy?

Nick said: "Start in equilibrium: demand for haircuts=haircuts produced=haircuts supplied. Desired saving=0

Suddenly everyone wants to save more."

How about a few want to save and can sucker the rest into currency denominated debt?

How about relating excess savings and retirement?

Nick said: "For antiques, substitute bonds, bank loans, whatever. It doesn't matter, unless it's the medium of exchange."

Does it matter if it is a financial asset (something bought for a return on savings) vs. a real good?

Nick said: "At the initial equilibrium, there suddenly appears an excess supply of haircuts matched by an equal excess demand for money. (Each person wants to buy \$1 less haircuts than he produces per month, and grow his stock of money by \$1 per month. Production of haircuts (=income) falls, and as it falls demand for haircuts falls further, as people try to save. Assume the price level is fixed."

winterspeak said: "You have prices fixed, so eventually, people just become satisfied with their lower level of income."

Does that mean quantity(ies) fell?

Nick:

In the haircut only economy, if a single person decides to pass on a haircut (and save the dollar) it means someone else loses the opportunity to give a haircut and is thus out of the dollar as income. You transfer some of the money from one person in your economy to another, but sector-level net financial assets stay the same. Sector level net savings stay the same too. If everyone decides they want to save, then all haircuts stop, but again, net financial assets stay the same, and net savings stay the same. Money has just stopped circulating, but it's still there (as savings).

I think I am 100% inline with JKH.

In your description, people started to want to save for "some reason" and then decide to stop trying to save for "some other reason". This is fine, the economy can run with any quantity of haircuts happening or not happening. The more people want to save, the fewer haircuts will happen. There can be a situation where everyone is saving, letting their hair grow long, and 2 people swap \$1 a haircut back and forth, back and forth. At every instant, there will be the same quantity of money and saving in the economy, but the distribution will change depending on who bought the haircut last, and sector-wide income will fall of course. This would be a high unemployment state, certainly a bad (harmful) outcome. The ACTUAL savings level is the same, but since it is lower than the DESIRED savings level you get reduced AD, less real output, less consumption, and high unemployment.

I think I am missing the point of your antiques example. It seems like they can either give up trying to save in antiques and go back to trying to save in haircuts (and we are back to square one) or they give up trying to save in antiques and continue trading haircuts. At a sector level, there is no way to increase the number of antiques.

P.S. The fixed money supply represents the wealth of the economy. You can think of it as cumulative or prior saving inherited from Nick the Grand Wizard. Annual saving is zero at any level of income. Therefore, nominal wealth remains unchanged over time. The national balance sheet doesn’t change, just the micro distribution of it. If the inherited currency is fiat, you can think of it as the net financial asset position as well. But currency could be gold or anything, depending on the verities endowed by the Wizard.

P.P.S. I did the accounting for your economy, Nick. Looks like Winterspeak agrees with me. But I still don't know what point you're trying to make that's related to accounting. You seem to be switching to the theme of a previous post.

Nick,

Here’s another take on another role of accounting in economics.

Economists in general may not be as interested in accounting as they should be. In addition, they may not be as interested in risk management as they should be. Accounting is vital to risk management. Therefore it should be vital to economics on a compounded basis through this particular channel.

Risk management involves running scenarios about the future, determining their relevant consequences, attaching probabilities to them, and summing it all up into some kind of conclusion and/or decision about risk exposure.

You can’t run such scenarios rationally unless you fit them into the ex post accounting framework that you’re starting with. Otherwise, you have an implausible scenario.

"BTW, very few people seem to be aware that US households have been big buyers of US government debt directly, since the deficit began expanding. I don’t recall a single economist noting this fact. "

Krugman.

Now that doesn't surprise me.

Adam P: I have seen one video where Krugman says they have but the argument is completely wrong. He says households deposit money at the banks and banks have bought the government debt. And that is a very double-entry-incorrect statement.

