“Add that to a household balance sheet that includes market value, and you net to book value of corporate equity.”

There’s no stock version of bonus households “get” from the net worth of firms.

The equation is a simple addition of net worths across sectors – a simple mathematical addition for the whole economy or a subgroup of an economy. Because an economy is bigger than “households”.

Households do NOT behave as if equity is valued at book value. Neither G&L nor SNA claims so. Equities in households’ assets is the *market value*. So if there is a boom in the stock market, households would tend to spend more.

“The difference from Fed Flow of Funds is that (K + I) is effectively valued to include corporate book value instead of market value.”

The K+I is valued according to market price as a general rule – i.e., current/replacement cost. So real estate is valued at market price. Capital goods at their current replacement price. And inventories at current cost of production (not at the price at which firms are expected to sell them).

Equities are treated as if they are equivalent to debt securities. Even for debt securities, if the market value of bonds rise to $103 or fall to $97 – having initially priced at $100, corporates liabilities increase or decrease respectively.

So there is absolutely no reference to historical costs whatsoever. Nothing called book value appears anywhere.

If I add net worths of sectors as per Z.1, I get a huge value – simply because of the fact that equities exist as assets in households’ balance sheets and do not appear as liabilities in corporates’ balance sheet.

But why would I do that? In order to do so, I have to change the definition of numbers obtained from Z.1 so that it is more SNA consistent. Fortunately, it is easy. Just move the item “market value of equities” in Z.1 above “net worth” to get the SNA definition of net worth.

What is the purpose of addition? Not to “add anything to the household balance sheet” but to confirm that the sum of net worths of an economy (in the case of a closed economy, at any rate) is equal to the value of tangible capital. i.e., financial assets cancel out with counterpart liabilities. To double check.

I do not know what the issue is really.

Not sure I can work through your equations above.

But NIPA does not include cap gains. Everything is done at book value, in effect.

Looks like SNA tries to fit itself to NIPA results as much as possible, which is why it would effectively strip out market values.

Fed Flow of Funds incorporates cap gains on the household balance sheet. So the end result is a net worth position that reflects the market value translation of corporate equity book values, as I’ve said before. It’s intended to represent what people (households) see in their portfolios, including real estate and financial assets in total. The entire corporate sector is seen through the prism of how the household views it and values it, and everything is intended to be represented that way.

Household Net Worth + NW (firms) + Govt Net Worth = K + I.

The difference from Fed Flow of Funds is that (K + I) is effectively valued to include corporate book value instead of market value.

The Fed shows corporate equity claims directly on the household balance sheet, which is why it doesn’t add a corporate net worth item to household net worth.

The only reason LG/SNA gets away with adding the first two items is because of the artificial definition of corporate net worth to mean book value minus market value. Add that to a household balance sheet that includes market value, and you net to book value of corporate equity.

This is an artificial construction of corporate net worth to facilitate adding the 4 sectors together. That’s what it’s all about. LG/SNA wants to show additivity.

The other difference is that the Fed report doesn’t subtract (NFA) as negative government net worth.

It’s also possible LG/SNA includes a value for real assets held separately by the government. I wouldn’t know. That would obviously not be included in the Fed report.

“This may be a fool’s errand, because it’s equally obvious that shareholders have an equity claim on that net worth, so you can’t depict both — and add them — without double-counting. (Right?)”

Right – that’s why the Fed Flow of Funds doesn’t do it.

Q is a red herring from the Fed Flow of Funds perspective. It incorporates equity claims on household balance sheets at market value, which means it incorporates Q in doing that.

And it has all the information on historic cost and replacement value (from corporate balance sheets) that you could want otherwise.

My guess remains that LG/SNC substitutes the book value of equity claims for the market value of equity claims, IN EFFECT, compared to the Fed calculation …

… BUT, they/it go through a torturous manipulation whereby they define “net worth” of corporations as the book value of equity minus the market value of equity. They then define “net worth” of households to include market value of equity, which is the same treatment that the Fed report does directly. LG/SNA then adds those two to arrive a result which is what you’d get with the Fed report IF it used book value instead of market value. This is a very artificial construction and an equally artificial result.

That’s the only way I can reverse-engineer this whole discussion to some seemingly likely interpretation of what’s going on with LG/SNA.

