July 6, 2017

A crash course in macro accounting

Comment on Peter Cooper on ‘Fiscal Policy, Sectoral Balances, and Financial Sustainability’

Blog-Reference and Blog-Reference

You say: “PRIVATE Balance + GOVT Balance + FOREIGN Balance = 0” and “This is an accounting identity, which means it always holds true.

This is NOT the case because you messed up the elementary mathematics of accounting.#1 In order to see this one has to go back to the MOST ELEMENTARY economic configuration, that is, the pure production-consumption economy which consists of the household sector and the business sector.#2

In this elementary economy, three configurations are logically possible: (i) consumption expenditures are equal to wage income Ec=Yw, (ii) Ec is less than Yw, (iii) Ec is greater than Yw.

In case (i) the monetary saving of the household sector Sm≡Yw−Ec is zero and the monetary profit of the business sector Qm≡Ec−Yw, too, is zero.
In case (ii) monetary saving Sm is positive and the business sector makes a loss, i.e. Qm is negative.
In case (iii) monetary saving Sm is negative, i.e. the household sector dissaves, and the business sector makes a profit, i.e. Qm is positive.

It always holds Qm≡−Sm, in other words, at the heart of national income accounting is an identity — the business sector’s deficit (surplus) equals the household sector’s surplus (deficit). Put bluntly, loss is the counterpart of saving and profit is the counterpart of dissaving. This is the most elementary form of the macroeconomic Profit Law.

The balances of the business sector, the household sector, the government sector, and the rest of the world are interrelated as follows Qm≡−Sm+I+Yd+(G−T)+(X−M), and THIS is the correct accounting identity for an open economy (X−M) with a government sector (G−T) and with the business investment I and distributed profit Yd.

Your accounting blunder consists of lumping together the business sector and the household sector. This makes the crucial relation between profit, distributed profit, saving, and investment invisible#3 which amounts to an intended/unintended destruction of valuable information which in turn is contrary to the very purpose of accounting.

Egmont Kakarot-Handtke

#1 The Common Error of Common Sense: An Essential Rectification of the Accounting Approach
#2 (A0) The objectively given and most elementary configuration of the economy consists of the household and the business sector which in turn consists initially of one giant fully integrated firm. (A1) Yw=WL wage income Yw is equal to wage rate W times working hours. L, (A2) O=RL output O is equal to productivity R times working hours L, (A3) Ec=PX consumption expenditure Ec is equal to price P times quantity bought/sold X. For a start it holds X=O. Note that ALL variables are measurable. Ec and Yw appear in National Accounting.
#3 How Keynes got macro wrong and Allais got it right

Related 'Rectification of MMT macro accounting' and 'Down with idiocy!' and 'Is Nick Rowe stupid or corrupt or both?' and 'A tale of three accountants'. For  details of the big picture see cross-references Accounting

REPLY to jrbarch on Jul 7

You say: “Therefore it makes perfect sense to sum businesses and households as the ‘private sector’ who hold these tax credits.”

It makes a real difference whether what you call tax credits are held by the households or by the firms. By lumping both together in what Peter Cooper calls the "private sector" this difference is made invisible.#1

If this is done unintentionally it is sheer scientific incompetence, if this is done intentionally it is what people call cooking the books. If one is not committed to science, though, it is merely brain-dead blather.

#1 For the political implications see Austerity and the idiocy of political economists.

REPLY to jrbarch on Jul 8

Peter Cooper argues: “For the economy to grow in a financially sustainable way, the private sector should normally be allowed to maintain a financial surplus (spending less than its income). For many countries (the majority with current account deficits), this means government needs to spend more than it taxes under normal circumstances.”

Because ‘spending less than income’ is the definition of saving the condensed form of the argument reads: because the households should be allowed to save the government must dissave, because from accounting follows with mathematical certainty that for any surplus there must be a deficit of equal magnitude somewhere else in the economy.

The problem with this argument is that economists in general and Peter Cooper, in particular, do not understand the elementary mathematics of accounting.

The balances of the business sector, the household sector, the government sector, and the rest of the world are interrelated as follows Qm≡−Sm+I+Yd+(G−T)+(X−M). This boils down to Qm=−Sm+(G−T) for I, Yd, X, M = 0.

So, there are two limiting cases: (i) If the household sector’s saving Sm goes up and the government’s deficit (G−T) goes up by the same amount the profit of the business sector Qm remains unchanged. (ii) If the household sector’s saving Sm remains unchanged and the government’s deficit (G−T) goes up the profit of the business sector Qm goes up by the same amount. It holds Public Deficit = Private Profit.

So, the counterpart of an increased public deficit is either increased saving of the households or increased profits of the firms, or some combination of the two. Therefore, to say that the counterpart of an increased public deficit is an increased surplus of the “private sector” obscures important real-world differences.

Worse. In the past decades, US households increased their debt, that is, they were dissaving. So, BOTH private and public households ran deficits. From the formula above follows that this boosts profit Qm TWICE. And this is exactly what has been observed and criticized as a catastrophic deterioration of the income distribution.

So, by arguing for government deficits because the “private sector should normally be allowed to maintain a financial surplus” Peter Cooper is de facto arguing for profit increases of the business sector.#1 He obscures this fact by lumping together the business sector and the household sector to the “private sector”.#2

#1 See also Keynesianism as ultimate profit machine.

REPLY to jrbarch on Jul 9

You say: “So, to me, you are all on the same page, but with different concepts.” You are simply ill-informed. The formal foundations of MMT are logically defective and because of this MMT policy guidance has NO sound scientific foundations. For more details see these comments
REPLY to jrbarch on Jul 10

You say: “you have asked me to move logically from the sectoral balances framework to your own, but I can see no reason to do so?”

There is obviously a gross misunderstanding on your side.

The purpose of my post is to inform Peter Cooper that the accounting identity he starts with is defective and that, as a consequence, the rest of his intro is garbage.

The purpose of my post is NOT to educate jrbarch. And if you “can see no reason” to think logically then simply do not. There is NO need to tell me.

Peter Cooper’s accounting identity is mathematically false. Whether you understand this or not is a matter of indifference.


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