Unfortunately Benedikt Kotruljević had plowed the ground 36 years earlier with his Delia Mercatura et del Mercante Perfetto (Of Trading and the Perfect Trader) and the accounting profession had actually missed the quincentenary of the presentation of double entry bookkeeping to the world.
From Credit Writedowns:
How QE works and what this means for asset prices and credit
America is a land of contention, and one of the most contentious topics here (I’m in Seattle as I write) is the impact of the Federal Reserve’s policy of “Quantitative Easing” – otherwise known as ‘QE’. The Federal Reserve has committed to spending $85 billion every month buying a wide range of bonds from banks, until such time as the US unemployment rate falls below 6.5 per cent.
The Fed has implemented this policy because it believes it is the best way to stimulate demand in a depressed economy. Its critics oppose it because they believe this massive amount of ‘money printing’ must inevitably lead to ruinous inflation.
I reckon they’re both wrong, and in a seriously wonky post I’ll try to explain why, using my modelling program Minsky.
Minsky develops a model of monetary flows using double-entry bookkeeping – which is the same way that banks run their businesses – so it’s a powerful way to cut through the confusion over what actually happens in QE. But double-entry bookkeeping can make your head spin because it involves lots of ALE – and unfortunately not the fun intoxicating kind, but the boring accounting trio of Assets, Liabilities and Equity.
The heart of accounting is the principle that the difference between the debts other people owe to you (your Assets) and the debts you owe to them (your Liabilities) is your net worth (your Equity). This is drummed into accounting students as the “Fundamental Equation of Accounting”: “Assets equal Liabilities plus Equity”.
Double-entry bookkeeping (DEB for short) enforces this equation in two ways. Firstly, it records any Asset as a positive amount, and Liabilities and Equity as negative amounts. Secondly, it ensures that any transaction between accounts sums to zero. So, for example, if a rich aunt died and left you $1 million in her will, your accountant would show that as your Assets changing by plus $1 million and your Equity changing by minus $1 million. It sounds counter-intuitive when you first learn it, but it works to make sure you don’t make mistakes when tracking financial transactions.
Minsky uses a similar approach: Assets are shown as positive sums, so assets are increased by adding to them – no big deal there. But Liabilities (and Equity) are shown as negative sums, so increasing a Liability involves subtracting from it (is your head spinning yet?). So a loan of $1,000 from a bank is recorded as plus $1,000 in its loan account – an increase in its Assets – and as minus $1,000 in your deposit account – an increase in its Liabilities to you. The sum across the row that records the transaction is zero.
Then Minsky assembles a model of financial flows from the economy’s point of view, in which everything is shown as a positive – just as the Federal Reserve does when it compiles its Flow of Funds record of the entire economy.
Boy, I’ve probably lost half my normal audience already – and probably to Ales of a different kind. But if the rest of you have survived that intro, let’s plug on and build a model of QE....MUCH MORE
