Let’s Talk About The Utility Of Balance Sheet Consolidation

I caused a bit of a fuss in my last post regarding MMT and what I believe is an obscure consolidation of government entities in their accounting. But I want to go into this a bit more because it’s useful to understand in a bit more detail.

Accounting is a nice way of constructing and deconstructing the financial world so we can better understand it. Part of the way we do that is by looking at the various components of the world in terms of sectors. There are households, corporations, governments, and then governments inside the governments, corporations inside corporations and households inside households. These are very general views of the world, but they do provide some perspective. For instance, you can consolidate every financial asset and liability in the world and conclude that they all net to zero. That’s useful for the context of understanding the macro world’s financial relationship to everything, but it’s not that useful for understanding specifics. You have to get really granular for that. The more granular you get the more detailed you can be and the better you’ll understand things.

For instance, to understand the cause of the financial crisis you have to get granular within the private sector. Sure, all of the private sector’s financial assets/liabilities net to zero. But if you want to understand the specific flows and potential imbalances then you have to get more granular. In the case of the housing bubble the household sector took on too much housing debt to fund unsustainable asset price increases. When the asset prices collapsed so too did the household sector’s ability to fund its liabilities. That rippled through the financial sector and the entire economy. The point is, if you lazily consolidate all of the private sector’s financial assets/liabilities then you don’t understand the specific flows that cause certain things and lead to specific outcomes between intra-sector sectors.

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