In an economy with finite actors, if every account is perfectly balanced against another account, how can the economy grow when new money enters? I am thinking of the following chain of events:

  1. The Fed prints money
      + Fed: $+$ debit (imbalanced book)
  2. A Bank recieves cash from one of the 12 regional Fed banks
    • Fed: $-$ credit (balanced book)
    • Bank: $+$ debit (imbalanced book)
  3. Lady takes loan out from the Bank
    • Bank: $-$ credit (balanced book)
    • Lady: $+$ debit (imbalanced book)
  4. Lady is payed by her company
    • Lady: $-$ credit (balanced book)
    • Company: $+$ debit (imbalanced book)
  5. People buy good or service from company
    • Company: $-$ credit (balanced book)
    • People: $-$ debit (imbalanced book)

And from here I am too confused to continue $\dots$ I am not sure we can say credit and debit in this sense, I just mean to show there is someplace that is always unbalanced. The conclusion I always end up with is that this chain is complete (all parties are balanced) when a new loan is taken out, .. but this makes another chain, which I feel just cannot be the answer!

  • $\begingroup$ Again, "How can economies grow if every account is perfectly balanced against others" is a much better title. $\endgroup$
    – FooBar
    Feb 19 '16 at 16:32

The Accounting mistake is in step 1, obviously, since you performed a single-entry and not a double-entry: The Central Bank books are not imbalanced: schematically speaking the CB credits the account "money creation" (or "Our future") and debits its own "Cash Available": this is the essence of "the printing privilege": the CB has the right to create money out of thin air. Then, it credits its Cash Available account and debits the customer/borrower "Commercial Bank" -because Commercial Bank don't just get money from the Central Bank, they borrow it (or the Central Bank instead of lending money, it buys shareholder stock of the commercial bank or any other so-called "open market operations").

So all books balance. As regards growth in such a balanced-book situation, the key is in step 5, "People buy good or service from company":

What tells you that the firm has the capacity to serve the demand it faces? If demand is now increased because new money have flown into the economy (and initially people treat money as a store of value/purchasing power, not just as a medium of exchange in a static situation), the firm may have to increase its productive capacity to satisfy total demand.

If it cannot do that, the firm will see an opportunity to raise prices, hence new money will just cause inflation. But if the firm can increase its productive capacity, namely, if there is people unemployed and capital laying idle, then the firm will "call to arms" these currently unemployed factors of production, and it will put them to work and produce, thus increasing output and so creating growth.

This effect can certainly be written using the balanced-book Accounting Language, but I will leave that as an exercise.

  • $\begingroup$ Thank you again @Alecos Papadopoulos, I started to think the error was in step 1 after your answer to my first question(: $\endgroup$
    – Sunhwa
    Feb 19 '16 at 17:54
  • 1
    $\begingroup$ If I understand please: as you said demand increases from new money in the economy then in the Supply-Demand curve this shifts the demand curve right. And if the firm can increase productivity then that also shifts the supply curve right and the price of the goods/service stays the same but output has increased, which is growth in the economy. Or if the firm can't increase productive capacity then the price of the good increases which is inflation what we usually think happens when new money enters the economy. $\endgroup$
    – Sunhwa
    Feb 19 '16 at 17:56
  • 1
    $\begingroup$ @Sunhwa Yes this sums it up. This is why in periods of depression, it is advocated that we should pump up demand in any way possible: because in a depression productive factors are laying idle, so increasing demand even with new money, will bring them back to production. $\endgroup$ Feb 19 '16 at 18:02

Debt to the Federal Reserve is not considered debt by accountants. Thus, the economy is able to maintain the appearance of positive net worth. In reality all money originates from debt and nobody besides the Fed owns anything.


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