Homework 2

Q1.1. Why must the Vertical Columns sum to zero?

"The vertical columns must necessarily sum to zero, because the change in the amount of money held must always be equal to the difference between households' receipts and payments." (Godley & Lavoie, 2007: p.62)

Households for example, -ΔH_h = W.N_s-C_d-T_s

The household’s factor income is the total amount of money supplied to the household through the wage bill from supplying labour to the production element of the behavioural matrix. The government in turn demand taxes which is supplied by the household through income tax (-Ts). Households demands goods and services from the economy, they therefore use their income (minus taxes) to satisfy this demand.

The consumption of the household is therefore also deducted from their income (-C_d). That amount of money not consumed can be defined as the change in the money stock (ΔH_h). The vertical column must therefore equal zero.

Q1.2. Why must the horizontal Rows sum to zero?

"The matrix shows that every component of the transaction-flow matrix must have an equivalent component, or a sum of equivalent components, elsewhere." (Godley & Lavoie, 2007: p.60)

Every demand in the behavioural matrix can be fully satisfied by the supply in the economy. For example, producers supply the goods and services to the households and are able to satisfy their demand. It is assumed that if the households demand increases, the producers have the capacity to satisfy this demand instantaneously.

Total production (Y) is the only component which does not have an exact opposite in the matrix. This is due to the fact that it is not a transaction akin to the other components in the matrix.

Q2. Write out an explanation for each row.

1. Consumption: “sales are always equal to demand because it is assumed that inventories are always large enough to absorb any discrepancy between production and demand” (Godley and Lavoie, 2007: p.64). Consumption is that percentage of the household's income which is spent on purchasing the goods and services they demand that are supplied by the producers in the economy. The producers supply a level of goods and services that exactly offsets that demanded by the household.

2. Government Expenditure: The principle is the same as that of the consumption element of the transaction matrix in that the producers are supplying goods and services in return for payment. The difference is that the government is the recipient of the service in this case and this represents an outflow of money from the government.

3. Output: The output is the total production in the economy. "the sum of all expenditures on goods and services or [as] the sum of all payments of factor income"(Godley and Lavoie, 2007: p.61).

Y = C + G = WB

4. Factor Income: The producer pays the household a wage rate for employment services rendered. It is assumed that there is an unlimited amount of labour to satisfy demand and there is a willingness to work at the fixed wage rate.

5. Taxes: The income of the household is taxed at a rate -T_s. This in turn, is a source of income generated for the government in the amount +T_d which is used to fund government expenditure going forward.

6. Change in Money Stock: The change in the money stock represents changes from one period to the next resulting from the household not consuming all of their disposable income. When this happens and households have a surplus of money, they use this to purchase financial assets from the government.

References

1. Godley, W., and M. Lavoie (2007) Monetary Economics: An Integrated Approach to Credit, Money, Income, Production and Wealth, Palgrave Macmillan.

2. Lavoie, M. (2001) “Endogenous Money in a Coherent Stock-Flow Framework” available: http://129.3.20.41/eps/mac/papers/0103/0103007.pdf [accessed 16 Feb 2008].

3. Leddin, A., and B. Walsh (2003) The Macroeconomy of the Eurozone: An Irish Perspective, Dublin: Gill and Macmillan.