I’ve noticed that many others, like me, are puzzled by the mechanics of the Saving=Investment accounting identity. How do household savings get instantly and perfectly intermediated, in a period, into investment spending — the purchase/creation of long-term productive fixed assets?
An Aha! for me: According to Krugman’s textbook, they don’t (click for larger):
First a correction: “The savings[sic]-investment identity is a fact of [the] accounting [methods developed in the 30s by Kuznets and company to model production of goods and services the national economy].”
But that aside.
If people spend less than producers expect in a given year, the producers create too much product, and it builds up their inventories. That’s easy to understand. (It’s easier if you think about the producers instead of the car-dealer intermediaries that Krugman talks about.)
In the NIPA model, that inventory is counted as “investment.” This makes sense as far as it goes — that inventory is stored real value, stuff that can be consumed/sold for consumption in future periods. As Mankiw explains it in his textbook:
But this explanation also pretty much obliterates the widespread and sloppy notion that increased saving (“not spending”) results in — causes — more productive “fixed investment.” The increased “investment” resulting from increased personal savings just expands inventory. The causations/incentives driving fixed investment are utterly other.
This also makes sense: when people are spending less (are “saving” more), does that spur producers to invest more in their businesses — to buy/create more fixed assets?
Both recent and immemorial history suggest quite the opposite.
Cross-posted at Angry Bear.
Comments
48 responses to “Saving Equals … Inventory?”
Hasn’t this more or less been refuted by MMT already? May have been true in an age long past when there was still a real gold standard (so pre-FDR, i guess), but after that..
Having said that, (following David Harvey) there *is* a link between saving via pension funds and the like and investment, although it is probably less direct than Harvey suggests in his splendid book The Enigma of Capital.
[…] Cross-posted at Asymptosis. […]
[…] Cross-posted at Asymptosis. […]
@Foppe Any online links to Harvey’s thinking? Or a quick explic by you?
Good points.
In fact economists are so used to “market clearing” at a “price” that they forget such simple explanations.
So economists tend to think that the mechanism which makes sure S=I is that interest rate (“price”) adjusts – without specifying which interest rate, whose saving, how much time does it take and so on.
The confusion of economists is worse than what weak students go through when they study elementary mathematics.
Steve,
This is an interesting discussion.
Two points:
1, Remember that income *is* output. In order for output to be invested, it cannot be consumed.
2, Just because somebody doesn’t want to spend any money today, that doesn’t mean that they won’t want to spend any money tomorrow. Over time, the general trend is that people become more wealthy. If people are saving, then the demand for current output might fall, but cause the demand for future output to be higher.
I’ll try. Basically what Harvey argues in his book (and elsewhere) is that because the total amount of savings floating around looking for investment the average RoI keeps increasing, it becomes ever more difficult to find sufficient profitable investment opportunities to yield a rough average of 3% YoY.
At the national (but also the international) level this happens through a process of what’s generally referred to as “economic maturation”, the consequence of which is that economies require less money (relative to the total amount available, which keeps growing) for investment. This causes producers to either invest in tech innovation (think Germany), or lay off workers directly, causing AD drops, making further demand growth (necessary for the investments to yield what they are expected to yield) difficult.
Now, the harder finding profitable venues for investment becomes, the stronger the incentive will be (for people looking for that amount of RoI) to find alternative investments; which generally means asset bubble blowing. This problem obviously becomes worse the more an economy develops. (I suppose Minsky has made similar arguments, though he — iirc, and I haven’t read him first-hand — explains them somewhat differently.)
Furthermore, this yield problem changes (becomes worse) the less constrained banks are wrt money creation through lending, as it will mean even more competition for profitable investments.
The basic point, however, seems to me quite sound: back in the early 90s, at least here in NL, there was lots of gnashing of teeth concerning the fact that pension funds and large institutional investors were having trouble finding sufficient things to invest in relative to the amount of money they were trying to invest. This was “alleviated” by changing the rules in such a way as to allow them to “invest” money in stocks, helping the dot com bubble along, among other things. Post-dotcom, they of course started hoarding sov OECD debt and AAA-rated CDOs (because of the relatively superior yields), and the world hasn’t been the same since.
(I may be forgetting parts of the argument/explanation I should be giving in order to answer your question; if so, please say so, and I’ll try to do better. In addition, though, see this: http://davidharvey.org/2011/07/the-vote-to-end-capitalism/)
I was gonna quote Keynes on saving and investment. I went to the Marxists Internet Archive to search for the text, but found this statement:
The Marxists Internet Archive is on strike for 24 hours in protest against the SOPA laws before the US Congress which would make sites like ours illegal.
JMK, TGT, Chapter 2:
Contemporary thought is still deeply steeped in the notion that if people do not spend their money in one way they will spend it in another.
…it is natural to suppose that an act of an individual, by which he enriches himself without apparently taking anything from anyone else, must also enrich the community as a whole; so that …an act of individual saving inevitably leads to a parallel act of investment. For …it is indubitable that the sum of the net increments of the wealth of individuals must be exactly equal to the aggregate net increment of the wealth of the community.
Those who think in this way are deceived, nevertheless, by an optical illusion, which makes two essentially different activities appear to be the same. They are fallaciously supposing that there is a nexus which unites decisions to abstain from present consumption with decisions to provide for future consumption…
Perhaps there is a tendency to confuse equality with sameness. But it is one thing to say that saving EQUALS investment — the two numbers are equal — and it is quite something else to say that saving IS investment or that saving is THE SAME AS investment. But that’s just my impression.
Art
I can’t find the reference, but I thought Keynes said that the change-in-inventory number is the number that brings the saving-number and the investment number into balance. Same as you say.
Possibly I have blurred his word.
@The Arthurian “confuse equality with sameness”
Right. JKH talked about this a lot in his comments on the MMT Thought Experiment post. I’m still trying to grok his explanations fully.
At the S=I juncture, Real becomes financial/monetary/nominal/synthetic/whatever. And vice versa.
It’s basically “philosophy of accounting” (epistemological? ontological? both?) and it’s much more difficult, conceptually, than one might expect. At least it is for me.
For the equation will be Savings = Future.
“At the S=I juncture, Real becomes financial/monetary/nominal/synthetic/whatever. And vice versa.”
This is a good point. What’s real? Here is JKH:
“The corresponding “saving†numbers are those generated per accounting period. For example, suppose the government runs a $ 1 trillion deficit and the economy adds $ 2 trillion in real assets, both in a given year. Then incremental NFA is $ 1 trillion, incremental investment is $ 2 trillion, incremental private sector saving is $ 3 trillion, and incremental national accounts saving is $ 2 trillion.”
This is 100% correct and must be according to accounting. But what is real and what is nominal? How did those real assets get valued?
This is where the rubber hits the road, and it’s part of the source of the confusion.
It doesn’t help most economists aren’t even bothering to add in govt.
Saving = Investment for a closed economy.
But saving must defined as national saving, not as S.
S = I for a closed, balanced budget economy.
National saving = S + (T –G) = I for a closed economy
For illustration purposes, assume a closed, balanced budget economy with S = I
Then, I determines S for any time period [t1, t2].
Suppose an agent purchases consumer goods (not services) at time τ, where τ ⊆ [t1, t2].
Consider a time period [ε, τ], where [ε, τ] ⊆ [t1, t2].
Then as ε → 0, (S) determines (I).
In other words, the flow of investment determines the flow of saving over any given time period.
But within that time period, for any purchase of consumer goods “from the shelfâ€, there is a conversion of inventory investment to final consumer goods, along with a destruction of both investment and saving in that amount. At a given moment in time, with the next discrete economic event occurring within an upcoming period epsilon, possible outcomes are reflected as a simple decision tree:
a) A shopper buys something from the store shelf
b) He decides not to, and moves on
What he either bought or didn’t buy was already part of GDP, classified as investment before he made that decision either way (assuming the thing was produced within the current measurement period, covered by the current GDP measure).
His decision results in it either being reclassified as consumption or remaining as investment.
And it also results in both saving and investment (micro and macro) either declining, or remaining the same. His decision to buy would mean his marginal dissaving determined marginal disinvestment.
A recession means he decides not to buy too often. The other part of the recession dynamic is a parallel notion for services, which is a little more nuanced. The idea of micro dissaving is critical there as well.
(I touched on this area briefly in comments under the recent “MMT Thought Experiment” post. Steve R., I’ve also made a brief note on Steve Waldman’s earlier comment there.)
@JKH
I’d really like to hear your thoughts on this, which is philosophical/conceptual. Can you help us understand better what the accounting “means”?
“Real becomes financial/monetary/nominal/synthetic/whatever. And vice versa.â€
Individuals save money, but the value of those savings is stored is in fixed assets — drill presses that can be consumed in the future. How does that (conceptual?) transformation happen?
