Debt, Deficits, and Modern Monetary Theory

Possibly one of the best initial overviews of MMT written so far:

Debt, Deficits, and Modern Monetary Theory

Good comment as well:

"Every dollar spent is somewhere saved." The important thing is to maximize the number of pit stops that dollar makes (in whole or, inevitably, fractionated form) before coming to rest as [long term] savings (ie reserves).

A Double Entry View on the Keen Circuit Model

Over the last few months I've enjoyed Steve Keen's lecture series on You Tube, which are definitely recommended for anybody wanting a solid understanding of why neo-classical macroeconomics is complete bunkum.

In there is an iteration of Steve's horizontal money circuit and the tables and equations he uses to build that model. He's rejigged those models in response to a challenge by Scott Fullwiler to fit the model into double entry bookkeeping tables.

Now Steve is a great speaker, a good writer and formidable mathematician. But I'm afraid he would get a fail in a bookkeeping exam. For something to be consistent with double entry there has to be at least two entries in the journal and the journal must sum to zero. To abuse Minsky’s words: a double entry model with a single entry in it isn’t a double entry model.

So its easy to see why the presentation of this particular model causes a few fireworks in schools of thought who are more fastidious in their bookkeeping.

My background is in Information System design and architecture, with a dose of accountancy thrown in for good measure, and I’ve worked in and around the Free Software movement for over twenty years. So my natural tendency is to look at ways of re-integrating ‘forks’. I believe all the issues commonly complained about in this model can be reconciled by making the tables double entry complaint and extending the model slightly. I hope this will show to all sides that they are talking about the same thing.

And by doing so I am almost certain to upset everybody. Such is life.

First the current tables. This is a copy of table 14.1 in Debunking Economics (similar to table 1 on this post at Steve's site):

	Assets		Liabilities		Equity
Operation	Vault	Loan Ledger	Firms	Workers	Safe
Lend Money	-Lend Money		+Lend Money
Record Loans		+Lend Money
Charge Interest		+Charge Interest
Pay Interest			-Charge Interest		+Charge Interest
Record Payment		-Charge Interest
Deposit Interest			+Deposit Interest		-Deposit Interest
Hire Workers			-Wages	+Wages
Bankers Consume			+Bankers Consumption		-Bankers' Consumption
Workers Consume			+Workers' Consumption	-Workers' Consumption
Loan Repayment	+Loan Repayment		-Loan Repayment
Record Repayment		-Loan Repayment

From a double entry viewpoint there are a few things that feel uncomfortable with this table.

1. the liabilities side is strictly the wrong sign. Liabilities are generally shown negative so that when you add them to assets you get zero. You can run them as a positive balance but that means the check of simply making sure the row adds up to zero doesn’t work so well (you have to multiply the sum of liabilities by -1 first). Also '-' is generally a credit and '+' a debit. So in the table you can see that firms appear to pay wages by 'crediting' and workers receive wages by 'debiting' which is inconsistent with the way bank accounts are usually described.


2. The bank only gets paid when the firm pays the interest. Yet in accounting the bank will ‘recognise’ the income (ie credit its profit and loss account) as soon as it charges interest and this will allow it to spend before it gets paid. This isn't seigniorage as the bank has indeed earned that money. So the table has a minor temporal error in it which may or may not be important.


3. The initial conditions on a balance sheet must be created by a series of journals and must balance to zero. Money shouldn’t magically appear in a Vault.


4. But most importantly there are a lot of single entries in the rows. That makes this table inconsistent with the fundamentals of double entry that requires every transaction to sum to zero. To be double entry there must be at least two entries and the journal rows must sum to zero - or it is not a double entry table. So there is something missing from this model to balance those lines.

Bear in mind that this is a limited horizontal circuit model with a lot of heuristic assumptions. It is has static parameters and ignores everything other than a simple private credit circuit. So there is no initial capital for the bank or equity considerations and all the parameters have a fixed value. Those are all deliberate.

It’s job is to show that a private credit circuit with a fixed stock of money can exist standalone which was, prior to Steve's work, thought impossible.

