Brad DeLong calls it my "self-imposed Sisyphean task". He's probably right. But it seems worth a try, as long as there's a small chance he's wrong. I have a Cunning Plan.
Like it or not (and there is much to like as well as dislike), New Keynesian macro has become the main accepted approach for teaching, research, and policy. It would be hard to persuade economists to ditch it. Rather than ditch it, I want to reinterpret the New Keynesian model as a model of a monetary exchange economy (and argue that it only makes sense as a model of a monetary exchange economy). Then I want to make small changes to the model so that the stock of money enters essentially (and argue that it only makes sense if the stock of money enters essentially). My Cunning Plan is a bait-and-switch.
Simplify massively, to clear the decks of anything that is not required for me to make my points. Large number of identical infinitely-lived self-employed agents who produce and consume haircuts (the only good). So wages and prices are the same thing, and output, consumption, and employment are the same thing. All agents set the same price (which may be sticky or flexible). The central banks sets a rate of interest (somehow, and this is a question that must and will be answered). To make it even simpler, we can assume the central bank indexes the nominal interest rate to the inflation rate, so it sets a real rate of interest. No shocks, nothing fundamental ever changes, and full employment equilibrium is 100 per period.
Suppose the central bank sets the rate of interest too high. Will this cause unemployment?
No. Any unemployed agent would simply cut his own hair.
Suppose we change the model so agents can't cut their own hair, to motivate trade. Can we get unemployment now?
No. Two unemployed agents would simply do a barter deal to cut each other's hair.
We need to change the model so that monetary exchange is essential — they can't trade without using money as a medium of exchange. So let's do that.
You can't cut the hair of anyone who cuts your hair. So we get a Wicksellian triangle. And agents can only meet pairwise, and have bad memories for names and faces and can only remember the central bank. Or whatever. So they have to use central bank money to buy haircuts. Every agent has a chequing account at the central bank. The central bank pays a rate of interest r on positive balances, and charges the same rate of interest r on negative balances. And the sum of the positive balances equals the sum of the negative balances, so the central bank has no other assets or liabilities and zero net worth and zero income.
Now we can get unemployment if the central bank sets the real interest rate too high. Each individual wants to accumulate a positive balance in his chequing account by spending less money than he earns, which is impossible in aggregate.
Reinterpreting the New Keynesian model as a model of a monetary exchange economy, where every agent has an interest-earning chequing account at the central bank, kills two birds with one stone (it explains how the central bank can set the rate of interest, and explains how this can cause deficient-demand unemployment). Yet it leaves the equations of the model unchanged. No sensible New Keynesian macroeconomist should object to this reinterpretation. It's a friendly amendment — and not even really an amendment.
That was the easy part — the bait part of my Cunning Plan to bait and switch. And I'm just recapitulating my old post on solving the riddle of the New Keynesian Cheshire Cat.
Now for the harder part — modifying the model to make the stock of money essential. That's the switch part.
There are two definitions of the stock of money that would be useful in a model like this:
- The Net money stock = the sum of positive balances minus negative balances.
- The Gross money stock = the (absolute) sum of positive balances plus negative balances.
In the model I have sketched above, Net money is zero by assumption. The central bank could make Net money positive by buying some asset, or negative by selling some asset (open market purchases or sales).
In the model I have sketched above, Gross money will be zero, because all agents are identical. Holding Net money constant, aggregate receipts of money must equal aggregate payments of money by accounting identity, but if agents are identical this also is true for each individual agent. Each agent's receipts and payments of money are perfectly synchronised, so his inventory of money will always be zero.
If we add individual-specific shocks to agents' receipts and/or expenditures of money, we can change the New Keynesian model so that agents' receipts and payments of money are not automatically perfectly synchronised, which means the Gross money stock is now strictly positive.
Assume that the central bank sets a spread between the interest rate it charges on negative balances and the interest rate it pays on positive balances. Assume it is costly for agents to synchronise their payments and receipts of money (for example by agents with a positive balance lending to agents with a negative balance). We now have a demand for gross money as a negative function of the spread set by the central bank.
We now have something that looks a bit more like a traditional macro model, because it does have a money demand function.
Hold that thought. Because I now want to take a detour, and talk about the New Keynesian IS equation.
There is a very big problem with the New Keynesian Macro model. It simply assumes, with zero justification for this additional (hidden) assumption, that agents in the model expect an automatic tendency towards full employment. As I explained in my old post, Old Keynesians would be screaming blue murder if they understood that New Keynesians were making this illicit assumption. Because it is precisely this question that Keynes wrote the General Theory to address.
To repeat the point I made in that old post, if the central bank always sets the real rate of interest equal to the natural rate of interest, that is a necessary but not a sufficient condition for output being at the natural ("full employment") level. There is a continuum of equilibria, with anything from 0% to 100% unemployment being an equilibrium. This result follows immediately from the Consumption-Euler equation. In the simple case of log preferences, where n is the rate of time preference proper, it is: C(t)/C(t+1) = (1+n)/(1+r(t)). The real interest rate only pins down the expected growth rate of consumption, not the level of consumption. And New Keynesians evade this problem by simply assuming that in the limit, as t approaches infinity, C(t) approaches the full employment level.
That's a problem with the New Keynesian model. A very big problem. How can we fix it?
This big problem with the New Keynesian model is the result of the New Keynesian Long Run IS curve being horizontal. It is horizontal at the natural rate of interest. So if the central bank sets the real rate of interest equal to that natural rate, the long run equilibrium level of output is indeterminate. As any second-year economics student knows, if you have a horizontal IS curve, you need an upward-sloping LM curve to determine the level of output.
Back to that thought you were holding, about how we can modify the New Keynesian macro model so there is a well-defined demand function for the gross stock of money. What else do we need to get something like a standard upward-sloping LM curve? You guessed it: we need a supply function for the gross stock of money. And if we want the LM curve to slope up, so that the level of output is determinate, that supply function cannot be perfectly elastic at any given rate of interest.
It is not sufficient for a central bank to set a rate of interest (or one rate of interest plus a spread) and let the stock of money be determined by demand at that rate of interest. Long run output (not to mention the price level) is indeterminate if it does that, even if it sets the correct rate of interest. It needs to control the nominal quantity of money too. The central bank needs to set some nominal anchor, not just to make the price level determinate, but to make the level of output determinate.
The only mechanism that can provide an automatic tendency towards full employment (if, and that's a big "if", the central bank does the right thing) is the hot potato mechanism. If we reinterpret and reform the New Keynesian model the way it needs to be reinterpreted and reformed, we end up with Keynso-monetarism.
I ought to talk about "haircuts" in the financial market sense, and how collateral constraints mean the central bank puts limits on individual agents' negative balances, and how this creates a link between the Gross and Net stocks of money, and how Open Market purchases increase both Net and Gross money. But this post is already too long, so I will stop there.