Directly related, I think: monetary exchanges that spur transfers of real goods result in surplus from trade. But it’s a *utility* surplus — the buyer gets more human value from consuming the good than the purchaser/producer would have. How does that utility surplus turn into financial assets? (When net financial assets can only increase due to government deficit spending?)
It’s back to economic theories of “value” — really the very crux issue, which doesn’t seem to (?) have been resolved.
My intuition tells me that the answer is here:
http://www.economics-ejournal.org/economics/journalarticles/2010-31
But I haven’t grasped it yet. Any help? Do you think it’s useful?
Steve,
I think you may be confusing two things here.
The first thing is that real vs nominal is not a distinction between tangible stuff and money. Everything has a real and a nominal price (assuming it has a price). A flow of money has a real value and a nominal value; a flow of goods or of factor services has a real value and a nominal value, and so on.
The second thing is that individuals save their income. That saving can be denominated in money but it doesn’t have to be. Often it can be helpful to think about income in terms of flows of output.
If no output in a given period is invested (think of a closed economy with no govt), then all of the output must have been consumed. And any individual who did not consume all of his “income” (i.e. share of aggregate output) must be matched with another individual whose consumption exceeded his income (i.e. was greater than his share of output).
Aggregate saving can then be seen to represent output that is not consumed in the current period but rather is invested in fixed capital, and so raises potential output in future periods. (This asset can be monetized, of course. But I don’t see any reason why it must be). Without that increase to potential output, savers would not be able to realise their savings on aggregate–only through parallel savings and disavings that net out to zero increase in aggregate consumption.
Steve, Remember the post on the 15 fatal fallacies of financial fundamentalisim from Vickrey? Here’s part of #2″….In a money economy, for most individuals a decision to try to save more means a decision to spend less; less spending by a saver means less income and less saving for the vendors and producers, and aggregate saving is not increased, but diminished…
@vimothy
“real vs nominal is not a distinction between tangible stuff and money.”
Right, I totally get that. Somebody did a post recently on how we shouldn’t call “inflation-adjusted” “real.” I generally agree. Causes confusion.
“individuals save their income. That saving can be denominated in money but it doesn’t have to be. Often it can be helpful to think about income in terms of flows of output.”
This is exactly the issue. “think about…in terms of.” There’s a conceptual flip: individuals save money. But national savings is stored in fixed assets.
“any individual who did not consume all of his “income†(i.e. share of aggregate output) must be matched with another individual whose consumption exceeded his income (i.e. was greater than his share of output).”
“Without that increase to potential output, savers would not be able to realise their savings on aggregate”
I think not really, or maybe not really the right way to think about it? Assume an investment in fixed assets merely creates value that can be consumed in later periods. Inventory, for instance. Or a drill press that just produces its own value, and no more. The extra productivity/production is a bonus.
@nanute “less spending by a saver means less income and less saving for the vendors and producers, and aggregate saving is not increased, but diminished”
There is no such thing as aggregate private *monetary* saving (except net private saving caused by gov deficit or trade surplus). One person’s spending is another’s income, and saving (not spending) isn’t even that.
In aggregate, “economists’ saving” is not not saving as most people mean it. It’s investment.
But yes: less *expected* spending (more saving) means less expected GDP means (causes) *less* current investment.
As Nick said somewhere around here, it’s not an accounting assertion; it’s a behavioral one.
@Asymptosis
Steve R.,
“Even Steven†eclipsed by the trifecta!
There was a good discussion a few years back between MMT types and Steve Keen types. You might be interested in scanning the thread. My own comments started here:
http://www.debtdeflation.com/blogs/2009/09/27/it%E2%80%99s-hard-being-a-bear-part-sixgood-alternative-theory/comment-page-8/#comment-15324
Somewhere in there or following I suggested to Steve that conventional financial accounting could cover any issue that he was dealing with through his own model. He seemed to be open to that possibility in admitting that accounting wasn’t his strong suit.
There is no issue of a capitalist system being unable to come up with the money to pay interest or earn profits, etc. Every single economic or financial transaction is representable in accounting terms.
Keen proved in his model that the Circuitists didn’t fully understand the distinction between stocks and flows. The same can be shown through normal accounting. E.g. bank deposit liabilities and equity are key points for recording both income flows and the financial intermediation of savings. I find it staggering that the Circuitists seem to have been stumped by the correct insight here, as if they were struggling to solve Fermat’s Last Theorem of economics.
Keen does interesting work and his on-line lectures are very interesting. His attacks on neo-classical economics are particularly entertaining, especially his put down of their ostentatious use of second rate mathematics. That general theme is aligned with the MMTers, but there are big differences too.
@Asymptosis
Steve R.,
“How does that utility surplus turn into financial assets? (When net financial assets can only increase due to government deficit spending?)”
I think there’s an important point to be brought out here.
The MMT construction of “net financial assets†is a device.
It’s a device MMT uses as an anchor in developing a general theme for an economic justification for government deficits.
In doing so, they tend to emphasize the position of the private sector and the foreign sector relative to the government sector. “Sector financial balances†is another device.
These are OK devices.
But there should be a BIG CAVEAT in the interpretation of the private sector balance, and I think this has been the source of considerable confusion in outsiders trying to get inside the MMT thinking box. And wouldn’t you know it – it’s an accounting interpretation problem. I’ve alluded to this earlier.
Here’s the issue, I think:
MMT breaks down the world into two top tier macro sectors – government and non-government.
It then typically breaks down non government into private and foreign sectors.
What it has done as well, but not very often in blogosphere presentations, is break down the private sector into business and household sectors.
Unfortunately, the private sector consolidation obscures a great dealing of the important accounting that lies beneath in the accounting interface between business and household sectors.
If business holds investment I, and finances that with debt and equity claims held by the household sector, those financial claims are eliminated at the level of consolidated private sector accounting.
So what that consolidation obscures is a massive net financial asset position of the household sector with the business sector. It’s a much larger position than the bilateral NFA positions that the household sector may hold with each of the government and the foreign sectors.
So that HNFA position is fundamentally important to household economic behaviour as well.
Household behaviour is not driven only by conventional MMT NFA interpretation, but by this interpretation as well.
I would maintain that households do not “desire†NFA only in the MMT sense. What they desire is more saving per se, when saving is the issue. And that desire includes any of these NFA outlets described, on top of any real investment (e.g. residential real estate) they already hold.
It just turns out that government can open its bilateral NFA effect on a dime, when aggregate demand is sagging. And that’s important. But private sector accounting consolidation obscures the total dynamic of the thing.
@Asymptosis
Finally (for now), here’s a little JKH paradigm riff on the role of accounting in economics:
Consider a change in the economy between point A and point B.
The following things are true:
a) A and B as economic conditions can always be represented in accounting terms
b) Economic behaviour determines the change from A to B
c) Standard accounting identities always hold * – at A, B, every point in between, and every point before and after
d) The LEVEL of the numerical accounting variables within the identities can change from A to B, but not the identities themselves as generic accounting truths
e) BEHAVIOUR determines the change in the LEVEL at which the identities hold
f) The identities CONSTRAIN behavioral outcomes, such that c) is always true
* This assumes of course that identities are always correctly formulated, including for example various permutations around S, I, national saving, closed economies, etc.
MMT recognizes all of this, I think. It’s not necessary to be an MMTer to understand it, but it’s a big plus for their camp, IMO.
IMHO, there are two people (outside of MMT) who I always think of immediately, in terms of their understanding of the relationship between accounting and economics.
I think Paul Krugman understands it (even though he’s demonstrated occasional wobbliness in understanding the details of central bank accounting).
And I think John Maynard Keynes understood it. I think it infuses the GT, and that his ripping apart of the classics using the fallacy of composition at a general level was informed by his inherent understanding of the mathematically closed nature of double entry bookkeeping. (Sorry, that’s not such a humble observation on my part, so maybe I should attribute my own paradigm at least in part to Keynes.)
One reason I mention Krugman is that this accounting identity stuff is quite prominent in his bashing of Chicago in “Dark Age of Macroeconomicsâ€, etc. including recently. If you read Krugman’s posts closely, he’s very careful about putting accounting in proper context, which is what this is all about. He’s very cognizant of the required logical relationship between economic behaviour and accounting.
@Foppe “This causes producers to either invest in tech innovation (think Germany), or lay off workers directly, causing AD drops, making further demand growth (necessary for the investments to yield what they are expected to yield) difficult.”
Very interesting. I wandered down a similar path a while ago:
Update: Forgot the link:
http://www.asymptosis.com/all-cashed-up-with-nowhere-to-go-what-caused-the-depressions-and-what-to-do-about-it.html
Harvey link: “Marx even toyed with but then rejected the idea that the gold producers (in our day, the Federal Reserve) could do it. If all these options are taken off the table, then the mystery deepens.”
