Banking Example #9: Paying Taxes

This reader inspired example simply shows what happens when an individual pays taxes to the Federal government.

Setup: the Treasury Dept. (Tsy), the central bank (CB), a commercial bank (A) and two persons: x and y. Assume that y had owned a house which x purchased exactly as laid out in balance sheet sets 1 and 2 of Example 8. Balance sheet set 2 from that example is repeated here for convenience as our starting point (I number the initial set of sheets below "2" to emphasize this). I also color the balance sheet entries to focus on.

 2. Balance sheets after person x takes a loan from Bank A and buys person y's house with it. (the yellow colored cells are the ones to watch)

Tsy, CB

Assets	Liabilities
$0	$0

Bank A

Assets	Liabilities
$100k mortgage to x	$100k deposit for y

Person x

Assets	Liabilities
$100k house	$100k mortgage at A

Person y

Assets	Liabilities
$100k deposit at A	$0
Negative Equity	Equity
-----------------------	$100k

3. Assume that Person y made a profit on the sale and now owes the Federal government $10k in taxes, and then pays the tax. The resulting balance sheets look like:

Tsy

Assets	Liabilities
$10k CB deposit	$0
Negative Equity	Equity
--------------------	$10k

CB

Assets	Liabilities
$10k loan of reserves to A	$10k deposit for Tsy

Bank A

Assets	Liabilities
$100k mortgage to x	$90k deposit for y
-------------------------	$10k reserve borrowing from CB

Person x

Assets	Liabilities
$100k house	$100k mortgage at A

Person y

Assets	Liabilities
$90k deposit at A	$0
Negative Equity	Equity
---------------------	$90k

Please excuse the extra complication of two people and a house. I could claim I did that to be consistent with my desire to have most of these examples "net to zero" meaning that if all the balance sheets are consolidated together for any one step, all the financial assets should add up to $0 equity (as long as no coins are involved). But the reality is I was just lazy and so I cut and pasted from Example 8. ;^)

Banking Example #4.1: The Two Kinds of Quantitative Easing

This post is a variation on Example #4. I've eliminated some parts and added others in an attempt to simplify, clarify and explain the two kinds of quantitative easing (QE) and the difference between them.

Setup: one Treasury Dept. (Tsy), one central bank (CB), one commercial bank (Bank A), and one person x. No reserve requirements. We start off with the Tsy having sold a $100 Tsy bond and spent the proceeds into the private economy on goods and services. This results in a net liability of $100 at the Tsy and a net asset of $100 (the Tsy bond) in the private sector, but not necessarily any bank deposits in the private sector. See Example #8 to see how this can be.

In Case 1, the Tsy bond is owned by Bank A. In Case 2, it's owned by Person x. In both cases the bond owner sells it to the CB during the QE operation. The Tsy balance sheet looks like this both prior too and after the QE operation in both cases:

Tsy

Assets	Liabilities
$0	$100 Tsy bond
Negative Equity	Equity
$100	------------------

Case 1: First kind of QE: The bank sells its Tsy bond to the CB. 

Initial balance sheets prior to the QE operation (Person x not involved: assume his balance sheet is empty):

CB

Assets	Liabilities
$0	$0

Bank A

Assets	Liabilities
$100 Tsy bond	$0
Negative Equity	Equity
---------------------	$100

Balance sheets after the QE operation:

CB

Assets	Liabilities
$100 Tsy bond	$100 deposit for Bank A (reserves)

Bank A

Assets	Liabilities
$100 reserves	$0
Negative Equity	Equity
---------------------	$100

Case 2: Second kind of QE: The non-bank sells its Tsy bond to the CB.

Initial balance sheets prior to the QE operation (both Bank A and Person x are involved):

CB

Assets	Liabilities
$0	$0

Bank A

Assets	Liabilities
$0	$0

Person x

Assets	Liabilities
$100 Tsy bond	$0
Negative Equity	Equity
---------------------	$100

Balance sheets after the QE operation:

CB

Assets	Liabilities
$100 Tsy bond	$100 deposit for Bank A (reserves)

Bank A

Assets	Liabilities
$100 reserves	$100 deposit for x

Person x

Assets	Liabilities
$100 deposit at A	$0
Negative Equity	Equity
---------------------	$100

Notice that nobody's equity changed due to QE in either case. For a fuller discussion of this fact see the discussion at the end of Example 4. Also notice that in both cases the CB's balance sheet changed in exactly the same way.