One example is here, light on the details though:

http://krugman.blogs.nytimes.com/2009/06/06/wheres-the-money-coming-from/

I seem to recall there were others where he goes he actually goes into the details of how private savings is funding the deficit.

That's interesting Ramanan.

I've noticed a number of economists also suggesting that banks have been buying the debt. That's not true at all. Non bank dealer brokers have positioned some, but not commercial banks. And the dealers haven't positioned anything near what households have directly. And when I say households directly, I don't mean pension funds or mutual funds or banks. I mean households directly. I'd be interested to see where Krugman has picked that up, but it sounds like he hasn't.

That is domestic private savings of course.

My guess is that lots of it is through non-bank intermediaries like pension funds and life insurance and the like. But I've no doubt a lot is being bought by households directly as well though I haven't seen any data on it myself.

Yes JKH : I was just looking at the table F.209 of Z.1 ...

No, Adam. That doesn't show the point about households at all, which was my very point.

It's a reasonable point, but it's higher level macro - the basic MMT idea about non government net savings as the offset to the government deficit.

Krugman is actually fairly close to a closet MMTer. I don’t know how much detail about the reserve system he’s familiar with, but his top down accounting logic is typically impeccable, often arriving at a similar point as MMT.

Wow! Too many comments for me to respond to all.

JKH: Your accounting of my haircuts example looks right to me, except for one thing. You said that person Y has negative *income*. I think that must have been a typo. You meant negative saving? And you had just one person wanting to save more. I was imagining all people wanting to save more. But if we just multiply your accounting up, I think we get to my example.

What was i trying to do in the haircut example? Three things:

1. Getting the accounting right is sometimes easy and sometimes hard. Getting the accounting right for "savings" has always seemed the hardest thing to me. So I wanted to work through a simple example.

2. I said in the post that some ways of doing the accounting were more useful and others less useful. (Example, is Y=C+I+G+X-M a useful way to divide things up?) I wanted to show that dividing "saving" up into "saving in the form of money" and "other saving" might be really useful and important (in the context of a keynesian/disequilibrium monetarist model where monetary exchange was essential).

3. Winterspeak seemed to maybe have been saying something close to what I had been saying in previous posts, something I think is important, and I wanted to engage him on that point by seeing if he might agree with me. Plus showing everyone else that he might be onto something important.

On the role of antiques in that model: if I am right, then "antiques" in that model are a stand-in for saving in *any* other form, except money. Saving in the form of money (the medium of exchange) has qualitatively different effects than saving in antiques, bonds, shares, land, whatever. Within the context of that class of model, an increase in desired saving in any other form but money is either: successful, and leads to an increase in investment; unsuccessful, and doesn't do anything (unless it leads to increased desired saving in the form of money). Only increased desired saving in the form of money leads to the recession.

Ramanan: "Adam P: I have seen one video where Krugman says they have but the argument is completely wrong. He says households deposit money at the banks and banks have bought the government debt. And that is a very double-entry-incorrect statement."

Leaving aside the question of whether it's empirically true or false that banks have bought government debt recently, why is that statement "double-entry-incorrect"? It sounds OK to me.

Nick,

“You said that person Y has negative *income*. I think that must have been a typo. You meant negative saving?”

Right! My error - you’re on top of the accounting!

"And you had just one person wanting to save more. I was imagining all people wanting to save more. But if we just multiply your accounting up, I think we get to my example."

Right! - just approaching it iteratively.

Nick: "why is that statement "double-entry-incorrect"?"

Because banks don't buy Tsy's with deposits. They buy them with reserve balances . . . when a bank buys a Tsy, there is no debit of its deposits. Also, the qty of bank deposits has virtually nothing to do with the qty of reserve balances for most any bank and in the aggregate.

Adam: "I seem to recall there were others where he goes he actually goes into the details of how private savings is funding the deficit."