My job is to reconcile this table so that it works from a double entry viewpoint, still have loans creating the equivalent deposits and have them both destroyed and not destroyed at the same time all while satisfying as many viewpoints as possible.

In other words the perennial accountant’s dilemma - how to present a set of accounts.

So let’s have a go at fixing this and see how many people we can upset.

Let’s start with the first line and fix the signs. We're going to impose a 'all rows sum to zero' restriction on this table.

	Assets	Liabilities			Equity
Operation	Vault	Loan Ledger	Firms	Workers	Safe
Lend Money	+Lend Money		-Lend Money

So we have an accurate journal on the firm side - crediting their account with money is definitely correct. But the balancing entry now appears wrong - why would crediting a Firm account increase a vault asset?

Answer: it wouldn’t. Vault is on the wrong side of the balance sheet. Paper notes in a Vault are a stock of non-circulating bank liabilities - as are the electronic equivalent. So let’s move Vault.

	Assets	Liabilities			Equity
Operation	Loan Ledger	Vault	Firms	Workers	Safe
Lend Money		+Lend Money	-Lend Money

Now it makes sense, the flow is moving the liabilities from the non-circulating stock in the Vault to the circulating stock at the Firm.

Which then leads onto the next question. How are there any liabilities in the Vault in the first place?

Well, thinking in paper for a moment, notes have to be made and there will be a limit to how many can be made. And only banks can make these notes, not firms. So what’s the difference?

The banks have a 'licence to print money' that the firms don’t have  (even if its one they gave themselves - as a truly independent central or private bank would do for example). Technically of course this is a 'licence to create money' - they are not required to print it. A licence is an ‘intangible asset’. The value of the licence to create money will vary over time depending upon the terms of the licence, the amount of outstanding loans and various other factors. And, like the intrinsic goodwill of the firm or its ‘human resources’, you don’t usually see the value on a bank balance sheet.

But in this model we want to know how much ‘potential money’ is in the system at any point in time so let’s add in a journal to give the bank the ability to create a fixed amount of money (remember this model is operating under fixed parameter heuristic assumptions). This neatly solves the problem of where the ‘initial value’ comes from and makes new money and old money the same thing - the value of the licence can vary dynamically like any other variable.

	Assets		Liabilities			Equity
Operation	Licence Value	Loan Ledger	Vault	Firms	Workers	Safe
Grant Licence	+Grant Value		-Grant Value
Lend Money			+Lend Money	-Lend Money

And then finally add in the recording of the loan.

	Assets		Liabilities			Equity
Operation	Licence Value	Loan Ledger	Vault	Firms	Workers	Safe
Grant Licence	+Grant Value		-Grant Value
Lend Money			+Lend Money	-Lend Money
Record Loan	-Lend Money	+Lend Money

So now we have an extended balance sheet with the money creation system declared explicitly on the face of the balance sheet. A credit licence has value and that initial value is added to the balance sheet as a non-circulating intangible asset and the associated non-circulating revaluation reserve liability - which we have called Vault in this model for want of a better name.

Issuing Loans reduces the remaining value of the credit licence and at the same time the Deposit reduces the remaining amount in the Vault. Loans still create deposits - but by changing non-circulating liabilities into circulating ones.

So far so good. Let’s add some interest.

Interest can be seen as an extension to the loan, where the associated deposit is immediately paid over to the Bank. So we can add that in.

	Assets		Liabilities			Equity
Operation	Licence Value	Loan Ledger	Vault	Firms	Workers	Safe
Charge Interest			+Interest Charge			-Interest Charge
Record Interest	-Interest Charge	+Interest Charge

Generally there is no separate paying of interest. As anybody who has a mortgage knows you just make one repayment which covers the principal and accrued interest.

But this is really a stylistic point at this stage as the value of the payment is the Loan Repayment + Interest Charge anyway.

