Understanding money: "Minsky for Dummies"

This is a very technical book, for the simple reason that it explains how to build economic models using a mathematical program. But you can do a lot with Minsky without having to create a mathematical model, because many of the issues in dispute these days in economic theory and policy come down to a simple question: “How are you going to pay for it?”

To really answer that question, you have to understand the dynamics of our monetary system—and that means you have to understand double-entry bookkeeping, because that’s the way banks and governments create money, and keep track of financial transactions. Minsky was built to do that, with its unique feature of “Godley Tables”. You can use the Godley Tables alone to answer many of the questions that dominate political debate today:

Is there a “magic money tree”?
Do banks create money?
What are Reserves used for?
What do taxes do?

And so on. In this chapter I’ll show how to pose and answer questions like these using Minsky , without having to write a single equation. Instead, I’ll just use the unique feature of Minsky , its “ Godley Table” (see Figure 8).

Figure 8: The "Godley Table" icon

You can place a Godley Table on Minsky ’s design canvas in two ways:

By choosing “Insert/Godley Table” from the Insert menu; or
By clicking once on the Godley Table icon on the toolbar (see Figure 9), and then clicking again to place the icon somewhere on the canvas.
You may be used to using “click and drag” to insert objects in other programs, like Paint, This doesn’t work in Minsky —instead you click once to attach an object to the cursor, and then a second time to place the object somewhere on the canvas.
At some stage in the future we might support both “click, then click and place” and “click and drag”, but for the moment, we only support the first method.

Figure 9: Minsky's Toolbar, with the Godley Table icon the 3rd from the right

Once you’ve inserted the Table on the canvas somewhere, it will look like Figure 10.

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To use the Godley Table, either double-click on the icon, or click on your right-mouse-button and choose “Open Godley Table” from the menu—see Figure 11.

Figure 11: The right-click (context-sensitive) menu for a Godley Table

That will bring up a new window for editing the Godley Table—see Figure 12. This is a free-standing Windows/Mac/Linux window, so you can switch between it and the canvas using Windows commands and their Mac and Linux equivalents (Alt-Tab is the keyboard shortcut to move between windows in Windows ). You can have multiple Godley Table windows open at once, as well as the window for the main canvas.

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The top row of the Table has tools for running a model, and for zooming in and out on the Table itself. The most useful tools at this stage are the magnifying glasses, which let you zoom out, zoom in, or set the size of the Table to its default. Figure 13 shows the same blank table as in Figure 12 after six clicks on the zoom in tool.

Figure 13: A magnified view of a Godley Table

The next row shows that all accounts in a Godley Table have to be classified either as an Asset (a claim that you have on someone else), a Liability (a claim that someone else has on you), or Equity (the gap between Assets and Liabilities).

The Table starts with room for just one Asset, one Liability, and one Equity column, but of course a significant model is going to have more than one of each. That’s what the +−←→ symbols on the next row are for: the + adds a new column, the − deletes an existing column, and the ←→ symbols move a column to the left or right. Now let’s build a simple model that, without the need for any equations, will show how a modern monetary system works.

4.1 Fiat Money

To use the table, you first have to name the Assets, Liabilities and Equity columns on the table. That’s where the next row—which starts with “Flows ↓⁄ Stock Vars →”—comes in. If you click in one of the cells on that row and start typing, you are providing a name for one of the stocks in the Table (ignore the upside-down triangle there for now—we’ll come to that soon). In Figure 14, I’ve clicked

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in the Asset cell and I’ve started to type the word “Reserves”. Once I press the Enter key (or click outside the cell using the mouse), I’ve defined the stock “Reserves”.

Figure 14: Naming a stock in a Godley Table

Click in the cell below Liability and enter “Deposits” (without the inverted commas of course!), and in the cell below Equity, type Bank_E. The underscore tells _Minsky_ to subscript the next character, so when you press Enter, or click outside the cell, the program will display BankE in that cell (the subscript stands for “Equity”). When you’re finished, you’ll have the basic elements of the simplest possible model of banking—in fact, one that’s too simple, because it doesn’t include the key thing that defines a bank, its capacity to make loans.

Figure 15: A basic Godley Table with 3 stocks: Reserves, Deposits and BankE

We’ll add that by using the + key below the Asset heading. That creates an additional blank cell next to Reserves. If you type “Loans” into this cell, you have Figure 16: the starting point for understanding our monetary system: a banking sector with the Assets of Reserves and Loans, the Liability of Deposits, and the difference between them, the banking sector’s equity BankE—which must be positive, since one rule of banking is that a bank must have more Assets than Liabilities.

Figure 16: The minimum stocks to show the credit and fiat money roles of banks

If we were going to build a simulation model, then the next row would be critical: this shows the initial amounts in the various accounts. But since this chapter is about using Minsky without building a simulation, we’ll skip over it and instead click on the + key at the beginning of the row. This adds a row for recording a financial transaction. Let’s start with government taxation, using the name “Tax” as a placeholder for the flow of money out of Deposits. If you type “ −T ” into the cell beneath Deposits, you’ve recorded what taxation does—it takes money out of the bank accounts of the T public. At this stage, Minsky lets you know that your entry isn’t complete, because you have only one entry for Tax, when every financial operation requires two entries per row.

