I caused a bit of a fuss in my last post regarding MMT and what I believe is an obscure consolidation of government entities in their accounting. But I want to go into this a bit more because it’s useful to understand in a bit more detail.
Accounting is a nice way of constructing and deconstructing the financial world so we can better understand it. Part of the way we do that is by looking at the various components of the world in terms of sectors. There are households, corporations, governments, and then governments inside the governments, corporations inside corporations and households inside households. These are very general views of the world, but they do provide some perspective. For instance, you can consolidate every financial asset and liability in the world and conclude that they all net to zero. That’s useful for the context of understanding the macro world’s financial relationship to everything, but it’s not that useful for understanding specifics. You have to get really granular for that. The more granular you get the more detailed you can be and the better you’ll understand things.
For instance, to understand the cause of the financial crisis you have to get granular within the private sector. Sure, all of the private sector’s financial assets/liabilities net to zero. But if you want to understand the specific flows and potential imbalances then you have to get more granular. In the case of the housing bubble the household sector took on too much housing debt to fund unsustainable asset price increases. When the asset prices collapsed so too did the household sector’s ability to fund its liabilities. That rippled through the financial sector and the entire economy. The point is, if you lazily consolidate all of the private sector’s financial assets/liabilities then you don’t understand the specific flows that cause certain things and lead to specific outcomes between intra-sector sectors.
In the case of the actual financial world within the government there are many different types of entities that issue different types of financial assets for specific purposes. They issue these financial assets/liabilities for the specific purposes of running a large and complex government that interacts with different parts of the private sector serving different purposes. For instance, the Fed interacts mostly with the banking system to enact monetary policy. It also interacts with the Treasury to help it enact fiscal policy. So, if we consolidate these two entities into “the total government” we obscure the specific policy actions that specifically differentiate monetary policy and fiscal policy. In other words, you are using a consolidated view of the world that obscures the reality of what certain entities do. And while it might be technically true to say that their financial assets and liabilities net to zero, it is specifically misleading because it obscures the real purpose of those outstanding assets/liabilities.
Of course, this is precisely what MMT wants you to think. They hate monetary policy and they want to basically wrap it up into the Treasury’s operations so that we only use fiscal policy as a tool. This is an interesting view and it might even be valid to some degree. Personally, I think it’s a little extreme and although I am not the world’s biggest fan of monetary policy I wouldn’t go to the extreme position of saying it doesn’t do anything or is completely ineffective. In fact, I’ve been pretty clear that monetary policy can be highly effective when inflation is high so it’s a tool that’s better to have and not need than to need and not have. But we should all be clear – while consolidation is useful in a general sense, it is wrong and misleading in a specific sense. And the specific sense is what matters for understanding things properly.
In the case of the private sector the same basic fact is true. We don’t consolidate it into one sector when understanding the intra-sector relationships because that would obscure the way in which we hold net financial assets against other parts of the private sector. And this is where the rubber meets the road when you want to understand how the private sector grows and expands its balance sheet. Sure, it might be useful to consolidate it for the purpose of understanding its relationship against other macro sectors. But if you really want to understand how the private sector grows you need to get granular within the intra-sectors of the private sector.
Look, consolidation is fine for certain purposes and it can even provide some insights that are helpful at a basic macroeconomic level. But if you want to really understand the nuts and bolts of the monetary system and its various components you have to get more granular. Consolidating sectors excessively obscures reality and leads to misunderstandings about how things work and how certain things can work better.
NB – I am of course consolidating equity on the RHS of liabilities. Which is another problem within MMT all on its own…
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.