Update: In a comment on my previous Cheshire Cat post, Brad DeLong asks: "If it isn't an RBC model minimally-tweaked to deliver Old Keynesian conclusions, why is it what it is at all? What other telos could it possibly have?"
On Thursday I heard Michael Woodford give a talk at a Bank of Canada conference. He started his talk by saying he visited the Bank of Canada in the late 1990's, spent time talking with Chuck Freedman and Kevin Clinton about how the Bank of Canada conducted monetary policy, which had been very influential in his subsequent work. I understood him to be talking about his "Interest and Prices". Indeed, the only important difference is that it is commercial banks, and not regular people, who have chequing accounts at the Bank of Canada. Otherwise, the model fits pretty exactly. I think that is the telos. Blame Canada.
Worthwhile Canadian Initiative 
JKH, what happens from a balance sheet perspective when someone deposits currency at a commercial bank? Thanks!
TMF, and others:
In order to understand what I mean when I say that no asset changes hands, or accounts, when we make entries on two checking accounts, please have a look at my comment to Roger Sparks here. (It’s so long that I don’t want to paste it here.)
Put in the language I use in the comment, Nick is seeing rabbits in boxes (or should it be ‘hats’?), because he doesn’t want to accept that there are only ducks in existence. Currency is the original “rabbit illusion”, the reason why we see rabbits where there are none. (Did I mention that I’m not 100% sure if I’ve gone slightly mad? But please read the comment before you judge.)
I find Nick’s posts on green and red money fascinating. I don’t see how economics can progress without an agreement on the underlying logic of money. Specifically, I don’t see how any model of the macro-economy can be critiqued without an understanding on how it diverges from the “real” logic of money.
After one of Nick’s previous posts on this subject, I set myself the task of defining a basic set of “big rules” for the logic of money which build on Nick’s ideas and could be understood by any interest party, but which would also satisfy at least my own concerns with the details (but not the main principles) of Nick’s logic, and my frustrations that these debates never lead to an agreed conclusion.
I documented my version in a pack of Google slides. After reading most of this current thread, when many of the same detailed concerns and frustrations have been raised but again not agreed, I have adapted my slides to create a tailored version relevant to some of the points in this thread. I have published these slides at the link below. You should be able to navigate through the slides using a mouse or using the arrow keys on any keyboard. You can see the specific impact of the individual steps in my simple examples by using the arrow keys to move back and forward between the slides for neighbouring steps.
I would be interested in Nick’s comments on my version of his ideas. However, I would make a couple of points of my own first.
On content. It seems to me that money and loans are two closely related, but not identical, concepts. My version considers BOTH concepts in green and red terms. For example, when Nick’s dad has an overdraft, the overdraft is a relationship between Nick’s dad and the bank. It is NOT a relationship between Nick’s dad and whoever currently has the green money which Nick’s dad spent after taking out his overdraft. This is important. For example, it explains why Nick’s dad cannot just walk away from what Nick calls his “red money”.
Also, my version is consistent with the quote from the Fed, mentioned earlier: “Overdrafts in demand deposit or other transaction accounts are not to be treated as negative demand deposits or negative transaction accounts and shall not be netted since overdrafts are properly reflected on an institution’s books as assets”.
On method. Irrespective of opinions on the content of my version, one of the problems in these debates is that there is no agreed format for articulating the logic of money. My version explicitly sets out my assumptions and my big rules for the underlying logic. It also shows the position of each actor in my toy economy at each step in a set of simple example transactions, and it shows these positions in an easy to understand diagrammatic style. It also shows explicitly that, at all stages, the gross amount of money and loans in the economy is zero.
I don’t see how these debates can ever reach an agreed conclusion without this level of explicit documentation and easy to follow format. I don’t mean that my format is the only possible format. Rather, I mean that the absence of an agreed format between economists is one of the reasons for the many misunderstandings on display every time these subjects are debated.
Anyway, here is the link to my slides. Let me know if there are any access problems.
https://docs.google.com/presentation/d/1F1PtEv-PARUzzAxS4Bk3HY5l3jMwW8M4i-c9kDRSNV0/pub?slide=id.p
Sounds good, Jamie! Your attempt at clarification is more than welcome.
I’ll go through your slides tomorrow and will comment when I find the time! (If you have time, check out the comment thread on my own blog post — link above. That might help you understand where I come from, and where I come from will probably affect how I interpret your slides.)
Jamie: When you say that gross money is zero, do you really mean NET money?
Jamie, I like the idea that you stated assumptions.
I am going to partially disagree with A6:
Currency can’t be directly defaulted on. Electronic “money” (which I consider bonds) can be directly defaulted on.
I don’t get P4, which means P2 and P3.
Why not just when a borrower takes out a loan with the commercial bank, it is just “green money” and “green loans denominated in green money”?
Jamie: Only once through but I seem to agree with you all the way except maybe at the conclusions.
I say “maybe” because you have government concluding with assets on account. To me, that takes the slide sequence back to just after government had created a green loan and sold it to commercial bank. Government had not yet paid all it’s newly acquired green money to Nick, Nick’s dad, and the produce store and therefore, still had green money in hand.
It took a lot of work to create your slide series. Thanks for sharing it.
Now, if someone has an easier-to-understand model, I guess it would be up to them (or a creative friend) to build a presentation of assumptions, rules, and accounting records. Not an easy challenge!
Nick, any way to extend this post so the comments don’t close?
Jamie: I’ve gone through your slide set. I like the explicit format! What bothers me is that it seems your “red money” is not Nick’s “red money”, so that we have again new terminology to learn. But perhaps I interpret you wrong. Let’s see.
I’ll start with questions regarding slide 8 (commercial bank creates money and loans):
Is this an imaginary step (like Nick’s creation of red and green bits of paper), without any entries made in real-life ledger? As far as I know, the real-life entries, one credit and one debit, are made only on accounts where the holder of the account is Nick’s dad (his checking account and his loan account).
Correct me if I’m wrong, but it looks like your red and green money, as well as your red and green loans, are actually one money (a credit balance on Nick’s dad’s checking account in the bank ledger), and one loan (a debit balance on Nick’s dad’s loan account in the bank ledger), seen from two different perspectives — the bank’s perspective and the non-bank’s perspective? This makes your “red money” the same as Nick’s “green money”. With the color code you only want to emphasize that it is considered — due to an accounting convention only — the bank’s liability (red) and the account holder’s, Nick’s dad’s, asset (green). The same goes for the loan: an asset (green), accounting-wise, to the bank and a liability (red) to Nick’s dad.
Antti: I had roughly the same thoughts.
Thanks for the comments. I have split my replies into multiple comments. Sorry for the length of the replies.
Antii: When you say that gross money is zero, do you really mean NET money?