Why are those taken off the table? Revise “Federal Reserve” to “government deficit spending.”
Which comes back to my question about how increases in real wealth/assets (including the fixed assets that we measure), Update: and increased transaction volumes,/ seemingly, effectively forces the government to deficit-spend sufficiently, to create the money needed for that larger economy to operate without monetary/financial lockups. What are the (necessarily) political mechanisms/incentives/effects that cause that to happen?
I think it has a lot to do with recessions/depressions occurring when that money creation is insufficient. Politicians in those periods get voted out office and are replaced with ones who will deficit-spend sufficiently.
@JKH
Okay you lost me here. Aren’t these three statements mutually contradictory?
This pretty much encapsulates my “lostness.”
How about:
saving must defined as national saving [a.k.a. investment], not as S. Again: “saving” should be abolished, as in Godley’s construct?
But this still doesn’t sort it out for me.
“E.g. bank deposit liabilities and equity are key points for recording both income flows and the financial intermediation of savings. I find it staggering that the Circuitists seem to have been stumped by the correct insight here, as if they were struggling to solve Fermat’s Last Theorem of economics.”
I’m *not* going to go read that whole Keen thread. Instead, I take your word for it on the above, and add that my intuition has also pointed me directly to “bank deposit liabilities and equity” as key conceptual accounting explanations for my confusion. (Like all arithmetic things, once you understand it it’s obvious! Working on that…)
“Keen does interesting work”
As I’ve said, I think it’s incredibly important that he’s actually encoding a runnable dynamic simulation model of the economy based on more or less rigourous accounting principles. Nobody else is doing that, to my knowledge, and it strikes me as the only feasible method for modeling the economy. (Everybody with their IS/LM stuff is trying to do it in their heads!) And he seems reasonably open to having those principles explained and adjusted by others. I’d like to see it be even more so: as “open source” as possible — not necessarily so much the code as the conceptual. It would be even better if multiple people/groups were all doing the same thing independently, creating multiple models, as in climatology. (You?)
“Unfortunately, the private sector consolidation obscures a great dealing of the important accounting that lies beneath…a massive net financial asset position of the household sector with the business sector.”
Ah! *Very* useful. I’ve been trying to think about this using some vague notion of net vs gross financial assets, but I think this will work far better, or maybe even will make that notion actually make sense.
“a little JKH paradigm riff on the role of accounting in economics”
Love it.
“d) The LEVEL of the numerical accounting variables within the identities can change from A to B, but not the identities themselves as generic accounting truths”
Should say LEVEL or QUANTITY, to suggest both stocks and flows? Maybe not necessary. The words are bit squishy.
“f) The identities CONSTRAIN behavioral outcomes, such that c) is always true”
Maybe reformulate slightly, because this wording implies causation?
The identities CONSTRAIN behavioral outcomes (but NOT behaviors), such that c) is always true
That doesn’t quite do it for me, but in any case this one’s a conceptual key, I think. Bears further editing for crystal clarity.
Very interesting to hear your endorsement of the two K’s accounting understandings, given your demonstrated same. Adjusting my priors accordingly…
I’m thinking of adding a signature to all my posts and comments:
*** Why doesn’t JKH have a blog? ***
And who is that guy, anyway?
(Interesting how many important MMT thinkers/contributors are anonymous commenters on the interwebs. Kinda wacky, given our normal thoughts about such. What’s with that?)
Yes, what you wrote there is fairly similar to what Harvey writes about in the book, with the main difference being that he places more of an emphasis on the mechanism of the wage/profit split and the changes made there, and how they are related to revenue growth stagnation, while the expectations wrt profit growth on the part of investors remains constant (Japan has explicitly chosen not to go this route, btw.). This then encourages speculation (and in time, forces normal savers to start speculating as well, because the surplus cash floating around drives down interest rates on savings and other accounts, as well as bonds for pensions. Which means speculative ‘investment’ in the stock market, commodities, or housing, which in the former cases means that in aggregate people start losing money to brokerage fees and popping bubbles; while in the latter case it means ever-rising interest payments to the banks (which obv. cannot be spent on other goods either, ensuring a further long-term reduction in demand for goods), although this might partly be recycled back into their pension funds (to the extent people still have those).
And to make things worse, among other reasons because of the the way politicians are rewarded/punished for the state of the macro environment during their time in office, politicians also became more receptive to bank arguments about loosening lending regulations periods of stagnation — because that might keep up GDP growth etc. (Apologies if I’m pointing out the perfectly obvious.)
Now, the other response to the problem of stagflation of the seventies/eighties is slightly less recognized as such, I think: privatization. That way private revenues and profits can still grow in previously stable/mature markets. But this, in term, also causes problems, first because lots of people with stable jobs get fired/forced to take lower pay/robbed of their pension funds, and second because the price of primary goods goes up, therewith lowering the amount of money left for the consumption of other goods..
But the basic problems seem to be the expectations of first permanent wealth growth on the part of investors (perhaps partly caused by the fact that banks charge interest on loans), and second the fact that it is considered reasonable to expect constant profit growth from corporations regardless of ‘market maturity’.
Lastly, I am afraid I don’t quite understand why/when you think the government needs to deficit-spend, though. Which example are you think of/can you clarify/rephrase? 🙂
PS. Apologies for any and all convoluted and just plain messily structured sentences.
[/Rant/]
My own impression of Steve Keen is that he is someone who is seems to hold himself in very high regard, but whose criticism of mainstream economics seems mostly focused on principles and introductory micro. I remember a while ago reading a quote of his where he complained that economists don’t use dynamic models. I found it quite hard to take him seriously after that. Periodically, I come across commenters who’ve been exposed to this line but who miss the distinction between simple models used as undergrad heuristics with actual current research, who think that neoclassical economics should be thrown out because the ISLM model is static, or something. A recent example of that is:
unlearningeconomics.wordpress.com/2012/01/08/are-static-neoclassical-models-useless/
Are static models useless, the author asks, because they’re not dynamic models? Are my shoes useless, I might ask in the same vein, because they don’t keep my hands warm?
Here’s a choice quote from the man himself:
“The irony is that this decision not to use equilibrium and barter as “simplifying assumptions†has made my work easier, not harder. Centuries ago, mathematicians developed a method for modelling dynamic systems called “differential equationsâ€, and with them you necessarily begin with a system that is not in equilibrium: if you start from equilibrium, then nothing happens!â€
thenewinstrument.com/?p=57
Umm, thanks Steve.
[/Rant over/]
Ahem, sorry about that.
Anyway, I think JKH raises the most important issue vis-Ã -vis accounting identities. Krugman has a recent post that makes the point well. He’s a good critic of reasoning via accounting identity:
“And the key point is that individuals in general neither know nor care about aggregate accounting identities. Take the doctrine of immaculate transfer: if you want to claim that a rise in savings translates directly into a fall in the trade deficit, without any depreciation of the currency, you have to tell me how that rise in savings induces domestic consumers to buy fewer foreign goods, or foreign consumers to buy more domestic goods. Don’t tell me about how the identity must hold, tell me about the mechanism that induces the individual decisions that make it hold.
“And once you do that, you realize that something else has to be happening — a slump in the economy, a depreciation of the real exchange rate, it depends on the circumstances, but it can’t be immaculate, with nothing moving to enforce the identity.
…
“Accounting identities are important; in fact, they’re the law. But they should inform your stories about how people behave, not act as a substitute for behavioural analysis.â€
@vimothy
There is a difference between dynamic models that assume ergodicity and those that don’t. Keen criticizes the former as idiotic, especially when they are employed (as they frequently are) to make long-term predictions with (in whatever way).
(If you were ranting about something else, please specify about what, as I cannot really tell from your rant what you are taking issue with precisely.)
(Sinusoids and oscillating springs can be quite dynamic, but not in a way Keen is interested in.)
Sorry, that was a real rant. Please ignore it. I was just taking issue with the fact that Steve Keen does not seem to know what he’s talking about with regards to mainstream economics, but possibly this just reflects the fact that I don’t know what I’m talking about with regards to Steve Keen. 😉
vimothy #27, Keen is massively concerned about private debt. Everything else is bun.
Asymptosi of January 19th, 2012 at 12:34, #13: “Individuals save money, but the value of those savings is stored is in fixed assets — drill presses that can be consumed in the future.”
I don’t think that is correct. The value of savings is stored in the savings. Money has value. Money “is a store of value”. The value of real assets is stored in real assets. But anyway, value is in the eye of the beholder.
Money is financial savings, financial wealth; drill presses, I suppose I must admit, are real savings. Real wealth.
You ask: “How does that (conceptual?) transformation happen?” And again: “How does that utility surplus turn into financial assets?”