Final observation: I think the second kind of QE (case 2) is more prevalent. Also, I'm not showing some details in this case (the exact details of how the bank acts as an agent of the CB to purchase bonds on the open market), but these details are relatively unimportant.

Money Labels

This post attempts to depict the various labels used to describe US money in a Venn diagram and an accompanying table. I've simplified the world into just four entities: The Treasury (Tsy), the Fed, the banks and the private sector non-banks. You can think of Tsy as a stand-in for the all the (largely non-private) non-bank Fed deposit holders (such as Treasury, the IMF, foreign central banks, and government sponsored enterprises (GSEs)), except for in the "Created/Destroyed by" column in the table where only the US Treasury is really meant. "Non-banks" means private sector non-banks in the table. JP Koning has a lot of good information on "moneyness" related issues. So does Cullen Roche.

Update #1: Sept. 28, 2013: By "Face Value" in the table I simply mean the dollar value written on the paper note or the coin, to distinguish it from the production cost of the note or coin. The "face value" of deposits are simply the value of the deposits. Also, by "paper notes" I'm really referring to Federal Reserve Notes (reserve notes). There's also such a thing as United States Notes (US notes) which are also paper bills, but they are very rare and have not really been produced since 1971 (I did not include a row for these in the above table). Unlike reserve notes, US notes are not "face value" liabilities of the Fed, but instead are direct liabilities of the Tsy (after they were printed and sold by the Tsy) although they don't contribute to the statutory debt limit (search for "United States Notes" in this document). Reserve notes are much more common than US notes (I don't believe I've ever seen a US note!).

Coins are not liabilities of any entity officially (they don't appear on any balance sheets as liabilities) however they are described by the Fed and Tsy as being "obligations" of the Tsy. This most likely refers to the fact that coins are accepted as face value legal tender by the Fed and Tsy and that the US Mint (a branch of Tsy) will purchase back damaged coins for their face value. JKH has described coins as "contingent liabilities" of Tsy.

By "Created/Destroyed By" in the table, I mean literally the physical creation and destruction of the physical money in terms of notes and coins. In terms of electronic deposits I mean the crediting (creation) and debiting (destruction) of deposit accounts, which corresponds to the increase and decrease of the balance in these accounts respectively.

Reserve notes are created and destroyed by the Bureau of Engraving and Printing (BEP) which is a branch of the US Treasury (Tsy). Coins are likewise physically created and destroyed by the United States Mint, which is also a branch of the US Tsy. In the case of reserve notes, however, the face value can be thought of to be created and destroyed by the Fed which sells and buys them from banks. While at the Fed, reserve notes are not entered on the balance sheet of any entity. The Fed purchases the notes from the BEP for their production cost, however, once they sell them to banks for their face value, they are entered onto the Fed's balance sheet as a face value liability of the Fed and a face value asset of the banks which purchase them... until the banks in turn sell them as an asset to other non-Fed entities. It's not until they are sold back to the Fed that they again are removed from all balance sheets, and they remain off balance sheet at the Fed until they are resold. If they are not resold they will eventually be destroyed. In this sense the Fed can be thought of as creating and destroying the face value of reserve notes. Coins are different in that they are face value assets from they day they are minted by the Mint and remain so until they are destroyed by the Mint. Similar to notes, however, the face value of coins is not the same as their production costs. Any profit made in the sale of coins is called seigniorage. As can be seen from the table at the bottom of this page, the Mint does not currently make positive seigniorage on pennies and nickles. Does that means it "makes" negative seigniorage on pennies and nickles? I don't know how to refer to that situation! ... if you do, let me know in the comments.