This is a criticism of Krugman, not Adam. Nick's haircut example demonstrated that the attempt to increase saving by households doesn't generate any additional private saving. So, obviously it was the deficit that enabled the private saving, not vice versa.

Nick,

“I wanted to show that dividing "saving" up into "saving in the form of money" and "other saving" might be really useful and important (in the context of a keynesian/disequilibrium monetarist model where monetary exchange was essential).”

Saving is flow generated – a hold back of income from consumption expenditures. Annual aggregate saving in your model is zero.

Pre-existing saving or wealth is the fixed money supply.

When you introduce antiques, I’m assuming you introduce them as pre-existing assets (must be!). That also increases pre-existing NOMINAL wealth.

Then, you are into a dynamic where the annual saving is still zero, but people are starting to trade their pre-existing wealth. They are trading money and antiques back and forth.

And if money is still the medium of exchange, it has its own dynamic as a potential recession catalyst – as per X’s desire to micro save forces Y’s position as a micro dissaver. Aggregate annual saving is still zero.

I THINK ONE OF THE SECRETS IN UNRAVELLING THIS SAVING ALGEBRA IS TO RECOGNIZE THE POTENTIAL FOR MICRO NEGATIVE SAVING. THAT’S ASYMMETRIC RELATIVE TO THE NON-EXISTENCE OF MICRO NEGATIVE (GROSS) INVESTMENT OR MICRO NEGATIVE CONSUMPTION.

Nick, (@8:31)

That is because of the "MMTer" (JKH's terminology) way of looking at a bank. Unlike a mutual fund, banks do not take deposits and "give" the money to the government. The deposits just sit on the liabilities side of the balance sheet. Government bonds sit on the assets side. Bank is not an asset manager. Rather, banks occupy a unique position.

The bank's holding of government securities is irrelevant for a household unlike the case of a household invested in a mutual fund which holds government bonds. (Of course households can hold government securities directly without going through a mutual fund)

This may seem a bit like tautology, but the usual non-accounting way of looking at this is somewhat closer to a commoditizing money whereas a double-entry bookkeeping way is not.

Ok - I understand this may not be written clearly but consider this. If I buy a G-sec worth \$1000 directly at the auction, the deposits of the banking system goes down by \$1000 and so do the reserves. Bank's assets and liabilities hence go down by \$1000. However if the bank buys it directly, the bank's assets and liabilities do not change. This may sound like an accounting technicality but look at how the two case evolve - In the first case I am going to make the yield on the bond if held to maturity but in the latter case, its the bank making the money.

Nick,

Both you and Winterspeak seemed to agree with my accounting description of your economy (including your correction).

I'm not clear - is there another aspect of Winterspeak's earlier comment that you're still grappling with? If so, I'm interested.

"This is a criticism of Krugman, not Adam."

If Adam's citation of Krugman is correct, then I should withdraw my comment about his closet MMT credentials. Except to say that I think he gets the importance of the macro net saving offset with the government, although he gets sloppy at times with related descriptions of monetary causality. Maybe he hasn't thought through the monetary system flows in detail; I don't know.

JKH: "Pre-existing saving or wealth is the fixed money supply."

No, money is neither of these (you were correct on the preceding line). In an economy without capital (a technology that transfers forgone consumption today into increased POTENTIAL output tomorrow) there simply is no saving.

Take the example that Nick sometimes likes, an economy that produces only back scratching services where nobody can scratch their own back. Suppose there are 100 people in the economy and suppose that everyone only has the strength to provide one back scratch per day. Thus, daily potential output is 100 backscratches, the money supply is \$100 distributed uniformly in the population so each backscratch costs a dollar.

Now, suppose one person (only one) decides he'd like to save. He wants to forgoe todays scratch but get two tomorrow. Thus, he provides a backscratch and gets paid a dollar for it which is added to the dollar he already had. However, someone else was unable to sell a backscratch but still consumed his and now has no money. Today output fell to 99 backscratches.