Note: One limitation of Minsky at present is that entries in the rows must be variables—words like “Tax”, “Spend”, etc.—rather than numbers like “900”, “1100”, etc. This is because Minsky was

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developed to build dynamic equation, and the entries in those equations are variables rather than constants.[4]

Figure 17: Taxation entered as a deduction from Deposits

To complete this row, you need to add another entry so that the “Fundamental Law of Accounting”—that A A A −L L −E —is enforced. It should be obvious that the correct thing to do is to add another “ −T ” to the Reserves column as well: it doesn’t make sense TL ALA ELAE= 0 to do insert in the Loans column (which we’ll model in the next section), or to Bank Equity. T Therefore, taxation reduces not only Deposits, but also Reserves (Figure 18).

Figure 18: A fully entered double-entry bookkeeping record of taxation

Once you’ve made these entries in the Godley Table, your canvas should look like Figure 19 (where I’ve also used the “Title” menu item on the right-click menu to name this table “Banking Sector”). The stocks you’ve defined in the table are shown at the bottom of the icon; the single flow that you’ve defined is shown on the left-hand side.

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If you were defining an actual model right now, the next stage of the process would be place the mouse over the icon, and use the right-click menu to “Copy stock variables” and “Copy flow variables”. Figure 20 shows the model with both operations done, and the stock variables (Reserves, Loans, Deposits and BankE) placed on the canvas. Then you’d go about defining the flows using the stocks, additional parameters and variables, etc. But we’ll leave that for now and just continue using Minsky’s capability to model the interlocking financial assets and liabilities that define a monetary economy.

To make the canvas less cluttered, I’m going to use the right-click menu to turn off display of these variables: the option ”Display variables” is ticked by default, and a click on that turns it off so that all you see is the bank icon itself.[5] Page 19 Understanding money: “Minsky for Dummies”

Figure 20: The stock and flow variables copied and placed on the canvas

At this stage, we’re simply seeing the financial system from the point of view of the banking sector. A complete model involves seeing it from all perspectives, including here the public (where Deposits, which are a Liability of the banking sector, are an Asset of the public), the Central Bank (since Reserves, which are an Asset of the banking sector, are a Liability of the Central Bank), and the Treasury (which is the originator of the taxation operation).

To do this, we need to add an additional three Godley Tables—one each for the Public, the Central Bank, and the Treasury. In Figure 21, I’ve named them all appropriately using the Title option on the right-mouse menu (you can also name a table when working on the Godley Table itself: “Title” is an option on the Edit menu, and the right-click menu also has a Title option).

Figure 21: The model with 3 more blank Godley Tables

To populate these tables, we make use of one feature I haven’t yet explained, the upsidedown triangle or wedge , in the cells for naming stocks. If you click on one of these wedges, Minsky returns a list of all the Liabilities (or Assets) that haven’t already been recorded as an Asset (or Liability) for some other entity in the model.[6] Page 20 Understanding money: “Minsky for Dummies”

Open up the Godley Table for the Public and click on the wedge in the Asset cell, and one entry will appear in a drop-down menu: Deposits—see Figure 22.

Figure 22: Using the Assets and Liabilities Wedge

Click on Deposits to choose it, and Minsky will show Deposits as an Asset of the Public, and autopopulate the column with all the operations that have been entered on the Banking sector table that affect Deposits—so far, this is only the negative entry for taxation. This gives us Figure 23. Notice that the A-L-E column has the entry −T in it, showing that the matching double-entry for this table hasn’t yet been entered. T

Figure 23: Deposits as an Asset for the Public

The only sensible option here is that taxation reduces the equity position of the non-bank public sector.[7] Name the Equity cell PublicE, add the entry “ −T ” on the Government Taxation row, and this operation is now shown from the public’s perspective: taxation takes money out of the public’s T bank accounts, and reduces its equity. This is a fundamental proposition in MMT—Modern Monetary Theory—and it’s obviously true, when you see the world through the double-entry bookkeeping eyes of Minsky .

Figure 24: Taxation shown from the public's point of view

Next, let’s add the public’s liability in this model—loans from the banking sector. If you click on the wedge under Liabilities, the drop-down menu will reveal two choices: Loans and Reserves. Click on Loans, and you’ll get Figure 25. We’ll add flows to the Loans column in the next section—in this one we’re focusing on government operations.

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Figure 26: The Public's Godley Table completed

That’s taken care of Deposits, which is shown as a Liability of the Banking Sector and an Asset of the Public. Now we must do the same for Reserves. These, as is well known, are a Liability of the Central Bank: in effect, Reserves are the deposit accounts of private banks at the Central Bank. Open the Central Bank’s Godley Table, click on the wedge in the Liabilities cell, and choose “Reserves”. That generates Figure 27.

