MMTed - Home Page of Public Education in Modern Monetary Theory

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Part of the objectives over the course is to cut through all of the jargon. Now, a lot of students have said to me, why did we have all these terms in economics that don't make sense, that overlap with terms out in society, which means completely different things? Well, part of becoming part of a discipline is that you learn this language and it can become a barrier to entry, a barrier to understanding and so what we're trying to do in some of these segments is cut through all of that and make them as simple as possible, but not apologising for the fact that the language is important and the distinctions we're making are very important to developing your economic literacy.

So here's a nice river and it's flowing by under a bridge or wherever, and we call this a flow, and the defining characteristic of it is that we measure the cubic volume of water flowing under a bridge, for example, over a period of time. Now, in economics, we have flows of currency - so households consume. So when you go to the supermarket and pay the checkout operator, increasingly these days you just pay a machine. But you're paying money for your goods, that's consumption flow. And business firms invest in plants and machinery and technology. That's called an investment flow. And government's spending on health and education and the things that governments do is a flow of spending into the economy. And when we put things on boats and send them abroad as our exports, that's a flow of export spending coming back to us. The goods go to them, their spending comes back to us. And similarly, when imports come in, we're buying foreign cars and computers and telephones and what have you - that's a flow of spending that leaves the economy. And when you get your pay cheque, that's a flow of income coming to you. And that's specified in terms of so many dollars per month or so many yen per year, whatever their flows.

Now, here's a reservoir or a dam, depending where you live and that's what we call a stock, because the defining characteristic of it is that we measure that volume of water at a point in time, not over a period of time as we do a flow. And sort of the things we talk about in economics as stocks are wealth - so money you've got stashed away in your piggy bank, any debt that you hold or that government holds, that's a stock of debt. We measure it O IO X number of dollars at this point in time - when we talk about the labour market, total employment or total unemployment - is a stock measure because we calculate how many people are in jobs at the end of a month, not through the month.

Now, stocks also are fed by flows. So imagine you're sitting in a bath and you turn the tap on, the faucet, and a flow of water goes into the bath and steadily builds up as long as you keep the flow of water going in and the stock of water in the bath rises, and when you turn the bath tap off, the stock stabilises at whatever your desired bath level is.

Now, then if you turn off the tap and open the drain at the end of your bath, the water starts to flow out and the stock of water starts to get lower and lower until finally you've drained all the water out. And so the important point in economics is that, flows feed into stocks and that we have to understand that linkage and the implications of that. And we'll reveal that as we go but it's very important to be able to distinguish between those two concepts.

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Study Notes:

Our initial task in the course is to improve your economic literacy. The use of jargon can often serve as a barrier to understanding. Our aim in the first week is to break down the jargon and present some essential concepts in an accessible way.

First, consider the concepts of stock and flow variables, which as we progress will enable us to clearly set out the relationships between deficit spending and saving, and between financial deficits and debt.

Flow variables are measured over time. The simplest example is personal income, which can be stated as $10 per hour, or $400 per week, or $20,000 per year. Without a clear statement of the time component, any statement about a flow is incomplete and somewhat meaningless. If one says one’s income is $100, we need to know whether that is per hour, per day, per week, or per year to make sense of it.

What flows? When we speak of the flow of a river, it is obvious that it is water that is flowing, measured in terms of thousands of cubic metres per second. However, it is not so clear what is flowing when we refer to flows of income and expenditure. For example, what ‘flows’ to provide a wage income equal to $20,000 per year? The simple answer is ‘dollars’. You work for your employer for eight hours a day, five days a week, and after two weeks you receive an electronic transfer for the sum of $800 (ignoring tax deductions). Even on payday, it is difficult to think of the electronic transfer as the ‘dollars’ that were flowing while you were working. The payment (say, in the form of an electronic transfer) is just an IOU issued by your employer’s bank that is denominated in your nation’s money of account.

Flows of income or spending are measured in terms of the money unit (dollars here). The associated flow of currency can take the physical form of notes and coins, but equally can be an electronic deposit, say in a private bank account. Thus, in contrast to a flow of water, the flows of spending or income do not always take a physical form.

Flows accumulate as stocks. The flow of water in a stream can accumulate in a reservoir behind a dam. The stock of water is then the number of cubic metres in the reservoir. Unlike a flow, a stock can be measured without reference to a time period because it exists at a point of time.

Now consider our biweekly wage payment takes the form of an electronic transfer for $800, 25 times a year, for a total annual income of $20,000. On each payday, the electronic transfer appears in your bank account, increasing your deposits by $800. Your bank deposit represents a portion of your wealth, held in the form of a financial asset, which is a claim on your bank. Because wealth is measured at a point in time, it is a stock variable. In addition to your bank account, you might also hold other forms of financial wealth (shares, pocket cash, etc) as well as real wealth (a car, real estate, etc). These are stock variables whose value is measured in terms of the money of account at a point in time.

Once you have received the $800 transfer, you begin to draw down your bank account to finance your purchases. Let us assume that your annual consumption spending will be $18,000 for the year, comprising purchases of consumer goods and services. Hence, between wage payments, you spend a total of $720 for consumption, drawing down your bank account by that amount to finance these purchases.

Over the year, your flow of wage income has been equal to $20,000 and your expenditure flow has been $18,000. Thus, your flow of saving over the year is $2,000, because saving is defined as the residual dollar value of income that has not been spent over the period.

This accumulates as an addition to your stock of wealth, which you might accumulate in a zero-interest bank account. Alternatively, you could purchase interest-earning bonds, which is another form of financial wealth. In this case, however, you will also have a flow of interest earnings in addition to your labour income. The flow of interest income will also add to your stock of financial wealth.

1.3 Flows and Stocks

Study Notes: