Solv­ing the Para­dox of Mon­e­tary Prof­its

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    The paper below was sub­mit­ted to the jour­nal at the invi­ta­tion of the edi­tors for a spe­cial edi­tion on “Man­ag­ing Finan­cial Insta­bil­ity in Cap­i­tal­ist Economies”. It took some time to get through the ref­er­ee­ing process, but the paper is finally avail­able online (I was crit­i­cal of some of the feed­back I received—there are in my opin­ion some teething prob­lems still to be sur­mounted in bal­anc­ing the range of peo­ple that can com­ment on papers in this jour­nal against the need to have crit­i­cally informed read­ers mak­ing the ulti­mate deci­sion. How­ever the final paper was also much improved by the inter­ac­tions with ref­er­ees and the edi­tors).

    Click here for a PDF ver­sion of this paper ; you can also read it as a web­page below. I’ve changed the theme for my blog recently to get around for­mat­ting has­sles, since the pre­vi­ous theme inserted a page break every time I used italic font!. There were still some for­mat­ting hassles–I had to sub­sti­tute for some Greek char­ac­ters with the Eng­lish spelling of the Greek let­ter for example–but it is bet­ter than with the old theme.

    This post below deserves the moniker “wonk­ish”, but I hope that it is still gen­er­ally read­able.


    Bruun and Heyn-Johnsen (2009) state the para­dox that eco­nom­ics has failed to pro­vide a sat­is­fac­tory expla­na­tion of how mon­e­tary prof­its are gen­er­ated, even though the gen­er­a­tion of a phys­i­cal sur­plus in pro­duc­tion is an essen­tial com­po­nent of non-neo­clas­si­cal eco­nom­ics. They empha­sise that our abil­ity to explain phe­nom­ena like the “Great Reces­sion” will be lim­ited while ever we are unable to explain this fun­da­men­tal aspect of cap­i­tal­ism.

    In fact this para­dox can be solved very sim­ply, using insights from Cir­cuit The­ory Graziani (1990). Graziani’s bril­liant ini­tial propo­si­tion was that a credit econ­omy must be using a non-com­mod­ity as money, since the alter­na­tive of “an econ­omy using as money a com­mod­ity com­ing out of a reg­u­lar process of pro­duc­tion, can­not be dis­tin­guished from a barter econ­omy” Graziani (1995: 518). From the fact that an intrin­si­cally val­ue­less token is nonethe­less accepted as full pay­ment in the exchange of goods, Graziani derived the con­clu­sion that:

    any mon­e­tary pay­ment must there­fore be a tri­an­gu­lar trans­ac­tion, involv­ing at least three agents, the payer, the payee, and the bank… Since in a mon­e­tary econ­omy money pay­ments go nec­es­sar­ily through a third agent, the third agent being one that spe­cialises in the activ­ity of pro­duc­ing means of pay­ment (in mod­ern times a bank), banks and firms must be con­sid­ered as two dis­tinct kinds of agents (Graziani 1995: 518–519).

    Unfor­tu­nately, attempts by Graziani and sub­se­quent Cir­cuitist authors to develop a viable math­e­mat­i­cal model of the cre­ation of mon­e­tary prof­its in a pure credit econ­omy have to date been a failure—a sit­u­a­tion well expressed in Rochon’s lament “How does M become M+?” (Rochon 2005: 125). This fail­ure was not due to any weak­ness in the under­ly­ing vision of a pure credit econ­omy, but to con­fu­sions of stocks with flows ema­nat­ing largely from inap­pro­pri­ate math­e­mat­i­cal approaches use by these authors. A sim­ple dynamic mon­e­tary model that uses the bank account as its fun­da­men­tal unit explains how cap­i­tal­ists can and do make a profit. In brief, “M becomes M+” via the price mech­a­nism, which con­verts the sale of the phys­i­cal sur­plus gen­er­ated in pro­duc­tion into money.

    The topic has become clouded by many other issues—from the basis for the value of money itself to the impact of debt repay­ment on the money stock. So that I can focus solely on this issue of how mon­e­tary prof­its are gen­er­ated, I delib­er­ately abstract from these impor­tant but—in this context—tangential issues, as out­lined below.

    There are dis­putes in Post Key­ne­sian mon­e­tary the­ory over the log­i­cal basis for the exis­tence and value of money—notably between Char­tal­ists who assert that tax­a­tion is the basis of money’s value, and some Circuitists—including Graziani (1989)—who assert that its accep­tance in com­plet­ing oblig­a­tions between buyer and seller in an exchange is suf­fi­cient. The math­e­mat­i­cal conun­drum about whether cap­i­tal­ists can make a mon­e­tary profit when the source of their ini­tial cap­i­tal is bor­rowed money exists inde­pen­dently of this philo­soph­i­cal debate. The con­sen­sus to date has been that it is math­e­mat­i­cally impos­si­ble for cap­i­tal­ists in the aggre­gate to make prof­its (see for exam­ple Bellofiore et al. 2000). I abstract from these philo­soph­i­cal and ex origo debates in order to focus sim­ply on the math­e­mat­i­cal issue, to show that this con­sen­sus is false.

    This dis­pute, and the cur­rent con­sen­sus con­clu­sion, also exist within the con­fines of mod­els of a pure credit economy—that is, mod­els that treat money as a non-com­mod­ity issued by a pri­vate bank­ing sys­tem, and abstract from the exis­tence of both the State itself, and State or fiat money. The math­e­mat­i­cal issue is there­fore best treated in a model of a pure credit econ­omy, even if a com­plete model of the exist­ing mon­e­tary sys­tem must include both fiat and credit money.

    Finally, there is a dif­fer­ence between mod­ern Post Key­ne­sian the­o­rists and Keynes over what hap­pens to money that is used to repay debt. The con­ven­tion in Cir­cuit lit­er­a­ture is that money used to repay debt is destroyed:

    To the extent that bank debts are repaid, an equal amount of money is destroyed (Graziani 2003: 29–30).

    Money is cre­ated as banks lend-mainly to busi­ness-and money is destroyed as bor­row­ers ful­fill their pay­ment com­mit­ments to banks. Money is cre­ated in response to businessmen’s and bankers’ views about prospec­tive prof­its, and money is destroyed as prof­its are real­ized Min­sky (1982: xxi).

    Keynes, on the other hand, spoke of a “revolv­ing fund of credit” which was con­tin­u­ously replen­ished by the repay­ment of debt, which implies that money used to repay debt may be tem­porar­ily taken out of cir­cu­la­tion, but is not destroyed:

    If invest­ment is pro­ceed­ing at a steady rate, the finance (or the com­mit­ments to finance) required can be sup­plied from a revolv­ing fund of a more or less con­stant amount, one entre­pre­neur hav­ing his finance replen­ished for the pur­pose of a pro­jected invest­ment as another exhausts his on pay­ing for his com­pleted invest­ment (Keynes 1937: 247).