Easy: Trade. Exchange. Transaction. I give you a dollar and you give me a thing. I got the real asset and you got the financial asset. Not transformation, but transaction.
Asymptosi of January 19th, 2012 at 18:17 | #16: “There’s a conceptual flip: individuals save money. But national savings is stored in fixed assets.”
If that is true, is shows the difference between micro- and macro-economics. But isn’t much of the national savings stored as financial assets? JMK TGT, Bk IV, Ch 16: “…there is always an alternative to the ownership of real capital-assets, namely the ownership of money and debts…”
@Asymptosis
More push ups, for the drill sergeant:
🙂
…..
“Saving = Investment for a closed economy.
But saving must defined as national saving, not as S.
S = I for a closed, balanced budget economy…
Okay you lost me here. Aren’t these three statements mutually contradictory?â€
…..
Maybe that was sloppy writing on my part. Perhaps I should have written the second point:
“In order for (saving = investment) to hold, saving must defined in desired context as national saving, not as S.â€
Nobody should ever write S = I, unless they using it in the specific intended context and meaning of S as private sector saving.
People should be equally specific when intending saving to mean national saving, and not confuse it with S.
The ONLY case where the two are equal is that of a closed, balanced budget economy.
(See more on context dependent meaning, below)
…..
For reference only, the applicable algebra, once again:
C + I + G + (X – M) = C + S + T
For a closed economy then:
S = I + (G – T) (1)
And:
S + (T – G) = I (2)
(1) Says that private sector saving equals investment plus the budget deficit (the latter being the change in net financial assets)
(2) Says that national saving equals investment, where national saving is defined as the sum of private sector saving plus government saving (which is the budget surplus)
Both of these equations, and all equations of this type, refer to the quantities or values of the variables, not what the variables represent in substance.
E.g., more correct formulation:
Q (S) = Q (I) + (Q (G) – Q (T))
And
Q (national saving) = Q (investment)
IF the economy is closed, with a balanced budget, then G = T, and:
S = I (3)
(3) Says that national saving equals investment, where national saving is defined as the sum of private sector saving plus government saving, in a closed economy
And, more correct formulation:
Q (S) = Q (I)
Finally, for an open economy, without budget constraint:
C + I + G + (X – M) = C + S + T
S = I + (G – T) + (X – M) (4)
And:
S + (T – G) + (M – X) = I (5)
(4) Says that private sector saving equals investment plus the government deficit plus the current account surplus (capital account deficit)
(5) Says that national saving plus the capital account surplus equals investment, where national saving is defined as the sum of private sector saving plus government saving, and the capital account surplus is the capital account inverse to the current account deficit
And also expressed better with Q’s, etc
…..
The proper general definition of saving, in my view, remains the conventional generic definition, which is disposable income not spent on consumer goods and services.
Using this general definition, the identification of instances of saving is context dependent. Each of the world, any country, sector, sub-sector, or agent, can save.
But any specific application of “saving†should conform to the general meaning.
Here’s another example of that.
Again, take the case of the closed, balanced budget economy for simplification.
So,
S = I in such an economy
Now assume a case in which there are only households and no businesses. In other words, households obtain all of their income by doing work for each other, completely bypassing the business sector. And assume any investment they make is by building new houses for each other.
That means household accounting has to cover everything inherent in the definition of saving.
And in this case, it’s very easy to see that macro income not spent on consumer goods and services must directly equal saving.
Now insert a business sector.
Suppose the business sector does all the investment, once again in housing. But suppose also the housing remains unsold for an accounting period. Then businesses will save on their balance sheets through retained earnings. And households will save on their balance sheets through the book value of the common stock that they hold in businesses.
The generic definition of saving still holds in this example. Consider saving as macro disposable income less spending on consumer goods and services. Indeed, households will have not spent on consumer goods and services, in the amount of macro saving. They will not even have earned this income in the current accounting period. Instead, they will have accumulated an indirect claim to a corresponding increase in the business book value of their stock holdings – even though this accumulation is not technically household income and even though it is businesses that have directly enjoyed the corresponding sectoral claim on both micro income and micro saving. Households in this case will have spent all their income, because their income from stock dividends will have been delayed, in effect. And even though the generic definition of saving includes no reference to businesses not spending on the cost of their own goods and services in trade, it still works. The residual logic still holds in this case, even though households in this example do not even earn the macro income that is the source of the saving in this particular accounting period.
There’s no avoiding the requirement for algebraic precision in understanding what saving means. No short cuts. But a fairly simple, residual definition ends up being logically complete and comprehensive across all sectoral breakdowns of the global economy.
……
Didn’t mean to suggest you read the Keen thread; just a reference for quick perusal, if interested.
Keen’s stuff is interesting. Just that he doesn’t need to depart from standard accounting practice in order to do what he’s trying to do. E.G. the modern economy does NOT have bank vault money or bank notes on the liability side of banks’ balance sheets. People don’t go into the bank and “store†physical notes as their exclusive mode of deposit. There is no such direct storage claim. The world is too liquid and too electronic for such nonsense. So it’s going to be difficult for people to relate the Keen model to the real world, even though it seems like an affable “nuts and bolts†operational model on the surface. But an operational model can be constructed from actual accounting methods that are used in the real world. Guess who does that already? Banks! That’s what debits and credits do. They ARE the nuts and bolts. The entire financial system is built on this accounting infrastructure.
…..
“Ah! *Very* useful.â€
And the concept of “net financial assets†is more universal than appears on the surface in MMT. If my only asset is a bank account with $ 1000, and if I have no liabilities, then my net financial asset position with the rest of the world is $ 1000. I’m my own sector – just declared myself to be one. All of this stuff about saving, etc., is sector specific in the way in which it’s applied across the full economic landscape. That’s why you have variants like “S†versus national accounts saving. And what you find, I think, is that when you go through the logic of how the world must add up consistently under double entry accounting, you’ll want to end up with a general definition of saving that holds across all sectoral applications. And that is basically why the general definition of saving MUST be in the form of the existing residual income concept. The proof of this ends up being a reductio ad absurdum argument, in which you find out the hard way that you can’t attempt to do it any other way, without running into road blocks of contradiction. E.g. you can’t define saving consistently as investment, when a current account surplus represents saving for the domestic sector, absent any direct claim on the foreign real investment. You can’t define saving consistently as actual real or financial assets, when the same assets can be held by funding them with liabilities, absent any saving. You can’t define saving exclusively as national saving, when the private sector has its own version of saving. There should be one general definition of saving, flexible enough to be applied with consistency across all sectors or economic units of interest. And then what you can do is set up various, well defined algebraic equivalences of quantities in the various relationships between saving and investment.
…..
“The LEVEL of the numerical accounting variables within the identities can change from A to B, but not the identities themselves as generic accounting truthsâ€
By “levelâ€, I meant magnitude or value (of the variable).
…..
“The identities CONSTRAIN behavioral outcomes (but NOT behaviours), such that c) is always true
(Where:
c) Standard accounting identities always hold * – at A, B, every point in between, and every point before and after)
The identities ARE a constraint on behavioural outcomes. The example that comes to mind here is Krugman’s classic one, in which the world needs to discover a new export market on Mars, in order to pull itself out of its current slow growth path. Every country in the world can hope to grow net exports, but they won’t all be able to succeed. The proof of why they CAN’T achieve this all together is a simple accounting identity. It may not constrain their behaviour in the sense of their efforts, but it will certainly constrain the actual outcome of their behaviour. It will happen somehow that they simply won’t all be able to achieve their objective, which is Krugman’s logical point. And this will hold at any point in time, ex post. So “outcome†here is a pretty pervasive idea.
Vimothy has a good Krugman quote above that I recognize:
“… to enforce the identity… accounting identities are important; in fact, they’re the law. But they should inform your stories about how people behave, not act as a substitute for behavioral analysis.â€
He’s relating behaviour and accounting correctly there.
(Obviously; it’s Krugman)
Accounting identities tell you something important about the nature of the economic relationships that will govern the world of the future, but not how people get there, or what the particular economic magnitudes will be that the accounting will then rule according to the understood laws of association.
In “Dark Age†etc. Krugman is objecting to Chicago’s use of accounting identities in such a way as to overlook the behavioural potential for the world to change between point A and point B, while still adhering to the accounting laws at either point.
Nick Rowe has his own take on this subject. It seems like he wants to yell at accounting identities at points A and B, and most points in between, blaming them for not explaining the behavioral change from point A to point B. Krugman recognizes more openly the distinct roles of behavior and accounting, and the way in which they work consistently together.
…..
“Why doesn’t … have a blog …â€
Ha!
Maybe I will at some point.
Still, appreciate the forum to discuss a few aspects here.
@The Arthurian “Easy: Trade. Exchange. Transaction. I give you a dollar and you give me a thing. I got the real asset and you got the financial asset. Not transformation, but transaction.”