Figure 27: The Central Bank Godley Table with Reserves entered

As with the earlier exercise with the Public’s[8] table, we have just a single entry for Tax: there’s nowhere obvious to record it a second time, since it’s not the Central Bank that does the taxing, but the Treasury. Therefore, the sensible thing to do here is to add an additional Liability for the Central Bank, the deposit account of the Treasury—which I simply call Treasury (see Figure 28). I’ve also named the Equity column for the Central Bank CBE.

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This now gives us a Liability for the Central Bank—the Treasury’s account—which is an Asset for the final entity in this model, the Treasury itself. Bring up the Treasury’s Godley Table, click on the wedge for Assets, choose “Treasury”, and you’ll have Figure 29.

Figure 29: The Treasury's Godley Table on initial entry of its Asset, the Treasury account at the Central Bank

To complete the model at this stage, you need to enter the balancing entry for Tax—and the obvious place for it to go is in the Equity column for Treasury: taxation increases the Equity of the Treasury (Figure 30). This is the obverse side of the MMT point that “the Public sector’s surplus is the Government sector’s deficit”: taxation subtracts from the Equity of the public and increases the equity of the government.

Figure 30: Treasury Equity shown

This is also the point at which a genuine Fiat money system differs from a commodity-backed system—a “Gold Standard”, for example—or from one like the Eurozone, where national treasuries cannot produce the currency they spend. In such systems, Tax would add to the Treasury’s stock of Gold (or Euros), while government spending—which I’ll introduce shortly—would run that stock down.

We now have a complete model of the impact of taxation in a Fiat money system, in that every Asset is shown as another entity’s Liability, and all flows are recorded four times: twice in each table they appear in, and once each as affecting an Asset and a Liability. Via double-entry bookkeeping, this gives us eight entries for the one operation.

To see this whole system, click on the Tab labelled “Godleys”, and you’ll see all the Godley Tables at once.[9] They’ll be a jumble when you first click on the tab, but you can easily move them around to produce an arrangement like Figure 31.

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We can now add government spending to the model, and it’s effectively the opposite of Tax: government spending increases the public’s equity and reduces the government’s. You can start anywhere you like in the system—from the Public’s Godley Table, or the Treasury’s, Central Bank or the Banking Sector—and Minsky will point out where the matching entries are needed. I started with the Banking Sector’s view in Figure 32:

Figure 32: Adding government spending into the model

A minute or so later, I had the picture shown in Figure 33.

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Figure 33: The complete model with government spending as well as taxation

This lets us see the key points of Modern Monetary Theory— not because I’ve been explaining the theory itself, but because the “theory” is fundamentally on an accurate portrayal of the accounting . A government deficit creates net financial assets for the public, and simultaneously creates negative net financial assets for the government: the government deficit is the private sector surplus.

To complete the picture of a modern fiat money system, we need to include bond sales by the Treasury to the Banking Sector in the initial auction, sales by the Banking Sector to non-banks (which can include other financial institutions, such as Pension and Hedge Funds), and purchases by the Central Bank of bonds from both the Banking Sector and the Public.

4.2 Bond Sales

In the model to date, if the Treasury spends more than it taxes, the Treasury’s account at the Central Bank will go into overdraft—notice in Figure 33 that the only flow entries in the Treasury’s account at the Central Bank are −S and +T . So if S is greater than T , then over time, this account will turn negative. AS T AS T

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For an ordinary customer of an ordinary bank, that’s a serious problem. A negative deposit account might not be approved in the first place—so that any intended transaction which sends an ordinary depositor’s account into negative territory would be rejected for insufficient funds. If an overdraft is approved by the bank, it attracts a punitive interest rate, normally higher than the interest rate on loans themselves. If the customer breaches the terms of the bank’s overdraft—by not making an interest payment, or breaching any of the many caveats that a bank can attach to an overdraft agreement—it can lead to the bank initiating bankruptcy proceedings against its customer.

But what is the situation for the Treasury and the Central Bank? In a country which issues its own currency, the Treasury is the effective owner of the Central Bank . Though specific laws can change the situation, technically, the Central Bank is obliged to let the Treasury do what it wants, even if that means a negative balance on the Treasury’s account at the Central Bank. It would be quite possible, in an accounting sense, for the government to simply operate with an overdraft account at the Central Bank: it doesn’t have to sell bonds at all.

However, most countries have passed laws forbidding the Treasury from operating in overdraft mode, except in exceptional circumstances like the pandemic—where, for example, the Bank of England initially allowed Treasury to operate its overdraft account, rather than having to sell bonds to avoid going into overdraft.[10] Some countries also require the Central Bank to charge the Treasury interest on either overdrafts or loans. But even in countries which do that, the interest is returned to the Treasury as part of the operating profits of the Central Bank. This is why there is a “magic money tree” : a currency-issuing country can create money by running a deficit, and it does not have to borrow from either private banks or the public to finance that deficit.

What do bond sales in fact do? Let’s add them to the model and find out. This requires one more Asset column for the Banking Sector, which is the sector that initially purchases Treasury Bonds. I’ve named the Asset for Banks BondsB, to indicate that these are Bonds owned by the banks—rather than, say, the Central Bank or the Public—and labelled the transaction BuyBondsB in Figure 34.