    I side with Keynes on this issue, but to avoid com­pli­ca­tions result­ing from this dif­fer­ence of inter­pre­ta­tion, I first con­sider the his­tor­i­cally rel­e­vant exam­ple of a pri­vate bank using paper notes that it itself creates—see Fig­ure 1 for an exam­ple of such a note issued dur­ing the “Free Bank­ing” period in the USA (Dwyer 1996).

    A paper note model is also con­sis­tent with Graziani’s orig­i­nal paper on the mon­e­tary cir­cuit, where he observed that “A true mon­e­tary econ­omy must there­fore be using a token money, which is nowa­days a paper cur­rency” (Graziani 1989: 3). These banks did not destroy their notes when debts were repaid, but treated their specie as a “revolv­ing fund”, with notes stored until they could be recir­cu­lated in new loans:

    Free banks were rarely able to keep all of their allow­able note issues in cir­cu­la­tion at all times. Ratios of idle notes to total legal cir­cu­la­tion in New York ranged from a low of 4 per­cent in 1852 to a high of 21.6 per­cent dur­ing the panic of 1857. The pro­por­tion of idle notes dipped below 10 per­cent in only three years and hov­ered around 15 per­cent through­out the 1850s (Boden­horn and Hau­pert 1996: 688).

    Though the his­tor­i­cal sta­bil­ity of this period is dis­puted,
    a pri­vate bank­ing sys­tem of this type is not intrin­si­cally unsta­ble, and as I show below, cap­i­tal­ists can make a profit in such a sys­tem, even if their ven­tures are 100% debt-financed.

    Fig­ure 1: Bank of Flo­rence (Nebraska) Dol­lar Note (Smith­son­ian Insti­tu­tion 2010)

    The Basic Model: A Set Quan­tity of Notes

    Con­sider a pri­vate bank which, hav­ing ful­filled the legal require­ments for Free Bank­ing (see Boden­horn 2008: 183–184), cre­ates a stock N of dol­lar notes like those in Fig­ure 1. These notes are ini­tially held by the new bank in its vault. The bank then issues loans to firms, which enables the firm to hire work­ers, who then pro­duce out­put which is sold to work­ers, cap­i­tal­ists and bankers.

    A min­i­mum of 5 classes of accounts are needed to model this sys­tem:

    1. The bank vault (BV), into which the newly-minted notes are first placed
    2. Firm deposit accounts (FD), into which actual trans­fers of loaned dol­lars are made
    3. Work­ers deposit accounts (WD), into which wages are paid by firms
    4. A bank trans­ac­tions account (BT), into and out of which inter­est pay­ments are made
    5. Firm loan accounts (FL), where ledger entries that record the quan­tity of notes that have been lent to firms

    The first four of these are phys­i­cal repos­i­to­ries of notes. The fifth is not a repos­i­tory for notes, but a ledger record­ing the legal claim that the bank has upon those to whom it has lent. Oper­a­tions on it there­fore do not involve mon­e­tary trans­fers, but record the impact of those trans­fers on the indebt­ed­ness of bor­row­ers.

    The basic trans­ac­tions that occur in this model are detailed in Table 1. Seven of these steps involve the phys­i­cal trans­fer of money:

    1. Lend­ing of money from the bank vault to the firms’ deposit accounts (row 1)
      1. Pay­ment of inter­est by firms to the bank’s trans­ac­tions account (row 4)
      2. Pay­ment of inter­est by the bank to firms’ deposit accounts (row 6)
      3. Pay­ment of wages (row 7)
      4. Pay­ment of inter­est on work­ers’ account bal­ances (row 8)
      5. Pay­ment for con­sump­tion of the out­put of firms by bank and work­ers (row 9)
    2. Repay­ment of loans by firms (row 10)

    Four steps are ledger entries only, involv­ing the record­ing of a money trans­fer related to the level of debt:

    1. Record­ing the loans to firms (row 2)
    2. Com­pound­ing the debt at the rate of inter­est on loans (row 3)
    3. Record­ing the pay­ment of inter­est on loans (row 5)
    4. Record­ing the repay­ment of loans (row 11)

    Table 1: Basic Finan­cial Trans­ac­tions in a Free Bank­ing Econ­omy

    Row Trans­ac­tion Type Bank vault (BV) Bank trans­ac­tion (BT) Firm loan (FL) Firm deposit (FD) Worker deposit (WD)
    1 Lend money Money trans­fer



    2 Record loan Ledger entry


    3 Com­pound debt Ledger entry


    4 Pay inter­est Money trans­fer



    5 Record pay­ment Ledger entry


    6 Deposit inter­est Money trans­fer



    7 Wages Money trans­fer



    8 Deposit inter­est Money trans­fer



    9 Con­sump­tion Money trans­fer




    10 Repay loan Money trans­fer



    11 Record repay­ment Ledger entry


    Sum of flows






    The finan­cial flows in each col­umn of Table 1 can be summed to describe the dynam­ics of the bank accounts in this model:

    To model this sys­tem, we need to pro­vide val­ues for the oper­a­tions a to i. Table 2 spec­i­fies these, with each oper­a­tion being related to the cur­rent level of the rel­e­vant account—lending from the vault, for exam­ple, is assumed to occur at a con­stant rate “beta“V related to the cur­rent amount of money in the vault at time t, BV(t).

    Table 2: Finan­cial Oper­a­tions

    Flow Descrip­tion
    a Loans to firms at the rate bV times the bal­ance in the vault at time t BV(t) bv.BV(t)
    b The rate of inter­est on loans rL times the level of loans at time t FL(t) rL.FL(t)
    c Pay­ment of inter­est on loans rL.FL(t)
    d Pay­ment of inter­est on firm deposits FD(t) at the rate rD rD.FD(t)
    e Pay­ment of wages by firms at the rate fD times firm deposits at time t FD(t) fD.FD(t)
    f Pay­ment of inter­est on deposits at the rate rD rD.WD(t)
    g Pay­ment for goods by banks at the rate bT times the level of the bank trans­ac­tion account at time t BT(t) bT.BT(t)
    h Pay­ment for goods by work­ers at the rate wD times the level of the bank trans­ac­tion account at time t WD(t) wD.WD(t)
    i Repay­ment of loans at the rate “phi“L
    times the out­stand­ing loan bal­ance at time t FL(t)

    The full dynamic sys­tem is given by Equa­tion :

    As is eas­ily shown, with real­is­tic para­me­ter val­ues (see Table 3; the val­ues are explained later in the text prior to Table 5, and Table 5 itself) this describes a self-sus­tain­ing sys­tem in which all accounts set­tle down to equi­lib­rium val­ues, and in which cap­i­tal­ists earn a mon­e­tary profit.