The concept of "inside" and "outside" money is normally defined with respect to the view from the private sector (which includes both banks and non-bank entities). All this means is that "inside money" is a liability of an entity inside the private sector (in this case banks). Outside money is NOT a liability of any entities within the private sector. This is the usual way of defining inside and outside money, however they are more generally relative terms. For example from the point of view of the Fed, reserve notes and Fed deposits are "inside money" even though they are both strictly liabilities of the Fed. In a similar manner, if a non-bank private entity were able to issue IOUs that were used as a form of money, those would also be "inside money" in the typical sense (i.e. w.r.t. the private sector). From the point of view of the non-bank private sector, bank deposits could be considered to be "outside money." However, I will almost always stick to the typical definitions of inside and outside money (as depicted in the above table) in this blog: i.e. w.r.t. the private sector.

Inflation Targeting as a Feedback Control System

 This post examines the process of inflation targeting by the Fed as a classic feedback control system. I think looking at it this way illuminates the differences between the neo-classical schools (at least the ones which accept the endogeneity of money in the short term, such as the Market Monetarists) and the post-Keynesian schools regarding the long term endogeneity of money (the post-Keynesians accept both the short term and long term endogeneity of money).

Figure 1: Fed and economy as a feedback control system tracking a targeted inflation rate

Figure 1 above illustrates the concept, and in particular how the actual measured inflation rate is subtracted from the target inflation rate (treated as an independent input variable here) to create an error signal, which the Fed's (central bank's) control law attempts to drive to zero. This is depicted this way in keeping with classic feedback control system theory diagrams, where an error signal is typically an input into the controller, which in turn produces in input signal to the "plant" (the system which the controller is attempting to control). The controller's outputs are manipulated in such as way (according to the control law) so as to minimize this error. In this case the federal funds rate (FFR) and Fed open market operations (OMOs: i.e. the buying and selling of Tsy debt and other assets by the Fed) are the signals which minimize the error. A more detailed depiction showing how the FFR and the OMOs work within another inner feedback loop, with the actual overnight rate achieved being fed back to create an inner loop error signal is depicted in figure 2 and discussed later in this post. Suffice it to say for now that the OMOs are adjusted to drive this inner loop error signal to zero.

One could argue that only the OMOs are important inputs into the economy, because the inner (unshown in figure 1) control loop already incorporates the FFR information into the OMOs, however, I show both the FFR and the OMOs as inputs into the economy because the targeted FFR not only determines the OMOs in this inner loop, but it acts as an important input all on its own (i.e. if the banks knows ahead of time what the targeted FFR is, they're unlikely to "fight" with the Fed ... they know the Fed can use the unlimited OMOs at its disposal to hit that targeted rate).

Also not shown in Figure 1 are the dependent state variables present inside the box "The Rest of the Economy" on the right hand side. One (several?) of those variable could be called "The Money Stock." Since the "loop is closed" on this control system (i.e. some of the economy's outputs are fed back to the input), it's difficult to say which of the dependent state variables in the economy determine the others. Post-Keynesians tend to put many factors determining the private sector's "Desire to Borrow at Terms Offered" (another state variable) as independent inputs, while I think the neo-classicals tend to think of this desire as wholly determined by the FFR or other dependent state variables. At least that's one possibility. Another possibility is that both schools accept that the desire to borrow is wholly determined by other state variables but that in an open loop system (where we cut the feedback signals) they disagree about which states determine other states (i.e. which states are more downstream than other states).

Figure 2 is a detailed view of the control law and two of the feedback loops shown in figure 1. The view here is narrower and focuses just on the control laws and the primary two feedback paths, especially the inner path associated with the FFR (the target or reference signal to track in the inner loop) and its associated control law (shown as the box with the conditional if-then statement inside). The differencing junction to the left in figure 2 is for the outer control loop and is the same as the differencing junction in figure 1: it likewise produces an inflation targeting error signal, although in figure 2 it's given the subscript "I" to distinguish it from the now explicit error signal produced by the rightmost differencing junction which represents the inner loop's FFR error signal (and  likewise distinguished by having an "R" subscript and being lower case). The inner FFR targeting loop in figure 2 can be assumed to be one of potentially a number of inner loops with feedback signals represented by the identifier "Other Feedback Outputs" in figure 1 (all depicted there without differencing junctions or control laws). Other outputs (feedback and otherwise) and fed-forward inputs illustrated in figure 1 are not shown in figure 2. The outer inflation targeting loop in figure 2 operates as described above for figure 1, tracking the targeted inflation rate with a large sample time period (low sample rate), in this case every six weeks, representing the time between Fed (or central bank) meetings to set a new target FFR. However, figure 2 makes explicit that a Taylor Rule is the outer loop control law and thus utilized to determine the new FFR target for the inner loop. Any similar rule (or the judgement of the board) could be substituted for this outer loop Taylor Rule control law.