Figure 34: Banks buy Bonds from the Treasury

That’s showing the increase in the Banking Sector’s Assets from buying the bonds, but how do they finance the purchase? In other words, where is the second entry required by double-entry bookkeeping to show the purchase? The only viable option is that the funds used to purchase the bonds come from Reserves—and these Reserves were created by the deficit : the excess of Spend over Tax. So, as well as creating money for the private sector, the deficit creates excess Reserves, which the Banking Sector uses to buy the bonds . As long as the value of bonds sold be Treasury is equal to or less than the deficit, the Banking Sector has the Reserves needed to buy them: see Figure 35.

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Figure 35: Bond purchase balanced by showing bonds are bought using Reserves created by the deficit

This completes the Banking Sector’s Godley Table, but it leaves the Central Bank’s incomplete—see Figure 36.

Figure 36: The Central Bank's Godley Table after the Banking Sector's Table has been completed

The obvious way to complete the Central Bank’s Table is that the proceeds from the sale of Bonds tops up the Treasury account: see Figure 37.

Figure 37: The Central Bank's Table with the sale of Bonds fully recorded

This shows the real purpose of bond sales, from the Government’s point of view: they enable the Treasury’s account at the Central Bank to avoid going into overdraft. If the revenue bond sales (BuyBondsB here) equals S −T , then there’s no change to the balance in the Treasury account from running a deficit. AS T

What bonds certainly are not is borrowing money from the banks in the way that individuals do when they take out a mortgage. When you take out a mortgage, it’s because you haven’t got the money needed to do what you want to do—buy a house. If you don’t get the mortgage, you can’t afford to buy the house.

But the government has already created the money it needs to do whatever its proposed activities are by running the deficit itself. Secondly, the Reserves that are used to buy the bonds were created by the government running a deficit. If the deficit didn’t exist, then (at least initially—there’s a change coming when we consider interest payments on bonds) the banks wouldn’t have the funds needed to buy the bonds.

The final step in recording the impact of the bond sales is to add BondsB as a Liability of the Treasury. Open the Treasury’s Godley Table and it will look like Figure 38. Click on the wedge below Liability,

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and the drop down will show BondsB as an Asset (for the Banking Sector) that hasn’t yet been recorded as some other entity’s Liability.

Figure 38: Treasury Godley Table before BondsB is recorded as a liability

Select BondsB and Minsky automatically balances the table: see Figure 39.

Figure 39

To complete modeling bond sales to banks, we need to include the payment of interest on those bonds. In Figure 40, I’ve labelled this InterestBB —the subscript is there to indicate that it’s interest on bonds, the superscript to indicate that it’s paid to the banks, to distinguish it from interest paid to the public when, at a later stage, banks sell some of these bonds to the public. A superscript is entered into Minsky using the ^ character, which is normally the Shifted character on the 6-key on your keyboard (So the string you type into the cell is Interest_B^B).

Figure 40: Payment of interest to banks on Treasury Bonds

I’ve already made the obvious deduction that this interest payment increases the equity of the banking system—which is one obvious reason that, when the Treasury offers to sell bonds to the banking sector, the offer is always taken up. To do otherwise is to turn down an offer to turn a nontradeable, non-income-earning asset—Reserves—into a tradeable, income-earning asset—Bonds. To complete the model at this stage, we now need to add this flow to the Central Bank’s and the Treasury’s Godley Tables. When you open up the Central Bank’s Godley Table, it will look like Figure 41: the addition to Reserves is already shown, but the second balancing entry is still needed.

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The obvious thing is that the interest payments come out of the Treasury’s account. Make the entry −Interest in the Treasury column, and you have Figure 42. B Figure 42 B

This change in turn cascades into the Treasury’s Godley Table now—see Figure 43.

Figure 43

The obvious closure of this entry is that paying interest reduces the Treasury’s equity—and by precisely as much as it increases the equity of the banking sector. So just as a deficit creates net financial assets for the non-bank public (by crediting their deposit accounts with more money from government spending than is removed by taxation), the interest payments create net financial assets for the banking sector—see Figure 44.

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So how does the Treasury pay the interest? In practice, there could be many methods. What I’ll model here is the most sensible for a currency-issuing government: it borrows from the Central Bank.

In practice, this is forbidden in most countries, by legislation that prevents the Treasury borrowing directly from the Central Bank. However, the same outcome can be achieved in a two-step process: the Treasury sells bonds to the private banks to the value of the interest on outstanding bonds, and the Central Bank then purchases these bonds from the private banks on the secondary market.[11]

If you’ve followed me this far, you should be familiar with the steps needed to show this: we add an Asset to the Central Bank’s Godley Table—LoansCBT (which uses another of Minsky ’s formatting tricks: encase the characters CB in a pair of curly brackets— Loans_{C —and _Minsky_ subscripts the two characters together), and use to show the actual loans. Figure 45 shows the entries on the Central Bank’s table (with the actual entry of the text string into the Treasury column, before T }^T CB LAS _Minsky_ formats it).