    Table 3: Para­me­ter Val­ues

    Para­me­ter Value Descrip­tion
    bV ¾ p.a. Rate of out­flow of notes from the vault BV
    rL 5% p.a. Rate of inter­est on loans
    rD 2% p.a. Rate of inter­est on deposits
    fD 2 p.a. Rate of out­flow of notes from FD to pay wages
    bT 1 p.a. Rate of out­flow of notes from BT to pay for bankers con­sump­tion
    wD 26 p.a. Rate of out­flow of notes from WD to pay for work­ers con­sump­tion
    fL 1/7 p.a. Rate of repay­ment of loans

    Fig­ure 2: Bank Account Bal­ances over Time

    Fig­ure 2 shows the dynam­ics of this sys­tem with an ini­tial stock of N=100 mil­lion dol­lar notes.

    The equi­lib­rium val­ues of the accounts can be solved for sym­bol­i­cally in this con­stant money stock model:

    From Account Bal­ances to Incomes

    The equi­lib­rium yearly wages of work­ers (and gross inter­est earn­ings by bankers) can be cal­cu­lated from Equa­tion , and they in part explain why, in con­trast to the con­ven­tional belief amongst Cir­cuitist writ­ers, cap­i­tal­ists can bor­row money, pay inter­est, and still make a profit. Though only $100 mil­lion worth of notes were cre­ated, the cir­cu­la­tion of those notes gen­er­ates work­ers’ wages of $151 mil­lion per annum (given the para­me­ter val­ues used in this sim­u­la­tion), 1.5 times the size of the value of the notes in the econ­omy (see Fig­ure 3):

    This indi­cates the source of the Cir­cuitist conun­drums: the stock of money has been con­fused with the flow of eco­nomic activ­ity that money can finance over time. A stock—the ini­tial amount of notes cre­ated in this model—has been con­fused

    Fig­ure 3: Wages and Gross Inter­est

    with a flow—the eco­nomic turnover in notes per year. In fact, for a wide range of val­ues for the para­me­ter ?D, the flows ini­ti­ated by the money bor­rowed by the firms over a year exceed the size of the loan itself.

    This is pos­si­ble because the stock of money can cir­cu­late sev­eral times in one year—something that Marx accu­rately enun­ci­ated over a cen­tury ago in Vol­ume II of Cap­i­tal (though his numer­i­cal exam­ple is extremely large):

    Let the period of turnover be 5 weeks, the work­ing period 4 weeks… In a year of 50 weeks … Cap­i­tal I of £2,000, con­stantly employed in the work­ing period, is there­fore turned over 12½ times. 12½ times 2,000 makes £25,000” (Marx and Engels 1885, Chap­ter 16: The Turnover of Vari­able Cap­i­tal).

    Aggre­gate wages and aggre­gate prof­its there­fore depend in part upon the turnover period between the out­lay of money to finance pro­duc­tion and the sale of that pro­duc­tion. This turnover period can be sub­stan­tially shorter than a year, in which case fD will be sub­stan­tially larger than 1, as I explain below.

    The Mak­ing of Mon­e­tary Prof­its

    A sec­ond fun­da­men­tal insight from Marx lets us explain what fD is, and simul­ta­ne­ously derive an expres­sion for prof­its: the annual wages bill reflects both the turnover period, and the way in which the sur­plus value gen­er­ated in pro­duc­tion is appor­tioned between cap­i­tal­ists and work­ers. The value of fD there­fore reflects two fac­tors: the share of sur­plus (in Sraffa’s sense) that accrues to work­ers; and the turnover period mea­sured in years—the time between M and M+. Labelling the share going to cap­i­tal­ists as s and the share to work­ers as (1–s), and labelling the turnover period as tS and express­ing it as a frac­tion of a year, I can per­form the sub­sti­tu­tion shown in below:

    Money wages are there­fore:

    Since national income resolves itself into wages and prof­its (inter­est income is a trans­fer between classes, and sums to zero across all classes), we have also iden­ti­fied gross profit:

    Using a value of s= 40%—which cor­re­sponds to his­tor­i­cal norm of 60% of pre-inter­est income going to work­ers (see Fig­ure 4)—this implies a value for tS of 0.3.

    This means that the turnover period in Marx’s ter­mi­nol­ogy is roughly 16 weeks. This is much longer than in Marx’s numer­i­cal illus­tra­tion above, but still suf­fi­cient to give cap­i­tal­ists prof­its that are sub­stan­tially greater than the ser­vic­ing costs of debt. Fig­ure 5 shows the annual incomes for each class in soci­ety over time; all are pos­i­tive and the equi­lib­rium lev­els (once account lev­els sta­bilise) are $151 mil­lion, $98 mil­lion and $2.5 mil­lion for work­ers, cap­i­tal­ists and bankers respec­tively out of a national income of $252 mil­lion (see Equa­tion ).

    Fig­ure 4: Wages Per­cent­age of US GDP

    Fig­ure 5: Class Incomes after Inter­est Pay­ments

    The value of tauS also deter­mines the veloc­ity of money: the ratio of nom­i­nal GDP to the pro­por­tion of the money stock in cir­cu­la­tion (the equiv­a­lent of M3–M0 in mon­e­tary sta­tis­tics, since in this pure credit model there is no fiat money), which is 3 given the para­me­ters used in this sim­u­la­tion. This is within the highly volatile range sug­gested by his­tor­i­cal data (see Fig­ure 6).

    Table 4 sum­marises the equi­lib­rium val­ues for account bal­ances, gross and net incomes in this hypo­thet­i­cal pure credit econ­omy.

    Fig­ure 6: US GDP to Money Sup­ply Ratios

    Table 4: Equi­lib­rium Account Bal­ances, Gross and Net Incomes

    Account bal­ances Class incomes Net incomes
    Bank vault 16 N/A N/A
    Firm loans 84 N/A N/A
    Firms 75.6081 100.811 (prof­its) 98.123
    Work­ers 5.8205 151.216 (wages) 151.333
    Bankers 2.5714 4.2 (debt ser­vic­ing) 2.571
    Totals 84 (in Deposits) 252.027+4.2 252.027

    We can also derive a sym­bolic expres­sion for the equi­lib­rium level of prof­its


    This allows us to spec­ify the gen­eral con­di­tions under which equi­lib­rium mon­e­tary prof­its will exceed zero, given the exis­tence of a phys­i­cal sur­plus from pro­duc­tion. They are far from oner­ous: the rate at which the bank trans­ac­tion account turns over each year has to exceed the rate of inter­est on loans and the rate at which the work­ers’ deposit account turns over has to exceed the rate of inter­est on deposits . Rea­son­able val­ues for these para­me­ters eas­ily meet these con­di­tions, as detailed below.

