Modern Money Theory: A Primer on Macroeconomics for Sovereign Monetary Systems

by L. Randall Wray

But that does not mean that the domestic private sector’s creation of financial assets and liabilities should be ignored. Of course it matters who is in debt and who is the creditor.

Generally, the business sector goes into debt in order to expand capacity to make profits. The household sector goes into debt to buy houses and consumer products; however, the household sector is a net creditor as it accumulates net financial assets – to save for college and retirement, for example.

Scholars outside MMT have tended to focus on distributions of financial wealth within the private sector; MMT has tried to open the discussion to the impact of fiscal austerity on the private sector’s source of outside wealth. These are complementary, not exclusionary, efforts.

it spends less than its income, this is called a budget surplus for the year; if it spends more than its income, this is called a budget deficit for the year; a balanced budget indicates that income equalled spending over the year.

flows (deficits) and stocks (debts).

It is even more difficult to project if and for how long a budget deficit might continue. Projections are darned hard to get right – if they were easy, we would make lots of money placing bets on outcomes.

We have established in our previous section that the deficits of one sector must equal the surpluses of (at least) one of the other sectors.

We have also established that the debts of one sector must equal the financial wealth of (at least) one of the other sectors.

Economics is a social science, that is, the science of extraordinarily complex social systems in which causation is never simple because economic phenomena are subject to interdependence, hysteresis, cumulative causation, and “free will” influenced by expectations.

Keynesian theory.

causation largely goes from income to expenditure.

These liabilities will be accumulated as financial wealth by another household, firm, or government that is saving.

However, it is the decision to deficit spend that is the initiating cause of the creation of net financial wealth. No matter how much others might want to accumulate financial wealth, they will not be able to do so unless someone is willing to deficit spend.

This does not mean that every individual firm or household will be able to issue debt so that it can deficit spend,

but it does ensure that many firms and households will find willing holders of their debt.

We conclude that while causation is complex, and while “it takes two to tango”, causation tends to run from individual deficit spending to accumulation of financial wealth, and from debt to financial wealth.

Aggregate spending creates aggregate income. At the aggregate level, taking the economy as a whole, causation is more clear cut. A society cannot decide to have more income, but it can decide to spend more. Further, all spending must be received by someone, somewhere, as income.

while at the individual level, income causes spending, at the aggregate level, spending causes income.

Deficits in one sector create the surpluses of another. Earlier we showed that the deficits of one sector are by identity equal to the sum of the surplus balances of the other sector(s). If we divide the economy into three sectors (domestic private sector, domestic government sector, and foreign sector), then if one sector runs a deficit at least one other must run a surplus.

“inside debt”

the causation mostly goes from deficits to surpluses and from debt to net financial wealth.

That is to say, there is a desire to accumulate financial wealth – which by definition is somebody’s liability.

will strictly apply to the accounting of balances of any currency.

Still, for every country and for every currency there will be a macro balance equation.

But foreigners or the government can step in to fill the demand gap, buying goods that otherwise would accumulate as unsold inventory.

My household’s income is mostly determined by my employer’s decision to spend on my wages and salaries.

There is also a logical angle: a society can decide to spend more but it cannot decide to have more income (unless it spends more). Spending is thus logically prior.

Each item in the balance sheet of a firm, household, or government records the outstanding amount of an asset or a liability.

The outstanding amount is a stock, that is, the measure of value at a point in time. Stocks are affected by flows because inflows accumulate to a stock, while outflows reduce a stock.

This gives us the first part of the well-known National Income and Product Accounts accounting identity:

(hence the three bars equals sign, which stands for “true by identity”).

This is J.M. Keynes’s well-known “paradox of thrift” – trying to save more by cutting aggregate consumption will not increase saving but reduces income instead.

Global Financial Crisis (GFC),

Such fiscal tightening (called fiscal drag) often is followed by a downturn, and the downturn that accompanied the GFC was no exception.

The automatic stabilizer – and not the bailouts or stimulus – is the main reason why the economy did not go into a freefall as it had in the Great Depression of the 1930s.

With counter-cyclical spending and pro-cyclical taxes, the government’s budget acts as a powerful automatic stabilizer: deficits increase sharply in a downturn.

Lower economic growth could conceivably reduce the US current account deficit – by making Americans too poor to buy imports, by lowering US wages and prices to make our exports more competitive, and by reducing the value of the Dollar.

While we can take government spending as more-or-less discretionary, government tax revenue (government’s equivalent to its income) depends largely on economic performance.

Turning to the foreign sector, exports are largely outside control of a nation (we say they are “exogenous” or “autonomous to domestic income”). They depend on lots of factors, including growth in the rest of the world, exchange rates, trade policy, and relative prices and wages (further, efforts to increase exports will likely lead to responses abroad).

It makes most sense to promote spending that will utilize domestic resources close to capacity, and then let sectoral balances fall where they may. As we will argue later, the best domestic policy is to pursue full employment and price stability – not to target arbitrary government deficit or debt limits, which are mostly nondiscretionary anyway.

One of the most important concepts in macroeconomics is the notion of the fallacy of composition: what might be true for individuals is probably not true for society as a whole.

Exactly how I value the house and car is tricky and subject to accounting rules.

net wealth. That of course will be comprised of real assets plus net financial wealth.

As a result of the Global Financial Crisis, many Americans are “underwater” in home mortgages: the outstanding mortgage debt is greater than the monetary value of their home.

Domestic services, childrearing, recreation and relaxation, and so on are critical and mostly do not involve monetary transactions.

“stock” dimension – accumulation of the knowledge and skills our youngsters will need later

(often called “human capital” by economists).

Financial assets are financial claims on other economic units and real assets are physical things (cars, buildings, machines, pens, desks, inventories, etc.). Financial liabilities are claims of others on the economic unit.

Households , banks, and nonfinancial businesses broadly represent what we call the private sector.

Private sector “inside” financial wealth nets to zero. Only the real asset – the car – remains.