I mean that green and red money together always total to zero. I might change the word Gross to Total in any future version of my slides as that would be less ambiguous.
Roger: I seem to agree with you all the way except maybe at the conclusions
If you are referring to slide 24, I intended that as a general conclusion rather than as a re-statement of the position at the end of my examples. For example, only the central bank CAN and DOES hold red money issued by itself. All other parties CAN and DO hold green money issued by the central bank, but that does not preclude them from having no green money at certain points – such as the government in my examples after it distributed the green money it raised by selling the bonds. On the other hand, the central bank and the government DO NOT hold green money issued by commercial banks at all. Maybe my slide is ambiguous about what I intended.
Roger: It took a lot of work to create your slide series
Not really. It doesn’t take long when you know how to use the presentation tool and it’s free to use for anyone with a Google email address. I used to be a management consultant. In that world, the extra time producing easy-to-follow slides is more than offset by the reduced time in explanation and argument with clients.
TMF: I like the idea that you stated assumptions
Another idea from consulting. Most people are quite smart and can articulate the logic of their own position. Disagreements often arise from underlying assumptions rather than from the logic of a position. However, people defend their positions using their logic and leave the assumptions unstated so disputes are never resolved. Making my assumptions explicit forces others to declare their assumptions. It also helps control the scope of the discussion.
TMF: Currency can’t be directly defaulted on. Electronic “money” (which I consider bonds) can be directly defaulted on
I hadn’t thought of defaults but they are not central to the argument so I would add another assumption that exceptions such as defaults are out of scope. The main argument here is about whether green and red loans are required in a model such as this in addition to Nick’s green and red money.
Another point here is terminology. I have tried to define terms explicitly. My argument is based on that terminology. When you say that you think of electronic money as bonds, we have a terminology dispute. We can’t proceed with a discussion of logic until we agree a common set of terms. That doesn’t mean that you are wrong. You can use whatever terminology you like. However, you can’t criticise my argument based on your terminology. Think of my terminology as further assumptions if that helps.
TMF: I don’t get P4, which means P2 and P3
I can’t remember why I included P4. Maybe just for emphasis. You are correct that it doesn’t really add any substance.
TMF: Why not just when a borrower takes out a loan with the commercial bank, it is just “green money” and “green loans denominated in green money”?
Accounting is mostly about the principle of conservation. We are all taught at school in physics and chemistry classes that certain things are conserved under change in the physical world.
The same principles apply in the real world. If a car factory takes in parts for five cars, it can manufacture only five cars. If six cars emerge, the factory would have broken the laws of physics. If only four cars emerge, we know that the parts for one car are still inside or that they have gone missing. It is the laws of conservation that provide that discipline.
Money and loans are artificial human constructs. However, they have been designed such that they are conserved. That is really the main point that I understand Nick is making by talking about green and red money – they are equals and opposites, so money is conserved. I am just extending that to loans as well.
Also, we need to look at money and loans from the point of view of BOTH parties. In my example of a loan, that is the commercial bank and Nick’s dad. Nick’s dad sees the green money as an asset he can use to buy other things (a positive thing). He sees the red loan as a debt he must repay (a negative thing). The bank sees the opposite view.
In these discussions, you often see people who work in finance say that “money is a liability”. That is because they look at money only from the bank’s perspective. Accounting, at a macro level at least, requires us to look at money from BOTH perspectives at the same time. That is why there is always a combination of green and red at a macro level, even though each party sees only one or the other colour at a micro level.
Antii: It seems your “red money” is not Nick’s “red money”, so that we have again new terminology to learn
I am just putting forward a position developed after reading earlier posts by Nick on this subject. The key difference I see is that Nick says that his dad has red money when he runs an overdraft. I say that he has a red loan, so the difference in terminology is central to the debate.
As I said previously, I don’t see how you can discuss macro-economic models without discussing money. Yet Nick is the only mainstream macro-economist I know who engages in debates about the logic of money. My understanding of one of Nick’s complaints about New Keynesian models is that they don’t consider money properly. I’d guess that is why there is no agreed terminology and why these discussions are always painful.
Antii: Is this an imaginary step (like Nick’s creation of red and green bits of paper), without any entries made in real-life ledger?
No and neither is Nick’s step imaginary. Think of the accounting tables in my slides as the macro-economic ledgers. See my answer to TMF for more. If we are dealing with the macro-economy, we must view the economy from all perspectives at the same time.
Forget about creating money for a moment. Imagine the simplest possible economy where only one economic transaction takes place anywhere in the entire economy during an accounting period.
Imagine that the transaction is that my business sells you a bicycle for €100. Let’s look at this from both our perspectives.
Jamie’s perspective: I lose a bicycle and gain €100.
Antii’s perspective: You gain a bicycle and lose €100.
Macro-economic perspective: No gain or loss of either bicycles or money as the changes in Jamie’s position and Antii’s position cancel out. The macro-economy doesn’t care who has the bicycle and who has the money.
Note that there are FOUR position changes in the macro-economy that we must account for even in this simplest possible economy with only one transaction (two changes in bicycle inventories, two changes in money inventories).
In monetary terms, using Keynes’ terminology, I have saving of €100 and you have dissaving of €100 so there is no overall saving at the macro level.
Antii: It looks like …. seen from two different perspectives.
Exactly. That’s the difference between macro and micro. That’s why “thinking like a household” doesn’t work in macro. Thinking like a household means thinking from only one perspective.
Jamie:
I would like to add another perspective to this excellent quote of yours:
“Forget about creating money for a moment. Imagine the simplest possible economy where only one economic transaction takes place anywhere in the entire economy during an accounting period.
Imagine that the transaction is that my business sells you a bicycle for €100. Let’s look at this from both our perspectives.
Jamie’s perspective: I lose a bicycle and gain €100.
Antii’s perspective: You gain a bicycle and lose €100.
Macro-economic perspective: No gain or loss of either bicycles or money as the changes in Jamie’s position and Antii’s position cancel out. The macro-economy doesn’t care who has the bicycle and who has the money.
Note that there are FOUR position changes in the macro-economy that we must account for even in this simplest possible economy with only one transaction (two changes in bicycle inventories, two changes in money inventories).”
An additional perspective: When the bike is sold, we have TWO barter transactions. The bike is bartered for 100 units of money AND 100 units of money is bartered for the bike. Money is a simple link used in the transaction; the value established arbitrarily to be 100 units. There was no time delay in your example, but if there was a time delay, money would have been the barter counter-product in a more obvious fashion (fitting with Antti’s gifting model)
I think this is a macro-economic perspective which may-or-may-not include a time perspective.
Does this make sense?
Jamie: “If we are dealing with the macro-economy, we must view the economy from all perspectives at the same time.”