But I’m getting tired of the guessing game, given that I know how the Fed report does it, and it serves the overall purpose very well.

“I don’t get it actually.”

It’s the SNA interpretation of my example a) from # 8 above.

The example is quite feasible in terms of entries, along with the other two.

I was hoping we were past that stage.

Sorry should be:

SNA doesn’t add corporates’ net worth to households’ balance sheet. These two are separate.

Of course assuming I at the start of the comment is instantaneously created.

Else one has to bring in how firms create this and what it hires etc.

I don’t get it actually.

Suppose a firm invests I and finances the purchase by issuing equities. Households fund this. The firm pays another firm. Household net worth does not change because it is holding equities instead of deposits.

Firms have an additional asset I and a deposit I – because another firm is holding it and the full firm sector has these two assets. There is no change in firms’ liabilities because equities are excluded from the liabilities.

So the Z.1 net worth of firms changes by 2I!

In the SNA it changes by I because equities issued are counted in liabilities. Because firms have a nonfinancial asset I and a deposit I now and a new liability I.

Hence the net worth of the whole nation changes by I – exactly how it should be!

Now it is not necessary to say to it doesn’t matter behaviourally. Because firms will give dividends and hire more etc and this increases the demand in the whole economy.

Suppose the stock price starts rallying. Households’ net worth increases and that of corporations decreases but the latter isn’t an issue really.

And if there is a stock market rally, households feel richer and consume more as many behavioural economists say.

So in the SNA stock market rally or a dip does lead to behavioral changes because households’ net worth is changed as a result of the market value of equities held as assets in their balance sheet.

Now of course, the catch here is that in Z.1 one can say it one shouldn’t blindly go around adding the net worth of households and corporates.

But here’s the trouble with Z.1 – it treats foreigners’ holdings of equities as if it is not a liability of the corporation. Well firms can liquidate their equity assets and purchase the corporation’s bonds. Suddenly, the nation become more indebted? But lets just keep that discussion for another day.

“The full difference is that Z.1 excludes BOTH the asset value I of corporations AND the so-called liability value of the market value of equity from the calculation, meaning that the Fed calculation excludes direct reference to corporate balance sheets ENTIRELY.”

Sorry I did not get this. Are you talking of households’ balance sheet?

SNA doesn’t add households’ net worth to corporates’ net worth. These two are separate items.

But the accounting identity derived is that the sum of net worths is equal to the tangible capital. An identity and nothing more. Just a statement of the whole nation. Neither do G&L.

I think you should simply ignore everything said in Table 3 of the paper referred. It doesn’t appear anywhere before or after.

Btw, column 7 is right. Just change the sign of NW in firms in Table 3 and the equation below.

So Households’ Weath + NW (=firms’ net worth) = GD + K + I

bring GD to the left

Households’ Net Worth + NW (firms) + Govt Net Worth = K + I.

(which is different I from the same comment above)

which is the same as in G&L.

If the cb wishes to set a target rate above zero, then govt is providing the funding for the ability to set rates, so it more of an operational expense than a subsidy to savers.

The question is whether this expense for the ability to set the rate above zero justifiable. And is it appropriate for a smal group of unelected and unaccountable technocrats to control the monetary policy of a country. Some see this as anti-democratic political and a command system economically.

Therefore some MMT economists, Warren Mosler for one, recommends that the cb set the overnight rate to zero, which is “the natural rate” in Mosler’s terms, and leave the adjustments to the economy to fiscal policy, which is arrived at democratically by temporary office-holders who are periodically accountable to the public at the voting booth.

MMT economists argue that fiscal policy is economically superior to monetary policy anyway, since it can be tightly targeted whereas monetary policy is blunt instrument in which there are inevitably winner and losers, i.e, savers and borrowers. Why should the cb be using monetary policy to target inflation using a buffer stock of unemployed as a policy tool, which is what it dones now. Why should the cb favor savers or borrowers in controlling for inflation when monetary policy is rather inefficient and ineffective in comparison with the sectoral balance approach and functional finance.

But isn’t paying IORs equally a subsidy?

Yes, we’re doing both now, but (haven’t thought this through) absent bonds, would IORs (have to) be higher?