There’s still only one dollar. It just happens to be in my bank account, not yours.
Assuming real surpluses build up over time, how does that human utility become money? (My intuition: through a political mechanism involving private debt issuance and government deficit spending.)
I’m far from the first to puzzle over this. Marx (a lousy political thinker, but a deep though muddled economic one) was all over this, but never resolved it. Keen’s paper goes after it, and gives some history of others’ stuggles with the issue.
@JKH
“More push ups, for the drill sergeant:”
Ha. I do appreciate your calisthenics. But I think I’ll suggest you stop juggling the accounting identities, because it apparently doesn’t help me (or maybe it does, but only slowly and cumulatively). I’ve spent untold hours doing so myself, and “watching” others do so.
*Here’s* the crux where I get stuck, which you’ve nicely encapsulated:
“the quantities or values of the variables, not what the variables represent in substance”
I’m trying to grasp (or even better, grok) what they represent. It’s a conceptual barrier I’m hitting (along with many others, I believe, though they may not know it), not an arithmetic one.
(Isn’t it nice that bookkeeping/accounting is all just pluses and minuses? My sister, after abandoning the Berkeley Phd astrophysics program, ended up [with no programming experience] programming those Visa mainframes that process billions of transactions a night — in assembler! I asked her once if she used any of her higher math from college, calculus and such. “No,” she said, “we pretty much just add and subtract. On rare occasions we’ll get really abstruse and multiply or divide.” 😉 )
But perhaps I’m getting closer, based the above and similar. Some recent muddled struggling:
Individuals do not contribute to national savings by saving/not spending. They only contribute by producing and not consuming — in particular, by not consuming real long-term assets (including those tallied in the national accounts — fixed assets).
If I build a second bathroom for my house, I am contributing to national savings — real wealth that can be consumed in the future.
If I drive my car to elsewhere and back, I’m consuming the car. If I *don’t*, I am saving its value for the future.
IOW: the distinction between consumption and consumption spending.
Consumption spending in a period is (reasonably) assumed to represent actual real consumption; stuff is bought and consumed in short order, within the period.
But consumption of fixed capital/durable goods is also consumption. So real “consumption” in a period is Consumption Spending + Consumption of Fixed Capital.
I don’t know that we need to go anywhere with that; I’m pretty clear on how that tallies up in the national accounts via the arithmetic of Y = C+I, inventory adjustment, net versus gross I, and valuation adjustments for inventory and fixed assets. But it’s getting me closer to understanding what the variables represent, in terms of real and virtual entities. Understanding intuitively what they mean in the context of the model’s necessary simplifications/methods/constructs (i.e. all income flows to households).
It’s impossible to really understand what they represent, conceptually, unless you’ve got the whole context — the structure and necessary simplications of the accounting system — clearly represented, in toto, in your brain. (As you seem to have.)
Which leads me back to:
You assert (and I believe, partially because you say so) that:
o All the relevant flows and stocks can be coherently and consistently represented in an accounting structure.
o The accounting structure we use (NIPAs + FOFs) achieves that.
What you might also be saying, I’m not sure:
o There is no accounting structure that can achieve that that does not include a construct called “saving.”
o There is no other coherent and internally consistent accounting structure — one with no construct called “saving,” for instance — that would be as useful as our current structure.
By useful I mean:
Conceptually tractable. Intuitively representative of all important aspects of how the economy works. Conducive to mental manipulation. Unlikely to cause errors of logic in those seeking to understand it and build models based upon it.
Such like that.
I ask because I’ve been back into Godley’s accounting matrix again:
http://www.asymptosis.com/?attachment_id=4842
In his seminal paper:
http://www.ipc-undp.org/publications/srp/TOWARDS%20A%20RECONSTRUCTION%20OF%20MACROECONOMICS.pdf
(I’ve also pre-ordered the new edition of his/LaVoie’s book, due out in Feb/March, which I believe extends/expands this matrix considerably.)
Some darned interesting passages from the paper:
=========
The co-ordinating role of banks is one of the main
features of the model to be described here, while the accounting framework is so rigorous
and complete that, as in a Walrasian equilibrium, each individual stock or flow variable is
logically implied by the sum of all the others.
===
There is little original or disputable about this matrix arrangement of the National
Accounts, which is the recognizable world we live in. Yet it does contain one realistic
feature which runs counter to the mainstream deployment of basic relationships – which
invariably assumes that all the factor income generated by expenditure turns up
instantaneously as income in the hands of households. This assumption is wildly incorrect
as a matter of brute fact, for only a tiny fraction of profits (at least in the US and UK) is
actually distributed, the great bulk being transferred to firms’ capital account where it
becomes a major source of funds for the finance of investment.
===
Five major simplifications have been made. All government expenditure consists of purchases from
firms. The economy is closed. Households neither invest nor borrow. Firms do not hold cash. All taxes
are indirect and paid by firms. [SFR: again: I think this model has been expanded, some simplifications removed]
=========
Investment in fixed and working capital (stockbuilding) is all paid for by firms
themselves, hence under the double entry system of accounts we need to call into
existence a capital account for firms, shown in the upper part of column 3, which
describes how the sector makes these purchases from itself.
========
We may point to a bonus straightaway. We do at last (with no originality on the part of
the author who is just exploiting the official systems of accounts already produced in the
US, the UK and all countries who use the SNA) have a systematic way of incorporating
credit money and financial variables into what has been called the production-income-expenditure
nexus. Such integration simply does not exist in the textbook literature (c.f
Mankiw op.cit. once again for a recent instance).
We only have, so far, a complete system of accounts measured in money terms. But some
of the most important decisions, for instance, the decision of firms regarding how much
they will produce, and of households as to how much they will consume, are made in
terms of real physical quantities. The reader is asked therefore to imagine a
supplementary system of real quantities, with an accounting relationship, outlined in the
final section of this paper, between prices, quantities and the distribution of income which
also describes how nominal and real wage rates fit into the story.
=========
Back to me: I think it may be very significant that he *starts with the money,* unlike Kuznets who tried to start with the real economy of goods and services, modeled as a barter economy. (FOFs were only added a decade or so later.) That may make the Kuznets approach less useful/conceptually tractable. (Related: my notion that the financial asset market is the *real* barter economy.)
I note, again, that the word “saving” never appears in this paper. It is unnecessary, I think, except when trying to discuss the matrix in terms of/relation to the current SNA.
On accounting identities and behavior: how about this:
Accounting identities tell us nothing about how humans will be behave (individually or collectively) when facing incentives and constraints. They do tell us what accounting outcomes will result if humans respond to incentives and constraints in particular ways. Those accounting outcomes may themselves change the incentives and constraints that humans face — not because the identities exist within the accounting structure, but because the outcomes (represented by the accounting) happened.
??
“I’m trying to grasp (or even better, grok) what they represent. It’s a conceptual barrier I’m hitting (along with many others, I believe, though they may not know it), not an arithmetic one.â€
For what it’s worth, my very rough intuition about what lies beneath:
C, I, G, and (X- M) are real flows (“real†in a physical sense), mirrored by real/monetary exchanges. C is a flow of production of real consumer goods and services, with monetary income allocated to expenditure on same. “I†is a flow of production of real investment goods, with a flow of funds allocated to expenditure on same. G is a flow of real goods and services (and monetary transfers), with a flow of funds (taxes, debt purchases) allocated to expenditure on same. (X – M) is a flow of net trade in real goods and services, with foreign net inflow of funds allocated to expenditure on same.
T and S are intermediate allocation destinations for monetary income. They are connecting points in the flow of funds. T is an intermediate allocation of income to government. S is an intermediate allocation of income to a floating residual – what is determined by netting taxes and consumer spending from income. Unlike the cases of consumption and tax, there is no specific allocation of income to a further point. S is a collection or pooling of income at the origin, so to speak. The subsequent allocation of saving to something else occurs in subsequent flow of funds steps. Flow of funds includes allocation of saving to real investment or to acquisition of financial assets. And allocation to financial assets can include multiple steps in itself.
The algebra should be mastered, not avoided. Otherwise, there’s no dealing coherently with reference to such variables noted in economics discussions here and there. I’ve found that manipulating the identities by setting certain elements to zero in various scenarios helps sort out the logic:
E.g. the pair (X, S), with everything else set to zero, is a marginal current account surplus. X represents exports, mirrored by a capital account flow of funds deficit. S is a record of income not spent on domestic consumption and therefore is domestic saving and accumulation of equity. S provides no further information than that. A flow of funds analysis is then required to connect S to the nature of the financing that appears in the capital account deficit.
(I, M) alone is a marginal current account deficit. M represents imports, mirrored by a capital account flow of funds surplus.
