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April 20 - June 6, 2020
issuing cash to the car manufacturer
We call this positive financial balance of the private sector “outside wealth” because it is a claim on an entity outside the private sector.
“Great Recession” in the United States and the “Global Financial Crisis” (GFC) elsewhere.
the current account deficit fell (as US consumers bought fewer imports), and the budget deficit grew mostly because tax revenue collapsed as domestic sales and employment fell.
We should say a word about a more common approach adopted in almost all economics textbooks. And that is to begin with the Gross Domestic Product (GDP) identity (GDP = consumption + investment + government purchases + net exports; which equals gross national income).
NIPA accounts (National Income and Product Accounts)
The “balance” can be either positive, zero, or negative for any sector.
However, the accounting principles that apply to a sovereign currency will still apply (separately) to each of these currencies.
The national currency is often referred to as a “sovereign currency”, that is, the currency issued by the sovereign government.
If any entity other than the government tried to issue domestic currency (unless explicitly permitted to do so by government) it would be prosecuted as a counterfeiter, with severe penalties.
The word “currency” is frequently used to designate not only the money of account adopted by sovereign government, but also to designate a money token issued by the sovereign government and denominated in the money of account.
In other words, we confusingly use the term “Dollar” to indicate both the sovereign currency (money of account) and the money token (paper note or coin) issued by the US government.
Other privately issued money tokens also frequently function as media of exchange – above all, checks drawn on bank deposits (although debit cards are rapidly replacing them).
When I started teaching three decades ago, most students thought the US Dollar had gold backing, that it was valuable because Fort Knox was filled with gold, and if they drove to the Fort with a stash of cash, they could load up their cars with gold.
Today, very few students entertain such beliefs; they have all learned that our currency is “fiat” – it has “nothing” backing it up, or so many claim!
It was thought that if the population could always return currency to the government to obtain precious metal, then currency would be accepted because it would be thought to be “as good as gold”.
In the United States, the Treasury did maintain gold reserves in an amount equal to 25 percent of the value of the issued currency through the 1960s.
And even with no gold backing, US currency is still in high demand all over the world, so the view that currency needs precious metal backing is erroneous.
most governments of developed countries issue a currency that is not “backed by” foreign currencies.
Many sovereign governments have enacted legislation requiring their currencies to be accepted in domestic payments.
(In some cases, the penalty for refusing to accept a king’s coin included the burning of a red-hot coin into the forehead of the recalcitrant, indicating that without such extraordinary compulsion, the population refused to accept the sovereign’s currency.)
We conclude that legal tender laws, alone, cannot explain why currency is accepted.
The typical answer provided in textbooks is that you will accept your national currency because you know others will accept it. In
The typical explanation thus relies on an “infinite regress”: John accepts it because he thinks Mary will accept it, and she accepts it because she thinks Walmart will probably take it.
the authority to levy and collect taxes (and other payments made to government, including fees and fines).
are now able to answer the question posed earlier: why would anyone accept government’s “fiat” currency? Because the government’s currency is the main (and usually the only) thing accepted by government in payment of taxes and other monetary debts due to government. To avoid the penalties imposed for nonpayment of taxes (including prison), the taxpayer needs to obtain the government’s currency.
However, these other uses of currency are all subsidiary, deriving from government’s willingness to accept its currency in tax payments.
It is the tax liability (or other obligatory payments) that stands behind the curtain.
The “promise to pay” that is engraved on UK Pound notes is superfluous and really quite misleading. The notes should actually read “I promise to accept this note in payment of taxes”.
This is really how government currency is redeemed – not for gold, but in payments made to the government.
(Note the asymmetry that is open to a sovereign: it imposes a liability on you so that you will accept its IOU.
Let us say that the government imposes a tax liability equal to one-third of measured GDP.
For example, imposing a tax can drive more production into the “informal market”, leaving measured GDP and taxable income even lower. That is the thinking behind the “Laffer Curve”: higher tax rates are said to lower measured GDP and thus lower tax revenue.)
capture a larger percent of national output, government needs to pursue policies that will (a) reduce tax evasion and (b) formalize more of the informal sector.
While it would be incorrect – for reasons explored later – to argue that taxes “pay for” government spending, it is true that inability to impose and enforce tax liabilities will limit the amount of resources government can command.
The government needs a tax not to produce revenue but to produce sales of labor, resources, and output for currency.
Most people think the purpose of a tax is to raise revenue so government can afford to spend.
To move even more resources, government could try raising the price it pays (but that might fail to actually move more resources – it might just cause inflation), or it can try to increase taxes. But the purpose of raising tax rates is not revenue but rather to increase demand for currency! The
Until government can impose and collect more taxes, its real spending will be constrained by the population’s willingness to sell for domestic currency. And that, in turn, can be caused by a preference for use of foreign currency for domestic purposes other than paying taxes.
While this is not a big problem in developed countries, it can be a serious constraint in developing nations.
It cannot typically tax foreigners in their own countries – that impinges on sovereignty and the foreign government would not allow enforcement of the tax.
At the extreme, it could find no takers even at an infinite exchange rate against the Euro. (Zimbabwe! Weimar!)
Domestically, government can buy anything for sale if it is for sale in terms of its own currency. And it can create that demand by imposing taxes. If stuff is for sale only in foreign currency, the government of Kazakhstan might not be able to buy it with its Tenge, so must face exchange markets.
private banks are our score-keepers.
denominated in a money of account
The central bank will debit reserves of the employer’s bank, by an amount equal to the cashed check.
Unlike water flowing in a stream, or held in a reservoir behind a dam, the money that is flowing or accumulating does not need to have any physical presence beyond ink on paper or electrical charges on a computer hard drive.
Modern treasuries maintain deposit accounts at their bank – the central bank. So the central bank will debit the treasury’s demand deposit by an amount equal to the payment of wages.
Unlike the game of football, in the game of life every “point” that is awarded to one player is deducted from the “score” of another – either reducing the payer’s assets or increasing her liabilities.
help us to remember that money is not a “thing” but rather is a unit of account in which we keep track of all the debits and credits, or “points”. And these “scores” are almost always kept in the sovereign’s money of account.