As Warren Mosler first pointed out in “Soft Currency Economics” (1994), the operational purpose of tsy security issuance under a non-convertible floating rate system (“soft currency”) is to drain excess reserve introduced by govt fiscal deficits. Tsy issuance is an interest rate management instrument.

However, if the cb pays interest on reserves equal to or greater than the target rate, then tsy issuance is not operationally necessary. Actually, the Fed is paying IOR now, obviating the operational need for tsy issuance.

Even though operationally unnecessary under the present monetary system, Tsy issuance is mandated politically, in that the Treasury cannot run an overdraft at the Fed.

What this means is that a political decision has been taken to provide a subsidy in form of interest on a default risk-free credit instrument.

Then the question becomes whether this subsidy is justified by some overarching public purpose that counterbalances the inefficiency incurred. Based on this some MMT economists, but not all, have called for ending this extraordinary subsidy for savers, which also creates fiscal drag, adding to the deficit reducing fiscal space for other more contributory uses, such as lowering taxes or increasing public investment.

Max :

In the case of government guaranteed bank deposits, it’s like buying government bonds for the depositor, but like selling corporate bonds for the bank. The difference in yield is an unearned profit for the bank (does Mankiw mention this in his textbook? )

I would only defend the system here by saying that in return for those insurance payments, and regulations/restrictions on their activities, banks get a license to print money (with regulations and restrictions on that license.) Generally a (at least potentially) balanced deal.

But government bonds in general are another story, perhaps. Govt pays interest on risk-free holdings. Yes, that’s what the market wants/demands, but is govt obligated to provide it? Could just print dollar bills instead of t bills…

In return for distorting the market by giving free income to banks, government gets the ability to manage the market via OMOs.

Is it worth it? I dunno.

Max :

The desire to invest implies a desire to postpone consumption, but the reverse is not true; you can postpone consumption without investing by holding safe financial assets or paying down debt.

The desire to postpone consumption, without the desire to take risk, can only “fund” government spending, not private spending.

Very nicely put.

Yes, but no. Definitions of “save.”

We can “economist save” (increasing national savings) by creating more real assets, and consuming less of them. (Saving does not equal investment; saving is investment. And vice versa.)

We collectively save in a given period by producing assets that we don’t consume in that period. (By definition, these assets are investment goods — structures, hardware (equipment), software, and inventory. If they were consumed within the period, they’d be consumption goods.)

But that has nothing to do with individual’s and businesses’ decisions (even in aggregate) to “save” or spend. When you spend less, you’re keeping the “savings” in your bank account. When you spend more you’re transferring them to firms’ bank accounts. Individuals own firms, so…

Investment is economist-/national-saving. Not-spending (vernacular saving) does not do investment — the exact opposite in fact.

Household Net Worth (not including Equity Ownership of Firms’ Net Worth)

Again, the Fed calculation ends up at MVEC.

Your calculation ends up at “I”, which is an entirely different number.

This is how I ended up with one bit of the preceding, Firm’s Net Worth = Cap Gains

Dammitall, you just can’t not call household’s equity claims an asset.

Basically, translating the accounts into the terms of vernacular usage. Yet again, probably a fool’s errand.

Godley (still assumes that ony households consume and only firms invest, but FIRMS CAN SAVE)

Household Income = Earned Income + Cap Gains – (Profits – Dividends)
Household Saving = Earned Income + Cap Gains – Profits + Dividends – C

Firm Income = C + I
Firm Saving = C + I – Earned Income – Dividends = Cap Gains

NIPA
Household Income = Earned Income – Cap Gains + Corp Profits (attributed)
IOW:
Household Income = Earned Income + Undistributed Corporate Profits

Household Saving = Earned Income – Cap Gains + Corp Profits – C

Firm Income = C + I – Earned Income (wages/compensation) – Profits (attributed as income to households) = 0
Firm Saving = C + I – I – Earned Income – Profits (attributed to households) = 0

I got an aha from this:

This is because Tobin’s q is greater than 1 (line 38)
Only when Tobin’s q = 1 can one get “intuitive” results.

Understanding (changes in) book/historical/replacement/market value — and representing their relationships clearly — is obviously crucial to this project.

