I usually agree with Geoff Tily at the TUC on economic issues, and even interpretation. Likewise with Ann Pettifor. But I think we differ on the issue of sectoral balancing wrong. Geoff has a post on the issue on the TUC blog in which he argues:
The whole purpose of increasing government spending is to increase incomes, and the logic of four balances is based on actions not affecting income.
I think we have a difference of opinion, or maybe understanding, on the use of accounting data and identities.
I think sectoral balances show relationships that exist in the economy. Knowing them encourages questioning on how they came to be, and what can be done about the consequences, including what the power relationships that could hinder change might be.
I do not think this analysis implies adoption of a 'household economy' approach or an acceptance that the the economy is constrained to be rearranged within existing means. If accounting data based on sectoral balances helps identify ways to reduce risk, increase return, and rearrange finance to benefit in that process of growth then all well and good: the accounts have done their job. They're not a constraint in that case, they're a planing opportunity.
Arguing anything else is, in my opinion, first to deny that there are accounting constraints in the economy, second that money balances play a key role in it and third that accounting can inform decision making. Geoff may have got this one wrong, I think. But I stress, sectoral balancing is not and should not be a goal in itself: it's just a tool for understanding.
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But sectoral balances do not, from an a priori logical point of view, sum to zero.
Consider a closed economy with public and private sector. Public can borrow/lend from/to private. But there is also a capital stock which either the public or private sectors can invest into. So a reduction in borrowing by the public sector from the private sector, only implies an effective increase in borrowing by the private sector (increase in private sector consumption), if the private sector does not switch its savings from the public to the capital stock.
That’s where the economics comes in. Osborne’s fatal error is to attempt to reduce government borrowing without changing the environment/incentives for private sector investment. This has the sectoral balance consequence that reduced government borrowing implies increased private borrowing. Government borrowing should only ever be reduced when there is a clear expectation of increased private investment (or, bringing in other sectors ignored here, increased borrowing from abroad). If government wants to “cut the deficit” in the absence of increased private borrowing (which should be more properly thought of as reducing the rate of deterioration of the government’s net asset position), then it should be reducing the deficit on current spending, and making public investments in assets which have positive NPV.
Capital stock is an illusion of micro-economics
It does not feature in this euation because it is an artificial subdivide of financial market structuring
In macro what matters is what is really happening, not how markets dress it up
We need to be careful here about the concepts of ‘capital’ and ‘investment’, both of which have mutiple interpretations. ‘Capital stock’ can indeed be interpreted as a financial concept but it can also refer to tangible and intangible assets usable with labour and ‘land’ to produce goods and services. In this latter sense, it is not an illusion but includes real things like machines and buildings.
In terms of sectoral balances, an increase in investment (understood as expenditure on such assets) will have the same outcome as an equivalent reduction in saving (increased consumption) but it will also expand the productive capacity of the economy.
Sorry:
If government wants to “cut the deficit” in the absence of increased private INVESTMENT (which should be more properly thought of as reducing the rate of deterioration of the government’s net asset position), then it should be reducing the deficit on current spending, and making public investments in assets which have positive NPV.
I think that’s a good point Richard-I take what you are saying to mean that:
(I-S)+(X-M) +(G-T) = 0
tells us nothing about the social and economic realities of how a society chooses to spend in reality but gives us the framework of our choices and also allows us to challenge Tory crap about ‘living beyond our means’ when we don’t really discuss what those means are?
It’s an equation
It’s a useful equation
It helps us understand
But it does not, as you say, tell us what to do
I am bemused that anyone should think it does
(I-S)+(X-M) +(G-T) = 0
Is it not the case that rhs of equation identifies change in gdp? So any imbalance on lhs produces increase/reduction in gdp. So 0 represents no change.
The RHS is not GDP
This equation holds at a point in time at which moment it is a statement of fact
It does not define a progression over time
It can tell us what to do indirectly. If we see household and business debt rising, and the trade current account rising, and cintinued fiscal deficit cutting continuing, we could (if we were not George Osborne) predict another serious recession or crisis? I believe this is what the 77 economists were predicting with the letter to him in June?
It was
But then I co-authored that letter
Here is a practical illustration of how an accountancy approach to economic analysis must be taken with a pinch of salt.
Let’s say I have a banana and you borrow it from me in return for paying back two bananas in the future. And then you eat the banana. What does our simple world then look like? One way of looking at it would be that I have an asset of two bananas. I’ve doubled my banana wealth! But actually the world now has zero bananas, they have all been consumed. All I have is a promise for two bananas, and you now have a burden to somehow produce two bananas. In real terms the world is poorer than before the banana consumption.
