July 29, 2017

Money and time

Comment on Peter Cooper on ‘Self-Imposed Constraints as an Obfuscating Factor’

Blog-Reference

Peter Cooper describes how money comes into the world: “From inception of a monetary economy with a government-issued currency, it is clear that government spending must come before tax payments …. The order of requirements is basically: (i) government defines its monetary unit of account; (ii) government imposes taxes and other obligations that can only finally be settled in that currency; (iii) government spends its currency into existence; (iv) non-government can now obtain the currency and, among other things, pay its taxes and purchase government debt.”

From this follows for the time sequence of spending and taxation: “Since the destruction of something cannot logically occur prior to its creation, clearly government spending (which creates government money) logically precedes tax payments (which destroy government money).”

This suggests that money comes into the world through deficits. This is true in principle but from this does not follow a rationale for ever expanding government debt.

To see this one has to start with the basics, i.e. with the time pattern of transactions and the emergence of deficits. The pure consumption economy is for a start clearly defined by three macro axioms (Yw=WL, O=RL, C=PX), two conditions (X=O, C=Yw) and two definitions (Qm≡C-Yw, Sm≡Yw-C).#1

What is needed for a start is two things (i) a central bank which creates money on its balance sheet in the form of deposits, and (ii), a legal system which declares the central bank’s deposits as legal tender.

Deposit money is needed by the business sector to pay the workers who receive the wage income Yw per period. The need is only temporary because the business sector gets the money back if the workers fully spend their income, i.e. if C=Yw.

Overdrafts are needed by the household sector for consumption expenditures if the households want to spend before they get their income. This time sequence is no problem for the central bank because the temporary overdrafts vanish with wage payments.

The two transaction sequences for the case of a balanced budget C=Yw are combined in Figure 1 which shows the deposits/overdrafts of the household sector at the central bank over the course of one period.
The household sector’s deposits/overdrafts are zero at the beginning and end of the period. The business sector’s transaction pattern is the exact mirror image. Money = deposits is continually created and destroyed during the period under consideration.

As a matter of principle, the time sequence ― spending before income or income before spending ― is NOT an issue at all. The central bank can handle EVERY transaction pattern. What matters is whether the budget is balanced at the end of the period or not, i.e. whether C=Yw.

So we have two cases. First case, the household sector’s spending C is greater than wage income Yw. The transaction pattern in the case of continuous dissaving is shown in Figure 2.
The household sector ends up with overdrafts. As a mirror image, the business sector ends up with deposits. The household sector’s debt increases through dissaving. It holds -Sm = Qm.

The transaction pattern in the case of saving, i.e. C is less than wage income Yw, is shown in Figure 3.
In both cases, the quantity of money = deposits at the central bank increases. In the first case the additional money is in the hands of the business sector (= profit), in the second case the additional money is in the hands of the household sector (= saving).

Now, exactly the SAME holds when government is included. Whether government spending comes before taxes or vice versa is a matter of INDIFFERENCE. It is merely a technical issue and the central bank can handle it without difficulties.

The all important question is whether the government ends up with a deficit or a surplus. If government spending G is greater than taxes T then government debt increases ― analogous to Figure 2 ― and this has NOTHING to do with whether spending comes before taxes or whether taxes come before spending.

Peter Cooper confounds the question of the time sequence of transactions with the question of government deficits/surpluses. The deficit ceiling of the US government refers to the accumulated debt and NOT to short term overdrafts which are only a minor cash management problem as long as G=T.

Egmont Kakarot-Handtke

#1 For the detailed verbal description see ‘How money emerges out of nothing ― the functional account


Related 'Money: from silly stories to the true theory' and 'A tale of three accountants' and 'The ultimate ― analytical ― origin of money' and 'Refutation of MMT: all proofs and arguments you ever need'

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REPLY to Neil Wilson, Matt Franko on Jul 29

Neil Wilson maintains: “Accounting is an historic convention. You tot up *after* the date.”

This is an old cliche from the pre-computer era and it is downright false with regard to money. Money in our days is, in the most elementary case, deposits at the central bank which is nothing else than the debit side of the central bank’s balance sheet. In the general case of a differentiated banking system, this translates into the consolidated balance sheet of the banking sector (= central bank + commercial banks).

So, when the firm wants to pay its workers it orders the central bank to transfer the amount x. The initial deposits of the firm are zero. Then the central bank makes a book entry: firm’s overdrafts -x and worker’s deposits +x. The balance sheet of the central bank lengthens. Thus, money is created out of nothing BY accounting, or UNO ACTU with the book entry, in real time and NOT ‘after the date’.

Money = information, and creation/destruction of money = accounting at the CB.

The problem of economists is that they are storytellers and when it comes to doing the elementary mathematics of accounting, that is, to simply write down effective real world monetary transactions and to eventually sum them up, one-half of their two brain cells burn through.#1

The mathiness problem of economists does not consist in the application of advanced mathematics but in the incapacity to apply the straightforward arithmetic of accounting.#2

The whole intellectual misery of economics reveals itself when somebody says “It’s only an accounting identity”.#3

#1 The Common Error of Common Sense: An Essential Rectification of the Accounting Approach
#2 A tale of three accountants
#3 For details see cross-references Accounting

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REPLY to Matt Franko on Jul 29

You say: “You are redefining "G" as under the NIA, "G" does not include transfer payments.”

This is correct. In order to keep things simple G is spending on goods and services analogous to the consumption expenditures C of the household sector. All other things have to be dealt with separately.

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REPLY to peterc on Jul 29

(i) You say: “EKH, this is more in relation to a previous thread, but you mention it here also that you think money is better thought in general terms as information rather than an IOU. I actually think the IOU construction adopted by MMTers and some others captures the nature of money better.”

This is a misunderstanding. Money = information, and money = public IOU, and money = the debit side of a credit relationship on the CB’s balance sheet are only different ways of expressing the same thing. Whether the IOU takes the form of a clay tablet, a piece of paper, or of a series of 0/1 in the working memory of a CB server is only a question of technical sophistication.

(ii) You say: “So, for example, when you refer to ‘Cooper’s view’ of money as an IOU, it is of course not my view, but a view developed by others who I am in agreement with.”

I am not refuting you as a person but your argument and by implication all others who come forward with the same argument.

The point at issue is NOT the policy proposals of MMT or their proponents but the lack of sound theoretical foundations.*

* See cross-references