Given that one often thinks of CA surpluses and deficits as being “oppositesâ€, these two explanations are surprisingly asymmetric.
……
“Individuals do not contribute to national savings by saving/not spending. They only contribute by producing and not consuming — in particular, by not consuming real long-term assets (including those tallied in the national accounts — fixed assets). If I build a second bathroom for my house, I am contributing to national savings — real wealth that can be consumed in the future.â€
Assuming the bathroom is classified correctly as investment, I think of this as a current expenditure on a real investment good that is consumed in the future. It is saving in the sense of not consuming in the present. I don’t think of this as “consuming wealth†in the future. It is “consuming investment†over time, which has the consequence of reducing wealth over time. The consumption of the investment directly affects the measured residual (wealth, or equity). Perhaps this is a nuance only.
……
“If I drive my car to elsewhere and back, I’m consuming the car. If I *don’t*, I am saving its value for the future… Consumption spending in a period is (reasonably) assumed to represent actual real consumption; stuff is bought and consumed in short order, within the period. But consumption of fixed capital/durable goods is also consumption. So real “consumption†in a period is Consumption Spending + Consumption of Fixed Capital.â€
Yes, similar to the bathroom. I think it’s the difference between GDP and NNP, or something like. There are several classification tiers below/around GDP that deal with that and other stuff. But GDP is top line gross, I think. This detail can all be reconciled as required. Regarding the car, it reminds me that the GT (the book, not the car) includes an extraordinarily difficult chapter on this (chapter three I think, part of the reason I’ve never made it through the whole thing) – the difference between depreciation without use and the deterioration due to use. If you don’t drive the car, you’re still dissaving, although at a slower pace.
……
“What you might also be saying, I’m not sure:
– There is no accounting structure that can achieve that that does not include a construct called “saving.â€
– There is no other coherent and internally consistent accounting structure — one with no construct called “saving,†for instance — that would be as useful as our current structure.
– By useful I mean conceptually tractable. Intuitively representative of all important aspects of how the economy works. Conducive to mental manipulation. Unlikely to cause errors of logic in those seeking to understand it and build models based upon it.â€
I’ll put it a bit differently.
Very rough analogy:
Suppose I build a true model of a car, but don’t call the thing under the hood an engine. Everything else in the model has the same name as the real thing. Instead of calling the thing under the hood in my model an engine, I call it “net carâ€. OK, but that doesn’t give licence (!) to start calling the thing originally known as the steering wheel the engine, and have a coherent model. (Maybe the residual formerly known as engine)
Now tie that in to what Godley says in the paper you referenced:
“The accounts are set up so that, by definition, the change in the real stock of households’ wealth is equal, in each period, to the difference between real disposable income and consumptionâ€
Apart from the aspect of using real rather than nominal measures, that change in wealth is the same thing as saving* in the NIPA. And BTW that’s how he gets away with not mentioning the word “saving†in his paper.
* Slight detail – Godley defines saving directly as a change in stock rather than an income flow. Standard flow of funds analysis, tacked onto NIPA, does something along the same lines, with the consolidated attribution of wealth to the household level, when it converts the booked income of business over time to a market value change in the value of financial claims on business. This area is a bit confusing, but the key is not to double count business income with the income or accumulated wealth attributable to household financial claims on the same business income.
I believe Godley refers to this book/market conversion process implicitly in the following excerpt (which you quoted as well):
“Yet it does contain one realistic feature which runs counter to the mainstream deployment of basic relationships – which invariably assumes that all the factor income generated by expenditure turns up instantaneously as income in the hands of households. This assumption is wildly incorrect as a matter of brute fact, for only a tiny fraction of profits (at least in the US and UK) is actually distributed, the great bulk being transferred to firms’ capital account where it becomes a major source of funds for the finance of investment.â€
I’m not really saying that you can’t create a valid model of the economy without using a “construct called savingâ€. I am saying that you can’t create a valid model unless you can discern the inevitable presence of that logical construct one way or another – that which is known as saving in NIPA – regardless of its named identification in the model. And this condition holds in fact in the case of Godley’s model, as described above.
……
“On accounting identities and behaviour: how about this: Accounting identities tell us nothing about how humans will behave (individually or collectively) when facing incentives and constraints. They do tell us what accounting outcomes will result in humans respond to incentives and constraints in particular ways. Those accounting outcomes may themselves change the incentives and constraints that humans face — not because the identities exist within the accounting structure, but because the outcomes (represented by the accounting) happened.â€
My quick stab:
– Accounting identities tell us nothing about how humans will attempt to behave within a given time period (the accounting period). They do tell us something about collectively feasible outcomes, expressed in accounting terms – income, balance sheet, and flow of funds. And as a result of that, humans may face outcomes at the end of a given time period that they did not anticipate at the beginning. Simple example – it is not possible for the world to run a current account surplus. Feasible accounting outcomes are a constraint on what ends up being achievable collectively, when individual units are competing for their own realization and share of that outcome. And this is true operationally and iteratively, since every economic decision that results in a transaction has a representation in accounting terms. To the degree that accounting is the record of what actually happened, accounting identities are a constraint on what can happen. The last nation standing will simply not be able to show a current account surplus, if the others have come to the point of realizing theirs. To the degree that accounting is a record of events, accounting identities are constraints on the overall pattern of actual events. They rule out certain combinations of things that cannot happen.
– I note that blog posts continue to come out in recent days emphasizing the idea that accounting ideas don’t explain behaviour. In doing so, such posts still tend to underemphasize their importance as a check on feasible outcomes at the macro level. The fact that you can’t use an accounting identity to try and push through Say’s law doesn’t mean that identities don’t have an important role in economics.
……
Final point:
I’m much more comfortable with the Godley model than the Keen model. Here is a smattering of quotes from the Godley paper (some the same as yours) and my reaction to them, explaining in part my preference for his model:
“Commercial banks are reckoned to play a central role in the macroeconomic process because they co-ordinate all the disparate aspirations, expectations and actions of the different sectors and this is one of many ways in which the model deployed here differs, not only from mainstream models, but also from “old fashioned†Keynesian models which have largely become extinct.â€
– And, unlike Keen, he uses accounting that corresponds closely to real world accounting. In particular, the clear delineation of a correctly constructed capital account (i.e. RHS banking equity) is critical. (Keen doesn’t have this clarity)
“Those models never achieved, any more than frankly neo-classical theoretical models, a satisfactory incorporation of credit and finance into their accounts and this is one of the reasons why they fell victim to the monetarist counter-revolution. The co-ordinating role of banks is one of the main features of the model to be described here while the accounting framework is so rigorous and complete that, as in a Walrasian equilibrium, each individual stock or flow variable is logically implied by the sum of all the others.â€
– Keen does share this general approach, which is good, but with the caveat noted above
“This definition of profits corresponds closely with that used in the national accounts. But the capital account of firms must show, in the lower part of the matrix, exactly how any investment in excess of retained profits is to be financed, namely by borrowing from banks or by issuing either equity or some other security.â€
– Again, Godley follows real world double entry bookkeeping, as oppose to Keen’s rather tortured free banking account structure, with blurred and confused liquidity and capital elements
“With no originality on the part of the author who is just exploiting the official systems of accounts already produced in the US, the UK and all countries who use the SNAâ€
– Again, real world accounting consistency
“The reader is asked therefore to imagine a supplementary system of real quantities, with an accounting relationship, outlined in the final section of this paper, between prices, quantities and the distribution of income which also describes how nominal and real wage rates fit into the story.â€
– He’s incorporating more micro income allocation characteristics here, but it does remind me of my point on “intuition†above with regard to the algebra of the identities and related real inferences
“Suppose that an individual makes an impulse purchase at a supermarket and pays using a debit card. In this case there must be changes to at least eight variables in the matrix.â€
– A good example of a practical analytical approach to institutional modeling, one that you won’t see from a “market monetarist†any time soon, out to eternity probably.