Now, tomorrow the guy with the extra money gets 2 backscratches and still provides one, the guy with no money gets none but still provides a backscratch. Output is back to 100 and the money is back to its uniform distribution. Furthermore, because potential output is capped at 100 total backscratches printing an extra dollar and giving it to the guy who was unemployed on day 1 just causes inflation, no increase in aggregate output. (Although it does have a welfare effect by allowing the unlucky guy to get a fraction of a backscratch.)

So, no net savings, just forgone ouput. Without capital, a way that forgone consumption today is transformed into increased potential outupt tomorrow there will always be zero net savings and any attempt on the part of agents to save in real terms will only result in an output loss. Money in nosense represents past savings here, only productive capital can do that.

It's pre-existing by construction.

correction to the last line: money in no sense...

By pre-existing, I mean it bears no relationship to the current dynamic of zero saving for the economy as defined.

I'm comfortable in calling it pre-existing wealth rather than pre-existing saving.

But given that it's been endowed magically by the wizard, I've got no real problem in referring to it as pre-existing saving (by the wizard).

And if the wizard transferred the money in from the fiat stock of a bizarro economy, it may well have had a prior existence as net financial assets in that economy, which is a form of saving, which is pre-existing saving relative to Nick's economy.

Sorry, I must have been repeating something Nick said earlier. Where is this hair cutting example?

JKH, the distinction I'm making is between individual saving at the micro level which can be accomplished if someone else dissaves.

Aggregate savings requires capital, that is, real assets.

Money/financial assets are not required at all. They serve other purposes.

That should have been:

The distinction I'm making is between individual saving at the micro level, which can be accomplished without capital if someone else dissaves, and aggregate savings.

Aggregate savings requires capital, that is, real assets.

Money/financial assets are not required at all. They serve other purposes.

BTW, you're right the link I provided didn't have Krugman making the same point. I thought I recalled him making the point directly but couldn't find the link. The one I posted was the only one I found.

"Aggregate savings requires capital, that is, real assets."

Not if aggregate saving in an economy without a government (Nick's economy) consists of net financial assets imported by the wizard from another economy and endowed on Nick's economy. Nick's economy has net financial assets by construction, provided that the money is financial (e.g. currency) rather than real (e.g. gold). This is all by construction, prior to the operation of Nick's economy, because you can't explain the existence of money otherwise in a way that doesn't contradict the structure and current operation of Nick's economy.

I'm aware of the truth of your statement for a normal economy. It doesn't necessarily hold given Nick's construction of his abnormal economy. It depends upon the origin of the pre-existing condition, which is a fixed money supply.

But look at the example, aggregate savings requires that in the future period when the aggregate savings are going to be consumed potential output must be more than 100. If it's not then we can't have the extra consumption even if we had forgone consumption in the past.

Capital is what increases productive potential. Without capital we can't have aggregate saving no matter where the money comes from.

Again, I don't insist on calling it pre-existing saving, but you can interpret it that way if its imported as a pre-existing condition from another economy that created it via MMT net financial assets.

Better to refer to it just as pre-existing wealth or even pre-existing money assets, to make it more general.

The critical point is that it's pre-existing, not what you call it.

You're missing the pre-existing point.

The existence of this money is unrelated to the operation of Nick's economy in the future, where aggregate investment and aggregate saving is zero.

Clearly, what does it have to do with saving? Saving is intertemporal substitution, less today is traded for more tomorrow. What is the pre-existing point?

Pre-existing is how Nick constructed the initial conditions for the economy.

It's a balance sheet that includes a pre-existing fixed supply of money as an asset of those who hold the money.

Nothing else. No financial institutions, no government, nothing but haircuts.

The balance sheet is the initial or pre-existing condition.

The income statement then describes the operation of Nick's economy, including zero aggregate investment and zero saving, but positive and negative micro saving that can force a recession.

That's all Nick's construction.

I've translated into accounting terms - initial conditions (opening balance sheet) and the dynamic from there (income statement).

