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In this article the focus is on where the flow of money in a reporting period comes from, where it goes, and the rules by which it all happens.
Introduction
In every nation's economy, regardless of the system type--hard or soft currency--in each reporting period products and services are manufactured or imported, bought and sold, and currency flows in and out of the system. The system consists of (1) a private sector where labor gets and spends, manufacturing is financed, production occurs, products and services are bought and sold, and taxes are paid, (2) a government sector where taxes are collected, money spent is borrowed or created, spending budgets are created, and accounting monitors the economy, and (3) a foreign sector where imports are bought, exports are sold, and taxes are paid.
The rules governing all this are imposed by the sovereign, but they need not be specified in detail to use the concepts discussed here. We will focus here on the US economy only. The model used here was invented by a British economist, Wynne Godley, in the 1990s (or maybe later). It is called the Finance Sectoral Balances Model. Using the fundamental identity derived by Godley Modern Money Theory economists Stephanie Kelton and L. Randall Wray have invented a new way to manage the economy of a sovereign nation that has a fiat money system that is independent of any outside constraint. It applies to the US economy.
The Sectoral Balances Identity
This identity begins with two equations that yield the National Income (Y) for any reporting period, say two months. The data in the equations are compiled by the Bureau of Economic Analysis of the Department of Commerce and are called the national income and product accounts (NIPA).
The two equations for Y are for (1) sources and (2) uses, respectively. The "sources" equation is
Y = C + I + G + X Eq. (1)
where
C = Private sector spending
I = Private sector Investment
G = Gov't spending
X = Exports.
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