Figure 45

If the loan from the Central Bank to Treasury equals the interest payments on the bonds, then the Treasury’s account at the Central Bank can avoid going into overdraft. It doesn’t change the aggregate picture: the Treasury’s negative equity from the deficit creates positive equity for the nonbank public, while interest payments on bonds creates negative equity for the Treasury and identical positive equity for the banking sector.

Even without attempting to build a mathematical model, this exercise in laying out the structure of the financial system eradicates a lot of popular myths in mainstream economic thinking:

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A deficit doesn’t take money from the public—in the sense of the government borrowing from the public to finance its deficit—but actually puts money into the hands of the public;
The deficit creates Reserves for the banking sector, and those Reserves are what banks later use to buy government bonds;
The deficit creates net equity for the non-bank public, while interest on government bonds creates net equity for the banking sector.

This symmetry—that a deficit for the government means a surplus of precisely the same magnitude for the non-government sectors—is apparent in Figure 46. The sum of the non-bank Public’s and the banking sector’s net equity position is S + Interest −T ; this is the opposite of the Government’s net equity T −Interest . B B AS B T Figure 46: Full system with bond sales to banks B T−S AS

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The final two steps to show to cover the fundamentals of fiat money are sales of bonds by the banking sector to the public, and purchases of bonds by the Central Bank from both banks and the public. Figure 47 shows the full system—which, if you want to learn how to use Minsky , you should try to complete for yourself. It needs:

Two additional stock variables—BondsCB for bonds owned by the Central Bank, and BondsP for bonds owned by the public;
The relevant flows for these stocks: sales of bonds by the Banking Sector to the Public, SellBondsP; purchases of bonds by the Central Bank from the Banking Sector, BuyBondsCBB ; and purchases of bonds by the Central Bank from the Public, BuyBondsCBP .

As with the previous stages of this exercise, several insights can be gleaned from these Tables that contradict widespread beliefs about government money creation. One of these is even something that I used to believe—that money is only created to the extent that the Central Bank buys government bonds. But in fact, Central Bank purchases of Treasuries are irrelevant to money creation, and indirectly slightly reduce the amount of money created, because they reduce payments of interest to the banking sector and the non-bank public to whom banks have sold bonds they purchased in the primary bond auction (in practice, these bonds are normally purchased from banks by non-bank financial institutions).

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Figure 47: Full MMT system with bond transactions between Treasury, Banks, Central Bank and the Public

The reason why Central Bank bond purchases from the banking sector don’t affect the amount of money created by a deficit is apparent in the second table in Figure 47: the purchase reduces the monetary value of the bonds held by banks, and replaces them by an equivalent value of Reserves. The Banks would hope to make a trading profit out of this sale,[12] but the sale itself simply swaps one Asset for the Banks (Bonds) with another Asset (Reserves). In practice, this reduces the process of the Treasury selling bonds to the banks in the first place: it replaces Bonds with Reserves. It is Page 33 Understanding money: “Minsky for Dummies”

therefore irrelevant to money creation, because since the level of Assets remain constant, so too do Liabilities and Bank Equity.

This is an important general point that will recur frequently in this book, and when building models using Godley Tables: for money to be created, an operation must affect both the Asset and the Liability/Equity sides of the Banking Sector’s ledger . Central Bank bond purchases from the Banking Sector only affect the Asset side, and therefore are irrelevant to money creation. The only effect they do have is to reduce money creation slightly, because the Treasury will no longer pay interest to the Banks on these bonds.

On the other hand, Central Bank purchases of Bonds from the public do create money: the sale of the Bonds credits both the public’s deposit accounts at banks, and the reserve accounts of the banks.

Conversely, the sale of bonds by the Banking Sector to the non-bank Public destroys money: the Public’s deposit accounts fall and their holdings of Bonds rise. But even in this case, the money being destroyed was initially created by the deficit itself: only if all the bonds initially purchased by the banks from the Treasury at the bond auction were sold to the public would the actual creation of money by the deficit fall to zero.

That covers government money creation. Now let’s turn to private money creation by the Banking Sector.

4.3 Credit Money

I’m now assuming that you have some fluency with Godley Tables— you have been following my explanation by reproducing these tables in Minsky yourself, haven’t you? —and so I’ll just cut to the chase, and enter the three necessary operations for private money creation in one go: new loans by banks, paying interest on loans, and loan repayment by bank customers. Use the words “Lend”, “Interest”, and “Repay” for these flows, and make the entries so that the checksum column always sums to zero (Figure 48). A−L− Figure 48: The basic operations of fiat and credit money from the Banking Sector’s point of view E

As an aside, if you have a background in accounting, you may prefer to see Minsky ’s operations using DR and CR rather than plus and minus entries. You can engage that from the Options menu on the Table: choose “DR/CR Style”. Then the model in Figure 48 will look like Figure 49 (I prefer the plus/minus approach, so that’s what I’ll stick with from now on).