The inner loop in figure 2 operates from the control law as depicted when there is not an abundance of excess reserves (ER) in the banking system (e.g. as it did in the USA in the three or so decades prior to 2008). The loop operates to track the targeted FFR provided by the outer loop, and fixed for six week intervals between estimates of the economy's actual inflation rate (the feedback signal for the outer loop). Note that the central bank offers discount window funds to the banks in the banking system at this targeted FFR, although there are disadvantages to using the discount window and most banks avoid doing so if possible. These disadvantages include a negative perception of the borrowing bank from other banks (and the central bank), penalty fees, and heavy collateral requirements. Instead the central bank prefers to ensure that the inter-bank funds market tracks the FFR by adjusting the liquidity of this market through OMOs.

The actual rate experienced in the market differs from the explicit FFR of the discount window and is referred to as the actual FFR and it indicated by the label "FFR*" in figure 2. FFR* is the measured true overnight rate for reserves in the inter-bank market and the measurement sample period for this signal is no more than 24 hours. Thus the inner FFR tracking loop operates with a much higher sample rate than the outer interest rate tracking loop. In terms of classical control systems, the plant for the inner loop mainly consists of the banking system which is a sub-component of the overall "rest of the economy" which serves as the plant for the outer loop and overall control system. Of course this is a bit of an oversimplification since the rest of the economy influences the banking system and thus the FFR*. The FFR* signal is fed back to a  produce an error signal (FFR - FFR*) which is an input into the inner loop's control law. When the reserve level in the banking system is too high the FFR* drops below the target FFR producing a positive error signal, which causes the central bank to engage in open market sales (OMSs): selling assets (Tsy debt & mortgage backed securities (MBSs)) on the open market for reserves, which removes reserves from the banking system and causes the FFR* to rise. Conversely when the reserve level is too low, this causes the FFR* to rise above target, the error signal is then negative, and the central bank engages in open market purchases (OMPs): purchasing these same kinds of financial assets on the open market with reserves, thus injecting reserves into the banking system and driving down the FFR*. The movement of reserves in both cases is indicated by the supplemental green arrows in figure 2. OMOs take place on a daily basis in response to rapid changes in the FFR*. Additionally, just the fact that the FFR target is publicly known helps to cause the system to converge more quickly as discussed above. Also note that OMOs here are often accomplished by the CB by using what's known as "repos" (OMSs) and "reverse repos," (OMPs) which are repurchase agreements: one party sells an asset at a discount with the agreement to repurchase it again for full price from the counterparty at a later date. A reverse repo is simply a repo from the asset purchaser's point of view.
 

Figure 2: Detail of inner and outer loops: especially inner FFR targeting loop for ER = 0 (pre-2008)

Note that with an abundance of ER in the banking system (e.g. due to quantitative easing (QE) post-2008 in the USA), figure 2 is no longer a good description of how tracking of the FFR is implemented by the Fed. With ER much greater than zero (ER >> 0), then the conditional statement serving as the inner loop's control law is ignored and the "switch" in figure 2 is essentially frozen in the up position (as pictured), and the CB always does more OMPs than OMSs which tends to drive the FFR* down as low as it can go. When the CB pays interest on reserves (IOR) this lower bound is the IOR rate itself. So in order for the CB to track the FFR with ER >> 0, it announces the target FFR (as always), sets the discount window rate to this same value (as always), but most importantly, sets the IOR rate to be equal to the target FFR. Scott Fullwiler, Cullen Roche, and Steve Randy Waldman all have good posts up about why the FFR = IOR when ER >> 0.

Update: Sept. 28, 2013: Here's some other people discussing "optimal control" in this context.

