This visualizer does not yet show how sectors dynamically react to changes in flows by altering other flows!
For example, if GDP falls then other changes may occur that are NOT currently triggered in the visualizer:
Example: reducing government spending might not reduce the deficit, despite current appearances in this visualizer.
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The + and - buttons only increase the font size in the sidebar and above and below the diagram.
The diagram and text within it stretch to fit within the browser window, so make your browser window as large as possible. Tip: the shortcut for full screen is F11 on Windows.
The flow animations currently only illustrate the macroeconomic circular flow concept in a general way. Limitations:
1. The magnitudes of the animated flows do not yet correspond to the magnitudes of the leakages and injections as controlled in the sidebar.
2. The inject once demo doesn't work properly yet, but it does let you see roughly how the core flow diminishes over time (lost to the leakages) when there are no ongoing injections.
The step-by-step narration has completed playing for this page.
The yellow information boxes that were just read aloud sequentially now all appear on the diagram.
Choices of next action:
Net Financial Assets example: A company that holds $100 in bank deposits as assets but owes $60 in debt has net financial assets (labeled Net Worth in the diagram, and sometimes also called Equity) of $40 (i.e., $100 minus $60).
Financial assets exclude tangible assets. If the company also owned a computer worth $30, its net financial assets would still be $40, though its overall net worth would be $70.
Most of the concepts shown here will be familiar to anyone with a knowledge of mainstream macroeconomics. However, the field of macroeconomics has multiple schools of thought, and they disagree with each other on some topics.
This tutorial's content is most influenced by a branch of economics sometimes referred to as Modern Monetary Theory (MMT) or neo-Chartalism, a part of the larger heterodox Post-Keynesian school. Here are some of its characteristics:
Sources for additional information on these topics:
Loans Create Deposits: When a bank lends, it creates a new loan on the asset side of its balance sheet and a new customer deposit on the liability side of its balance sheet. At the same time, the borrower gains a bank deposit asset and a bank loan liability. (To see this graphically, try the Macroeconomic Balance Sheet Visualizer and choose 'Bank Loan' from the operations list.)
Bank Reserves: A bank does not need "money" or reserves before it can lend! The old textbook money multiplier model is obsolete for countries such as the US today (i.e., countries that issue their own free floating currency and have no gold standard).
At the end of each day, if a bank does not have sufficient reserves to meet liquidity needs or regulatory reserve ratios then it borrows reserves from other banks or from the central bank. System-wide, as part of managing overnight interest rates, the central bank always ensures that sufficient reserves are available — typically via open market operations. So if banks overall are expanding lending, then the central bank expands bank reserves as an "automatic" response to accomodate the new lending.
Bank Capital: Banks do need to meet regulatory capital ratios, but this is no constraint on aggregate lending either. Banks can raise new capital or retain earnings. There can be no macroeconomic shortage of capital (with the exception of during a national financial crisis) — because loans create deposits, and because banks can adjust the mix of liabilities they use (such as replacing deposits with additional equity capital by selling new shares to depositors), then it is effectively possible for "loans to create bank capital" also, via one intermediate step.
What are the Limits? Just because banks can create money when they lend, that doesn't mean they automatically benefit, since they create a liability for themselves at the same time. Banks have to be sure to lend to credit-worthy customers. When borrowers default, the combined effect of the loan and default is like a gift from the bank and represents a direct loss that eats into its interest profit from other loans! Too many defaulting loans can render a bank insolvent.
"Borrower Defaults on Bank Loan" is another of the options you can try in the Macroeconomic Balance Sheet Visualizer (after doing Bank Loan first).
Why does the private sector (households and businesses) typically save overall, thereby introducing a leakage to the circular flow? A positive savings rate (spending less than income) for the private sector is "normal" for most countries throughout most of modern history. Reasons include:
Below are some examples of government spending. Most people consider these valuable national priorities for governments to ensure are provided on behalf of the population. However, this does not preclude government paying private companies (such as contractors) to aid in providing these services. The choice is in part a political one.
GDP for the United States (the world's largest national economy) was over $14 trillion in 2010.
Note that not all value-producing activity is included in GDP — for example, a day care center's income would be included while a stay-at-home parent's child-rearing effort would not — but GDP is still considered a valuable estimate of national income.
As of mid 2011, US households owned real estate worth over $16 trillion and had total net worth of over $58 trillion.
(Net worth is assets such as housing, stocks, and bonds, minus liabilities such as mortgages and credit card debt).
In the graph below of real (inflation-adjusted) GDP for the United States since 1978, the shaded grey areas represent recessions. While the true definition of recession is more nuanced than the sometimes cited "two or more quarters of negative growth", the decline in real GDP is visible in each case (*except perhaps 2001).
The recent recession that spanned 2008 is the most severe of those shown, and the worst since the Great Depression of the 1930s! And unfortunately employment levels (not shown) have been much slower to recover than GDP.
This chart shows that investment falls rather than rises during recessions, thus it contributes to the fall in GDP. The types of investment shown are residential (housing), nonresidential structures (commercial real estate and industrial facilities) and equipment and software.
Federal Government Deficit/Surplus and Recessions
Annual Change in the Consumer Price Index. This shows the 1970s stagflation and the subsequent disinflation back toward the 2.5 per cent per year range.
Annual Change in the GDP Deflator Index. This measures prices of domestically produced goods and services included in GDP, so it differs somewhat from the general CPI measure.
This includes the foreign sector (via the Capital Account), though we have not discussed that yet.
Source: L. Randall Wray
Federal Government Tax Receipts, Consumption Expenditures, and Transfer Payments (Growth Rate Relative to the Same Quarter of the Previous Year)
Source: Government Budget Deficits are Largely Nondiscretionary: the Case of the Great Recession of 2007 by L. Randall Wray
Real Output Per Hour for the United States: Year over Year Change:
[COMING SOON: A relevant chart.]
[COMING SOON: A relevant chart.]
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