The last three or four decades have seen a remarkable evolution in the institutions that comprise the modern monetary system. The financial crisis of 2007-2009 is a wakeup call that we need a similar evolution in the analytical apparatus and theories that we use to understand that system. Produced and sponsored by the Institute for New Economic Thinking, this course is an attempt to begin the process of new economic thinking by reviving and updating some forgotten traditions in monetary thought that have become newly relevant. Three features of the new system are central. Most important, the intertwining of previously separate capital markets and money markets has produced a system with new dynamics as well as new vulnerabilities. The financial crisis revealed those vulnerabilities for all to see. The result was two years of desperate innovation by central banking authorities as they tried first this, and then that, in an effort to stem the collapse. Second, the global character of the crisis has revealed the global character of the system, which is something new in postwar history but not at all new from a longer time perspective. Central bank cooperation was key to stemming the collapse, and the details of that cooperation hint at the outlines of an emerging new international monetary order. Third, absolutely central to the crisis was the operation of key derivative contracts, most importantly credit default swaps and foreign exchange swaps. Modern money cannot be understood separately from modern finance, nor can modern monetary theory be constructed separately from modern financial theory. That's the reason this course places dealers, in both capital markets and money markets, at the very center of the picture, as profit-seeking suppliers of market liquidity to the new system of market-based credit.
Flow of Funds Accounts
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Del curso dictado por Universidad de Columbia
Economics of Money and Banking
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Introduction, continued
The next two lectures are meant to introduce a key analytical tool, the balance sheet approach to monetary economics, that we will be using repeatedly throughout the course. As inspiration, first I provide a concrete example of how the approach works by "translating" the Allyn Young reading into the balance sheet language. I follow that with a more systematic introduction to this essential tool.
Conoce a los instructores
Perry G MehrlingProfessor
Economics, Barnard College
of the, a Study of Money flows in the United States.
So, this is, this is Maurice Copeland's book, 1952.
This is a published by the National Bureau of Economic Research, in fact.
And he was proposing this set of accounts that
you're seeing right here as a framework for macroeconomic analysis.
What it is, it's based on this conceptional framework.
Okay. Uses and sources for each individual.
Okay.
But of course, we don't have data for every single transaction for
every individual. Okay.
So there's a lot of sort of aggregation and netting, and things like that.
And that's what makes it difficult for people to understand the flow of funds.
Because they're, they don't have this back in their mind.
Okay.
But this is exactly how it's structured there.
And you can see that it's the whole macroeconomy there.
Okay.
So there's a column here, it's probably too
small print for you to, to read from there.
but the first column, I'll just
read it to you, households and non-profit organizations.
And there's two columns\: the left one is uses and the right one is sources.
Okay?
So, what they're doing is thinking of all households, you know,
all, all households in the whole United States as one entity.
And they're looking down and they're saying, the first dah, dah, dah,
dah, 13 lines well the first 12 lines are sort of the above the line part.
It's the goods,
it's the goods and services part that we're talking about.
Everything below that is the financial assets the, you can
see lines 14 to 22 is basically different kinds of money.
You have US official reserves, you have SDR's, you
have Treasury currency, forigne deposits, you have stuff like that.
And then from 23 on down, these are forms of credit.
Okay?
So, they do it in reverse order from, they put money on top and forms of credit,
credit below in, in, in, in here. And what you're seeing in, in, in,
uses, and they're aggregating, but aggregation will still preserve this rule.
Okay? These rules still apply.
Okay?
And what these rules mean, the consequence of these rules in the flow of funds
account is that the columns, the column sums
are supposed to some to the same number.
So for each column for each column
households, the left hand column. Okay?
Which is uses should sum to same number as the right hand column.
Okay?
It's also sum it rule number two, says that wills should sum to okay, to zero.
and they don't.
You can see these statistical discrepancies here.
That just means that you don't really,
you haven't, your statistical net hasn't captured something.
|Okay?
But you know where the mistake is, kind of.
Because it, the rows
are supposed to sum, and the columns are supposed to sum.
So you kind of know where the, where the problem is.
so there's households, there's non-financial
businesses, there's state local governments.
There's federal government, there's domestic non-financial sectors,
domestic financial sectors, rest of the world.
Okay?
This set of accounts okay, is the concrete instantiation of the point
of view that Minsky was saying in that quote that I gave him.
Right? It's treating every, every unit.
State and local government.
and households, businesses, bank. As if they're banks.
We're thinking about sources and uses of funds.
Okay? For, for all of them.
and this is a a framework for thinking about the economy.
So there's netting, it's, it's a little.
When you look there, you see some of these.
Some of these sources are negative.
That's like an odd sort of concept.
How can there be a negative, a negative source?
This puzzled me when I was trying to learn, learn this sort of thing.
it's, think about they're constructing it. Okay?
They're constructing it by saying, borrowing is a source of funds.
Okay?
If your total quantity of borrowing went down.
Okay?
That's a negative source of funds, so that's repayment.
Is basically what that is.
So, instead of doing it
as we're doing, where we have repayment as a use of funds,
[INAUDIBLE],
they, they, they're treating reduction and debt as,
as a, as a negative, as a negative source.
But that retains these rules.
Okay?
Just, then, the, they're, they're just moving it
to the other side of the balance sheet.