Banking Example #8: Treasury Deficit Spending

This example illustrates what happens when the Treasury department deficit spends (this includes auctioning bonds and then spending the proceeds). The core of this process is illustrated on balance sheet sets 2, 3, and 4 (debt auction depicted on the transition from 2 to 3, and spending the proceeds on the transition from 3 to 4).

Setup: the Treasury Dept. (Tsy), the central bank (CB), a commercial bank (A), and two people, x (Peter), and y (Paul). There are no reserve or capital requirements, and all balance sheets start off clear except that person y owns a house*.

1. Initial balance sheets for all players:

Tsy, CB, A, x

Assets	Liabilities
$0	$0

Person y

Assets	Liabilities
$100k house	$0
Negative Equity	Equity
------------------	$100k

 2. Balance sheets after person x takes a loan from Bank A and buys person y's house with it (this step, with a bank deposit in the private sector's hand, can be considered the initial setup for the deficit spending process):

Tsy, CB

Assets	Liabilities
$0	$0

Bank A

Assets	Liabilities
$100k mortgage to x	$100k deposit for y

Person x

Assets	Liabilities
$100k house	$100k mortgage at A

Person y

Assets	Liabilities
$100k deposit at A	$0
Negative Equity	Equity
------------------	$100k

3. Now person y decides to use the proceeds from the house sale to invest in Treasury bonds (T-bonds) from Tsy (say through Treasury Direct):

Tsy

Assets	Liabilities
$100k CB deposit	$100k T-bonds

CB

Assets	Liabilities
$100k loan of reserves to A	$100k deposit for Tsy

Bank A

Assets	Liabilities
$100k mortgage to x	$100k reserve borrowing from CB (mortgage used for collateral)

Person x

Assets	Liabilities
$100k house	$100k mortgage at A

Person y

Assets	Liabilities
$100k T-bonds	$0
Negative Equity	Equity
------------------	$100k

4. Tsy spends all the proceeds from the bond sale on services provided by person x to the government. The resulting balance sheets are:

Tsy

Assets	Liabilities
$0	$100k T-bonds
Negative Equity	Equity
$100k	----------------

CB

Assets	Liabilities
$100k loan of reserves to A	$100k reserve deposit for A

Bank A

Assets	Liabilities
$100k mortgage to x	$100k reserve borrowing from CB (mortgage used for collateral)
$100k reserves	$100k deposit for x

Person x

Assets	Liabilities
$100k house	$100k mortgage at A
$100k deposit at A	----------------------
Negative Equity	Equity
--------------------	$100k

Person y

Assets	Liabilities
$100k T-bonds	$0
Negative Equity	Equity
------------------	$100k

5. Finally Bank A pays back its reserve borrowing from the CB. The resulting balance sheets are:

Tsy

Assets	Liabilities
$0	$100k T-bonds
Negative Equity	Equity
$100k	----------------

CB

Assets	Liabilities
$0	$0

Bank A

Assets	Liabilities
$100k mortgage for x	$100k deposit for x

Person x

Assets	Liabilities
$100k house	$100k mortgage at A
$100k deposit at A	----------------------
Negative Equity	Equity
--------------------	$100k

Person y

Assets	Liabilities
$100k T-bonds	$0
Negative Equity	Equity
------------------	$100k

One way to interpret what happened during this Tsy deficit spending sequence (covered by the balance sheets illustrated in steps 2 through 5) is that Tsy deficit spending resulted in person y's bank deposit being redistributed to person x, and in the process person y was issued a net financial asset (NFA) (in this case the T-bonds). This is the usual pattern for Tsy deficit spending when the Tsy spends all of its proceeds and it must fund its CB deposit prior to spending (as in the USA) and it must turn to the private sector for this funding (also the case in the USA). Keep in mind that the only players here that can and do have CB deposit accounts are the Tsy and Bank A. That is why Bank A (person y's bank) must facilitate the funding of Tsy even though person y purchased the T-bonds through the Treasury Direct program: behind the scenes, and invisible to person y, Bank A borrows reserves from the CB (using its assets, in this case x's mortgage, as collateral) and transfers this CB deposit (reserves) to Tsy. What's the upside for Bank A in doing this? It get's to erase y's deposit from the liabilities side of its balance sheet. Also note that Tsy can only spend from its CB deposit, and to do this it transfers its CB deposit to the payee's bank (Bank A in this case), and the bank in turn credits the payee's bank deposit (person x's deposit in this case). Note that CB deposits held at commercial banks are called "reserves" while those at Tsy are not.