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Following the general principle noted just above, that to create money, an operation must add to both the Asset and Liability/Equity sides of the banking sector’s balance sheet, it should be obvious that lending creates money while repayment destroys it.[13] This simple fact is ignored by the mainstream model of lending, known as Loanable Funds, which treats banks as “financial intermediaries” that take in deposits from one set of customers (“Patient people”, to use Paul Krugman’s non-pejorative[14] term) and then lends them out to other people (“Impatient people” in Krugman’s lexicon).

I’ll spend a lot of time on the macroeconomic impacts of private money creation in Chapter 8. For now, without writing a single equation, we’ve come up with a picture of the monetary aspects of a mixed fiat-credit money system that contradict the conventional wisdoms promulgated by economics textbooks and mouthed by politicians.

If you’ve followed the argument here to date— especially if you’ve done so by reproducing the model in Minsky for yourself —then you’re well on the way to understanding the monetary dynamics of capitalism. I’ll repeat a lot of the points here in subsequent chapters, but with the addition of defining a mathematical model, rather than stopping at laying out the balance sheets, as I do here.

4.4 A significant extension: Nonfinancial Assets

One weakness of Minsky was that it handled only assets which are also liabilities: something like a deposit account, for example, is an asset for the depositor, and a liability for the bank. But there are also assets—such as a house, gold, the market value shares (a share is only a liability for the issuing company up to its issue price), cryptocurrencies, etc.—which are assets of the holder, but a liability of no-one. These go by the general moniker of “non-financial assets”.

This term is a bit misleading, since, in most people’s eyes, things like houses and precious metals are very much financial assets. However, they are not “at call”: your house might be “worth” $2 million in the current market, but to realize that valuation you’re going to have to sell it, which could take 6- 18 weeks even in a buoyant housing market.

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We have just[15] added a means to handle such assets: you can define an Asset for a particular Godley Table as an Equity for that same Godley Table, once you have enabled multiple Equity columns (this is an option on the Options/Preferences main menu, and on the menu for Godley Tables). Once you have recorded some assets for a given entity on its Godley Table, the wedge dropdown on the Equity column will show assets on that same Godley Table that have not yet been allocated to another Table’s Liabilities.

Research alert : since we’ve just added this feature, and we are still fine-tuning it, I haven’t personally explored its implications yet. I believe, but I don’t yet know, that it will enable the modelling of (a) the “ab initio” creation of a monetary system, complete with the initial formation of banks, and (b) asset price booms and busts, and how they are generated and fuelled by the banking sector. Since these are very important topics that have been discussed but, to my knowledge, have not been modelled, these could both be excellent topics for a PhD.

Figure 50 shows using this feature: the Asset WHouses is obviously an Asset that has no balancing Liability, while WDeposits is obviously also a Liability of the banking sector.

Figure 50: Dropdown Wedge on Equity column now shows unallocated Assets on the same Godley Table

Notice that WDeposits turns up twice on the Workers Godley Table in Figure 51.

Figure 51: Non-financial assets in a simple model

This feature should support modelling everything from the ab initio creation of banks in a fiat-credit money system (since banks were often established on the basis of ownership of land by their founders) to asset bubbles and their denouement in crashes—though to model all this will require a lot of additional work. But the basic structure needed to do this now exists in Minsky . I’ll sketch the basics of both topics and leave taking this further as an exercise for the reader.

4.4.1 Ab initio creation of banks

Modern Monetary Theory describes the functioning of an existing monetary system—consisting of a government with a Treasury, a Central Bank, and its own currency, a private banking system, and the non-bank public with deposit accounts at the private banks. One common and correct defense of the MMT proposition that a government spends first and taxes later is that, when a currency is first created, it must be spent into circulation before it can be taxed back. This pre-supposes the Page 36 Understanding money: “Minsky for Dummies”

existence of banks at the time, but how can they come into being with the key prerequisite of having Assets that exceed their Liabilities?

Nonfinancial assets provide the answer: banks are formed by wealthy people pledging various assets of theirs to the bank, so that it starts with positive nonfinancial assets. You can imagine something like the situation shown in Figure 52: a bank’s founders form a company and pledge various assets to the bank, so that it starts with an amount of nonfinancial assets—showing gold and land here—that give it net positive equity.

Of course, this involves someone valuing these assets (which are denominated in weight and area respectively) in terms of the new currency. That “someone” will be the ruler or political system establishing the currency—King Offa in the example I give in Manifesto —so there is, as usual, a foundational role for the government in establishing a financial system in a fiat money world. This “ab initio” situation is shown in Figure 52.

Figure 52: "Ab initio" formation of banks

Next, the bank would pledge these assets as collateral to back the bank. These would be valued at a discount—in Figure 53 I show this as a roughly 10% discount, but it would surely be larger in practice. As noted earlier, Minsky doesn’t support using constants like 1,000 as flow entries in Godley Tables. I’ve cheated here by typing 1000 inside parentheses, which is a LaTeX way of typing a string of characters: {1000} .

