This is a working draft. There is a small chance of errors in the content so far that I will correct as they are uncovered. Expect eventual improvement in usability and features, and coverage of more concepts.
Please post corrections and constructive feedback to the comments section of this placeholder blog post, or email me at thoughtofferingsblog{{at}}gmail[[dot]]com.
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My initial goal with this tool is to help provide some clarity to attempts I see at discussion of the Post-Keynesian schools of Modern Monetary Theory (aka MMT, or Neo-Chartalism) and Circuitism. Words alone can be highly ambiguous and people frequently talk past each other in comments sections with respect to equity, capital, money, debt, etc!
For more information, please visit the blogs of MMT authors such as Bill Mitchell or Warren Mosler, though unfortunately there is not yet a solid concise summary of core concepts available (as far as I've seen).
A longer MMT starting point is Mosler's 7 Deadly Innocent Frauds.
Other Post-Keynesians such as Steve Keen focus more on the horizontal (non-government) than the vertical (government <--> non-government).
There are also papers from the US Federal Reserve and other "official" sources that support this modern understanding of bank loans, reserves, and related concepts (list TBD).
How to Understand and Use This Tool: (click here to show or hide tips)
The difference between assets and liabilities is balance sheet equity (also called net worth), and it can be negative. I don't know if there are established conventions for showing balance sheets graphically but I followed Calculated Risk's example (and part two) of putting negative equity on the left side.
The lower row of balance sheets represents entire sectors (e.g., all households combined into one balance sheet).
The upper row of balance sheets is the real-time summation of the lower balance sheets. The first pair shows "federal government" and "private sector" (ignorning foreign sector, for simplicity, though it could be lumped in this second bucket). To their right, the total economy balance sheet sums everything, and balances to zero equity by definition. It is shown at half scale.
Point the mouse at an asset (in the second row, i.e., excluding aggregates) to see all corresponding liabilities highlighted (because every financial asset is somebody else's liability), and vica versa.
Point the mouse at an aggregate statistic (the orange money and debt bars) to see what it is composed of.
Choose an operation in the menu below the balance sheets, and click 'Run Operation' to see the balance sheet transition animated. To watch again, click 'Reverse Operation' to reverse it, then click 'Run Operation' again. Repeat these two clicks as many times as desired to visualize the aggregate impacts.
Point the mouse at the name below a balance sheet to see a floating copy of how it looked before the last operation, so as to more easily see what changed.
You can edit the operation amount.
The 'Reset Balance Sheets' button restores the default set of sample values. These are made up numbers for simple illustration, not real economic data.
The assets and liabilities with a yellow border during animation of an operation are those being directly modified by the operation.
This page shows only financial assets and liabilities. Tangible assets (machinery, real estate, etc) are an important part of real world balance sheets also, but are not affected in the same way by the various financial operations shown here.
Excluded for simplicity: state and local governments, the foreign sector, and non-profits.
Choose Operation:Operation Amount:Invalid Operation: One or more balance sheets has insufficient assets or liabilities. Try another operation first or reset the balance sheets.
Details of selected operation:[Direct link to this operation]
SHOWN:
Households buy goods and/or services from companies.
EFFECTS:
Transfer of balance sheet equity from buyer to seller.
Generates income for the seller, and contributes to Gross Domestic Product.
SHOWN
Government (treasury) buys goods and/or services from household sector.
Households deposit proceeds in bank accounts.
Related Operation: The government paying interest/dividends on its treasury debt owned by the private sector is exactly equivalent to this from a balance sheet perspective.
EFFECTS:
Government generates larger private sector equity (wealth) by making its own financial balance sheet equity even more negative. This is one of the core points of emphasis of Modern Monetary Theorists.
Treasury spends by reducing its deposit account balance (held at the central bank) and increasing the reserve balance at the bank where the recipient has an account. The recipient's (in this case, household's) bank deposits rise to match.
As emphasized by MMT, there is no theoretical limit to this spending for governments that issue their own non-convertible currency. Just run the "Government Issues Debt" operation next, and then you can repeat "Government Spends" once again. In fact I have combined the two in a "Government Spends (Consolidated)" operation to make this clear.
Banking sector expands assets and liabilities (due to increased deposits) but its equity is unchanged.
Generates income for the private sector, and contributes to Gross Domestic Product.
SHOWN
Government (treasury) taxes the household sector.
Payments by households reduce their deposits held by banks.