Oh dear
Bananas are not money, are they?
That’s my point. Converting the real world into money is necessarily limiting our understanding of reality. Life is not about money, it is about real things that we desire and use. Money is mostly a veil covering these things.
But by ignoring money macroeconomics got us into the mess of 2008
“Life is not about money” There’s plenty who would disagree with that!
But accounting certainly is, and it’s incomprehensible that some economists can be so dismissive of the importance that money and money flows have in the economy. We don’t have a recession and high levels of unemployment if we run short on bananas! But we certainly do if we all run short on money. That’s when we need Govt to step in and reflate a depressed economy.
Jamesg,
Just to answer your point about the bananas slightly less dismissively I should say that the net position originally is plus one banana. You lend it to me on a long term loan and you have a net asset of two bananas, I have a liability of two bananas plus the asset of one banana. Net overall position is still one banana.
I eat the banana. Net position is now zero bananas.
So everything makes perfect sense!
So here’s what I do and don’t get about sectoral balances approaches. I understand that any given division of the whole economy (inc it’s net foreign position) must sum to zero.
And I get that tightening fiscal policy is (ceteris paribus) contractionary and loose fiscal policy the reverse.
What I don’t get is the idea that a net private sectoral deficit necessarily entails that total private debt increases, as has David Graeber and a number of economists argued in a recent letter to the Guardian. I see why something similar would be true for the public sector, because the govt must borrow or tax from the private sector, not within itself.
But most private sector debt is surely owed to the private sector, so that increases or decreases in its level are a function not only of the position re the govt, but due to its internal dynamics.
I can see that contractionary fiscal policy may encourage more private debt *if* firms and households borrow more to make up what they’ve lost from changes in govt expenditure minus taxes. But surely there are other ways they could do that – if increased economic activity increases total gross profit or wages, for example. (Osborne’s changes might not produce such an increase, but it’s possible in principle that exogenous changes such as innovation or smart deregulation might.)
So I can see how sectoral balances arithmetically sum to zero, but not how total sectoral debt changes in response with the same arithmetic certainty.
But you are confusing micro with macro
Sectoral balances are stated after netting out imtra-sector balances like consolidated accounts are stated after netting off intra-group balances
I am not sure whether this article is relevant or not. (Sectoral balances are a bit over my head). But I thought it gave an important insight.
http://www.nakedcapitalism.com/2015/11/wait-maybe-europeans-are-as-rich-as-americans.html
As I understand it, the argument is that in the private sector, if Apple makes an iPhone for a few pounds and sells it for hundreds of pounds, the contribution to the economy is valued as the cost of the sale. If the NHS in the public sector spends billions treating patients, that cost is estimated as the cost of supplying the service. i.e. It is formally equivalent to what Apple spends making the phone. If we valued the NHS on the basis of the equivalent cost of private medical treatment, it would be clear that the public own as profitable an enterprise as Apple. However, our dividends are a health service, rather than things bean counters can measure.
Its frustrating to see, the otherwise brilliant, Ann Pettifor being so in awe of Keynes that she overlooks that the world has changed since Keynes day and so ends up unknowingly stuck in the past.
Since her recent tweet that “The concept of sectoral balances belongs to the sphere of accounting, not economics” Ann has further tweeted several times (including the tweet you mention) to generally support this attack undermining the role of accounting.
This feels like a concerted put-down of MMT. Very disappointing from Ann. Perhaps she needs to re-read Keynes words below in particular the word I have put in bold…
Someone needs to tell Ann (and Geoff), tThe contemporary world is a nonconvertible, floating exchange rate currency one (not a the fixed Gold Standard one of Keynes time).
I must say that I’m a bit concerned about some of those on John Mc’s economics advisory panel, especially the neo-keynesians. As you say, things have changed since Keynes’ day. “When the facts change I change my mind”…
Indeed. Wish Ann, who supposedly is a Post-Keynesian, would be more open minded and learn some MMT/stock-flow consistent economics, rather than rubbish it with out-moded arguments.
To my mind the most interesting appointee to the panel is Mariana Mazzucato as she has fairly close ties to MMTists Stephanie Kelton and Randy Wray.
Anastasia is a Minsky specialist
But has reservations about some aspects of MMT
So is Randy Wray, who was a student and colleague of Minsky.
Wray’s new book is “Why Minsky Matters: An Introduction to the Work of a Maverick Economist”
But much better Anastasia Nesvetailova’s book on Minsky
In reply to a previous comment “Sectoral balances are a bit over my head” I’d just make the point that they aren’t that difficult.