I fully agree, but I wouldn’t try to achieve this by splitting one object into two separate objects, just because I want to highlight that the same object can be viewed from two opposing perspectives. It looks to me that this is what you do, and instead of double-entry bookkeeping you end up with quadruple-entry bookkeeping. In your macro-economic ledger you combine two different ledgers: the bank ledger (which is often a real, physical ledger) and non-bank’s ledger (which, like in the case of Nick’s dad, is not a real, physical ledger; unless Nick’s dad keeps other than just mental records). Perhaps it’s partly because I’m an accountant, but I don’t see any need to do this. It’s clear to me that a credit balance on a checking account in a bank ledger is my asset, but that the same credit balance is conventionally considered the bank’s liability.
This all reminds me of what one of my favorite thinkers, Jacob Bronowski, talks about in his magnificient little book “Science and Human Values”. Starting on page 39, he tells the story of how some experienced native climbers in the Himalayas were not able to fit together different faces of a mountain; they didn’t think of it, or even see it, as one mountain.
If I talk about Mount Everest, I talk about the mountain — not one specific face of it (say, the north face). The same is true when I talk about a credit balance on a checking account in a bank ledger (“money”). I’m viewing the object from both perspectives at the same time (as you say, this is macro). By talking about “green money” and “red money” as if those were two separate objects, you bring in two micro-perspectives without, at least explicitly, combining them into one.
I don’t see what you would lose if you only talked about money and loans (I’d prefer ‘debt’ instead of ‘loans’)? At least part of our disagreement might be due to the fact that for me the bank ledger (or all banks’ ledgers combined) is in itself a “macro-economic ledger”. In it, all the agents of the economy — or these agents’ debts and credits, to use the language of Alfred Mitchell-Innes — come together.
Nick had his reason to talk about red and green money (those are two separate objects; not perspectives). I don’t yet see your reason.
Jamie: “If we are dealing with the macro-economy, we must view the economy from all perspectives at the same time.”
I fully agree, but I wouldn’t try to achieve this by splitting one object into two separate objects, just because I want to highlight that the same object can be viewed from two opposing perspectives. It looks to me that this is what you do, and instead of double-entry bookkeeping you end up with quadruple-entry bookkeeping. In your macro-economic ledger you combine two different ledgers: the bank ledger (which is often a real, physical ledger) and non-bank’s ledger (which, like in the case of Nick’s dad, is not a real, physical ledger; unless Nick’s dad keeps other than just mental records). Perhaps it’s partly because I’m an accountant, but I don’t see any need to do this. It’s clear to me that a credit balance on a checking account in a bank ledger is my asset, but that the same credit balance is conventionally considered the bank’s liability.
This all reminds me of what one of my favorite thinkers, Jacob Bronowski, talks about in his magnificient little book “Science and Human Values”. Starting on page 39, he tells the story of how some experienced native climbers in the Himalayas were not able to fit together different faces of a mountain; they didn’t think of it, or even see it, as one mountain.
If I talk about Mount Everest, I talk about the mountain — not one specific face of it (say, the north face). The same is true when I talk about a credit balance on a checking account in a bank ledger (“money”). I’m viewing the object from both perspectives at the same time (as you say, this is macro). By talking about “green money” and “red money” as if those were two separate objects, you bring in two micro-perspectives without, at least explicitly, combining them into one.
I don’t see what you would lose if you only talked about money and loans (I’d prefer ‘debt’ instead of ‘loans’)? At least part of our disagreement might be due to the fact that for me the bank ledger (or all banks’ ledgers combined) is in itself a “macro-economic ledger”. In it, all the agents of the economy — or these agents’ debts and credits, to use the language of Alfred Mitchell-Innes — come together.
Nick had his reason to talk about red and green money (those are two separate objects; not perspectives). I don’t yet see your reason.
Antti: instead of double-entry bookkeeping you end up with quadruple-entry bookkeeping
Yes, that’s the point I am making! See my example of the simplest possible economy which you seem to have ignored. It has one transaction and four accounting entries.
Quadruple entry bookkeeping is used in the national accounts. See paragraph 1.63 on page 10 at this link with quoted extract below:
Click to access SNA2008.pdf
“As two matching entries are also needed for the buyer, the transaction must give rise to four simultaneous entries of equal value in a system of macroeconomic accounts covering both the seller and the buyer. In general, a transaction between two different institutional units always requires four equal, simultaneous entries in the accounts of the SNA (that is, quadruple entry accounting) even if the transaction is a transfer and not an exchange and even if no money changes hands”.
You understand the difference in our views but my view (backed up by the SNA document) remains that quadruple entry is required in the national accounts i.e. at a macro level.
Antti: I don’t see what you would lose if you only talked about money and loans (I’d prefer ‘debt’ instead of ‘loans’)?
You would lose the bank’s perspective. The fact that you want to replace ‘loan’ with ‘debt’ means that you don’t think that the bank would also record the loan as an asset from its own perspective. That is wrong. The borrower has green money and red loan. The bank has the opposite. The bank records all four.
Roger Sparks: There was no time delay in your example
I agree with that, and that time can be significant in accounting, but I don’t understand your point, I’m afraid.
If I were talking about time in my bicycle example, I would point out that there could be a time difference between me providing Antti with the bicycle and him paying me the money. For example, we might agree that he can pay me any time in the next month, or that he can pay me in instalments. However, that takes us from cash accounting to accruals accounting which only adds another layer of complexity.
I don’t think that is the point you are making, though, as it’s not about barter. I would be happy to discuss further but I don’t understand why you think that we should introduce barter into the discussion. (Maybe it was discussed earlier and I have missed it. I have not read every reply in this thread in detail).
Roger Sparks: … fitting with Antti’s gifting model …
I don’t know what this is. I searched the thread for ‘gifting’ but your mention of it was the only hit I could find. All I can say is that there are no gifts in my examples.
Jamie: “The bank records all four.”
Does it? On which accounts exactly? Are all four in the General Ledger (GL)? I can only think of the checking account (account-holder: Nick’s dad) and the loan account (account-holder: Nick’s dad). What are the other two? As far as I know, they cannot be in the GL, because that would lead to double-counting.
Regarding SNA: Notice that in the document they talk about a buyer and a seller of goods. In your example, the bank is neither buying nor selling goods (incl. services; banks do sell and buy goods, but not in your example). Banks don’t produce or sell money — they perform accounting services, and “money” is just a part of that accounting.
You said: “You would lose the bank’s perspective.”
Because I see the bank ledger as a macro-economic ledger in itself, I kind of want to lose the bank’s perspective. (This doesn’t mean I’m blind to it.) My thinking is not that far away from Nick’s thinking. In Nick’s world, the whole point is that “red money” (I agree with you: this is the same as “loan”) is not the bank’s asset and “green money” is not the bank’s liability. In other words, in Nick’s world we can forget the bank’s perspective as you describe it.