    Other Para­me­ters and Time Lags

    The para­me­ters rL and rD are nom­i­nal inter­est rates, and their val­ues are roughly in line with his­tor­i­cal norms at times of low-infla­tion; that leaves the para­me­ters bV, fL, fD and bT to account for.

    The val­ues for “phi“V and fL respec­tively spec­ify how rapidly the bal­ance in the vault is turned over, and how rapidly loans are repaid, and were cho­sen so that the equi­lib­rium value of BV would be roughly the value noted by Boden­horn and Hau­pert (1996: 688) of 15% of avail­able notes:

    The para­me­ters “omega“D and “beta“T sig­nify how rapidly work­ers and bankers respec­tively spend their bank bal­ances on the out­put pro­duced by firms: work­ers are assumed to turnover their accounts 26 times a year—which cor­re­sponds to work­ers liv­ing from fort­nightly pay­cheque to pay­cheque, with only mod­est sav­ings. Bankers are assumed to turnover their account just once a year, reflect­ing their much higher per capita incomes.

    In the remain­der of the paper, all para­me­ters are expressed using the sys­tems engi­neer­ing con­cept of a time con­stant, which gives the fun­da­men­tal fre­quency of a process. In every case, the time con­stant is the inverse of the para­me­ter used thus far; for instance, the value of 26 for wD cor­re­sponds to work­ers’ con­sump­tion hav­ing a fun­da­men­tal fre­quency of 1/26th of a year, or two weeks.

    Table 5: Time Con­stants in the Model

    Para­me­ter and value Time con­stant and value Mean­ing
    bV = ¾ tV = 4/3 years Banks lend their reserve hold­ings of notes every 15 months
    fL= 1/7 tL= 7 years Firms repay their loans every 7 years
    wD = 26 tW= 1/26 years Work­ers spend their sav­ings every 2 weeks
    bT = 1 tB= 1 year Bankers spend their sav­ings every 1 year
    tP= 1 year Time con­stant in price set­ting (intro­duced in Equa­tion )
    t M= 15 years Banks dou­ble the money sup­ply every 15 years (intro­duced in Table 7 on page 24)

    Pro­duc­tion, Prices and Mon­e­tary Prof­its

    Con­sider a sim­ple pro­duc­tion sys­tem in which out­put is pro­por­tional to the labour input L with con­stant labour pro­duc­tiv­ity a:

    Labour employed in turn equals the mon­e­tary flow of wages divided by the nom­i­nal wage rate W:

    Prices then link this phys­i­cal out­put sub­sys­tem to the finan­cial model above. In equi­lib­rium, it must be the case that the phys­i­cal flow of goods pro­duced equals the mon­e­tary demand for them divided by the price level. We can there­fore derive that in equi­lib­rium, the price level will be a markup on the mon­e­tary wage, where the markup reflects the rate of sur­plus as defined in this paper.

    To answer Rochon’s vital ques­tion, M becomes M+ (that is, mon­e­tary prof­its are realised) via a price-sys­tem markup on the phys­i­cal sur­plus pro­duced in the fac­tory sys­tem. This markup can be derived sim­ply by con­sid­er­ing demand and sup­ply fac­tors in equi­lib­rium. The flow of demand is the sum of wages and prof­its (since inter­est pay­ments are a trans­fer and do not con­tribute to the value of output—despite Wall Street’s bleat­ings to the con­trary). The mon­e­tary value of demand is thus:

    The phys­i­cal units demanded equals this mon­e­tary demand divided by the price level:

    In equi­lib­rium this phys­i­cal demand will equal the phys­i­cal out­put of the econ­omy:

    Solv­ing for the equi­lib­rium price Pe yields:

    The markup is thus the inverse of work­ers’ share of the sur­plus gen­er­ated in pro­duc­tion. Cir­cuit the­ory there­fore pro­vides a mon­e­tary expres­sion of Marx’s the­ory of sur­plus value, as it was always intended to do.

    With these phys­i­cal and price vari­ables added to the sys­tem, we are now able to con­firm that profit as derived from the finan­cial flows table cor­re­sponds to profit as the dif­fer­ence between the mon­e­tary value of out­put and the wage bill (in this sim­ple sin­gle-sec­toral model).

    Table 6: Para­me­ters and Vari­ables for Phys­i­cal Pro­duc­tion Sub­sys­tem

    Vari­able, para­me­ter or ini­tial con­di­tion Def­i­n­i­tion Value
    a Labour pro­duc­tiv­ity a = Q/L 2
    W Nom­i­nal wage 1
    Pe Equi­lib­rium price  0.833
    P0 Ini­tial price 1
    Le Equi­lib­rium employ­ment 151.216
    Qe Equi­lib­rium out­put 302.432

    Using the val­ues given in Table 6, it is eas­ily con­firmed that the equi­lib­rium level of prof­its derived from the finan­cial flows cor­re­sponds to the level derived from the phys­i­cal pro­duc­tion sys­tem:

    The price rela­tion given above applies also only in equi­lib­rium. Out of equi­lib­rium, it is rea­son­able to pos­tu­late a first-order con­ver­gence to this level, where the time con­stant ?P reflects the time it takes firms to revise prices. This implies the fol­low­ing dynamic pric­ing equa­tion:

    A sim­u­la­tion also con­firms that the mon­e­tary flows (demand) and the mon­e­tary value of phys­i­cal flows (sup­ply) con­verge over time (Fig­ure 7).

    This solves the “para­dox” of mon­e­tary prof­its: it was not a para­dox at all, but a con­fu­sion of stocks with flows in pre­vi­ous attempts to under­stand the mon­e­tary cir­cuit of pro­duc­tion.

    Fig­ure 7: Sup­ply, Demand and Price Con­ver­gence

    Analysing the “Great Reces­sion”

    We can now use this frame­work to con­sider one aspect of the cur­rent finan­cial cri­sis: if a “credit crunch” occurs, what is the best way for gov­ern­ment to address it?—by giv­ing fiat money to the banks to lend, or by giv­ing it to the debtors to spend?