6. Now we examine one additional step: person x repays his loan (this step is not part of the deficit spending process, but it's useful in clarifying how equity, in the form of NFAs, are moved from Tsy to the private sector):

Tsy

Assets	Liabilities
$0	$100k T-bonds
Negative Equity	Equity
$100k	----------------

CB & Bank A

Assets	Liabilities
$0	$0

Person x

Assets	Liabilities
$100k house	$0
Negative Equity	Equity
------------------	$100k

Person y

Assets	Liabilities
$100k T-bonds	$0
Negative Equity	Equity
------------------	$100k

Notice how the non-bank private sector (persons x & y aggregated together) have obtained an NFA (the $100k T-bonds) as a result of Tsy deficit spending and the Tsy now has negative equity in this same amount (the government's debt). The overall result is as if Tsy just "printed" the T-bonds and handed them to the non-bank private sector in exchange for services the private sector performs for it. Meanwhile, bank A's and the CB's balances sheets are unchanged from the initial step 1. Also note, that like in step 1, no bank deposits exist after this step (making it a little easier to compare with step 1.).

*Why have person y start off owning a house? No particular reason. I was going to have person y simply perform some service for person x (like I usually do) but thought I'd change it up a bit. Plus that gives the bank a nice "mortgage backed security" (i.e. the mortgage itself) as collateral for borrowing reserves from the CB... perhaps moving the needle an incremental bit towards a more realistic example. Ha!

The Three Places Reserves Can Go

This post is very similar to my previous list of ways in which reserves can leave the banking system, but here I'm not worrying about what's inside or outside the banking system, which greatly simplifies matters. Also keep in mind that the titles to both this post and the prior one are technically incorrect and misleading: by definition reserves are base money INSIDE the banking system, so they can't go anywhere outside of it. Basically there's only three places reserves (really the base money that makes up the reserves) can go (not making a distinction between required and excess reserves here):

1. To an entity with a Fed deposit account: Treasury, GSEs, banks (foreign and domestic), foreign central banks, IMF, etc. Note that private individuals and non-bank businesses and organizations don't have Fed deposit accounts, and thus reserves cannot go to them*. Also note that not all banks (for instance) have reserve accounts either.
2. Withdrawn from commercial bank customer deposits as paper bills or coins, in which case they cease to be reserves (vault cash). They return to vault cash reserve status once they're redeposited at a bank.
3. Back to the Fed (central bank), where they are annihilated**. This is because reserves are liabilities of the Fed***. Electronic reserves are literally annihilated. Paper bills and coins, of course, might not physically be "annihilated" but instead might be sold again (i.e. exchanged for electronic reserves) to another bank. Of course they might also be literally annihilated (i.e. taken out of circulation permanently due to wear and tear).

Please see my other post for more details and an explanation of terms used here!

*Reserves can be credited to the bank where a private individual or non-bank business or organization holds its account with the bank instructed to in turn credit the private non-bank entity's deposit. This happens, for instance, when the Treasury pays a non-bank individual or business for services to the government from its Treasury General Account (TGA) Fed deposit (Note that funds held in the TGA and other non-bank Fed deposits are not technically "reserves" unless they are transferred to banks). It also happens when banks pay for goods or services or when they pay salaries or dividends to private non-banks when the non-bank recipients of the funds hold their deposit accounts at other banks. Note that in both cases, however, Fed deposits don't disappear: they simply move from one Fed deposit to another. Also note that this doesn't mean that banks can "loan out reserves" to non-banks. That's not how commercial bank lending works. I suppose you could claim that reserves could be loaned out indirectly in this manner, but that's always the case, even when there are no excess reserves in the system: when there are no excess reserves in the banking system, commercial banks will simply borrow the needed reserves from the Fed... and the bulk of this borrowing is on a very temporary basis (the exception being required reserves needed, by regulation, to support expanding commercial bank demand deposits). This is because the Fed (central bank) ALWAYS provides the reserves (if needed) to transfer deposits, clear payments, or expand the deposit base. That's one of the main things it's chartered to do! Also, if it didn't, it couldn't control the overnight rate (one of the other main things it does). Thus having excess reserves in the banking system really doesn't make commercial bank loans more likely. Non-bank private entities literally have no use for Fed deposits, which is why they don't need Fed deposit accounts. Non-bank private entities are really only concerned with their bank deposits and physical cash, and that physical cash (most of it anyway) originates from bank deposits (e.g. ATMs).