You've effectively blurred the issues around the composition of the opening balance sheet with those that relate to the dynamic income statement as it evolves into the future.

Sorry. I've gotta go. Will return later.

Too many interesting comments i want to reply to, but no time.

Adam P. My haircuts model is earlier in the comments. But it's exactly the same as backscratching.

JKH: yes, when money is the only asset, your, my, and Winterspeak's accounting is the same. But what about when we add antiques? By the standard definition of "saving", demand for antiques is part of desired saving. But Winterspeak's earlier comments about what he meant by "saving" would exclude it, if I understood him correctly. I say we can include it as savings if we want, but it's important to distinguish between these two forms of "saving", because they have very different macro consequences. So it would not necessarily be wrong to re-define "savings" to exclude antiques, and it might be useful to do so.

Of course, if the price level were pefectly flexible, my haircuts model would not generate a recession. The incipient excess supply of haircuts would cause an immediate fall in the price of haircuts, and increase the real value of the stock of money, until it equalled the desired stock, so desired saving would fall to zero again.

Now, here's an interesting point: if an increased desire to save did cause an increased stock of real money balances (because the price level fell), so assets have increased (in real terms), do we say that "actual saving" has increased? Not if we follow the textbook definition of "saving" (Y-C). But if we define saving as "increased (real) stock of assets", then actual saving has increased!

JKH @6.34. I don't understand everything you say here (required buyer, required supplier?), but I agree with what I do understand.

When I did my "I hope Hillary Fails" (to persuade China to buy US bonds) post a few months back, I was sort of thinking along these same lines. "If China stops buying US bonds, what does it buy instead?" You can't just change one item in their budget constraint; the accounting won't work if you try this.

Thinking through possible scenarios in which people stop wanting to buy US bonds, in almost all cases (except one) I can think of, the US would also stop wanting/needing to sell bonds. Either because the US returns to full employment (they buy US goods instead), or interest rates rise (so the Fed takes over and does an OMO), so an expansionary fiscal policy is not needed anyway. The only nasty scenario I can think of is where the US returns to full employment, inflation starts to rise, and political gridlock prevents the US from eliminating the deficit. Maybe there are others.

I think that Adam P and JKH are touching on an issue that I would be interested to see discussed (more) by the great minds here. Somehow, money seems to have value beyond its notional value. For example, I suspect that, if someone was given a thousand dollars in banknotes, they would be more inclined to increase their spending than if they were given a thousand dollars worth (in terms of present market value) of bonds. What is the nature of that value (I believe Pesek and Saving wrote about this, but I do not have access to that book) and can it be quantified? I think that this is a particularly topical question today, because US treasury bills are reportedly trading at negative yields, and Krugman, for example, would argue that OMOs between zero yield treasury bills and base money cannot break the liquidity trap. But if there are more reasons to pass on money than the wealth that it represents, maybe a short term interest rate of zero does not imply a liquidity trap. Maybe money has some negative utility when you hold it (like an itch) and some positive utility when you don't, so that it gets passed around but does not represent wealth overall.

Nick: "Now, here's an interesting point: if an increased desire to save did cause an increased stock of real money balances (because the price level fell), so assets have increased (in real terms), do we say that "actual saving" has increased? Not if we follow the textbook definition of "saving" (Y-C). But if we define saving as "increased (real) stock of assets", then actual saving has increased!"

No, the textbook is right. If you read my bacscratching example there is a point there, financial assets like money do not, on their own, facilitate savings. You need the underlying physical capital to that.

In there is money but no productive capital then the economy has no NET assets.

That's the point I'm trying to make. Money can facilitate bilateral saving/dissaving combinations that allow individuals to save if another (perhaps forcibly by being unemployed) dissaves. This is how OLG models work, the young cohort saves and the old cohort dissaves. But money can't facilitate aggregate savings.