We can arrange and interpret this equation to be:
(I-S)+(X-M) +(G-T) = 0
Govt Deficit = Surplus of Private Domestic Sector + External Deficit (Trade and Int. Financial Transactions)
Some might object to this being called an equation. They’d prefer the term ‘identity’. They mean that we can’t say for sure that the Govt Deficit causes the PDS Surplus or external deficit or vice versa. That’s absolutely the case.
Nevertheless, we can say that the two deficits are very closely related. We can’t ignore that relationship.So if we wish to “balance the govt’s books’ then GD = 0
Which means that
Deficit of PDS = External Deficit.
As the external deficit is now about 5% p.a. of GDP this would mean that the PDS, too, would have to be in deficit. That’s you and me! Every year we get poorer to the tune of 5% of GDP to fund the trade deficit unless something is done to reduce it.
This is clearly nonsensical economics and shows the intellectual dishonesty of current govt policy.
So sectoral balances might have some economic and political use after all!
The two key equations which we need to prove the accounting identies are:
GDP = C + S + T (uses)
GDP = C + I + G + (X — M) (sources)
Where C is total consumption. S is Savings. T is Taxation
I is Investment G is Govt Spending. X are Exports. M are imports.
From which we can easily get:
(I — S) + (G — T) + (X — M) = 0
These starting equations are generally accepted and so we can’t say that the sectoral balances are the ‘intellectual property’ of MMT, per se.
It’s just matter of simple algebra.
Richard,
I’ve heard it said (by a supporter of Ann Pettifor’s who also claims to have experience doing company accounts) that sectoral balances, accounting identities etc. are suspect because “there’s accounting and then there’s ‘creative accounting'”.
In your professional opinion, is that a possibility? Just curious as, to me, there’s no such possibility as there is no loop-holes and wiggle room in the field of macroeconomics (unlike say the dodgy accounts booked by Tesco a year or two ago)
This is absurd
The identities involved have been noted here
I’d love to know where the abuse could be
It’s a very poor argument
Thanks Richard, really appreciate your thoughts – Straw man argument as I had imagined.
I am still trying to get my head round sectoral balances, and I may have got them wrong, since there seems to me to be an enormous hole in the concept. To explain where I think there may be a problem, I need to go back two steps.
After 2008, I spent a long time puzzling where all the money that everyone lost had gone. Were there winners and losers, as in a normal transaction? If so, where were the winners? In the end, I had to conclude that almost all the money that was lost just disappeared into thin air.
A couple of months ago, a similar thing happened on a smaller scale. £75 billion was wiped off the value of the UK stock exchange in a single day. Where did the £75 billion go? Again, I think it just disappeared into thin air. Next day £45 billion came back, again just appearing out of thin air. Of course, what happened was that only a small proportion of shares were actually traded, the value of the remaining shares was simply marked down. The shares were still the same shares, but part of the money they were thought to represent just disappeared.
As I see it, money is only truly real when it moves. “Money” held as assets may only have“notional” value, which can appear or disappear overnight. More exactly, most assets will be a mixture of real (realisable or intrinsic) value and notional (speculative) value. When Picasso paintings or gold bars rise in value, notional money appears out of thin air (the “value” of the Picassos and gold bars that are not sold). When they fall, notional money disappears.
Within each sector, there will be real money, notional money and thin air, and there will be movement between these classes. Richard’s argument that bank loans convert thin air to real money fits quite well with this idea. Where a loan is asset backed, then it may be notional money that is converted into real money.
This way of looking at things impinges on sectoral balances in several ways.
1) What happens when £75 billion just disappears out of one sector in one day? No movement of money between sectors has taken place, but the balance between sectors has changed. Movement in and out of thin air within sectors may be a far more significant factor than movement between sectors.
2) Different sectors may have different proportions of real and notional money, and different rates of movement between real and notional, or notional and thin air. If this is ignored, it may give a completely wrong idea of the value of different sectors and the likely effects of specific policies.
3) Government spending must be directed. It needs to be targeted towards real money and intrinsic value. Tax credits create real money, which will be spent and spent again. Infrastructure creates intrinsic value. Tax and spend is a virtue, not a crime. Tax breaks for the wealthy create notional money, which does nothing and can simply disappear. “Helicopter money” may end up anywhere, and almost certainly the wrong place.
Value recording is not money
No money (or at least very little money) flowed when £75bn was wiped off shares
That was money as a measure, not a flow