What’s driving me is the wish to give a presentation of national net worth (and flows that drive that), broken down into household, firms, govt, (banks), that a reasonably savvy businessperson/financier could understand quickly and fairly intuitively. With very few (one or two?) assumptions/caveats/footnotes attached. (i.e. “Note that firms’ net worth does not include retained earnings.” Or similar.)

In that “intuitive” view, firms have to have net worth — because they seem to, so apparently.

This may be a fool’s errand, because it’s equally obvious that shareholders have an equity claim on that net worth, so you can’t depict both — and add them — without double-counting. (Right?)

Also would like to see (as in Godley) cap gains treated as household income and retained earnings not treated as such — because that’s how people think about their income.

Also retained earnings increasing a firm’s net worth, because again, that’s how people think about it intuitively.

Again, perhaps a fool’s errand.

I came across the following, btw, which seems illuminating:

The long-term average value of q is below 1 because the replacement cost of company assets is overstated. This is because the long-term real return on corporate equity, according to the published data, is only 4.8%, while the long-term real return to investors is around 6.0%. Over the long-term and in equilibrium, the two must be the same.

The major cause of over-valuation of assets is almost certainly due to their economic rate of depreciation being underestimated.

http://www.smithers.co.uk/faqs.php

I’ve got some other observations regarding some of the numbers you referenced at your # 20 above, but would like to clarify the point in my # 24 first.

You say:

“SNA includes market value of equities in corporate liabilities. The residual then is the net worth. Hence one can add the net worth of households and corporates. Because equities issued by firms and held by households cancel out.

So the simple difference is that Z.1 excludes equities in liabilities and SNA includes it. That is the only difference. Both use “net worth””

I’m not sure I follow this.

First, let me do an example using the Fed Flow of Funds methodology. I’ll then try to compare your methodology using the same example.

Fed methodology:

Suppose business invests “I”, funded entirely with an equity claim EC.

Then conventionally calculated corporate net worth = “I”, where “I” is valued on some basis – historic cost, market value, whatever. That doesn’t matter for the purpose here. Just assign it some value “I”. That’s conventionally calculated corporate net worth in this case, given the simplicity of the balance sheet example.

Suppose the only asset held on household balance sheets is the equity claim EC.

The Fed Flow of Funds calculates the net worth of the household sector:

First, it observes the market value of EC (not the value of “I”).

Call that MVEC.

Then the net worth of households, in this example, = MVEC.

Whatever the direct valuation basis of I is, there is no reason why MVEC is the same value.

MVEC is what it is, calculated by the market.

The net worth of the household sector so calculated as MVEC is then a comprehensive picture of net worth across both the household and corporate sectors. Corporate sector net worth, translated at market value, is a subset of household net worth (in this simple example, the entire value; other non-equity claim financial assets and direct residential real estate etc. could be added at this point).

This is all consistent with what I’ve been describing generally.

Your methodology:

To repeat your statement from above:

“SNA includes market value of equities in corporates’ liabilities. The residual then is the net worth. Hence one can add the net worth of households and corporates. Because equities issued by firms and held by households cancel out.

So the simple difference is that Z.1 excludes equities in liabilities and SNA includes it. That is the only difference. Both use “net worth””

I’ll use the same example, and you can tell me if I’ve got it right:

As above, the conventionally calculated net worth of corporate balance sheets is “I”.

But modified, SNA corporate net worth, I think according to the above, would be (I – MVEC).

Household net worth would still be MVEC.

And the sum of the two would be “I”.

Is that right?

If so, it is critically NOT the case that the “only difference” between Fed and SNA treatments is that “Z.1 excludes equities in liabilities and SNA includes it”.

The full difference is that Z.1 excludes BOTH the asset value I of corporations AND the so-called liability value of the market value of equity from the calculation, meaning that the Fed calculation excludes direct reference to corporate balance sheets ENTIRELY. Indeed, this is an obvious fact with regard to Z.1. But saying it this way may be how to compare it to the SNA calculation.

I think this is why I was having so much trouble understanding your earlier explanations.

Again, the Fed calculation ends up at MVEC.

Your calculation ends up at “I”, which is an entirely different number.