EFFECTS:
Taxation is effectively the exact opposite of government spending with respect to balance sheet impacts.
Taxation reduces private sector balance sheet equity (wealth) and ultimately its spending power, and happens to make government's own financial equity less negative as a side effect. But Modern Monetary Theorists emphasize that the role of taxation is to reduce the demand of the private sector by an appropriate amount so as to control inflation, NOT to accumulate "money" for future spending, because a currency-issuing government is never revenue-constrained — see the "Government Spending (Consolidated)" operation.
Banking sector assets and liabilities shrink as a result of reduced deposits, but its equity is unchanged.
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Government (treasury) sells treasury debt (bonds, bills, notes, etc) to the household sector.
Payments by households reduce their bank deposits.
EFFECTS:
This simply swaps deposits for treasuries on private sector balance sheets.
Bank assets (reserves) and liabilities (deposits) are reduced by equal amount to match.
This is how the Treasury expands its balance sheet — it increases its assets (reserves) by drawing them out of the private sector, and creates new liabilities (treasuries) to match.
SHOWN
This combines into one operation the balance sheet effect of two others: "Government Spends" and "Government Issues Debt". Try them in turn and then try this to see they have the same net effect.
This example shows the government spending money on the household sector but it would work the same with the corporate sector.
EFFECTS:
The effect of this combined operation is that the treasury generates income and wealth for the private sector by increasing the private sector's assets (treasuries) and thus also its balance sheet equity.
In reality a household or business would get increased deposits (backed by bank reserves) that were spent by the government, then it would spend them on goods/services from other households or businesses, and then the government would typically sell the bonds to those secondary households or businesses to give them a more favorable yield on their new savings as well as to influence interest rates. Because this tool currently just shows the entire household sector aggregated, those intermediate intra-sector transactions are obscured, but the net macro-economic impact should still be clear.
One objection might be that the treasury might fail to sell the bonds and thus be unable to replenish its own assets (deposits), but the reality is that these auctions never fail in a non-covertible-currency-issuing sovereign nation (like the US) because the market knows that the treasury and central bank together are never operationally constrained in their spending. Even in the European Union (which does not fall under this category of currency and has serious inherent limitations), the European Central Bank has in 2010 been buying sovereign bonds of Greece and other countries in the secondary market, and the only limit to this is political.
Note that this combined operation doesn't even involve the Central Bank! The Central Bank's role is simply to transform the "right" number of treasuries into reserves and currency to set interest rates and to provide a transaction-friendly money supply (currency and reserves). The Central Bank's operations just remove one type of financial asset from the non-government sector and give it another kind of financial asset in exchange.
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A household withdraws currency (notes and coins) for use in making cash payments (or to store under a mattress!)
EFFECTS:
Household bank deposits are replaced by currency on the asset side of the balance sheet.
Bank balance sheets shrink as assets (currency) and liabilities (deposits) are reduced.
If banks run low on currency, the central bank can exchange reserves and currency as needed (this operation is not shown in this tool).
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Exact opposite of currency withdrawal (see notes on that operation).
EFFECTS:
SHOWN
A bank lends money to a household (but a loan could also be to a company).
EFFECTS:
Loans create deposits! Banks do not lend out reserves! The only constraint on lending, other than the ability to find credit-worthy borrowers, is regulatory capital ratios and reserve ratios for banks. Many countries don't even bother with reserve ratios as they make little difference given that the central bank provides unlimited reserves to the banking system to support its target overnight interest rate. [To be expanded on in a future update].
Both bank and household balance sheets expand with new assets and liabilities, but neither's balance sheet equity changes.
Both broad money supply and private sector debt are increased.
SHOWN
This shows a household paying interest to the bank on its loan.
EFFECTS:
This results in a transfer of balance sheet equity from the borrower to the bank, which is the same effect as private sector spending.
SHOWN
A household repays some (or all) of the principle from a bank loan.
EFFECTS:
The effect is the exact reverse of the original loan — bank and household balance sheets shrink but balance sheet equity is unchanged.
Both broad money supply and private sector debt are reduced.
SHOWN
A household defaults on some (or all) of its bank loan.
EFFECTS:
The individual household's liability (loan obligation) is reduced, as is the bank's asset (loan).