    Our cur­rent cri­sis is, of course, more than merely a “credit crunch”—a tem­po­rary break­down in the process of cir­cu­la­tion of credit. It is also arguably a sec­u­lar turn­ing point in debt akin to that of the Great Depres­sion (Keen 2009), as Fig­ure 8 illus­trates. While the model devel­oped here can­not assess this claim, it can assess the dif­fer­en­tial impact of a sud­den injec­tion of fiat money to res­cue an econ­omy that has expe­ri­enced a sud­den drop in the rate of cir­cu­la­tion and cre­ation of pri­vate credit. This is an impor­tant point, since although the scale of gov­ern­ment response to the cri­sis was enor­mous across all affected nations, the nature of that response did vary: notably, the USA focused its atten­tion on boost­ing bank reserves in the belief—as expressed by Pres­i­dent Obama—that the money mul­ti­plier made refi­nanc­ing the banks far more effec­tive than res­cu­ing the bor­row­ers:

    And although there are a lot of Amer­i­cans who under­stand­ably think that gov­ern­ment money would be bet­ter spent going directly to fam­i­lies and busi­nesses instead of banks – “where’s our bailout?,” they ask – the truth is that a dol­lar of cap­i­tal in a bank can actu­ally result in eight or ten dol­lars of loans to fam­i­lies and busi­nesses, a mul­ti­plier effect that can ulti­mately lead to a faster pace of eco­nomic growth (Obama 2009: 3. Empha­sis added).

    Fig­ure 8: Pri­vate Debt to GDP Ratios, USA & Aus­tralia

    The Aus­tralian pol­icy response to the cri­sis, on the other hand, was pith­ily summed up in the advice given by its Trea­sury: “go early, go hard, go house­holds” (Gruen 2008). Though many other fac­tors dif­fer­en­ti­ate these two countries—notably Australia’s posi­tion as a com­mod­ity pro­duc­ing sup­plier to China—the out­comes on unem­ploy­ment imply that the Aus­tralian mea­sures more suc­cess­ful than the Amer­i­can “money mul­ti­plier” approach (see Fig­ure 9).

    The next sec­tion applies this endoge­nous money model to con­sider a dif­fer­en­tial response to a credit crunch in a grow­ing econ­omy: an injec­tion of funds is made into either the Banks’ Vault accounts—simulating the USA’s pol­icy response—or into the Work­ers’ Deposit accounts—simulating the Aus­tralian response.

    Fig­ure 9: Unem­ploy­ment Rates USA and Aus­tralia

    Endoge­nous Money Cre­ation and Eco­nomic Growth

    To model a credit crunch in a grow­ing econ­omy, while oth­er­wise main­tain­ing the struc­ture of the Free Banking/pure credit money model above, I move beyond the lim­i­ta­tions of a pure paper money sys­tem to allow for endoge­nous money cre­ation as described in Moore (1979):

    In the real world banks extend credit, cre­at­ing deposits in the process, and look for the reserves later” (Holmes 1969, Moore 1979: 53); see also more recently Disy­atat (2010: 7 “loans drive deposits rather than the other way around”).

    In the model, new credit to sus­tain a grow­ing econ­omy is cre­ated by a simul­ta­ne­ous increase in the loan and deposit accounts for the bor­rower. The finan­cial flows in this sys­tem are given in Table 7. The two changes to Free Bank­ing model are the addi­tion of row 12 (and its ledger record­ing in row 13), with the qual­i­ta­tively new oper­a­tion of Money Cre­ation being added to the pre­vi­ous oper­a­tion of Money Trans­fer, and a “Deus Ex Machina” injec­tion of fiat money into either Bank Vault or Worker Deposit accounts one year after a credit crunch.

    Again, sim­ply to illus­trate that the sys­tem is viable, a con­stant growth para­me­ter “tau” M has the banks dou­bling the stock of loans every 15 years (see Table 3):

    A credit crunch is sim­u­lated by vary­ing the three cru­cial finan­cial flow para­me­ters tauV, tauL, and tauM at an arbi­trary time in the fol­low­ing sim­u­la­tion (at t=25 years): tauV and tauM are dou­bled and tauL is halved, rep­re­sent­ing banks halv­ing their rates of cir­cu­la­tion and cre­ation of new money and firms try­ing to repay their loans twice as quickly (see Table 8). The gov­ern­ment fiat-money res­cue is mod­elled as a one-year long injec­tion of a total of $100 mil­lion one year after the credit crunch.

    Sev­eral exten­sions to the phys­i­cal side of the model are required to model eco­nomic growth. In the absence of Ponzi spec­u­la­tion (which is the topic of a later

    Table 7: Endoge­nous Money Cre­ation

    Row Trans­ac­tion Type Bank vault (BV) Bank trans-action (BT) Firm loan (FL) Firm deposit (FD) Worker deposit (WD)
    1 Lend money Money trans­fer



    2 Record loan Ledger entry


    3 Com­pound debt Ledger entry


    4 Pay inter­est Money trans­fer



    5 Record pay­ment Ledger entry


    6 Deposit inter­est Money trans­fer



    7 Wages Money trans­fer



    8 Deposit inter­est Money trans­fer



    9 Con­sump­tion Money trans­fer




    10 Repay loan Money trans­fer



    11 Record repay­ment Ledger entry


    12 New money Money cre­ation


    13 Record loan Ledger entry


    14 Gov­ern­ment pol­icy Exoge­nous injec­tion into


    BE or WD



    Sum of flows






    ey sup­ply is only war­ranted if eco­nomic growth is occur­ring, which in turn requires a grow­ing pop­u­la­tion and/ or labour pro­duc­tiv­ity. These vari­ables intro­duce the issue of the employ­ment rate, and this in turn raises the pos­si­bil­ity of vari­able money wages in response to the rate of unemployment—a Phillips curve. These addi­tional vari­ables are spec­i­fied in Equa­tion :

    Table 8: Finan­cial Flow Para­me­ters before and after a Credit Crunch

    Pre-credit crunch Post-credit crunch Impact of credit crunch
    tV = 4/3 years tV = 8/3 years Banks lend their reserve hold­ings of notes every 15 months
    tL= 7 years tL= 3.5 years Firms repay their loans every 3.5 years
    t M= 15 years t M= 30 years Banks dou­ble the money sup­ply every 30 years
    k=$100 mil­lion Injected either into bank vault BE or worker deposit WD at year 26, one year after the credit crunch

    The para­me­ter val­ues and func­tional form for this phys­i­cal growth exten­sion are shown in Table 9.

    Fig­ure 10 shows the impact of the credit crunch upon bank accounts: loans and deposits fall while the pro­por­tion of the money sup­ply that is lying idle in bank reserves rises dra­mat­i­cally.

    The US empir­i­cal data to date has dis­played a sim­i­lar pat­tern, though with a much sharper increase in bank reserves as shown in Fig­ure 11.

    A very sim­i­lar pat­tern to the empir­i­cal data is evi­dent in the model when the US pol­icy of increas­ing bank reserves is sim­u­lated (Fig­ure 12).

