Balancing Act
Lining Up Cash Flows in Time
Imagine your future as a timeline of payments you expect to receive and debts you must pay. You can settle your debts as long as the cash inflows are sufficient to cover the promised outflows. If you find yourself in a payments deficit, that makes you a “deficit agent.” You must find a way to cover the gap.
Clip Length: 1:07 (2017 Lec 3, 19:42–20:49)
The survival constraint … emphasizes the time pattern of cash flows and cash commitments, and the necessity in each period to settle. If you're a deficit agent, you have to find a source of liquidity to meet that deficit. That's the [survival] constraint. And this is a constraint that binds deficit agents, not surplus agents.
(2017 Lec 3, 19:42)
How can we keep track of future cash inflows and outflows? Behold the mighty balance sheet.
If you've seen balance sheets before, you might be used to thinking of assets and liabilities as what an entity owns and owes. Your instinct is to add up the total value of the assets and subtract the liabilities to find "net worth." That's fine, but it doesn't help us understand the entity's liquidity position: its ability to meet payment commitments as time rolls on.
Even worse than netting assets and liabilities within a balance sheet is netting across balance sheets. That's why the money view keeps individual entities' balance sheets separate rather than consolidating them into aggregate "sectors."
Net-money doctrine consolidates private domestic accounts so that private domestic debt cancels out against an equivalent amount of private domestic financial assets in both monetary and nonmonetary form. The only financial assets remaining in aggregative analysis are those held by the private sectors as net claims against the outside world—against, that is, government and the foreign sector.
(Gurley and Shaw 1960, 187)
In the words of Gurley and Shaw (1960), we prefer "gross-money doctrine" over "net-money doctrine." To get a handle on liquidity, the money view interprets a balance sheet’s asset and liability sides as timelines of cash flows and cash commitments, respectively.
If we begin at any date, we have that at each and every future date, in order to survive, the firm must satisfy the condition that the initial cash plus the receipts minus the costs payable to that date are greater than zero. That is, in order to survive a firm must be able to pay debts when due.
(Minsky 1954, 96)
A balance sheet is like a zipper moving through time, zipping the two timelines together. Whenever a payment fails, someone's zipper has broken.
[M]y suggestion can be expressed by saying that we ought to regard every individual in the community as being, on a small scale, a bank. Monetary theory becomes a sort of generalisation of banking theory.
(Hicks 1935, 12)
Banks and the rest of us all have to manage our balance sheets to ensure that we can meet our payment commitments. We all want our zippers to zip.
References
Gurley, John G., and Edward S. Shaw. 1960. Money in a Theory of Finance. Washington, D.C.: Brookings Institution.
Hicks, John R. 1935. "A Suggestion for Simplifying the Theory of Money." Economica 2 (5): 1–19.
Mehrling, Perry. 2017. "Lecture 3: Fundamentals of the Money View." Warsaw School of Economics, recorded October 13, 2017. Video of lecture, 1:27:49. https://youtu.be/XzMXkJDksrE
Minsky, Hyman P. 1954. "Induced Investment and Business Cycles." PhD diss., Harvard University.