Okay?
And similarly, for, for uses.
Sometimes there are negative numbers in uses.
Okay?
And that's, again, if there's a negative number in uses, it
means you have some financial asset that you've reduced your accumulation of.
Okay? So it's decumulation.
So, if you have in mind these concepts, that
thi, this, that this is the underlying analytical framework.
The underlying conceptual framework.
Apply that to this matrix and you can see it all.
Often, when, when people are using these accounts,
they don't see it in a matrix like this.
You know, they'll just have one table that
tells you what's happening with open market paper.
Okay?
And or, or, or what's happening with non-financial
business or something. But this is the whole set of accounts.
This is macro-economy. Okay?
And what Copeland had in mind.
What he proposed in, in this book right here, he said Caines is wrong.
C plus I plus J equals Y, is
not a good framework for thinking about the macroeconomy.
Because it doesn't take into account personal sales
[UNKNOWN]
financial assets.
It doesn't take into account personal sales of secondary, of,
of goods that are usually, are already produced, like old houses.
You know, this is a very big market in the United States.
this is focusing new, on new production.
And that's all very fine and good.
but there's a lot happening in the economy
other than this, which you're basically just subtracting from.
and a lot of it is involving the monetary system and the financial system.
And you're just treating,
you're just subtracting from all, all of this.
Its not, it's not good enough for understanding the economy.
Similarly, he said umonetrous MV equals PT.
Okay. You're focusing on this M thing here.
Okay?
And, and treating all transactions as if they're made with money.
It's like Owen's daily roast.
The whole economy is like Owen's daily roast.
No, most of the economy is credit transactions.
Okay?
Most of the economy is varelly like transactions, and
you're just absorbing that into this v number here.
Just treating it as if money was just spinning around faster and faster.
These aren't good enough accounting structures for
understanding the modern monetary economy, said Morris Copeland.
I think he was right actually, but he didn't win.
[LAUGH]
And so this became, this was the, these sets counts were collected by a little
division of the Fed up on the fifth floor in the back of the border governors.
People were like an arcane set of accounts.
for years and years and years, they collected them
and kept, kept pouring over them and so forth.
But it was not used for, for economic policy,
because there was no macroeconomic theory that hung onto it.
Right?
The Keynesians grabbed onto this and had a whole macroeconomic theory.
Okay? About how spending causes income.
Okay?
The Monetarists hung onto this and they had a whole macroeconomic theory.
But there was never a macroeconomic theory For, for this.
So, there's a Nobel Prize for you.
Okay? I think there will be.
There will be a macroeconomic theory for this.
But not for flow funds as currently, as currently, it, it is, it is used.
Because, look at these statistical discrepancies.
These are large numbers.
Okay?
Look on the, look on the, the, the last column here.
The largest number there is 115 billion dollars, the statistical discrepancy
for the line 22, which is Fed Funds and Security RPs.
That's the wholesale money market.
Okay?
What this tells you is that the action in the wholesale money market is
not being caught in the statistical net of the of the federal reserve system.
It's not being caught. We, we know approximately
the size of the error, 115 billion, but we don't know exactly where it is.
We don't know where it is.
There's a lot of stuff happening that we
don't know about, and we're trying to make policy.
We're trying to make decisions, and a lot of stuff is happening.
Like only the fed funds, only this fed funds, sorry,
only the flow of funds even tells you this much.
Okay?
[UNKNOWN]
accounts, MV equals PTt doesn't even tell you this much.
Okay?
But fed funds is antiquated.
Okay?
It's a place to start, but it's not a place to finish.
Similarly, look at the sector discrepancies.
These are big numbers.
Household and non-profit organizations, that's
a 561 billion dollar discrepancy there.
Okay?
Where, and, and, and, similarly, large numbers here.
domestic non-financial sectors, $440 billion.
A lot of this is because non-financial
businesses are financial businesses.
These, these, the categories that we're, we're, we're drive,
we've divided things into, we're imagining that GM makes cars.
You know, GM makes cars, sure. Okay?
But they are really a financial institution, they're sort of a bank.
They have got international operations.
and the same is true with, with a, with non, non-profit organizations.
the world has changed
out from under Morris Copeland, 1952. Okay?
And so, the office of financial research which is a division of
the Fed, has been established after
this crisis to create new accounting structures.
Basically, everyone realizes that our accounting is, is in bad shape.
The accounting, corporate accounting for individual corporate accounts.
But I also want to say our
macroeconomic accounting doesn't, isn't designed to capture
the kinds of things we, that are happening in, in the economy today.
one thing you notice there, where's all the derivatives?
You know, where, where, where's the swaps, where's the options?
You know, it's not, there were no such things
at the, in 1952, and so they're not there.
They're all off balance sheet items, all these
exposures, that's why you got all these errors.
You know, that there is a lot
of stuff happening in the economy that's not
being caught even in this set of accounts.
Okay?
A lot of what I'm going to do in this cla, in this class, you'll see, is
to soup up these accounts so that we
can include swaps and derivatives, and so forth.
it's not so hard to do. and so I made a proposal to the OFR.
, maybe they'll accept it.
that this is the direction that, that we should be going.
There is a lot more detail, because I'm not an actual accountant.
I'm, I'm, I'm an economist.
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