“The accounts are set up so that, by definition, the change in the real stock of households’ wealth is equal, in each period, to the difference between real disposable income and consumptionâ€
– Once more, reflecting the nature of saving as a residual
“Expectations about incomes and asset prices are continuously being falsifiedâ€
– Great phrase about dynamic behaviour
“The model itself has 130 equations, and it would not serve my purpose to go through it in detail in this paper, nor would there be room for such an exegesis.â€
– Good excuse for me not having to concern myself about similar details in my response here
“So we come at last to the main purpose of the paper, which is to report some simulation results accompanied by a narrative which, it is hoped, will lend plausibility to each experiment as well as, eventually, to a whole system of thought.â€
– Simulation: an important conceptual and analytical tool for risk management in any approach to economics or finance (and BTW curiously one that appears almost totally absent from MMT methods and policy proposals)
“How exactly is this investment financed? This is a question which is seldom if ever asked in the mainstream macro story, though it is a continuous theme in the Cambridge Keynesian literature, and with the accounting framework deployed here it is a question that demands a precise answer. The answer built into the present model, which is consistent with a large amount of empirical evidence, is that in general investment is financed by retained profits. However, as the investment must be undertaken before profits can be increased, initial finance is provided by bank loans.â€
– Key to visualization. Investment creates saving, until purchases from inventory disinvest and dissave
– Although his model is built on the simplification he notes; investment can also be “financed†by new debt and equity issues, in addition to retained earnings – these permutations can be reconciled back to saving through flow of funds analysis
“The strength of this paper resides in the rigour and completeness of the double entry accounting framework used, which shows (largely following Tobin) how money and finance should be integrated into the analysis of income, expenditure and production flows.â€
– Excellent
“A different paradigm is indicated in which knowledge is gradually built up by empirical study, within the formidable constraints imposed by double entry accounting.â€
– “Formidable constraints” – love it.
– BTW, where else have I seen something like that?
🙂
“Why doesn’t … have a blog …â€
Ha!
Maybe I will at some point.
Or maybe JKH could simply become one of the regular posters here, like happens on many other blogs on the internets? Assuming Steve R. invites him (just thinking out loud).
@Asymptosis
P.S.
Have a VERY quick scan at this recent eruption of “extreme algebraic fightingâ€, with blood being spilled liberally in the comments.
http://uneasymoney.com/2012/01/22/advice-to-scott-avoid-accounting-identities-at-all-costs/
It has the potential to be quite depressing, particularly in context of the efforts of our recent discussions here. At the same time, it’s indicative of how much further the economics profession has to go on this stuff.
Looks to me like a dreadful confusion of identities, multipliers, and closed economy/balanced budget assumptions, all obscuring what the possibilities are for the relationship between “S†and “Iâ€, in both identity and “equilibriumâ€.
S = I as an identity only when you assume both a closed economy and a balanced budget. Otherwise, you get the sorts of permutations I noted above.
In this latest debate referenced, it seems to me (I may be wrong) that all these guys are assuming S = I as an identity. The problem is that a balanced budget multiplier (where incremental spending is financed by incremental tax) can drive the resulting end of period budget out of balance, simply due to a multiplier dynamic. That wrecks one of the identity assumptions. I don’t understand why nobody has pointed this out, which means maybe I’m wrong. But I don’t think so.
@JKH
“C, I, G, and (X- M) are real flows … T and S are intermediate allocation destinations for monetary income. … They are connecting points in the flow of funds.”
That’s very useful. Thanks. The accounting construct, S, used for intermediate allocation, does not have to (and does not) equal what households generally think of as saving — their “income” (including realized cap gains but not including undistributed corp profits) minus their spending. It serves rather as a vehicle for a more abstract(ed) representation of how funds flow (one where, for instance, in Godley’s words, “all the factor income generated by expenditure turns up instantaneously as income in the hands of households.”) And it’s because of this modeling approach, this definition/construction of S, that “S”=I.
“The algebra should be mastered, not avoided. … E.g. the pair (X, S), with everything else set to zero, is a marginal current account surplus.”
Oh agree completely. I was just saying that I’ve done a lot of pushups there, getting pretty good at holding it all (or a lot of it) in my head, but the conceptual confusion remained. To think coherently about the national accounts, you have to hold that whole algebraic matrix in your head, but *also* the assumptions underlying that matrix (i.e. factor income is modeled as flowing to households). Both almost intuitively. Hence the pushups.
“Assuming the bathroom is classified correctly as investment,”
Right. Since the owner built it, non-remunerated, it wouldn’t show in the NIPAs.
(I did a rough calc a while back, BTW, estimating the value of nonremunerated work from census time-use surveys at median wage: would add roughly 33% to GDP. Since Europeans have much more free time, I’m assuming that increase would be greater there.)
“I don’t think of this as “consuming wealth†in the future. It is “consuming investment†over time, which has the consequence of reducing wealth over time. The consumption of the investment directly affects the measured residual (wealth, or equity). Perhaps this is a nuance only.”
Yes perhaps, but a useful conceptual distinction. I’ve been struggling with the definition of “wealth.” RHS equity seems right. Remind me from that discussion (pushups needed…): does that just include the the $50 trillion in real assets, or also the $10 trillion in money that has been created through government deficit spending?
“the difference between depreciation without use and the deterioration due to use. ”
Right. There’s also the thorny related issue of of revaluation of both inventory (minor) and fixed assets (where you face the very sticky wickets of hedonics and obsolescence).
“call it “net carâ€.”
That might be really good, might have prevented all my conceptual confusion! It imparts, every time you look at it and think about it, the nature of this “thing” currently called S — an accounting construct with definition “blah blah blah,” used to model sources and uses of funds.
I love it, actually: “the accounting construct formerly known as Saving.” Nick’s abolition dream come true! Then we could use the word saving to mean what normal people mean by saving.
“I’m much more comfortable with the Godley model than the Keen model.”
I’m thinking you’re probably right. But not necessarily because of the double-entry thing that people have made a big deal about, cf Neil Wilson’s recent, which shows that the results are the same. I would also add that it would seem easy for Keen to programatically populate double, quadruple, or greater number of entries from a single entry. That’s just mechanics, not modeling. (Actual double entry is just for the purposes of human-error correction, which is not necessary in this context.)
And he intends to do so. In a comment the other day he said:
“one of the many design objectives with Minsky is to automatically generate a given class’s accounts from its point of view. When that is implemented, entries for banks will be shown as Neil has shown them here, while taking a look from (for example) the capitalist class’s perspective, you would see the transactions as I currently enter them. So that will make monetary economics completely consistent with standArd accounting –in strong contrast to the current situation where neoclassical economics and accounting are utterly inconsistent disciplines.”
http://www.debtdeflation.com/blogs/2012/01/11/guest-post-a-double-entry-view-on-the-keen-circuit-model/comment-page-4/#comment-35623
The big point, though, IMNSHO, is that HE IS ACTUALLY DOING THIS! Building a runnable dynamic simulation model based on accounting principles. We can talk about how that model should be structured to be most useful and representative, but that’s secondary to the fact that he’s building the damn thing. Why isn’t anyone else? (Me, I don’t have the chops.)
And putting aside some people’s view of his perceived arrogance (at least overstated, imo), I feel like this community should be offering any aid and assistance possible — including useful critiques and suggestions, especially when supported by the kind of rigorous work that Neil did.
“[Godley] uses accounting that corresponds closely to real world accounting”
I’m thinking that by this you mean accounting as it’s practiced by business, by banks, and in the FOFs. But I would assert that accounting as it’s stuctured in the NIPAs is *not* “real-world” — notably its treatment of undistributed corporate profits, and (non-)treatment of capital gains. This is *precisely* the reason that Godley makes his major departures from that structure, necessarily in the process amalgamating what we now think of as the NIPAs+FOFs.
“In particular, the clear delineation of a correctly constructed capital account (i.e. RHS banking equity) is critical. (Keen doesn’t have this clarity)”
I would add: neither do the NIPAs. Which is why they (absent a *very* clear understanding of their relationship to the FOFs) lack the conceptual clarity I would like to see (that lack of clarity being amply demonstrated by the almost universal misunderstanding of “Saving.”)
“the author who is just exploiting the official systems of accounts ”
This is a nice bit of humility on Godley’s part, but it should not obscure the fact that by “exploiting” he means “restructuring, and redefining some terms, in fundamental ways.” In the process making the structure *more* “real-world” that the existing one.
“- A good example of a practical analytical approach to institutional modeling, one that you won’t see from a “market monetarist†any time soon, out to eternity probably.”
Yeah, they all seem to believe, for instance, that Saving creates loanable funds. And their notion of “capital” is a vague, messy, undifferentiated quasi-amalgam of financial and real assets.
“”The accounts are set up so that, by definition, the change in the real stock of households’ wealth is equal, in each period, to the difference between real disposable income and consumption
– Once more, reflecting the nature of saving as a residual”
Yes but unless I’m misunderstanding (more pushups needed?), Godley is completely redefining that residual, and to a useful purpose. Because, a few lines later:
“disposable income *including real capital gains*”
And also his treatment of undistributed corporate profits via the capital account.
“Simulation: an important conceptual and analytical tool for risk management”
Risk management in its broadest sense, or among other things.
“curiously one that appears almost totally absent from MMT methods and policy proposals”
You’re right. Ditto neoclassicals and bastardized Keynesians. Which is why I’m so enthusiastic about Keen’s work.
“Key to visualization. Investment creates saving”
Disagree. The key to visualization is to understand that in the current NIPA/FOF structure — which you’re (very impressively and effortlessly IMO) translating into here — Investment creates “Saving.”