And “I” is derived as the sum of two “net worth” calculations, one of which is in my view an artificial construction designed to eliminate partially the effect of the other (i.e. eliminate the direct effect of equity claim ownership per se). The rationale for this presumably is to smooth out the effects of stock market volatility from the total net worth calculation. But given the utility of tracking stock market value from a purely economic perspective, I vastly prefer the Fed approach on this. For example, stock market value has obviously been of great importance in explaining the nature of the recession, and there’s no way that households view their own portfolios and factor that view into their behavioral decisions as if it directly reflected the value of physical corporates assets instead of stock market value. And the underlying corporate asset valuations that are tracked by your approach can always be backed out through supplementary analysis. Assuming my interpretation is correct I think it’s a bad idea for the main net worth calculation event.

So “SNA net worth” of corporations is, effectively:

“Conventionally calculated corporate net asset value, additionally net of stock market value”

Correct?

The desire to postpone consumption, without the desire to take risk, can only “fund” government spending, not private spending.

I feel like I tend to defend mainstream economics when I’m commenting here, so, staying in that role, I’ll take a stab at defending Mankiw as well.

In fact, I’ve seen this sort of criticism of Mankiw before–some time ago, Bill Mitchell wrote a blog post in which he totally misconstrued a similar passage from the textbook.

When thinking about the loanable funds model, it can help to replace “funds” with “resources”. Put like that it’s very clear that saving does increase the supply of loanable “funds” (i.e. resources).

Think of the most simple single sector closed economy model you can. In any time period there is a basic choice facing society between consuming resources and investing them. In this model a decision not to consume (i.e. to save resources) is necessarily a decision to invest, and a decision to invest is necessarily a decision not to consume.

Hence, not consuming resources really does increase the total available to invest, and consuming resources really does decrease the total available to invest. That’s just how life is on Planet 3.

That’s helpful, thanks.

However if I define Net worth as per SNA, I can add them easily and there’s is no double counting.

Yikes

should be:

For firms it displays equities (but at market value) in memo.

Yes will try to do an example.

However, there is nothing much in my opinion. This is because national accountants have differences with business accountants.

Since the market value of equities fluctuates everyday, the net worth is a balancing item. It’s a residual.

Even in the case of the US, the Z.1 uses market value of equities as in B.102

For firms it displays equities as liabilities (but at market value) in memo.

However it’s Net Worth is defined as Assets minus Liabilities excluding equities from liabilities altogether. Line 32 in B.102 of Z.1

So even though the market value of equities appears as assets in households’ balance sheet, it does not appear in corporates’ balance sheet.

Hence adding households’ net worth to corporates’ net worth by taking numbers from Z.1 will produce a huge number. (Because there is no cancellation).

SNA includes market value of equities in corporates’ liabilities. The residual then is the net worth. Hence one can add the net worth of households and corporates. Because equities issued by firms and held by households cancel out.

So the simple difference is that Z.1 excludes equities in liabilities and SNA includes it. That is the only difference. Both use “net worth”

If I use numbers from Z.1 and do it the SNA way, net worth of corporations in the US will be much lower. Z.1 shows a very high net worth for corporations.

So according to Z.1 the net worth of Nonfarm Nonfinancial Corporate Business at the end of Q3 2011 is $13,160.6bn but from an SNA viewpoint it is minus $1,329.8bn (Line 32 minus 34).

This is because Tobin’s q is greater than 1 (line 38)

Only when Tobin’s q = 1 can one get “intuitive” results.

You seem to understand the SNA, and the Lavoie/Godley adherence to it.

Maybe you could do an example or two like the ones I did, illustrating the difference between the SNA treatment and the Fed Flow of Funds definitions and treatment that I described.

“In the SNA, net worth of corporations is calculated in exactly the same way as for other sectors, as the sum of all assets less the sum of all liabilities. In doing so, the value of shares and other equity, which are liabilities of corporations, are included in the value of liabilities. Shares are included at their market price on the balance sheet date. Thus, even though a corporation is wholly owned by its shareholders collectively, it is seen to have a net worth (which could be positive or negative) in addition to the value of the shareholders’ equity.”

I can’t parse that. It’s totally confusing. Particularly the last sentence.

Does that mean they’re defining the net worth of corporations as IDENTICALLY ZERO? (i.e. as Vimothy suggested?)

But they’re valuing the equity claim on a corporation (e.g. held by a household) at market value?

So the net worth of corporations is zero but the net worth of households that own them includes the value of their equities?