You said (earlier): “Note that there are FOUR position changes in the macro-economy that we must account for even in this simplest possible economy with only one transaction (two changes in bicycle inventories, two changes in money inventories).”
Correct. And the bank is involved only on the money side: it debits my account and credits you account (two entries, not four). This is what I mean with the bank ledger being a macro-economic ledger. The bank doesn’t record its own trade; it records our trade.
Jamie: You did not understand my sentence “The bike is bartered for 100 units of money AND 100 units of money is bartered for the bike.” You seemed to think it was not about “barter”.
I am not surprised. After I wrote and posted, I wondered what I had written. Could I defend it? Please let me try.
First, I differ from Antti. I think money is much more than an accounting entry. I think it is real property that represents the results of labor performed sometime in the past.
To me, money is a tool that can be used universally to represent value. Because money in the most basic analysis represents labor-past-performed, and because labor is required in some fashion to prepare every property prior to exchange, money becomes a bridge that can link two very disparate decision makers, with vastly different motives and goals, as they decide whether to make an exchange or not. These same two decision makers likely received the money they are trading in very different ways.
Let’s use an example of a worker in a car manufacturing plant who wants to buy a piece of hand-made pottery direct from the pottery maker. What is their common link? Certainly not the car that the manufacturing worker spent his time building. The pottery? One wants it and one (the seller) does not want pottery. How about the desire or need for money? One has a steady job with benefits, the other sales of a handmade item when a customer can be found. Very probably there is a wide difference in perceptions of the value of money.
Yet they can come to agreement (or not) on the value of a piece of pottery and the exchange can be made. To me, that is clearly barter. Money as a form of property, a very dividable form of property, has been used as an intermediate store of value, forming a meeting point that unifies two vastly different perspectives of value.
Please notice that this example (upon completion) would represent an increase in the GDP calculation. Both the money value and the pottery are counted. The money is counted as the value of the exchange while the pottery is counted as a value of one(1).
Is my comment making sense now?
My Sisyphean task continues: A New Monetary System From Scratch, Part 3: Give and Take.
If Nick is Sisyphus, I’m probably on the other side of the boulder and my task is to keep it at full rest at the foot of the hill.
Nick, a question orthogonal to the green/red money paradigm, but rather just about one of your conclusions:
If the Fed pays interest on excess reserves equal to the target rate, then doesn’t your conclusion imply long-run output is indeterminate / not trending to full employment and that the CB has no real control over the price level?
The hot potato is the wedge between the price of risk-free short-duration bonds and reserves. If I’m earning interest on my excess reserves they aren’t hot at all – I have no reason to want to trade them for those bonds.
In this scenario, the Fed’s only way to change the size of the combined stock of (excess reserves + short-term bonds) is through something like Operation Twist, buying longer-term bonds. (This is assuming the Fed sticks to only buying government debt.) That… seems like a really weak source of a hot potato effect?
In general, I find the idea that monetary policy’s effectiveness is conditional on that wedge concerning.
Jamie: “The bank records all four (accounting entries).”
Antti: Does it? On which accounts exactly?
Loans are assets for a bank. Assets are usually recorded in asset registers. I can’t say if banks have a specific name of their register of loans but I am pretty confident that this is correct.
My view is based on listening to the views of people who work in banking and finance via their blog posts and comments, and on a number of independent articles. For example, JKH who posts on here and elsewhere knows what he is taking about. Nick and others can confirm that if you don’t believe me. I have merely documented what the experts say in an easy to digest format.
You can also confirm that this view is correct by a quick search on Google. For example, it took me about 10 seconds to find this:
“A bank makes a loan to a borrowing customer. This simultaneously, creates a credit and a liability for both the bank and the borrower. The borrower is credited with a deposit in his account and incurs a liability for the amount of the loan. The bank now has an asset equal to the amount of the loan and a liability equal to the deposit. All four of these accounting entries represent an increase in their respective categories: the bank’s assets and liabilities have grown, and so has the borrower’s”.
Roger Sparks: To me, that is clearly barter. Money as a form of property, a very dividable form of property, has been used as an intermediate store of value, forming a meeting point that unifies two vastly different perspectives of value.
I agree that money is an intermediate store of value. Nick and others often say that “money is unit of account, medium of exchange and store of value” and this seems like a good concise summary to me. Based on that quote, the store of value aspect of money represents timing imbalances between different exchange events.
However, I don’t understand why you want to introduce the term “barter” into a discussion on money. I don’t see that as adding anything to the quote in the previous paragraph. The first sentence of the Wikipedia entry on barter is:
“Barter is a system of exchange where goods or services are directly exchanged for other goods or services without using a medium of exchange, such as money”
In mature subjects, such as the natural sciences, there is an agreed vocabulary to which everyone conforms. Unfortunately, many economists seem to ignore money so, when it is discussed, there is no such agreed vocabulary. Einstein said “everything should be made as simple as possible, but no simpler”. The lack of agreed vocabulary on money over-complicates any discussion on the subject, so I prefer to minimise the use of terms that are contrary to their common definitions, wherever possible.
I like Nick’s use of “green money” and “red money” as they are neutral terms which allow discussion of the underlying logic of money without requiring us to agree on the many ambiguities in existing terminology. I tried to keep to that principle – my version just adds in the term “loan” which is well understood and which I think is essential to the logic.
“I hadn’t thought of defaults but they are not central to the argument so I would add another assumption that exceptions such as defaults are out of scope.”
Eventually, defaults need to be in a model, as in 2007 and 2008.
“When you say that you think of electronic money as bonds, we have a terminology dispute. We can’t proceed with a discussion of logic until we agree a common set of terms. That doesn’t mean that you are wrong.”
You have commercial banks in your model. I would say demand deposits are a certain type of bond that is used as “electronic money”.
Your model has a commercial bank, a central bank, and a gov’t. You should have currency, central bank reserves, demand deposits, and bonds in it along with goods/services. Stocks can be skipped for now.
“Money and loans are artificial human constructs. However, they have been designed such that they are conserved. That is really the main point that I understand Nick is making by talking about green and red money – they are equals and opposites, so money is conserved. I am just extending that to loans as well.”
I would say green money does not have to conserved. The system is set up that way. I would also say it is about how the green money is “backed”. Maybe a better description is if green money is put into an economy, how can green money be taken back out.
“Also, we need to look at money and loans from the point of view of BOTH parties. In my example of a loan, that is the commercial bank and Nick’s dad. Nick’s dad sees the green money as an asset he can use to buy other things (a positive thing). He sees the red loan as a debt he must repay (a negative thing). The bank sees the opposite view.”
OK, except that I see a red loan as a green bond denominated in green money.
“In these discussions, you often see people who work in finance say that “money is a liability”. That is because they look at money only from the bank’s perspective. Accounting, at a macro level at least, requires us to look at money from BOTH perspectives at the same time.”