Figure 53: Nonfinancial assets pledged at a discount in return for State-issued currency

Swapping back to the Minsky convention of using variable names for flows, I’ll call this Statevaluation of the nonfinancial assets backing the bank “Pledge”:

Figure 54: The same as Figure 53, but with the variable "Pledge" replacing the constant value 1000 in Figure 53

This is a feasible way to show how propertied interests can turn control over physical resources into the basis of a private monetary system. It would be relevant to the actual historical practice of “Free Banking” in the 19th century {Rockoff, 1974 #1171;Economopoulos, 1988 #1132;Flanders, 1996 #1161;Hickson, 2002 #1153;Lakomaa, 2007 #1157;Bodenhorn, 2008 #1146}, and also the logical “ab initio” proof of MMT’s assertion that government spending precedes taxation. Part of that process requires banks that can purchase government bonds (if we try to build a model that is congruent with current practices, where bonds are issued to avoid a Treasury overdraft at the Central Bank); this additional feature of Minsky helps show how that could happen. The State valuation of the

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nonfinancial assets pledged as collateral to establish a private bank gives the private bank both positive equity in financial assets, and the excess Reserves that will be needed to buy the bonds issued to cover the initial government deficit.

There is much more work required to this complete this model, but I’ll leave it at this level and invite research students to consider taking the concept further.

4.4.2 Financial Assets and Bubbles in Nonfinancial Asset valuation

A more contemporary problem is the role of financial assets—fundamentally, bank debt—in determining the value placed on nonfinancial assets—primarily, housing. The empirical link is obvious—and as usual, is ignored by Neoclassical economists. The causal relation is easily inferred from the facts that (a) the supply of housing is very inflexible, so the volatility in the housing market comes from the demand side, rather than the supply side; (b) the demand side is dominated by mortgage credit—new mortgage debt—since houses are overwhelmingly purchased with borrowed money; (c) if you divide new mortgage debt by the average house price, you get a measure of how many “average” houses can be purchased; (d) given the inflexible supply, there is a strong relationship between mortgage credit (new mortgage debt) and the house price index; (e) there is therefore a relationship between change in mortgage credit and change in house prices.

This relationship is apparent even in countries with very different house price and household debt histories, like the USA and Australia. The USA had a famous boom and bust in house prices, the “Subprime Crisis” {Silipo, 2011 #3925;Kaboub, 2010 #3922;Dymski, 2010 #3937;Wray, 2008 #3785;Bernanke, 2007 #5578} that led to the “Great Recession”. Australia, on the other hand, sailed through the “Global Financial Crisis”—as the “Great Recession” is known outside of America—with only a small dip in house prices, which are now 4 times as high, in real terms, as they were in the 1970s (in the USA, they are “only” 2.5 times as high). When you plot house prices in Australia and the USA against each other (the top left plot in Figure 55), you see two very different patterns: effectively always-rising prices in Australia; a boom, bust, and then rising prices once more in the USA.

Household debt also follows a very different pattern in both countries. Household debt in the USA rose strongly until 2008, and has fallen ever since—though with a slight blip at the beginning of the Covid-19 crisis. However, in Australia, household debt, like house prices, just keeps on rising (the top right plot in Figure 55).

However, when you plot the change in household credit against the change in house prices—the two bottom plots in Figure 55) you get a very similar pattern: rising house prices goes with rising household credit, and falling house prices with falling household credit.

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Figure 55: House prices, household debt & the "credit accelerator" in the USA & Australia

The link between rising household credit and rising house prices is therefore obvious: the question is, how to model it? In the Appendix, starting on page 257, I cover the mathematics of the relationship between rising household credit and rising house prices; here I show the stylized relationships between change in financial assets and change in the valuation of houses, using this new feature of Minsky .

Imagine that Homer Simpson wanted to buy a house off the real estate magnate Mr Burns. Homer first has to take out a mortgage with the bank, pay the money needed to buy the house to Mr Burns, pay interest on the mortgage (and principal, but I’m omitting that to focus on the nonfinancial assets issue here), maybe take out a Home Equity loan in his later years, and then sell the home at the end of his life. These transactions are shown in Figure 56.

Figure 56: The Bank and financial-assets-only view of house purchase and sale

This view shows the changes in financial assets and liabilities, but omits changes to the distribution and valuation of the nonfinancial asset which is the subject of the transaction—the house. These are shown in Figure 57, in the final three rows of the Godley Tables for both Homer and Mr Burns.

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The purchase of the house by Homer—the 3rd last row of his Godley Table—converts an amount of dollars worth of financial assets (Homer’s bank account) into an identical valuation of a nonfinancial assets (the house). If the purchase price was $450,000, Homer’s bank account declines STLA by $450,000, and he then owns a house with an initial valuation of $450,000. The reverse applies to Mr Burns—the 3rd last row of his Godley Table. Similarly, the eventual sale of the house (from Homer back to Mr Burns in this simple example) does the reverse. This will be at a different price to the original purchase however—so there will be a change in the value of the house when it is sold that will turn up as a capital gain or loss. In this case, a gain for Mr Burns will be an identical loss for Homer. The question to be explored in a proper model is what causes the change in valuation— which will come down to the dynamics of mortgage debt (and demographics and other issues) explored in the Appendix.

