EC6012 Homework 2

The Behavioural Transaction Matrix explains each sectors stock of assets and liabilities and how each sector relates to another such that all columns and rows in this matrix sum to zero. Below is the Behavioural Transactions Matrix for SIM.

1.1 Why must the Vertical Columns sum to zero?

The vertical columns must sum to zero because the amount of money created (Hs) must always be equal to the difference between the government receipts and outlays (Godley & Lavoie, 2006).
The government demands taxes which it receives by taxing the factor income on households; the households are therefore supplying the revenue for the government. The government then uses this income to fund government expenditure. The difference between what the government earns through tax and what it spends through government expenditure equals the change in the money supply.
This is represented by the following equation:
-Gd + Td = Δ Hs


1.2 Why must the Horizontal Rows sum to zero?

For every output in the matrix, there must be an equivalent input to achieve equilibrium. For example, producers supply exactly what is demanded by households. Thus in relation to household consumption (C):
Cs = Cd
-Cd + Cs = 0
The exception is output, which represents total production. Due to the fact that this is not a transaction, there is only one entry (Y) in this row.


2. 0 Explanation for each row of the Behavioural Transactions Matrix for SIM

2.1 Consumption:
Households purchase (demand) goods and services (-Cd) and firms supply what is demanded by households, thus generating income (+Cs). Consumption consists of some proportion of disposable income (the wage bill earned by households less taxes) and some proportion of the wealth accumulated by households in previous periods.

2.2 Government:
Governments demand goods and services from firms (-Gd) and pay for these orders using the taxes they collect from households. Producers supply these items as a means for generating their own income (+Gs).

2.3 Output Line:
Output (Y) is the total goods and services produced during a certain period of time as a result of economic activity. The government (G) spends money on goods and services, and households spend money on consumption (C). The sum of this expenditure is referred to as the total expenditure on output.
Y= C + G

2.4 Factor Income
Factor Income concerns the sectors of households and production, and consists of the wage rate*employment (W.N). Households earn income in the form of wages (+W.Ns), which are supplied by the production sector. The production sector demands a certain volume of employment, and must consequently pay wage bills to households, hence the negative entry in the matrix (-W.Nd).

2.5 Taxes
At what rate do governments collect money from households? In each period, governments must collect some proportion alpha of the output of workers as a source for their expenditure (+Td). Therefore households must pay taxes on their income (-Ts) which is collected by the government. Tax revenues collected by the government sector must by logical necessity be equal to the sum of the taxes paid by the other sectors of the economy (Godley & Lavoie, 2006).

2.6 Change in Money Stock
This row describes the changes in stocks of financial assets and liabilities which correspond, in principle, to the Flow-of-Fund Accounts and which are necessary to complete the system of accounts as a whole (Godley & Lavoie, 2006).
The money stock held by the government is the difference between government income and expenditure. Cash money held by households in the current period equals the balance of their disposable income minus their consumption. An increase in this amount constitutes household savings. If the amount decreases, households consume more than they earn. Thus the government must spend in order for firms to increase production to meet the demand of households’ consumption. Therefore the decrease in the money stock of households results in an increase of the same amount in the government sector.

References

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

Wikimedia Foundation, Inc., ‘Consumption (Economics)’, February 2008, [Online] [accessed 14th February 2008], available at: http://en.wikipedia.org/wiki/Consumption_%28economics%29