OK.
“That is why there is always a combination of green and red at a macro level, even though each party sees only one or the other colour at a micro level.”
I don’t agree with that one. Take green money as an example. It is a liability to central bank (I reserve the right to change that one in the future), and it is an asset to the holder. There may be no red money and/or red view at all. It is asset and liability view(s).
Alex said: “If I’m earning interest on my excess reserves they aren’t hot at all – I have no reason to want to trade them for those bonds.”
Exactly how are you (Alex) earning interest on my excess reserves?
“My view is based on listening to the views of people who work in banking and finance via their blog posts and comments, and on a number of independent articles. For example, JKH who posts on here and elsewhere knows what he is taking about. Nick and others can confirm that if you don’t believe me. I have merely documented what the experts say in an easy to digest format.
You can also confirm that this view is correct by a quick search on Google. For example, it took me about 10 seconds to find this:
“A bank makes a loan to a borrowing customer. This simultaneously, creates a credit and a liability for both the bank and the borrower. The borrower is credited with a deposit in his account and incurs a liability for the amount of the loan. The bank now has an asset equal to the amount of the loan and a liability equal to the deposit. All four of these accounting entries represent an increase in their respective categories: the bank’s assets and liabilities have grown, and so has the borrower’s”.”
Jamie, I seem to remember going over this with JKH. I like to think of it this way.
During the loan process, the borrower creates a bond. It is an asset and a liability to the borrower. The bank creates a demand deposit (a type of bond that is used as “electronic money”). It is an asset and a liability to the bank. This is referred to as “blowing up the balance sheets”.
When the loan is approved and used, there is an asset swap. The borrower gets the demand deposit as an asset. The demand deposit is still a liability to the bank. The bank gets the borrower’s bond as an asset. The bond is still a liability to the borrower. The borrower usually spends the demand deposit.
Jamie, what happens if you remove red money and red loans from your model?
“I like Nick’s use of “green money” and “red money” as they are neutral terms which allow discussion of the underlying logic of money without requiring us to agree on the many ambiguities in existing terminology.”
I am not sure about that. Let me try this way. Nick’s dad gets a $2,000 loan. It is “loans create demand deposits”. No red money. I think Nick would agree with that.
Nick’s dad gets a $1,000 loan and a $1,000 “overdraft”. I would say that is $2,000 of “loans create demand deposits”. No red money. I believe Nick would say $1,000 of “loans create demand deposits”. No red money. I believe Nick would say $1,000 of “overdraft”. There is red money. Now which is it?
As of right now, I can’t make the accounting work for red money.
Jamie, I think this post will end its comments soon. Any other place to continue the discussion?
“Exactly how are you (Alex) earning interest on my excess reserves?”
That may not be clear. I will try:
Exactly how are you (Alex) earning interest on excess reserves?
Jamie: I’m quite confident that you’ve got it wrong. Your CNBC quote is not convincing: everything before it mentions four entries describes a case of two entries in the bank ledger (a credit balance on customer’s checking account is at the same time an asset for the customer and a liability to the bank), and the four entries is most likely about the bank ledger and the customer’s (real or imaginary) ledger seen together.
Would be great if Nick or JKH could confirm.
Antti, if this is the post:
http://www.cnbc.com/id/100497710
Basics of Banking: Loans Create a Lot More Than Deposits
then I am pretty sure JKH will agree with it.
I can’t remember if it was here or at another site, but I remember JKH agreeing with the article at the time.
If I was an agent in your model I would never bother working since there is no particular consequence of running up a big overdraft. All agents live forever so they can always pay back mañana.
Mind you, since all the agents are thinking the same way, probably no one else would do any work either. Voluntary “full employment” of zero, regardless of what the Central Bank does with rates.
That’s going to quickly violate the rule “Net money is zero by assumption,” presuming at least one agent is silly enough to do a day’s work.
Suppose all accounts start at zero, then one haircut is purchased for $100 and one agent has a positive $100 balance (green if you like) while the other has negative $100 balance (presumably red). Central bank pays out 1% on the positive, and then charges 2% on the negative, you get a positive balance of $101 and a negative balance of $102.
Net money is now negative $1.
If you want the central bank to put together a special account for payments you can make that the “figure to balance” at positive $1 but that’s kind of a meaningless accounting trick if this new account never gets involved in any commerce. I guess the central bank could somehow disburse the left over amongst the population as some type of incentive payment, but that’s getting fanciful.
Jamie’s general point on quadruple entry accounting is correct (supported obviously by the SNA quote).
A simple example is the same as included in that discussion – a new bank loan creating a new bank deposit. The result is a loan asset and a deposit liability for the bank, and a deposit asset and a loan liability for the customer.
Quadruple entry accounting is a notion that has been picked up by some post-Keynesian writers who focus on macro level accounting (e.g. the book by Godley and Lavoie). Double entry accounting is required for a given counterparty to a particular transaction. Quadruple entry accounting acknowledges that there are two counterparties to a given transaction. So the quadruple entry idea is essential to a macro perspective on the accounting.
That CNBC post by Carney is pretty messy in the particular details. He works through some weird, idiosyncratic operational scenarios. To my liking, it’s a bit too “bottom up” and unwieldy in the actual examples he uses. But the general thrust behind it is correct.
My main point there would be not to think of the reserve requirement and the capital requirement as “liabilities”. That just messes up the discussion. Think of them as regulatory requirements concerning balance sheet structure. As to how banks ensure that their reserve and capital requirements are met – that is a matter of ongoing balance sheet operations. So they respond to regulatory requirements governing balance sheet structure by making various asset, liability, and equity adjustments through regular operations. There is an infinity of examples as to how they might get this done in full detail.
It’s not rocket science, but it is operations and accounting. Which I suppose can sometimes feel like rocket science.
🙂
If I sell my car to JKH, there are 2 changes in my balance sheet (cars down, cash up) and 2 changes in JKH’s balance sheet (cars up, cash down). 4 changes in total. It’s always going to be quadruple entry (or sextuple if there are 3 people involved in a trade) in general (as opposed to partial) equilibrium analysis.
Too Much Fed: do you mean “how does Alex as private citizen earn IOR”? The answer is I don’t, obviously, but neither do I hold reserves. I have interest-bearing (well… lol) bank deposits, private money.
But if you mean, “how does Bank of America earn IOR”? Well, the Fed is paying it.
JKH, is this correct?
During the loan process, the borrower creates a bond. It is an asset and a liability to the borrower. The bank creates a demand deposit (a type of bond that is used as “electronic money”). It is an asset and a liability to the bank. This is referred to as “blowing up the balance sheets”.
