Comments on winterspeak.com: Models vs. Accounting

I posted over at Nick's an illustration of how...

2009-11-22T18:04:45.758-08:00

I posted over at Nick's an illustration of how the basic accounting identities are equivalent to basic macro GDP equation:

C + I + G + X - M = Y

Y = C + I (eliminate government & external)

In accounting, debit accounts = credit accounts:

Assets + Expenses = Liabilities + Equity + Revenue

A + E = L + Eq + R

Rearrange to:

R = E + (A - L - Eq)

Revenue = Expenses + net(Assets - Liabilities - Equity)

Which is basically the same as:

Income = Consumption + Investment

So, its nice to know accounting is consistent with macro - in other words accounting DOES describe how the world works - at least as well as macro.

I certainly hope that economics strives to use words in a consistent manner - otherwise I would have doubt as to the consistency of any equations developed.

What I think the issue is with accounting and economics is that classical economics takes a "gods" eye view of things - a position that no economic actor has.

Accounting is more point-of-view oriented - one person's debit is another's credit. This is why economists get frustrated with accounting, they are required to state from whose position they are speaking.

You bring up a great point - without government and external - the economy is zero sum. You can't move beyond the posited starting point (which is always equilibrium).

I don't know how you can even discuss raising interest rates (or even HAVING interest rates) without the government and external sectors - all of which requires a theory of money.

The real economy can create real assets without any money. You and I can decide to collaborate and create an asset (say a song) that attracts other people. We can even create a barter exchange. But we cannot monetize it without money. We CAN create net assets (real), but we cannot create net financial assets without money.

Without a coherent theory of money, economics is playing around equations which are only valid under laboratory conditions - but don't function well in the real world.

Accounting at least brings human behavior in the picture - that economic activity is based on a concept of equity - of equal exchange - and that recording these transactions is absolutely required for a stable economic system.

Hi Nick . . . We agree!!!!

2009-11-17T14:28:02.183-08:00

Hi Nick . . . We agree!!!!

Scott: I can agree with that. If you get the accou...

2009-11-17T13:53:51.173-08:00

Scott: I can agree with that. If you get the accounting right, you can still get the behaviour right or wrong. But if you get the accounting wrong, the behaviour will make no sense whatsoever.

Nick, The distinction is between the BEHAVIORAL m...

2009-11-17T11:43:21.246-08:00

Nick,

The distinction is between the BEHAVIORAL model of, say, C, and the ACCOUNTING IMPLICATIONS for individual and aggregate financial statements of this change in C.

Modelers must get the accounting right or they won't get the implications right.

Best,
Scott Fullwiler

Hi Winterspeak: Certainly (or almost certainly) m...

2009-11-17T05:21:11.840-08:00

Hi Winterspeak:

Certainly (or almost certainly) my parameters (0.25, 0.5, etc) will be wrong. The best I can hope for is that they are "approximately" right. That's what makes my model a model: it says something about how the world works, and what it says cannot be right unless it could be wrong.

Assume a closed economy, with no government, and no investment. Then we can describe the national income accounting identity as c=y. Or equivalently, if we define s as y-c, as s=0.

If we are talking about actual c, y, and s, then those accounting identities must be true. They are true by definition (provided we are using the words c,y, and s consistently.

But if we are talking about desired c and s, they are equations, not identities, and are true only in equilibrium.

Suppose we start in equilibrium, then desired c falls (i.e. desired s rises). We are now out of equilibrium. It is logically impossible for people to do what they in aggregate desire to do. Something has to change to get us back to equilibrium.

In a "classical" model, the real rate of interest will fall until desired c increases enough to once again equal y (i.e. desired s falls back to 0).

(In a keynesian model it is y that falls until desired s=0).

I must do a post on this on WCI. It's a good conversation we're having.