Bank balance sheet equity is reduced, and household balance sheet equity increased. An individual household is likely to be insolvent (negative balance sheet equity) when filing for bankruptcy, but other households or companies will have benefitted from its spending before bankruptcy. And the default itself increases net worth whether the starting point is negative or not.
From a macro balance sheet perspective, the combination of a new bank loan and then a default is functionally equivalent to the bank giving a "gift" of currency to the household sector, which the household sector then deposits back to an account at the bank. With too many defaults banks can become insolvent (negative equity), requiring bankruptcy, private capital infusion, or government bailout.
Loan defaults reduce private debt but not broad money supply (since the deposits resulting from the original loan are still in circulation outside the bank, at a cost to the bank's balance sheet equity).
SHOWN
This example shows a company issuing a bond which a household buys.
EFFECTS:
Horizontal borrowing of this sort expands the balance sheet of the borrower with a new asset and liablity (and no change in balance sheet equity).
The lender simply has one asset (deposits or currency) transformed into another asset (a bond).
Non-bank borrowing increases private sector debt but not money supply.
Too much horizontal borrowing can make an economy vulnerable to debt deflation as first described by Irving Fisher during the Great Depression.
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Company pays interest on its bond to the lender (household).
EFFECTS:
Just like bank loan interest and private spending, this transfers balance sheet equity from one entity to another.
SHOWN
In this example the company repays some or all of its bond obligation to the household.
EFFECTS:
The borrower's assets (bank deposits) and liabilities (bonds) are reduced with no change in balance sheet equity. The lender's assets are transformed from bond assets back to deposit assets.
Debt is reduced but broad money supply is unchanged.
SHOWN
In this example the corporate borrower defaults on some or all of its bond at the expense of the household lender.
EFFECTS:
Borrower liabilities (bonds) are reduced and lender assets (bonds) are reduced.
Effectively equivalent to a gift of balance sheet equity from the lender to the borrower.
Debt is reduced but broad money supply is unchanged.
SHOWN
An existing bank loan is securitized and sold to a company that wishes to hold it as an investment.
EFFECTS:
Bank assets (the loan) are reduced, as is the bank liability (deposit) of the company buying the security. The company's asset (deposit) is transformed from a deposit to a securitized loan.
Broad money supply is reduced but private debt is unchanged. The combination of a new bank loan and then its securitization and sale to a non-bank is equivalent to a private sector bond offering, and likewise results in debt increasing faster than money.
Like bond issuance and other non-bank borrowing, securitization of loans has contributed to dramatic increases in debt to GDP ratios and made economies vulnerable to debt deflation as described by Irving Fisher.
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Quantitative Easing (QE) is when the central bank buys treasuries (or private sector securities) with newly created "money".
In this example the central bank buys from the household sector.
EFFECTS:
Quantitative easing simply swaps one type of asset on private sector balance sheets (e.g., treasuries) for another (deposits backed by bank reserves, or currency).
No sectors see any change in balance sheet equity.
The central bank balance sheet expands as it draws in assets from the private sector and creates new liabilities (reserves and/or currency) to offset.
Modern Monetary Theorists point out that from a macro perspective this may be deflationary as it replaces a higher yielding asset (treasuries) with a lower yielding one (money), reducing the dividend/interest income paid to the private sector by the government!
Broad money and base money both increase. This does not mean loan-driven inflation now or in the future, as banks never lend out reserves, rather loans create deposits (see "Bank Loan" operation).
This can be argued to lead to asset price inflation as the holders of now more numerous low yielding deposits and currency may desperately bid up asset prices in a search for yield, but whether this leads to inflation in the real economy depends on the extent to which this induces a subsequent increase in private sector demand for goods and services..
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Open market operations by the central bank are used to set the supply of reserves in the banking system in order that the short-term (overnight) interest rate hits the central bank's policy target.
To raise the overnight rate toward the policy target, the central bank sells government debt, in exchange debiting reserves from the banking system. This decreases the supply of reserves that are loanable between banks in the overall banking system (banks need reserves to meet reserve requirements and clear payments), thus raising the overnight interest rate.
EFFECTS:
SHOWN
Open market operations by the central bank are used to set the supply of reserves in the banking system in order that the short-term (overnight) interest rate hits the central bank's policy target.
To lower the overnight rate toward the policy target, the central bank buys government debt and pays with newly created reserves, thus increasing the supply of reserves that are loanable between banks in the overall banking system (banks need reserves to meet reserve requirements and clear payments). This lowers the interest rate.