	Assets		Liabilities			Equity
Operation	Licence Value	Loan Ledger	Vault	Firms	Workers	Safe
Repay Loan and Interest			-Loan Repayment ‑Interest Charge	+Loan Repayment +Interest Charge
Record Loan and Interest Repayment	+Loan Repayment +Interest Charge	-Loan Repayment ‑Interest Charge

So the revised Lending table looks like this in total:

	Assets		Liabilities			Equity
Operation	Licence Value	Loan Ledger	Vault	Firms	Workers	Safe
Grant Licence	+Licence Value		-Licence Value
Lend Money			+Lend Money	-Lend Money
Record Loan	-Lend Money	+Lend Money
Charge Interest			+Interest Charge			-Interest Charge
Record Interest	-Interest Charge	+Interest Charge
Repay Loan and Interest			-Loan Repayment ‑Interest Charge	+Loan Repayment +Interest Charge
Record Loan and Interest Repayment	+Loan Repayment +Interest Charge	-Loan Repayment ‑Interest Charge

As a check let’s remove the intangible asset and associated journals from the balance sheet and see what we get:

	Assets	Liabilities	Equity
Operation	Loan Ledger	Firms	Safe
Lend Money	+Lend Money	-Lend Money
Repay Loan and Interest	-Repayment	+Repayment
Charge Interest	+Interest Charged		-Interest Charged

Which should look familiar to anybody on the MMT side of the debate.

That’s the bank lending items sorted. Let’s adding the spending elements and complete the circuit. So for the expanded balance sheet the final table looks like this:

	Assets		Liabilities			Equity
Operation	Licence Value	Loan Ledger	Vault	Firms	Workers	Safe
Grant Licence	+Licence Value		-Licence Value
Lend Money			+Lend Money	-Lend Money
Record Loan	-Lend Money	+Lend Money
Charge Interest			+Interest Charge			-Interest Charge
Record Interest	-Interest Charge	+Interest Charge
Repay Loan and Interest			-Loan Repayment ‑Interest Charge	+Loan Repayment +Interest Charge
Record Loan and Interest Repayment	+Loan Repayment +Interest Charge	-Loan Repayment ‑Interest Charge
Pay Firm Deposit Interest				-Firm Interest		+Firm Interest
Pay Worker Deposit Interest					-Worker Interest	+Worker Interest
Hire Workers				+Pay Workers	-Pay Workers
Workers' Consumption				-Workers' Consumption	+Workers' Consumption
Bankers' Consumption				-Bankers' Consumption		+Bankers' Consumption

Write out the intangible assets and you get this:

	Assets	Liabilities		Equity
Operation	Loan Ledger	Firms	Workers	Safe
Lend Money	+Lend Money	-Lend Money
Charge Interest	+Interest Charge			-Interest Charge
Repay Loan and Interest	-Loan Repayment ‑Interest Charge	+Loan Repayment +Interest Charge
Pay Firm Deposit Interest		-Firm Interest		+Firm Interest
Pay Worker Deposit Interest			-Worker Interest	+Worker Interest
Hire Workers		+Pay Workers	-Pay Workers
Workers' Consumption		-Workers' Consumption	+Workers' Consumption
Bankers' Consumption		-Bankers' Consumption		+Bankers' Consumption

So as you can see the balance sheets that 'create' and 'destroy' horizontal money are consistent with the one where horizontal money merely changes state to dormant, and the difference is simply to introduce an accounting policy requiring an intangible asset to represent potential loan capacity that currently isn't in circulation.

This is a very similar to the approach taken in accounting under IFRS 3 when reporting purchased goodwill. Prior to 2005 purchased goodwill was written out of the balance sheet and essentially combined with the intrinsic goodwill of the purchasing business. After 2005 it had to be carried explicitly on the face of the balance sheet. To get to the prior position you just take a IFRS 3 compliant balance sheet and write out the carried goodwill.

But what benefit does carrying the amount of ‘potential loans’ give us in the model? Well it helps to show how ‘hungry’ a bank is to lend. A bank with a high valuation on its credit licence has a lot of capacity to make loans, whereas one with a low valuation hasn’t. It is very likely that the first is going to be selling loans as hard as its can whereas the second is more likely to be putting its efforts into lobbying regulators to relax the cap on its lending capacity.