With respect to Minsky ’s internal logic, the interaction of nonfinancial with financial assets means that the rule A A A −L L −E no longer applies. If house prices are rising, then Homer makes a capital gain, which captures the reason that people get caught up in asset bubbles in TL ALA ELAE= 0 the first place: it’s a way to escape the trap of net financial assets summing to zero, by stepping into another trap of asset price bubbles and private debt.

Figure 57: The full transaction set, including changes in nonfinancial assets (house ownership & valuation)

As this example is set up, there is no aggregate capital gain: Homer’s gain, should he be so lucky, will be Burn’s loss. This illustrates that the source of collective capital gain over time—the sort of increase in the aggregate valuation of houses and share (and cryptocurrencies) during asset price bubbles—must lie elsewhere. In the case of housing, it is in the rising aggregate level of mortgage debt, as both the correlations shown in Figure 55, and the logical argument made in the Appendix

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illustrate.[16] There would, I expect, be an interesting PhD thesis in taking this financial-nonfinancial asset valuation issue further.

Many other monetary questions can be answered simply by posing them in Minsky ’s unique Godley Table structure. However, to fully exploit Minsky ’s capabilities, you need to understand how to use the program to build dynamic simulation models. That is the topic of the next and subsequent chapters.

Note: This feature is still under development, and there are some issues we’re still not sure of. For example, looking at the sale of the house to Homer by Mr Burns, Burns’s equity changes form from a house valued at $X, to $X in the bank. So, in aggregate A A A −L L form, the sum is zero. But in terms of Mr Burns’s stock of houses to sell, the operation results in a fall of dollars in TL ALA terms of the valuation of his stock of houses—and this is shown both in the specific Equity column Houses, and in the sum for that row. −CE The Equity columns show the correct dynamics: the rate of change of Burns’s financial equity from A−L−E the transaction equals dollars per year, and the rate of change of his nonfinancial equity is dollars per year. As to what the A-L-E column should show? We’re still not sure. CE This feature will develop, and questions it raises solved, as we release new betas. This is another −CE reason to support Minsky’s development via its Patreon page https://www.patreon.com/hpcoder

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Footnotes

4 We realise, however, that it sometimes helps to see a model of financial flows using actual numbers rather than variables, and if we get funding to support this, we may add the capability to enter constants into Godley Tables at some point in the future.

5 Displaying flow and stock variables on a Godley Table icon is somewhat of a legacy feature of Minsky . At an earlier stage, we didn’t have the multiple tabs, including the “Godley Table” tab, so having the variables shown attached to the icon made it possible to look at the canvas and see the variables in it. The Godley Tables tab makes this less likely, and in a future iteration, it will be possible to access all variables from the toolbar as well, making this feature less necessary still. At that point, we’ll probably change the default setting so that variables are not displayed on a Godley Table.

6 There is one other option here, which we have only just introduced in the latest beta—2.31.0-beta 2: nonfinancial assets (like houses, precious metals, artworks) are assets for their owners, but not a liability for anyone else. If your model includes nonfinancial assets, these are recorded as an additional Equity column in the same Godley Table. See Section 4.4 on page 34 for a brief discussion of this issue.

7 Obviously the financial sector gets taxed as well (though it’s surely better than households and non-financial firms at evading taxes in practice).

8 One of the English language’s quirks that must be so confusing for those with a different native tongue is that we use the word “Public” to describe the non-government sector, and also refer to the government as the “Public Sector”. Go figure.

9 On Minsky’s design canvas, with “Display Variables” turned off, your model consists of just the 4 banking icons shown in Figure 21.

10 See https://www.theguardian.com/business/2020/apr/09/bank-of-england-to-finance-uk-governmentcovid-19-crisis-spending

11 I’m just simplifying this into a single process by calling it a loan from the Central Bank to the Treasury, because, as I hope you’re realized by now, this government operation is self-financing: the payments of interest on government bonds held by the banks creates the Reserves that the banks would need to buy the bonds that were issued to cover the interest.

12 This could be added to the model with another row showing the trading profit (or loss)—which would be the difference between the sale price and the purchase price, multiplied by the number of bonds sold. This would add to Reserves and Bank Equity, in which case it is a mechanism for money creation.

13 This last point is something that I myself didn’t accept before I designed Minsky : though both Minsky himself and Graziani made this claim, it sounded crazy to me that banks would let money be destroyed after they had created it, and I wrote the money chapter of the 2nd edition of Debunking Economics to be agnostic on this point. But in fact, Minsky and Graziani were correct whereas I was wrong, and one of the major reasons I’m writing a third (and final!) edition of Debunking Economics is to correct this mistake. 14 Irony alert.

15 At the time of writing, the current release is version 2.35. This feature was introduced in the beta for version 2.30

16 Rickard Nyman’s work for this unpublished joint paper showed strong Granger causality from change in household credit to change in house prices.