**Note that both coins and paper bills (notes) are minted by Treasury, but the Fed only pays Treasury the cost of production for the paper bills whereas they pay face value for the coins.

***Coins (as opposed to paper notes) are actually assets of the Fed after being purchased from Treasury at face value (but before being sold to banks): kind of a historical oddity, and I think the basis of the Trillion Dollar Coin idea for skirting the debt limit. The vast bulk of bank reserves (paper notes and electronic reserves) don't show up on the Fed's balance sheet until they are sold to banks, and then they appear as a liability to the Fed (in the case of electronic reserves they of course don't even exist until they are credited to banks!). Of course when coins are sold to banks, they are removed  from the Fed's balance sheet (i.e. they are erased as Fed assets).

Help Requested!

If you're like me, concepts stay fuzzy until you make a concrete example out of of them. There are still a couple of important MR concepts that I'm having a hard time understanding fully. One has to do with the "Corporate Profits Breakdown" chart on this post and the related Kalacki equations:

http://pragcap.com/chart-of-the-day-corporate-profits-vs-the-sp-500

Cullen has an explanation in his "Understanding the Modern Monetary System" paper/posts, but there's also this more detailed explanation here by JKH:

http://monetaryrealism.com/saving-stockflow-consistency-and-kalecki/

Right there at the top of JKH's post he also covers the other concept I'm still having a hard time with (because I still can't fully think of simple concrete examples for it), and that's the S = I + (S - I) and related formulas/identities.

I'm wondering if it's possible to create a tiny-Macro world to illustrate these concepts on balance sheets, similar to the way I've done it elsewhere in this blog. In particular, I'd love to be able to populate a world with a minimal set of entities with which to illustrate each concept. Perhaps that's a fools errand and I should quit now!! I don't know.

What I'm imagining I'd need is (at least one of each):

1. central bank (CB)
2. Treasury (gov)
3. domestic commercial bank
4. person
5. foreign CB with an account at the CB
6. foreign commercial bank with an account at the CB
7. foreign person
8. Some kind of physical asset(s)? (not sure if I need this)

Ideally I'd like to start off with everyone's balance sheets absolutely clear, except perhaps for ownership of some physical asset (perhaps a bull and a cow that can reproduce and create more), by a person say. Perhaps a bank loan could kick start the economy into gear. The goal would be to demonstrate in a concrete way on each entity's balance sheet, all the concepts/flows that JKH and Cullen cover in their posts on this subject. In particular I mean:

GDP = C + I + G + (X – M)

GDP = C + S + T

S = HS + FS

Business gross profit = undistributed gross profit + distributed profit

Business gross profit
= I – (HS + (T – G) + (M – X)) + DIV       
= investment – household saving – government saving – foreign saving + dividends

I'd also like to demonstrate, in a concrete way, exactly how JKH explains where MMT goes wrong (read JKH's entire post to see what I'm talking about). My level of understanding at this point isn't great enough that I could confidently dig in and start to populate balance sheets to demonstrate these concepts! To see how I struggle sometimes, take a look at this post which I put together after multiple comments exchanged with commentator "Joe in Accounting" here at pragcap:

http://brown-blog-5.blogspot.com/2013/03/banking-example-7-calculating-capital.html

Here's the thread:

http://pragcap.com/towards-a-mostly-cashless-monetary-system/comment-page-1#comment-141344

Anyway, the point of this post is to let people know about this project and ask for your help! I guess I could start with exactly which kind and quantity of entities I'd need to populate my world with. Or perhaps somebody has already done exactly what I'm looking for and I can save myself a whole lot of trouble by just looking at what they've already done!

Any ideas?? Please contact me or leave a comment. Thanks!