As I see it, the key point from the expanded model is that although it is easy to add credit potential to a system, it is somewhat more difficult (and may even be impossible in practice) to get rid of it again as it embeds itself deeply into the dynamic structure of the system.

In addition, by explicitly recording the value we can graph it over time and see how close to potential the economy gets, and as the model evolves we can compare dynamic caps on the credit licence to static caps and see what effect they have. Particularly as our current credit licences in the real world are linked to the amount of ‘regulatory capital’ a bank has and are therefore dynamic in their own right.

So whether you use an expanded balance sheet for your horizontal circuit or a collapsed one depends on what you’re trying to find out with your model.

I've created the double entry model using the QED program from Steve's site (which is based on the simplest stable model created in Steve's crash course lecture.). QED likes to see things positive (or it suffers an assertion failure), so the liability side has all been multiplied by -1 compared to the tables above.

The double entry model converges nicely and ends up looking like this (click for the full size version):

Whereas the original model ended up like this:

As you can see the figures converge to the same value - demonstrating that they are the same model at this level of dynamism. The double entry version shows the circulation between the assets and the liabilities happening separately (although in step of course) once the credit licence has created the initial stock of credit money. And if you add up the pots in each circulation at any point in time the total stocks should be the same value. The balance sheet now balances as it should.

Job Guarantee - it's really not that difficult

I have to say the furore over the Job Guarantee idea has been very instructive - particularly about what people value in the world. The amount of leaping to conclusions and post-hoc justification has been astounding to behold.

After all we're simply talking about trying to make sure an individual in a society has a way to earn a living.

As a systems person its blisteringly obvious to me why you'd want to operate this mechanism since it solves a lot of dynamic fluctuations in one go. However it is obviously not clear to most others. So let's see if I can distil it down to its essence and explain the mechanisms.

The Job Guarantee comes from the proposal that the economy should provide full employment and price stability.

Full employment means that if you want to you will be usefully engaged in society in a manner that allows you to feel of value in some way. Given that our school system trains us to derive value and status from work, then value can be given to the majority via a job of some sort. (For reasons why our school system is not really fit for purpose, see this excellent RSA Animate video).

The Job Guarantee essentially says that the state will guarantee to pay wages in exchange for your labour.

Note what it doesn't say:

• It doesn't say that the state will necessarily compel you to take a job.
• It doesn't say that the state will necessarily organise the work.
• It doesn't say that you can only work for the state.
• It doesn't say that you will necessarily receive no income if you don't want to work

It says the state will guarantee to pay you a certain amount of wages in exchange for a certain amount of your labour. That's it. Nothing else.

This is exactly the same as the state saying it will guarantee to buy your wheat, or your milk or your wool if you are a farmer producing those goods.

If you like you can view it as a put option. Every week you are essentially given a put option by the government that allows you to sell your week's labour to the state for a set price - the strike price. The state then sets the strike price. How much are the wages and how much and what type is the labour required in exchange for those wages.

That then becomes the nominal price anchor for the entire economy. Everything prices itself off that strike price.

Since the operation of the guarantee is a signal of private sector investment failure, the private sector is necessarily disciplined by its operation. Some of the consequences of that are:

• jobs of a worse quality than the guarantee cease to exist and the firms providing them go bust - freeing up space for the more enlightened. Good riddance to them.
• private sector firms in trouble go bust naturally and the government has no need to run around like a headless chicken panicking over the job losses - usually accompanied by a spraying of discretionary spending ineffectively in all directions. The guarantee pick up the slack automatically.
• government can thumb its nose at threats of job losses for any of its policies, since the guarantee picks up the slack.
• private sector malinvestment can be allowed to resolve and debt bubbles allowed to go down safe in the knowledge that aggregate demand will be maintained (but likely at a lower level - disciplining prices again) and we are less likely to lose sound investment in the maelstrom of insolvency.
• the employability gap between private sector workers and guarantee workers is smaller which actually reduces the negotiation capacity of engaged private sector workers.

