To paraphrase Churchill, accountants and economists are divided by a common language. We seem to be using the same words to talk about the same things, but we don't understand what the other is saying. This is my attempt to provide an economist's perspective on the relation between accounting and economics.
What I say here will not I think be new or controversial for economists (until I start talking about money). Accountants may find it hilariously wrong, like locals hearing tales from a traveller who can't speak the local dialect and gets everything muddled. Let's see.
Like most economists, I don't think about accounting much. Normally I only think about it when I teach the ECON 1000 bits on national income accounting and money and banking, and try to remember if assets go on the left or right side of a balance sheet (I rely on my students to remind me). I decided to write this after an interesting exchange with Winterspeak, both here and on his blog.
So, here's my take on accounting:
There are two fundamental accounting identities. Here's the first:
1. stuff bought = stuff sold
If some people bought 100 apples, some (other) people must have sold 100 apples. The "stuff" in question can be a flow or a stock, measured in monetary or real units, or whatever. If it's a flow we call it income accounting. If it's an accumulated flow, or stock, we call it balance sheet accounting. The stuff could be real goods and services, or it could be financial stuff. All accounting consists of dividing and subdividing stuff into different categories, trying to keep your head straight when doing it, so that the RHS and LHS both capture mutually exclusive and jointly exhaustive ways of dividing the same stuff. Don't miss anything out, and don't double-count.
This is an identity; not just an equation. it's true by definition of what we mean by "bought" and "sold". It's not something we could go out and test empirically. If we did test it empirically, and found the numbers weren't equal, we would figure we must have made some sort of mistake in the test, like adding things up wrong, forgetting something, defining "stuff" inconsistently, or somebody lied to us, or whatever. And because of that, it doesn't tell us anything about the world, only about how we must use words in a logically consistent manner if we are to think about the world without internal contradictions.
The equivalent sentence in economics has three different variants:
2a. stuff demanded = stuff bought = stuff sold = stuff supplied
is the complete version, though it's often shortened to:
2b. stuff demanded = stuff traded = stuff supplied
And sometimes we shorten it further still, to:
2c. stuff demanded = stuff supplied
First, 2a and 2b are logically equivalent, since the middle "=" is an identity, so that "stuff bought" and "stuff sold" are just two ways of saying the same thing.
Second, "stuff demanded" means the amount of stuff buyers want to buy, and would buy if it were available to buy. It doesn't mean "stuff bought". Same with "stuff supplied".
Third, the other two "=" are equalities, not identities. They can be empirically false, and are empirically false when there is excess demand or supply. They are only both true in full market-clearing equilibrium.
Fourth, 2b reveals that there are really two "=" in market equilibrium, where buyers get to buy what they want to buy, and sellers get to sell what they want to sell. Normally we impose the "short side rule" so that quantity traded is whichever is less, quantity demanded or quantity supplied. This means that if 2c is true, both sides of 2b will be true as well. But the short side rule is an empirical fact about markets: that exchange is voluntary. I can at least imagine cases where 2c is true, but both buyers and sellers are forced to trade either more or less than they want, so 2b is false.
By common stereotype, accountants are careful people; economists are usually sloppy people. We often get really sloppy in speaking to distinguish between 1 and 2, and between 2a or 2b, and 2c. That might be the problem. Or it might be that accountants just don't understand the difference between demand and buy, and supply and sell.
Let's take a specific example of 1. In national income accounting, we define "stuff" to be a flow of newly-produced goods. And we divide the stuff up according to who does the buying: households, firms, government, or foreigners (though we aren't altogether consistent here, because we often fudge investment, and imports are a weird category – more a subtraction from C, I, and G).
3. C+I+G+X-M = Y
(Newly-produced) goods bought = (newly-produced) goods sold.
We don't have to divide the stuff up in this way; we could divide it between goods and services; or stuff made on Mondays, Tuesdays, etc. We divide it this way if we think (or some economists think) it's useful to divide it up this way, because, for example, households, firms, and foreigners are influenced by very different things in deciding how much they want to buy. And it's economists, not accountants, who must ultimately decide what categories are useful to us. But already I'm starting to talk about stuff demanded, and economics, not stuff bought, and accounting.
