(3) Net Financial Assets — The Mechanics of Government's Adding Net Financial Assets to Non-Government

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The below is an excerpt from this post by The Heteconomist:
 

The government spending, in addition to creating income for the spending recipients (see part 9), causes an increase in the net financial assets (financial assets minus financial liabilities) of non-government.

To see this, consider the key changes to financial assets and liabilities that occur if the government pays wages of $1,000 into Minnie Motza’s account at River Bank. (Other balance-sheet changes are left out to highlight the points presently under discussion.

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In the above figure, the actions of the Treasury and central bank are combined into a single consolidated T-Account. Any intragovernment transactions between the Treasury and central bank net to zero, and so are left out. Only transactions between government and non-government show up in the consolidated government’s T-Account.

We can determine the overall financial impact of the government spending by considering its effects on each non-government entity.

On the one hand, River Bank’s net position is unchanged. The bank has extra reserves, which is its asset, but this is exactly offset by the new deposit, which is its liability.

Minnie, on the other hand, has a new asset (her deposit) with no offsetting liability.

So, for non-government as a whole, there has been an increase in financial assets relative to financial liabilities. In other words, there has been an increase in net financial assets.

This is possible, even though financial assets and liabilities for the system as a whole must sum to zero, because the extra financial asset held by non-government is matched by an extra financial liability for government. Namely, the extra reserves, which are an asset of River Bank, are a liability of the consolidated government sector.

The change in net financial assets, as presented so far, equals the change in reserves of $1,000.

Taxes have a financial impact opposite to that of government spending. If Minnie Motza pays $300 in taxes, this amount will be debited from her account at River Bank, and $300 of reserves will be debited from River Bank’s account with the central bank. The net effect will be a reduction in non-government net financial assets. For River Bank, the impact is neutral. Its liability (Minnie’s deposit) is reduced by $300, but its asset (reserves at the central bank) is reduced by the same amount. Minnie, however, has less financial assets than before, since her account now has a smaller balance. Offsetting this is a reduction in the government’s liabilities (since there are less reserves in River Bank’s account with the central bank).