It is important that the private sector feels the discipline so that they regain their appetite for investment as soon as possible. And that happens when profit margins return to something juicy and attractive - which is what maintaining aggregate demand and employability achieves.

Importantly though the system is also getting rid of private sector dross. You need to make spaces for the entrepreneurs to move into.

And once the private sector gets its mojo back the guarantee automatically decreases - as does the private sector discipline. Which then helps the private sector get back to its self-sustaining ignition point where it can become the driver for the recovery.

So enough of the theory. How do we actually get this into practice and reap the benefits.

Interestingly most of the objections refer to edge cases (Hi George). And I have a simple solution to those.

Ignore them.

Too difficult to address for now. We can deal with them later if necessary.

Let's deal with the majority problem - a lack of work opportunites for employable people who want to work.

So at the moment* I would set the guarantee price as follows:

• the state directly pays the wages of any new person engaged by the public, voluntary, non-profit or charity sector on receipt of a validated timesheet up to a maximum of 35 hours a week at the minimum wage.
• the employer employs the individual and is responsible for ensuring the individual gets paid.
• the employer is prohibited from topping up the wages or paying expenses or in any way increasing the remuneration of the individual for the work done.

And let's see how far down the road that gets us.

(* when the facts change, I change my mind. What do you do sir?)

Why not the private sector? Well the private sector lack of investment is the problem and giving them free or subsidised staff is hardly an incentive to amend their behaviour. The guarantee needs to generate a tension in the private sector that turns into a determination to reduce the number of guarantee staff via investment.

And anyway the private sector initially needs to focus on expanding output to service the newly restored aggregate demand.

I suspect that employers using significant amounts of banks loans would similarly have to be excluded from access to guarantee staff. Non-profit doesn't mean that they don't make money. Some of the best businesses I know are co-operatives. Since part of the problem is bank reticence we need to stop them getting access to the stimulus from any other direction than new investment in productive capacity.

So would prices start to go up when this is implemented? Undoubtedly some will at first. But wages would not, and that means putting up prices is a dangerous game. Finite wages purchase reduced amount of goods which means somebody loses out, goes bust and puts a few more people on the guarantee - which reduces wages some more. That is how the nominal anchor pulls prices back into line.

The existing unemployment or pension payment systems can be used to pay the wages. In the UK they are all part of the Department of Work and Pensions structure. Starting and stopping jobs is the same as starting and stopping unemployment benefit with the same PAYE implications and National Insurance registration requirements. HMRC is already into a pilot programme collecting 'Real Time information' about PAYE records to support the new Universal Credit. So those systems are there already, pay millions of people and can be adapted relatively quickly given that they are already half way through the process.

Minimum wage is already enforced by HMRC, so they would get the job of dealing with the 'Mr Donald Duck' applications. That may involve a slight increase in expenditure on rubber gloves and Vaseline admittedly.

So it's really not that difficult to reduce the jobs deficit. That state does what the state is good at - making payments and generally keeping out of the way. Aggregate demand is restored in a counter-cyclical fashion and we can run like this alongside the existing unemployment management structures for a while and see what the data says before trying to tune anything else.

To those who see Byzantine structures and government officials eating their first born I would suggest less Hollywood disaster movies and more Pulp:

You'll never live like common people,
you'll never do what common people do,
you'll never fail like common people,
you'll never watch your life slide out of view,
and dance and drink and screw,
because there's nothing else to do

And remember these are real people we're trying to help here. Real people just like you and me.

CofFEE Job Guarantee Report - alternative source

For those struggling to get the CofEE Job Guarantee report out of Australia (it is a largish document), I've created a Google view of it.

The usual questions about how JG can work are answered in the document. Please read it first - you may be pleasantly surprised to find that other people have the same concerns you do.

Creating effective local labour markets: a new framework for regional employment policy

Job Guarantee is a required part of MMT - official

Bill Mitchell's blog today states that the Job Guarantee (JG) is an essential part of MMT.

The reality is that the JG is a central aspect of MMT because it is much more than a job creation program. It is an essential aspect of the MMT framework for full employment and price stability.