The important point is this: economists can and should decide on their own ways to define the "stuff" that is bought and sold, and how to divide it into sub-categories of "stuff". We decide on a conceptual scheme that is useful to us, not to accountants. And it is useful to us if it matches our behavioural theories of how the world works. We don't have to follow the accountants' conceptual scheme, and shouldn't follow the accountants, if we have a different scheme that is more useful to us. Ultimately, we economists have to be our own accountants.
The second fundamental accounting identity is this:
4. The value of the stuff I buy = the value of the stuff I sell.
We have to be really careful with this one.
Think about a barter exchange: I swap my 10 apples for someone's 5 bananas. The price of a bananas is 2 apples. So I sell 10 apples and buy 10 apples' worth of bananas in exchange. Those "values" are the prices at which the transactions are made, even if the bananas turn out to be rotten. Unlike the first fundamental accounting identity, which can be expressed in physical units if you want, this one can't; it must be expressed in values. (Maybe this is why accountants have so much difficulty dealing with inflation? Dunno. Maybe not.)
What about monetary exchange? If I sell 10 apples at $1 each I "buy" $10 in the medium of exchange – money. That's what causes misunderstandings, because we don't normally talk about "buying" or "selling" money. But we have to in this case.
Now let's consider the economist's version of 4:
5. The value of the stuff I demand = the value of the stuff I supply.
In other words, when I go into any particular transaction, at any price, deciding how much I want to transact at that price, I get the maths right. I don't demand $20 and supply 10 apples at a price of $1 per apple. That makes sense. The only thing that could make it false would be if people made math mistakes. It's close to an identity, but isn't quite, because empirically people do make math mistakes.
Now, what happens when I aggregate up over all transactions I make? You get: the sum of the values of my excess demands must equal zero. Aggregate over all people (and firms and governments): you get Walras' Law. The sum of the values of excess demands must equal zero. [Update for clarity: an equivalent statement of Walras' Law is: the sum of the values of goods demanded must equal the sum of the values of the goods supplied. Excess demand=demand minus supply.] If you forget to include money as one of the goods, you get (one version of) Say's Law (and it's not a version necessarily believed by Say himself, but let that pass).
Now, many (most?) economists believe in Walras' Law (or think they do). But I don't. I think it's fine to aggregate over all transactions in the accountant's version 4 (the sum of the value of excess purchases is identically equal to zero). But I don't think it's fine to aggregate over all transactions in the economists' version 5, even if everyone has perfect math, and is perfectly rational.
If we make all our purchases and sales at the same time in one big market for all goods, then Walras' Law would be right (unless somebody got the math wrong). But in a monetary exchange economy, with n-1 [typo fixed] goods plus money, there are n-1 markets. In each of those n-1 markets we make a separate decision to transact in that market, subject to any constraints we expect we might face on how much we are actually able to buy and sell in each of the other n-2 markets, if any of those markets are in disequilibrium. Clower/Leijonhuvfud/Bennassy etc..
That means n-1 separate maximisation problems, in principle. Each one of those maximisation problems will satisfy Walras' Law, but the only way we can add them all up consistently is if we recognise that there are n-1 separate excess demands for money, coming from each of those separate decisions.
So the only generally correct aggregate economist's version of the second fundamental principle of accounting is this:
6. The sum of the values of the n-1 excess demands for non-money goods, plus the sum of the n-1 excess demands for money, is identically equal to zero, provided the people doing the demanding and supplying can do math.
I have no idea what the accountants will make of 6.
Worthwhile Canadian Initiative 
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.
Take the US deficit as an example. A really bad economist would do a back of the envelope grope about the deficit problem and conclude that it’s a problem simply by posing the question “where are they going to get the money?” and then becoming frantic about not being able to provide a reasoned answer. A good economist would have MMT as part of his toolkit, and realize that there is an answer, and that the starting point for the answer is the understanding that the money at least will at least be present in bank reserve accounts. And he will understand that net pressure on the foreign sector as a “required buyer” of US bonds must bear some logical relationship to the evolution of the US current account deficit and its consequences for net pressure on the foreign sector as a “required supplier” of dollars. The rest of the answer might involve accounting consistent scenarios about possible sector break downs for US government bond acquisitions. 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. In any event, these are all accounting issues that are helpful in projecting various plausible scenarios for risk and therefore various realistic economic prognostications for the future.
“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.
Do you have a link?
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.