    The sim­u­la­tion of Aus­tralian house­hold-ori­ented poli­cies gen­er­ates a very dif­fer­ent dynamic: reserves still rise dra­mat­i­cally dur­ing the credit crunch, but their increase is not fur­ther aug­mented by the pol­icy inter­ven­tion. Instead, firm and worker deposits rise sub­stan­tially (see Fig­ure 13), whereas they fall in the bank-ori­ented res­cue.

    This higher level of money in cir­cu­la­tion in the house­hold-ori­ented pol­icy inter­ven­tion is the cause of the dra­matic dif­fer­ence in the out­comes of the two pol­icy inter­ven­tions: the house­hold-ori­ented approach has a far more imme­di­ate and sub­stan­tial impact upon employ­ment (Fig­ure 14). Con­trary to the expec­ta­tions of Pres­i­dent Obama and his main­stream eco­nomic advis­ers, there is far more “bang for your buck” out of a house­hold res­cue than out of a bank res­cue.

    Table 9: Para­me­ters and Func­tion for Growth Model

    Vari­able or para­me­ter Descrip­tion Value
    alpha Rate of growth of labor pro­duc­tiv­ity 1% p.a.
    beta Rate of growth of pop­u­la­tion 2% p.a.
    Pop Pop­u­la­tion Ini­tial value = 160
    lambda Employ­ment rate Ini­tial value = 94.5%

    Phillips curve:

    Fig­ure 10: Bank Accounts before and after a Credit Crunch

    Fig­ure 11: Drop in Busi­ness Loans and Dra­matic Rise in Bank Reserves dur­ing Great Reces­sion

    Fig­ure 12: Sim­u­lat­ing US Bank-ori­ented Pol­icy towards a Credit Crunch

    Fig­ure 13: Sim­u­lat­ing Aus­tralian House­hold-ori­ented Pol­icy towards a Credit Crunch

    Fig­ure 14: Com­par­ing Bank-ori­ented and House­hold-ori­ented Poli­cies


    The para­dox of mon­e­tary prof­its is solved sim­ply by avoid­ing the prob­lem so wit­tily expressed by Kalecki, that eco­nom­ics is “the sci­ence of con­fus­ing stocks with flows” cited in God­ley and Lavoie (2007). With that con­fu­sion removed by work­ing in a frame­work that explic­itly records the flows between bank accounts and the pro­duc­tion and con­sump­tion they drive, it is obvi­ous that Cir­cuit The­ory achieves what it set out to do: to pro­vide a strictly mon­e­tary foun­da­tion for the Marx–Schumpeter–Keynes–Minsky tra­di­tion in eco­nom­ics. As an explic­itly mon­e­tary model, it also pro­vides an excel­lent foun­da­tion for explain­ing the processes that led to the “Great Reces­sion”, and for test­ing pos­si­ble pol­icy responses to it.


    This work results from a col­lab­o­ra­tive research effort between the United Nations Envi­ron­ment Pro­gram (UNEP) and CSIRO Sus­tain­able Ecosys­tems to estab­lish a regional report on Resource Effi­ciency: Eco­nom­ics and Out­look for Asia?Pacific. I thank 4 anony­mous ref­er­ees, an edi­tor and Trond Andresen (Nor­we­gian Uni­ver­sity of Tech­nol­ogy) for com­ments that greatly improved the final paper.


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    About Steve Keen

    I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.
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    • Tom Shaw

      Steve, sorry I should have addressed my ear­lier com­ment to you (August 4, 2011 at 12:33 am — except for the first para­graph).

      Tor­rey, I don’t sub­scribe to the dis­tinc­tions you’re mak­ing regard­ing objec­tive v sub­jec­tive, absolute v rel­a­tive, real v all in the mind, nat­ural v arti­fi­cial. It all depends on the level of abstrac­tion that you’re work­ing at. I think Steve taps into a much bet­ter frame­work when he talks about the fal­lacy of strong reduc­tion­ism (slides 17–18 at that link).

      I also rec­om­mend Leonard Susskind’s thoughts on what is “fun­da­men­tal” (from 1:11:10, but espe­cially from 1:19:10).

    • kys

      Tom Shaw,

      Sorry for my late rep­sponse.

      By def­i­n­i­tion,

      1. w_D is the rate of out­flow of notes from Worker Deposit W_D to pay for work­ers’ con­sump­tion.

      2. b_T is the rate of out­flow of notes from Bank Trans­ac­tion B_T to pay for bankers’ con­sump­tion.

      For sim­u­la­tion pur­poses, 26 p.a. & 1 p.a. are assigned to w_D & b_T respec­tively, both of which are real­is­tic. I there­fore do not see any “inter­nal con­tra­dic­tion” like you do.

      In equi­lib­rium, g = b_T * B_T = bankers’ con­sump­tion = bankers’ net income = Bank Trans­ac­tion Account, which means Steve’s reply is accu­rate.

      As to your assump­tion that g = $x,

      1. The assump­tion does not hold when x > c-d-f because bankers can not plun­der the vault.

      2. When x < c-d-f, bankers save money. Where do they put the money? do you need a new entry “Banker Deposit” that gives bankers inter­ests? do bankers seek to lend out their sav­ings to firms at higher inter­est rates? Do they sim­ply con­sume more when sav­ings reach cer­tain lev­els? Do these con­sid­er­a­tions help in solv­ing the para­dox of mon­e­tary prof­its?

      I look for­ward to a mean­ing­ful dis­cus­sion.

    • Tom Shaw

      Hi Kys, Steve’s reply is accu­rate in that he recog­nised that this would indeed pro­duce the out­come I noted 🙂

      The con­tra­dic­tion is sim­ple: w_D and b_T are said to be dif­fer­ent because of dif­fer­ent lev­els of savings/income. This implies that the con­sump­tion coef­fi­cient of a per­son (as reflected in w_D and b_T) is a decreas­ing func­tion of their savings/income. And yet b_T is said to be a con­stant for all val­ues of a banker’s savings/income. Con­tra­dic­tion, Q.E.D.

      Even ignor­ing the inter­nal con­tra­dic­tion, there is no empir­i­cal jus­ti­fi­ca­tion for say­ing that b_T is a con­stant value. I’ve given a real-world exam­ple of some­one whose con­sump­tion has remained rel­a­tively sta­ble once it reached a cer­tain point. It’s cer­tainly a much more real­is­tic propo­si­tion than assum­ing con­sump­tion is lin­early related to the account bal­ance. The truth is prob­a­bly some­where in the mid­dle (maybe g is pro­por­tional to ln(B_T), who knows) but that would still be enough to alter the qual­i­ta­tive out­come.

      Regard­ing your other points, you’re just con­firm­ing the diver­gent nature of the out­come. In your sce­nario 1, the banker goes broke and the sys­tem breaks down. In your sce­nario 2, instead of leav­ing the money in B_T, the banker earns inter­est on it, cap­tures the money sup­ply even faster and the sys­tem breaks down.