The JG is an enhancement to the existing automatic stabiliser arrangement that uses the concepts of buffer stocks to dampen the gyrations of an economy. Buffer stocks have been used extensively in the past to stop wild fluctuations in commodity prices. As Randy Wray pointed out:

I had never thought of it that way, but Bill’s analogy to commodities price stabilization schemes added an important component that was missing from Minsky: use full employment to stabilize prices. With that we turned the Phillips Curve on its head: unemployment and inflation do not represent a trade-off, rather, full employment and price stability go hand in hand.

Bill then states why:

I noted that this means that the government can thus choose – of all the “steady state” unemployment-stable inflation equilibria available – one that provides a job for all when the private market fails. For those well-versed in the history of macroeconomic thought rather than the day-to-day financial market trends, this MMT insight is crucial and relates to the need for an economy to maintain a nominal anchor (that is, maintain price stability).

The Job Guarantee is MMT's nominal price stability anchor. It is fundamental to how it is able to maintain stable prices and full employment.

Warren Mosler calls the jobs in the JG 'transition jobs':

My third proposal is for a federally funded $8/hr transition job for anyone willing and able to work, to help the transition from unemployment to private sector employment.

The problem is employers don’t like to hire the unemployed, and especially the long term unemployed. While at the same time, with the payroll tax holiday and the revenue distribution to the states, business is going to need to hire all the people it can get. The federally funded transition job allows the unemployed to get a transition job, and show that they are willing and able to go to work every day, which makes them good candidates for graduation to private sector employment.

This shows that MMT expects people to come out of JG just as soon as the private sector gets its act together. In fact the number of people in JG jobs is entirely in the hands of the private sector.

Since I come from a country with public education and public health care, it seems fairly obvious to me that the next step is to guarantee a job and an income. It is a straightforward argument and MMT shows the economic objections to it are groundless. So countries with a developed social welfare system - such as the UK, Japan and Sweden -  and that haven't hog-tied themselves to a currency peg should be able to implement it.

For those in the US you have to realise that many of us outside your country are gob-smacked by how backward your social safety nets are. Ignoring JG because its a bit hard politically is to ignore the key stabilising structure within MMT.

Discussing MMT without the Job Guarantee is to discuss some other economic theory, and one without any stability anchor to nominal prices.

UK Sectoral Balances and Private Debt Levels Q3 2011

Q3 Figures are out.

Quite a few revisions to the data this quarter - going back to Q1 2010! The major change is the marked upward revision of the external sector

And here's the private debt levels:

Private debt is down 10% of GDP from 452% of GDP to 442% of GDP, with last quarter revised down from 455%.

Source: Office of National Statistics, tables RPZD, RPYN, RQAW, RPZT, RQCH, DJDS (Seasonally adjusted Net Lending/Borrowing per sector plus residual error) and YBHA (Gross domestic product at market prices, seasonally adjusted). Private sector debt based on tables J8XI, NLBC, NKZA, NNQC, NNRE, NNXI, NNXM, NNWK, J8XK, NLSY, NLUA, J8XM, NJCS, and NJBQ (Lending, securites and derivatives per sector) scaled by YBHA.

UK Sectoral balances and private debt levels - Q2 2011

Q2 Figures are out.

The external sector is pretty much balanced this quarter, which means that the government sector deficit is entirely down to domestic private sector saving desires..

Interesting reduction in private non-financial savings, down to capital formation according to ONS. Are private companies really investing? Or is this just a dangerous run up in inventories?

Private debt stays at 455% of GDP overall. The amount paid off by households and private companies has been lent out again within the financial sector.

Source: Office of National Statistics, tables RPZD, RPYN, RQAW, RPZT, RQCH, DJDS (Seasonally adjusted Net Lending/Borrowing per sector plus residual error) and YBHA (Gross domestic product at market prices, seasonally adjusted). Private sector debt based on tables J8XI, NLBC, NKZA, NNQC, NNRE, NNXI, NNXM, NNWK, J8XK, NLSY, NLUA, J8XM, NJCS, and NJBQ (Lending, securites and derivatives per sector) scaled by YBHA.