Nick,

Re the antique variation:

I define saving as withholding income from consumption. As such, it is a passive economic activity. It is defined by what doesn’t happen, not by what happens.

E.g.

I save from income in the form of a bank deposit, because bank deposits are the channel through which my employer credits me with income. That’s the extent of my saving dynamic.

My saving is not defined by whether I choose to leave that money as a bank deposit, or buy bonds, or buy equities, or buy a house. None of those things determine the act of saving. They are a downstream portfolio choice for the form of my saving. But they are not my saving.

In your economy, the act of micro saving and dissaving is determined by your fixed money supply channel. That’s simple.

So you introduce antiques.

In doing so, I would classify your antique introduction as an initial conditions endowment addition. Those antiques are not the result of your dynamic economy in action. Like money, they are an initial endowment bestowed by you in your construction of your economy.

Income in your economy is paid in money. That’s the default form in which X attempts successfully to micro save, forcing Y to dissave by drawing down his pre-existing money balances to buy a haircut produced by X.

You introduce antiques. That changes the initial balance sheet and nominal wealth of the economy, which now has both money and antiques as assets.

To back track, X’s act of saving is not defined by his choice of whether or not to save in the form of money. It is defined by his act of withholding his purchase of a haircut, the consequence of which is saving in the form of money. In other words, money is the default form of saving.

Prior to the introduction of antiques, X had no choice for the form in which his saving took.

After the introduction of antiques, X has a choice for the form of his saving.

He can choose the default form of money, or he can trade or attempt to trade money for antiques.

Here’s what that has involved from an accounting perspective:

X has saved from income.

X initially saves in the form of money.

That money becomes an asset on X’s balance sheet – it becomes his share of the national balance sheet.

With the introduction of antiques, which expands the national balance sheet, X now can choose to trade money for antiques.

That’s a balance sheet transaction.

It has nothing to do with the dynamic of saving itself.

Saving is an income statement transaction.

The result of the income statement transaction is the default balance sheet position that includes money as the form of CUMULATIVE saving, which is wealth, or net worth, or equity. Balance sheets reflect such a cumulative position, extending beyond the accounting period that originally generated the position, and usually marked to market.

The swapping of money for antiques is a balance sheet trade. The saving event occurred prior to that swap.

Nick, there is a real value to the money stock but money is not a real asset.

You need a way that forgone consumption today is transformed into increased POTENTIAL outupt tomorrow in order for there to be aggregate savings. That transformation can only be accomplished by real capital. Money is NOT a real asset.

Nick,

It's fine to distinguish between real and nominal. If you noticed, I used the term nominal in a couple of places.

You can attempt to set up nominal and real accounting systems, but they must be able to "talk" to each other. They must be internally consistent.

The fact that you can introduce a real measure doesn't extinguish the value of a nominal accounting system. That would just be a variation on the ruse that accounting is no good because it doesn't solve all the problems of economics.

Nick,

"Actual" is a choice that depends on the measurement objective.

"Actual" is not a victory of real over nominal. It depends on the measurement objective.

Nick,

Required buyer refers to the mistaken propensity of some to predict that we'll all die if China doesn't buy a lot of bonds from the US. That completely ignores the natural influence of the bilateral current account deficit on reasonable expectations for net capital inflows from China and the composition of those inflows as between bonds and other things.

Required supplier refers to the fact that the US current account deficit generates dollars that China is required to make a decision on in some fashion - leave in reserves, switch for Euros, buy no bonds and instead leave in the bank, etc. etc. It's a cornerstone MMT-consistent proposition and fact.

Nick,

"Thinking through possible scenarios in which people stop wanting to buy US bonds, in almost all cases (except one) I can think of, the US would also stop wanting/needing to sell bonds."

Assuming other things equal for the government deficit, and looking at it through the operational lens, the commercial banking system expands by the amount of the cumulative deficit – excess reserves and deposit liabilities increase in tandem. On the central bank balance sheet, excess reserves increase, offset by an equal an opposite government overdraft position. The bank continues to pay interest on excess reserves, and the entire US deficit gets “short funded” via the banking system.