When the loan is approved and used, there is an asset swap. The borrower gets the demand deposit as an asset. The demand deposit is still a liability to the bank. The bank gets the borrower’s bond as an asset. The bond is still a liability to the borrower. The borrower usually spends the demand deposit.
The demand deposit gets a reserve requirement attached to it.
The bond/loan gets a capital requirement attached to it.
Alex at 11:19, that sounds right. You have the demand deposits, and the bank has the (central bank) reserves.
Nick said: “Reinterpreting the New Keynesian model as a model of a monetary exchange economy, where every agent has an interest-earning chequing account at the central bank, kills two birds with one stone (it explains how the central bank can set the rate of interest, and explains how this can cause deficient-demand unemployment).”
I can’t tell what is in the checking account at the central bank.
Is it (central bank) reserves or demand deposits?
JKH: Jamie’s general point on quadruple entry accounting is correct
Thanks. I thought I had represented you correctly. I am sure you are correct about reserves and capital. I was merely using the quote to show that I was not alone in my view of the quadruple entry point.
Nick: If I sell my car to JKH, there are 2 changes in my balance sheet (cars down, cash up) and 2 changes in JKH’s balance sheet (cars up, cash down). 4 changes in total. It’s always going to be quadruple entry
Yes!!!! Now we are getting somewhere, so if we throw away everything else in this entire thread and we can use that statement as a starting point to build on. A few further points in the same spirit.
The four entries form into two pairs. Two always represent the medium of exchange and two always represent the thing that is being exchanged.
In an exchange-only transaction, the four entries always cancel out at a macro level i.e. they obey basic accounting conservation laws. If Nick sells his car to JKH, they swap the car and they swap the money. However, the macroeconomy still has the same number of cars and the same amount of money. This really ought to be called the first law of macroeconomics.
Manufacturing of cars and “manufacturing” of money change the totals (the equivalent destruction events also change the totals). These events also obey conservation rules. Manufacturing a physical product obeys the conservation laws of physics. Manufacturing of money and loans obeys the artificial conservation rules of equal and opposite green/red pairs (or asset/liability pairs). This is analogous to creating matter and anti-matter from nothing in physics.
When Nick’s dad takes out a loan with a commercial bank, the bank first “manufactures” the medium of exchange (as a green money/red money pair) and it “manufactures” the thing that is being exchanged (as a green/red loan pair). The exchange then involves transferring two of the four things to Nick’s dad and keeping the other two.
Normal businesses manufacture only the thing that is exchanged. They are merely users of the medium of exchange (as are households). Commercial banks “manufacture” the medium of exchange AS WELL AS the thing that is exchanged (the loan). That is why banks are special.
Businesses manufacture the things that are exchanged. That is why they are special. Households are users of both the medium of exchange and the things that are exchanged.
When economists say that non-economists “think like a household”, what they mean, in these terms, is that households see only their own two accounting entries and ignore the other two. As Paul Krugman says “my spending is your income and my income is your spending”. That is why thinking like a household is wrong in macro. Households don’t understand quadruple entry bookkeeping.
Unfortunately, when most economists think about money, they too think like a household as they do not understand quadruple entry either – which is why it all goes wrong, and why these threads are frustrating for everyone! And, of course, many economists don’t seem to think about money at all – which is my limited understanding of Nick’s complaint about New Keynesian models! How on earth can anyone claim to be an expert in monetary economics without understanding money? That’s like claiming to be an expert in chemistry without understanding atoms and molecules.
Finally, Keynes’s two sector identity has four terms: I + C = C + S.
These are the same four terms! That is why it is called an accounting identity and why two of the terms represent the medium of exchange and two represent (a monetary evaluation of) the things that are exchanged.
However, many economists don’t seem to understand this either as they think of the terms in the identity in very abstract terms rather than as totals that are built up transaction by transaction. Note that this MUST be true as we can carry out a thought experiment where only one transaction takes place anywhere in the economy during an entrie accounting period e.g. Nick’s business sells a new car to JKH’s household. Keynes identity MUST then be consistent with the quadruple entry accounting for that single transaction.
Of course, virtually no-one will believe this – particularly economists! And don’t mention “profit” as that will make everyone’s head explode!
I second Jamie, Nick an JKH’s vote (FWIW).
TMF: When the loan is approved and used, there is an asset swap. The borrower gets the demand deposit as an asset. The demand deposit is still a liability to the bank. The bank gets the borrower’s bond as an asset. The bond is still a liability to the borrower. The borrower usually spends the demand deposit.
Yes. That is the same as what I am saying. I am just using Nick’s green/red terminology. Let’s break down your point.
The borrower gets the demand deposit as an asset (yes, I’m calling that green money)
The demand deposit is still a liability to the bank (yes, red money)
The bank gets the borrower’s bond as an asset (yes, green loan)
The bond is still a liability to the borrower (yes, red loan)
The borrower usually spends the demand deposit (yes, green money).
Note that green = asset and red = liability.
My point to you is merely that we must use consistent terminology to communicate effectively. We can’t mix and match. Otherwise, we just pass in the night and everyone gets frustrated.
TMF: I think this post will end its comments soon. Any other place to continue the discussion?
I’d prefer to stick here as my objective is to help this whole debate move forward and reach a consensus rather than going round in endless circles. Success for me would be reaching a common view acceptable to, say, Nick and JKH which was also easy to understand for you, me and others. That’s the only way for me to test that my own understanding makes sense. I don’t see the point in developing a Jamie view or a TMF view with which no-one else agrees.
Sorry, but let’s take this again: four entries in a real-life bank ledger, made by a real-life bank? Or four entries in a macro model where one tries to take into account that one man’s credit is another man’s debit (a positive checking account balance is a debit balance in the OWNER’S ledger, while it is a credit balance in the BANK’S ledger)?
I earlier said I understand the idea of quadruple entry (although I don’t agree it should be used to describe the relationship of a bank and its customers; in case of two non-banks I get it).
What I’ve been arguing that in a real-life bank general ledger there is only two entries. The debit entry/balance on customer’s loan account in the BANK’S ledger serves at the same time as a record of the customer’s liability AND the bank’s asset. The same goes for the credit entry/balance on the customer’s checking account in the BANK’S ledger. Outside the ledger there are of course loan contracts, etc. Often the customer himself doesn’t keep records (unless it’s a company).
Seriously? I’m an accountant, and as you see, I hate to be proven wrong on an accounting point by what I assume to be non-accountants 🙂
“When Nick’s dad takes out a loan with a commercial bank, the bank first “manufactures” the medium of exchange (as a green money/red money pair) and it “manufactures” the thing that is being exchanged (as a green/red loan pair). The exchange then involves transferring two of the four things to Nick’s dad and keeping the other two.
Normal businesses manufacture only the thing that is exchanged. They are merely users of the medium of exchange (as are households). Commercial banks “manufacture” the medium of exchange AS WELL AS the thing that is exchanged (the loan). That is why banks are special.