“”A different paradigm is indicated in which knowledge is gradually built up by empirical study, within the formidable constraints imposed by double entry accounting.â€
– “Formidable constraints†– love it.
– BTW, where else have I seen something like that?”
Yes indeed. Great minds think alike. But: I think in his sentence (parse it) he imparts the important distinction: the constraint is on our “knowledge.” Hence our beliefs (and assertions) about predicted future outcomes. In essence, our logic.
We can’t assert that all nations will run a surplus because — as the accounting representation of those flows demonstrates — it is logically impossible. Which means anyone suggesting the world should export its way out of depressions makes no sense.
Accounting definitions, identities, and conceptual constructs (properly understood within the context of the coherent and representative accounting model being used) constrain our *reasoning* — at least if we insist that reasoning to be logically coherent. Assuming that requirement of logical coherence, they also constrain our predictions and recommendations. Any behavioral assertions that violate that logic are, prima facie, wrong.
I think that explains the “constraint” accurately and usefully.
@Asymptosis
Ooops need to revise slightly, missed a key part of yours:
This doesn’t seem like a slight detail to me at all. The restructuring of accounts for cap gains and corp profits is a big deal. I think it seems that way to you because you can hold Godley’s whole set of constructs, plus the NIPA/FOF set, in your head all at once, and fluidly translate between them — allocating all the flows to their proper slots. I would suggest that very, very few economists are capable of that.
So when you say “This area is a bit confusing,” you’re making my very point. If the national accounts used a Godley(-like) structure (notably with structural changes in accounting for cap gains and undistributed corp profits/capital account), economists would make less errors in their thinking. They wouldn’t have to hold a complex conceptual construct called “Saving” in their heads (this assuming they’ve truly understood it in the first place, without having ever been trained in accounting) while envisioning all its related flows.
So I would say not that Godley “gets away” with not mentioning Saving. Rather, he *succeeds* in not doing so.
A Nick Rowe/Steve Rothian conceptual utopia!
@JKH
“Have a VERY quick scan at this recent eruption of “extreme algebraic fightingâ€, with blood being spilled liberally in the comments.”
I did take a very quick look. 😉 From my scan it seems your objection makes sense.
A very good example of reasoning being disproved by the logic embodied in accounting. (The reasoning should have been “constrained” ex ante, but that’s asking a lot in this world…)
@paulie46 “Or maybe JKH could simply become one of the regular posters here”
Seems like a good idea to me. JKH, if you have any thoughts you’re dying to share with a larger audience…
@Asymptosis
Just saw your last, but going to go ahead with this first:
“RHS equity seems right. Remind me from that discussion (pushups needed…): does that just include the the $50 trillion in real assets, or also the $10 trillion in money that has been created through government deficit spending?â€
Household RHS equity there was $ 50 trillion total, consisting of $ 40 trillion ultimate real, and $ 10 trillion in NFA.
The $ 40 trillion “ultimate real†was $ 20 trillion held directly by households and $ 20 trillion held by business, on which households held financial claims.
S was $ 50 trillion and national accounts saving was $ 40 trillion.
“In particular, the clear delineation of a correctly constructed capital account (i.e. RHS banking equity) is critical. (Keen doesn’t have this clarity)†I would add: neither do the NIPAs. Which is why they (absent a *very* clear understanding of their relationship to the FOFs) lack the conceptual clarity I would like to see (that lack of clarity being amply demonstrated by the almost universal misunderstanding of “Saving.â€)
NIPA is income flow, with no capital account balances per se presented. NIPA tracks accrual flows that end up changing capital accounts when incorporated in balance sheets and flow of funds.
NIPA are book value accrual inputs. Capital accounts are subsequently valued mostly on a marked to market basis, as recorded on balance sheet and flow of funds reports.
Speaking only personally, I’m comfortable with the task of conceptually reconciling capital accounts (i.e. RHS equity) by relating flow of funds to NIPA inputs. NIPA accumulates RHS equity (saving) at book value over the accounting period. Balance sheets and flow of funds at the macro by necessity absorb that book value accrual within the marked to market valuation of financial claims on business, as they are ultimately reflected as assets on the books of households. That’s the most practical way of assembling the macro data. Embedding book value NIPA accruals more explicitly as a revealed component within balance sheet and flow of funds presentations would be a data collection and assembly nightmare.
But I guess your point consistently has been that my claim to be able to do this probably results only from a personal push up program that exceeds normal expectations for same (plus the possibility of a wee bit of BS I suppose). There should be a clearer way of doing it.
That said, I think I’ll back off my criticism of Keen’s work for a while. I just have an instinctive dislike for the way he’s set up his accounts, but that’s not at all a charge that what he’s put together doesn’t work as intended.
On Godley again, I’m a little confused on how his treatment of RHS household equity corresponds to or doesn’t correspond to the flow of funds treatment. As noted, the flow of funds treatment is essentially a transformation from NIPA book value accruals (flows) to marked to market balance sheets (stocks). I avoided this in my previous comment, but to be honest, I don’t quite understand what Godley is doing on his page 3 Balance Sheet matrix, line 11. That looks to me more like a flow of funds equation than a balance sheet equation. Anyway, I didn’t go there because I basically trust the way he’s set up his accounts, and I’m comfortable with the assumption that everything should balance according to such an account structure.
“Yes indeed. Great minds think alike. But …â€
I.e. great minds think alike – unless one doesn’t quite recognize what the other is thinking.
🙂
@Asymptosis
“So I would say not that Godley “gets away†with not mentioning Saving. Rather, he *succeeds* in not doing so.”
That’s an interesting way of looking at it.
I’ve never denied (HA!) that you can construct a macro flow of funds or a micro sources and uses of funds without using the word “saving”.
If that’s the objective, consider yourself immunized and good to go!
🙂
But, I’m just saying that such a flow of funds statement is reconcilable back to NIPA, including the definition of saving, should the reader of the statement care to partake in that particular form of masochism. (And God knows I love it.)
🙂
BTW, maybe repeating myself here, but I’ve always visualized the default “transformation†for RHS equity to be a flow of the “medium of exchange†into a preliminary pool of same – i.e. defaulting into a bank account – in the case of a monetary economy. Then, that bank account gets distributed (or not) into such flow of funds destinations as real asset or financial assets, the latter as intermediate claims on real assets. However, that sort of default as an actual NIPA presentation distorts the NIPA purpose of tracking pure flows, without making assumptions about stock destinations, and bank accounts are stock destinations.
@Asymptosis
“if you have any thoughts you’re dying to share with a larger audience”
appreciate that –
maybe when I come up for air, after this particular dive …
@JKH “I just have an instinctive dislike for the way he’s set up his accounts, but that’s not at all a charge that what he’s put together doesn’t work as intended.”
A co-author of mine wrote a great line once, something about bodies of acquired knowledge that are understood so deeply “that they look and feel like intuition.”
Thinking about it, I think we often tend to mistake that kind of intuition in ourselves for natural intuition — the kind shown, for instance, when babies display surprise in experiments when things seem to violate physical laws. Our acquired intuitions feel like they’re expressions of natural law. (Which leads me to wonder whether logic forms part of natural law…)
“On Godley again, I’m a little confused on how his treatment of RHS household equity corresponds to or doesn’t correspond to the flow of funds treatment.”
Well that *does* make me feel better. 😉
My next task: really understanding expected and real values as discussed by Nick and Godley (relative to the conceptual constructs each uses to talk about them). Got some pushups to do…
out of the blue it occurs to me that “saving = investment” follows from
the Keynesian reduction of say’s law: Supply creates its own demand.
For if the law is accepted, then it follows that income is always used in one way or another,
and any income *not* spent on consumption is still BY LAW demand for something,
and if not for consumption then it must be for investment.
Perhaps old Kuznets had Say’s Law stuck in his head.
JKH #40: I’ve never denied (HA!) that you can construct a macro flow of funds or a micro sources and uses of funds without using the word “savingâ€.
JMK Ch6: So far as I know, everyone is agreed that saving means the excess of income over expenditure on consumption…
Clearness of mind on this matter is best reached, perhaps, by thinking in terms of decisions to consume (or to refrain from consuming) rather than of decisions to save. A decision to consume or not to consume truly lies within the power of the individual…
@The Arthurian
not quite sure how to interpret what you’re saying here, but its quite clear that the national income accounts construction faithfully follows your JMK Ch6, and I absolutely agree with the logic of both
[…] There’s been a running discussion of this on various blogs (sorry if I missed linking some!), inflated simultaneously by Krugman and by magisterial and mysterious commenter JKH’s “paradigm riff,” here. […]
[…] There’s been a running discussion of this on various blogs (sorry if I missed linking some!), inflated simultaneously by Krugman and by magisterial and mysterious commenter JKH’s “paradigm riff,†here. […]