(5) Net Financial Assets — Demonstrating That and How "Magical" Demand Management Works

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Like other reviewers of Modern Monetary Theory (MMT), I have wondered why the school's promoters attach so much weight to the concept of net financial assets. It seems to me the answer is: by pointing out the mechanics of net financial assets it is possible to demonstrate THAT and HOW Keynesian demand-management works in its two capacities to boost and cool the economy depending on what the economic cycle demands.

Unlike the non-government sector, government has the ability to create net financial assets in the non-government sector. It is in a position to add to the balance sheet of the non-government sector financial assets that are not balanced by liabilities of the same amount. In fact, government may add financial assets without any corresponding liabilities ensuing for the beneficiaries of the financial assets. In other words, by spending into the non-government sector more than it takes out of it through taxation, government is able to lengths the sector balance sheet on the asset side, without lengthening the sector's liabilities side. Net worth being the difference between assets and liabilities, an overhang of assets over liabilities translates to an increase in net worth. Put differently: net worth is the difference between what you own and what you owe. A positive net worth means that on calling in all claims represented by one's assets and discharging all of one's liabilities, there remains a positive amount: net worth (Reinvermögen).

Thus, by deficit spending government is able to increase the non-government sector's net worth, making it more wealthy and hence more willing to and capable of spending (itself out of a crisis), strengthening effective demand and derivatively the economy.

Putting more spendable money, i e. money available for spending, into the system, government promotes (a) effective demand, (b) the ability of the non-government sector to save at it's desired level and (c) in a riskless manner — by investing in debt instruments offered by an entity (government issuing its own money) that is free from default or liquidity risk.

Conversely, when government takes more out of the economy than it spends into it, it shortens the asset overhang, reducing the net worth of the non-government sector. A government surplus is tantamount to a deficit of the non-government sector which is forced to reduce its net worth to comply with the government-ordained drain of financial assets.

Summary:

In formalising the process of creating and destroying net financial assets we are able to show that what seems magical — the creation of wealth out of nothing — is actually well within the means of government, in other words: the ability to make the non-government sector richer than it is, when it needs to be richer than it is but cannot make itself richer than it is. For instance, when debt levels are too high, spending and investment activities are too sluggish to pull the economy out of a trough.

And also the ability to make the non-government sector poorer than it is when it needs to be poorer while not being willing or able to make itself poorer — such as when the non-government sector is so rich as to take away too many resources from government (so the latter is not able to fulfil its mandate) and an inflationary bidding war between government and non-government ensues for the finite resources available in the economy.