Monday, June 10, 2013

Steve Keen and Accounting

Occasionally, I've been asked about Steve Keen, and what I think about him from an MMT perspective. Keen surprises me because, while he seems to understand (more or less) that loans create deposits, and that the private sector generates gross assets by expanding both sides of its balance sheet, he does not extend this insight to the public sector and see how the Government, a currency issuer, creates net financial assets for the private sector.

So he can see how the private sector can become over-levered, but does not see how the public sector can step in to manage this and support aggregate demand through a deleveraging.

Anyway, JKH goes into detail about how Keen is trying to re-create double entry bookkeeping but getting it wrong. Worth reading in full, but here is a key graph:
Third, we turn to what must now be noted as an accounting error of extreme proportions – which is that it is certainly not the case that the Fed draws on its equity account when it acquires assets. The Fed creates reserve liabilities as a result of the payments process that is used in the acquisition of assets. The phrase “loans create deposits”, which has become popularized in the endogenous money view of commercial banks, applies equally to the Fed in its own case of asset acquisition and reserve creation. The equity account is not touched in such a transaction, just as it is not touched when a commercial bank makes a loan and credits a deposit to the borrower’s account.
An accounting error of extreme proportions indeed. Steve lost me at the start of his article when he says:
Double-entry bookkeeping (DEB for short) enforces this equation in two ways. Firstly, it records any Asset as a positive amount, and Liabilities and Equity as negative amounts. Secondly, it ensures that any transaction between accounts sums to zero. So, for example, if a rich aunt died and left you $1 million in her will, your accountant would show that as your Assets changing by plus $1 million and your Equity changing by minus $1 million. It sounds counter-intuitive when you first learn it, but it works to make sure you don’t make mistakes when tracking financial transactions.
Really? This may be a strange artifact of how Steve chooses to model the asset and liability side of the balance sheet, but in standard accounting, a $1M windfall would be booked as an asset ($1M in your bank account) plus an increase in equity to balance that (assets = liability + equity). Maybe it's a "credits/debits" nomenclature thing.

That said, I think the point Steve was trying to make is that all Quantitative Easing does is have the Fed alter the compositional mix (and therefore term structure) of extant assets but not the total absolute quantity of those assets themselves. They are changing $1 for $10, but the amount of money in circulation is the same (bad analogy, it gets the technical elements totally wrong by conveys my intent). I'm also exaggerating, as interest rates on Government bonds are an income channel for the private sector and therefore have a fiscal effect. Nevertheless, the core point still holds.


Blogger Neil Wilson said...

"So he can see how the private sector can become over-levered, but does not see how the public sector can step in to manage this and support aggregate demand through a deleveraging"

Yes he does. The models in his latest videos show the government sector countercyclically spending which dampens and eliminates the collapse initiated by the private sector bubble.

In other words if you pay the unemployed unemployment benefit then things don't get as bad.

See about 15:30

11:55 PM  
Blogger Ramanan said...


Soon more economists are going to sloganeering "aggregate demand = GDP + change in debt".

12:38 AM  
Blogger winterspeak said...

Ramanan: AD = GDP + change in debt has a nice ring to it!

Neil: Thanks for the link.

Well, this does seem like progress and I'm glad to see it : ) I watched both clips, and I didn't hear Keen explicitly say that when an economy is overburdened with private debt, the public sector could step in, run large deficits, and therefore make the debt burden manageable without reducing it in size. The AC analogy he used was more about filling in and making things bearable.

Still, I may be being unfair.

10:12 AM  
Blogger Oliver said...

assets = liability + equity

can also be written as:

assets - liabilities - equity = 0

Which seems to be how Keen prefers to do things.

7:37 AM  

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