    • kys

      Since you like to turn “sec­toral” into “indi­vid­ual”, I guess you must be able to re-model the whole thing. Please do not for­get us when you release your mag­num opus.

      I just won­der if the sys­tem break­down actu­ally means a com­puter break­down or a ner­vous break­down…

    • Tom Shaw

      Hi Kys, I thought you were after a rea­son­able dis­cus­sion..

      It’s Steve’s model which turns “sec­toral” into “indi­vid­ual” by posit­ing a sin­gle pri­vate bank — I’m just point­ing out the obvi­ous flaw in the model. I’ve never claimed to be able to model the econ­omy. In fact a cou­ple of com­ments ago I gave my opin­ion that eco­nomic real­ity may well be too com­plex to model from the bot­tom-up, thus my pref­er­ence for top-down analy­sis.

    • kys

      But what do you mean by top-down and Bot­tom-up? I can’t tell the dif­fer­ence.

    • Tom Shaw

      Hi Kys, this is dis­cussed a bit in this pre­sen­ta­tion includ­ing an inter­est­ing con­ver­sa­tion around 23:45. There’s also an arti­cle on Wikipedia.

      The bot­tom-up approach is to start from smaller, sim­pler com­po­nents and build upwards. For exam­ple, you could the­o­ret­i­cally take your knowl­edge of physics, and based on this derive the rules of chem­istry. Of course this is dif­fi­cult because even though the com­po­nents are sim­ple, the inter­ac­tions may cre­ate emer­gent behav­iour. Small flaws in your assump­tions can cre­ate qual­i­ta­tively dif­fer­ent out­comes. Only recently with super-pow­er­ful com­put­ers and extremely accu­rate phys­i­cal under­stand­ing can chem­i­cal prop­er­ties be mod­eled from the bot­tom-up.

      The top-down approach is to start from a birds-eye view of the whole sys­tem and derive rules from what you see. In prac­tice this is how chem­istry was really devel­oped. Friedman’s “F-Twist” actu­ally makes sense if this is explic­itly your approach. The prob­lem with the top-down approach is that it’s dif­fi­cult to extend your knowl­edge to new sit­u­a­tions.

      The tragedy of mod­ern eco­nom­ics is that the flaws of each approach have not been respected. The bot­tom-up approach failed because, as Steve likes to point out, the all-impor­tant assump­tions under­ly­ing keep being for­got­ten or ignored (e.g. SMD con­di­tions or expected util­ity). The top-down approach failed because not enough atten­tion was paid to his­tory (e.g. the great depres­sion) to get a big enough set of empir­i­cal data to analyse. By ignor­ing these flaws, econ­o­mists clearly became way too con­fi­dent in their mod­els, which is why so many were sur­prised by the GFC.

    • kys


      This dis­cus­sion is really mean­ing­ful but I’ve got to run now.

      I will talk to you soon in the next debate.

    • Thanks Tom. I appre­ci­ate your com­ments and will look into the links that you pro­vide. I do like Steve’s fal­lacy of strong reduc­tion, btw.

    • RJ

      I’m not sure from the above if Steve under­stands dou­ble entry book keep­ing or not?

      Or how dou­ble entry book keep­ing relates to the P+L account and bal­ance sheet

      Com­mer­cial banks, cen­tral bank, the trea­sury and com­pa­nies etc MUST post a jour­nal entry for every trans­ac­tion. It is from these jour­nal entries that the P+L account and bal­ance sheet is pro­duced

      Fail­ure to under­stand this results in many econ­o­mists form­ing incor­rect con­clu­sions (as I beleive Steve has in this report. Although I’m open to being con­vinced oth­er­wise).

      Exam­ple from fig­ure Fig­ure 1

      The jour­nal entries are for the BoF

      Action 1 Print notes BoF JE

      Debit Notes asset BoF dol­lars (bank asset)
      Credit Printed money off­set Lia­bil­ity
      This lia­bil­ity reflects a lia­bil­ity the bank has to the hold­ers of these $ notes

      Action 2 BoF issues notes to a cus­tomer

      BoF account
      Debit Cus­tomer loan (bank asset / cus­tomer debt lia­bil­ity)
      Credit Cus­tomer cheque account (bank lia­bil­ity / cus­tomer finan­cial asset)

      Cus­tomer accounts
      Debit Bank bal­ance at the BoF
      Credit Lia­bil­ity Bank loan BoF

      Action 3 Cus­tomer with­draws bank notes

      BoF account
      Debit Cus­tomer cheque account (reduce bank lia­bil­ity account)
      Credit Notes BoF dol­lars (reduce hold­ing on notes asset)

      Cus­tomer accounts
      Debit Notes BoF dol­lars
      Credit Lia­bil­ity Bank bal­ance at the BoF (reduce bank bal­ance)
      In effect the credit held at the BoF has been con­verted to a BoF sup­ported $ dol­lar notes

      And the dol­lar notes are sup­ported by debt and noth­ing but debt.

      What if the BoF had gold hold­ings. For me debt still sup­ports the dol­lar notes but gold is used as a safety cover (insur­ance) in case some debt can not be paid back.

      BoF JE
      Debit Gold on hand
      Credit Share­hold­ers funds

      When the full jour­nals are done as above it shows clearly that this state­ment

      Keynes, on the other hand, spoke of a “revolv­ing fund of credit” which was con­tin­u­ously replen­ished by the repay­ment of debt, which implies that money used to repay debt may be tem­porar­ily taken out of cir­cu­la­tion, but is not destroyed:”

      is incor­rect

      When money is taken out of cir­cu­la­tion to repay debt

      The banks jour­nal entry is

      Debit BoF notes
      Credit Cus­tomer deposit account

      And then

      Debit Cus­tomer deposit account (MONEY IS DESTROYED)
      Credit Cus­tomer loan (bank asset reduced / cus­tomer debt lia­bil­ity reduced)

      So this state­ment below is cor­rect

      Money is cre­ated as banks lend-mainly to busi­ness-and money is destroyed as bor­row­ers ful­fill their pay­ment com­mit­ments to banks.”

      The prob­lem occurs because Keynes con­sid­ered notes held in a bank safe as money. It is not.

      If a bank printed a 100 tril­lion note and left it locked in a bank safe. It would have no impact on the money sup­ply at all

      Only when it is released does it impact on the money sup­ply. This is why Notes and coins (cur­rency) in bank vaults do NOT form part of M1 M2 M3 or MZM

    • RJ


      Action 2 above is

      BoF loans money to a cus­tomer

      This arti­cle on money is worth read­ing

      Money, then, is credit and noth­ing but credit. A’s money is B’s debt to him, and when B pays his debt, A’s money dis­ap­pears. This is the whole the­ory of money.”