That’s purely operational of course. Then you have to consider the strategic response apart from that, which is an additional layer of complexity. But whatever that analysis is, it doesn't negative the immediate operational implications.

I'm running behind. Here's what i was going to post an hour or so ago:

Adam P.: There's an important sense in which you are right, of course, and I agree with you. But maybe you are also leaving something out. If the economy is hit by idiosyncratic shocks, that are independent, sum to zero in aggregate, but hit individual agents, then agents might want to "save" against those shocks, much like they buy insurance. And "saving" in the form of money would do this job fine. So if the variance of those idiosyncratic shocks increased, agents might respond by demanding more money, in my little model. And if the price level fell, so M/P increased, that does the job for them, in aggregate as well as individually.

I think that, once again, how you most usefully define terms, like "saving", depends on the model.

JKH: Income statements show flows; balance sheets show stocks. Suppose I am accumulating a flow of antiques over time (I plan to buy 1 antique per day for the next 10 years.) Now think in continuous time. In the first second when I start buying antiques, we see nothing on the balance sheet. But on the income statement we see a flow of 1 antique per day.

Nick, I agree completely with what you just said but it's not aggregate savings.

Using money as insurance in this sense, which clearly happens A LOT in real life still ends up requiring any successful attempt at savings, that is the successful substitution of more tomorrow for less today, to involve someone else dissaving.

When tomorrow comes and you try to consume your extra money (financial savings) then, if potential output has not increased, someone else must get a smaller share then they otherwise woul. The mechanism could appear as unemployment or inflation (like the OLG examples) or intentional dissaving but it all derives from the having a max potential output that can't be breached.

And of course, in real life there is some maximum output even if it's hard to estimate what it is.

To have aggregate savings you need some form of capital that actually increases future productive potential. It doesn't have to be physical capital, it could be intellectual capital, but it must be something that increases potential output.

Nick,

"Income statements show flows; balance sheets show stocks. Suppose I am accumulating a flow of antiques over time (I plan to buy 1 antique per day for the next 10 years.) Now think in continuous time. In the first second when I start buying antiques, we see nothing on the balance sheet. But on the income statement we see a flow of 1 antique per day."

Absolutely not. You are in error here. This is where you need some accounting in economics. I guess much of what I've written here has been in vain.

Your antique is a real asset, sometimes called a capital asset, sometimes called a real or capital investment. The purchase of a capital asset does not appear on the income statement. It is a balance sheet transaction.

E.g the income statement for a corporation does not reflect the acquisition of capital investments. Nor for that matter does it even reflect the acquisition of treasury bills, for example, with retained earnings. It only shows the retained earnings as the bottom line, after the distribution of dividends and after all revenues and expenses have been taken into account. In accounting terms, a capital investment would be considered a cost, but not an expense. Only outlays classified as expenses appear on the income statement.

There is a 3rd type of accounting statement called "sources and uses of funds", which captures all flows. It would capture the purchase of the antique as a flow. But that is not the income statement. And it is very important to understand the difference between a "sources and uses of funds" statement and an income statement.

At the macro level, the GDP and income accounts are the equivalent of a macro income statement. The Fed flow of funds report is the equivalent of a sources and uses of funds statement. And the Fed report includes balance sheet snapshots as supplementary information. Your antique transaction would be captured by the equivalent of a Fed flow of funds report but would not be included in GDP and income statements. Only the haircuts would be there.

This is all very basic accounting, and goes to the main point. Without understanding these differences, one is going to make some very serious mistakes in economic analysis. MMT refers to this as stock flow consistency.

This discussion convinces me more than ever that the MMT emphasis on accounting and its accurate portrayal of accounting logic presents the only sound analytical foundation in all of economics.

I'd love it if Scott Fullwiler could offer an overview comment on this discussion at some point.

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