Businesses manufacture the things that are exchanged. That is why they are special. Households are users of both the medium of exchange and the things that are exchanged.”
Leaving aside green money/red money pair, I’d rather think of the green loan being “manufactured” by the borrower because it is the borrower’s liability. The bank may assist in its production. That is a minor point. The point is the bond/loan is the borrower’s liability, and the commercial bank can’t force the liability onto a borrower.
Another minor point. Households could manufacture things that are exchanged. I could grow some apples and sell them.
“The borrower gets the demand deposit as an asset (yes, I’m calling that green money)
The demand deposit is still a liability to the bank (yes, red money)
The bank gets the borrower’s bond as an asset (yes, green loan)
The bond is still a liability to the borrower (yes, red loan)
The borrower usually spends the demand deposit (yes, green money).
Note that green = asset and red = liability.
My point to you is merely that we must use consistent terminology to communicate effectively. We can’t mix and match. Otherwise, we just pass in the night and everyone gets frustrated.”
True about the frustration. You will need to ask Nick about the red money and red loan part.
“I’d prefer to stick here as my objective is to help this whole debate move forward and reach a consensus rather than going round in endless circles. Success for me would be reaching a common view acceptable to, say, Nick and JKH which was also easy to understand for you, me and others. That’s the only way for me to test that my own understanding makes sense. I don’t see the point in developing a Jamie view or a TMF view with which no-one else agrees.”
That is fine with me. I think Nick will need to extend the comment post period or start another post.
Nick said: “If I sell my car to JKH, there are 2 changes in my balance sheet (cars down, cash up) and 2 changes in JKH’s balance sheet (cars up, cash down). 4 changes in total. It’s always going to be quadruple entry (or sextuple if there are 3 people involved in a trade) in general (as opposed to partial) equilibrium analysis.”
JKH and Nick, is this correct?
If I (Nick) sell my car to JKH, there are 2 changes in my (Nick’s) balance sheet (cars down, demand deposits up) and 2 changes in JKH’s balance sheet (cars up, demand deposits down). 4 changes in total.
Jamie: “This really ought to be called the first law of macroeconomics.”
Agreed, and based on that you need to check Godley & Lavoie book JKH was refering to (e.g. http://www.palgrave.com/br/book/9780230301849) if you hadn’t already.
Jamie: “However, the macroeconomy still has the same number of cars and the same amount of money. This really ought to be called the first law of macroeconomics.”
I don’t think Nick, deep down, agrees with this. For him, the amount of money changes if one of the parties to the transaction uses an overdraft.
It is also clear to me, like I said already in my first comment on your slides (a comment which seemed to express Nick’s thoughts as well), that your “green money” AND “red money” is Nick’s “green money” seen from two perspectives. You seemed to understand this (?), but then you say that you are using Nick’s terminology. I would say you use Nick’s words but give them a wholly new meaning.
I’ll try to be more constructive, so I’ll create an Excel for illustration. One can expect slides from management consultants and spreadsheets from accountants…
I think this discussion shows how the implicit models we all use to make sense of all this are very different. I can live with only accounts and balance sheets as the things I picture in my head, but many of you seem to prefer “manufacturing”, on top of the accounting itself, some things that are transferred between agents/accounts. Perhaps it’s “observationally equivalent”, as Nick says. We’ll see. It would also be good to be absolutely clear about whether we are talking about phenomena (real-life accounting entries) or a model.
“I’ll create an Excel for illustration”
This became a full blog post (on double-entry and quadruple-entry) which I will publish tonight (GMT+1 time zone). If we need to change the discussion venue (hopefully not), then one option would be to continue in my blog. Up to you.
Here’s the post: Double-Entry and “Quadruple-Entry” Bookkeeping
I really hope we could get to a common understanding on this issue. There are not many things in this world which are more frustrating than talking past each other.
Antti’s post said: “To simplify things, we can assume that Jamie sells the bicycle “at cost”, so that his inventory is diminished by €100. It seems the purpose of Jamie’s example is to highlight the asset positions, so we can overlook the income side (zero effect if goods are sold “at cost”). So, two entries: CR 100 Inventory, DR 100 Cash.
In the example, I, Antti, am not a business. That most likely means that I keep records only of my assets – not of my income. Two entries: CR 100 Cash, DR 100 Inventory (of assets/of bicycles).”
Notice there is an asset swap. Also, notice both people are storing the currency themselves. Let’s add a storage facility for currency (NOT a commercial bank) that both people use. Now what does the exchange (currency and bicycle) look like?
Antii,
I took a look at your last referenced post. Good work.
For what it’s worth, a couple of points:
a) At some stage, where more than one bank is involved, one must consider one type of double entry event (for example) being that of a bank crediting its reserve account and debiting a chequing account – as a reflection of a cheque drawn on it and presented to another bank. You’ve no doubt considered that, but I didn’t see reference to this category of transaction in your write up.
b) My own impression of Nick’s green and red money world is that the idea of a normal loan of money in the real world is fully displaced by the idea of red money. Red money takes the place of that kind of real world loan. It also serves the purpose of real world overdrafts. I think if you allow both red money and “loans” (of some type of money) to exist in Nick’s world, you get unnecessary ambiguity in the logical structure of his model. Maybe I’m wrong in that interpretation. Only Nick knows for sure.
Thank you, JKH!
Regarding your point B: You’re absolutely right. Well spotted. I should have clarified that Nick would call that a “loan”, and has done it in his posts I believe, but that “loan” doesn’t exist in Nick’s basic setup of green/red money. (Side note: I’ve been actually arguing, to no avail, that the “loan” is not different in kind from Nick’s “red money”…)
I fully agree with your point A as well. But I’d like to hear how exactly do you see that relevant in this context? Is it because it can be seen as a case of quadruple-entry when we consider that the other bank makes equal and opposite entries in its own ledger? And much like in my scenario 1 (the bicycle trade), the bank between the two banks — in this case the central bank — would make two entries: credit and debit the reserve accounts of the two banks, respectively. Hence, sextuple-entry? 🙂 (Another side note: In the theory I’m working on, transactions between banks are seen as a case of making changes in the record-keeping system. I don’t view it as “money transfers”, nor do I see the banks trading “central bank money”. I’ll try to explain all this in more detail in my coming posts.)
TMF: I see that me arguing earlier that a “book transfer” (a bank crediting your checking account and debiting mine)is not really an “asset swap” is still bothering you, right? I stick to it. What I mean is that it can be argued quite convincingly it is not an asset swap, although you’re free to view it as such; especially if you don’t see any alternative way to think about it. I have an alternative — that’s why I’m arguing this.
You won’t prove me wrong by insisting on the storage facility idea or similar. A bank is not a storage facility for currency. And I’m talking about a bank.