      Credit came first and notes and coins later.

      Notes and coins are noth­ing more than a token to allow the easy trans­fer of credit. Notes and coins are exchanged for bank credit (deposits). These tokens can then be exchanged for goods ser­vices or assets. The new holder can then bank these notes and coins in exchange for bank credit

      The jour­nal entries above clearly shows this.

    • RJ

      Keynes, on the other hand, spoke of a “revolv­ing fund of credit” which was con­tin­u­ously replen­ished by the repay­ment of debt, which implies that money used to repay debt may be tem­porar­ily taken out of cir­cu­la­tion, but is not destroyed:”


      Which implies”. Does it imply this though. 

      If Keynes just called bank held notes and coins a “revolv­ing fund of credit”. Yes debt repay­ment does replen­ish bank held notes and coins. But it does not imply credit is not destroyed. It just means notes and coins are replen­ished in the bank noth­ing more. Credit is destroyed as the jour­nal entries above show

    • Hi RJ,

      I think the tech­ni­cally cor­rect def­i­n­i­tion you gave ear­lier:

      This is why Notes and coins (cur­rency) in bank vaults do NOT form part of M1 M2 M3 or MZM” is not incon­sis­tent with Keynes as you’re read him here:

      ” Yes debt repay­ment does replen­ish bank held notes and coins. But it does not imply credit is not destroyed. It just means notes and coins are replen­ished in the bank noth­ing more. Credit is destroyed as the jour­nal entries above show”

      If one defines credit (or money) as “money in cir­cu­la­tion as defined by M1 M2 M3 or MZM” then yes credit/money is destroyed by debt repay­ment. How­ever the notes and coins are not destroyed, as you note. They can re-enter cir­cu­la­tion later when money is cre­ated once more by addi­tional debt.

      To han­dle this in a dynamic model of the money cre­ation and cir­cu­la­tion process, I am effec­tively work­ing with a broader def­i­n­i­tion of money that includes these “not in cir­cu­la­tion” notes and coins (and other liq­uid assets). This may be the source of the con­flict between me and other Post Key­ne­sians on this–certainly that’s what War­ren Mosler argued in a ver­bal debate some years ago. I argue for my approach and my wider def­i­n­i­tion when mod­el­ling a dynamic process, since to do oth­er­wise implies there is a “sink” (in dynamic sys­tems ter­mi­nol­ogy) through which the notes and coins lit­er­ally are destroyed.

    • Pingback: The Debtwatch Manifesto | Steve Keen's Debtwatch()

    • Keynes (Arti­cle above) : “If invest­ment is pro­ceed­ing at a steady rate…”
      … “then the Prof­its of the Busi­ness will decline to zero” — Me : … so using the CFS the Cur­rent Finan­cial Sys­tem, we may have no phys­i­cal need to increase “Invest­ment” — we might have all the machines we need but the CFS forces an increase to keep the show on the road as it where. So at base the Finan­cial sys­tem does not reflect real­ity and it would be a good idea to design one that does

    • Steve has failed to estab­lish that there is a “Para­dox of Mon­e­tary Prof­its”
      in the 1st place. A com­pany knows if it has made a profit or loss by look­ing
      at its accounts — not its bank state­ment and the equa­tion for prof­its across he whole econ­omy is :
      Retained Prof­its of Busi­ness = Fixed Assets Of Busi­ness + Gov­ern­ment Debt + House­hold Debt + Foreigner’s Debt
      This can be demon­strated using num­bers for the UK National Accounts :

      The step by step, Deb­its and Cred­its, of how it moves from one sit­u­a­tion
      to another through the bank­ing sys­tem you can see in the spread­sheet model financial_scenarios.xls in :

      - There is no Para­dox to solve

    • Econ­CCX

      Greet­ings All

      Steve, we’ve met. I was one of the lucky geeks who caught your pre­sen­ta­tion in NYC last fall around the impend­ing release of the revised Debunk­ing. We had a lively group con­ver­sa­tion on the way to and at din­ner: MMT vs. cir­cuit the­ory; the exor­bi­tant priv­i­lege; your planned work with Hud­son. The increas­ing and mis­placed con­fi­dence by bor­rower and lender (Min­sky) vs con­trol fraud and principal/agent con­flict (Black). At pre­sen­ta­tion Q&A, I flogged Soddy; you politely responded that you hoped to get to him some day. Thanks, belat­edly, for that great talk, and to Robert (com­menter Robert K?) for host­ing.

      I’m quite late to the dis­cus­sion, but hope you’ll still enter­tain a few ques­tions about the Mon­e­tary Prof­its Para­dox.

      First is a book­keep­ing ques­tion about a very sim­ple trans­ac­tion. But I think it pro­vides us a win­dow on more com­plex ones:

      A firm main­tains a bank check­ing account with a $10 monthly fee. Sup­pose its bal­ance is $1000 before the fee, and $990 after. Which do you believe most accu­rately describes the out­come of the trans­ac­tion:

      A) The firm’s bal­ance is reduced by $10; the banks funds are increased by $10. Whether the incre­ment is booked as reserves or prof­its or addi­tional loan­able funds, some account at the bank shows that jour­nal entry, and a $10 gain. Money in the amount of $10 has been trans­ferred from firm to bank, and from aggre­gate firm hold­ings to aggre­gate bank hold­ings.

      B) The firm’s bal­ance is reduced by $10. That $10 van­ishes com­pletely. It’s on nobody’s account; it sim­ply ceases to exist. That debit to the firm’s account has dimin­ished the universe’s total stock of money. –OR

      C) Some other out­come as yet unde­scribed.

      Prof. Keen: if you’re able to address this ques­tion, per­haps you could also tell us whether you believe Graziani would agree with your reply. Fel­low com­menters: I hope you’ll kindly take a stab at this as well. I have some terms or premises wrong, no doubt; so I look for­ward to see­ing how oth­ers book and char­ac­ter­ize this trans­ac­tion.


    • Bhaskara II

      Dou­ble entry jour­nal entries describ­ing the trans­ac­tion from the point of view of each entity would be:

      Firm entity:
      Dr. Fee Expense // Cr. House of Bank (asset account)* $10

      Bank entity:
      Dr. House of Firm (lia­bil­ity deposit account) // Cr. Bank’s Rev­enue or Equity $10

      * house of is an old term that could mean com­pany, bank, fam­ily, etc. Exam­ple “House of Mor­gan”.

      The firm’s bal­ance is reduced by $10; the banks equity or claim on funds are increased by $10. The incre­ment is booked as the banks’ prof­its. And the incre­ment of the firms expense or reduc­tion in firms’ equity. Money in the amount of $10 has been trans­ferred from firms’ equity to banks’ equity.