Ledger Accounting for the Monetary Circuit

I've seen a few things recently setting out the book entries involved in the monetary circuit.  These vary in accuracy quite a bit, but none of them are really set out in the form I'd normally expect to see.  I thought I'd have a go at it myself, partly because seeing it in action actually tells us something useful about the nature of money, but also it is going to be useful to refer to in future posts.

I've left the actual mechanics of this to the end of the post, so those who find this sort of stuff leaves them cold can quit reading before they get to it.

Some of the basics for double-entry book-keeping are as follows:

1. We can generate any number of ledgers for different items or stages in a process.  Note that a ledger does not necessarily relate to something that we might think of as a balance sheet item. Purchases and sales have ledgers as well, even though these are purely income items.  We may decide to be more or less aggregated with our ledgers, depending on what we want to record.  For example, we might have a single purchase ledger or we might have a number for different types of purchase.

2. A debit is any of: an increase in the value of an asset, a decrease in the amount of a liability, or an item of expenditure.  A credit is any of: a decrease in the value of an asset, an increase in the amount of a liability, or an item of income.

3. Each time we put a credit in one ledger, we must put an equal debit in another ledger.

Some of these ledgers may look familiar.  In particular, the ledger for a deposit account is essentially the same as the depositor's bank statement.  The statement dates will not typically coincide with the dates at which the bank is drawing up its own accounts but, apart from that, they record the same entries and balances.

The most interesting thing I think about this exercise is that we are seeing what bank money actually is.  In other words, this process is not simply a record of money movements - it is the actual money movements themselves.  If the non-bank agents maintain their accounts with the same bank, then nothing else is going on, beyond what we see here.  (If they have accounts with different banks, then each bank (and maybe the central bank) will need to make entries and there will also be wire confirmations, but the essence of the money movement is still just the entries in the ledgers.)

Another thing worth noting is that the transactions have a specific date, but no time.  Although there is an increasing use of real time gross settlement, it is not an essential feature of the way ledger money works.  This means that there is no fact of the matter as to in what order payments occur during the day. 

This has implications for how we interpret such things as the velocity of circulation, because it means that there is no unambiguous measure of the money supply during the day.  In the example below, the final day starts with a money supply of 100 (being the balance of the worker's deposit) and ends with a money supply of zero.  In between, there are additions to the money supply (deposit interest and bank purchases) as well as reductions (loan interest and loan repayments).  But because we can't say what order these happen in, there is no absolute amount of money "in circulation" when the payments happen.

Lastly, we can see that the complete monetary circuit stands alone, without needing to say anything about capital or reserves (if we were looking at inter-bank transfers, we would need to say something about reserves).  Clearly banks need capital and reserves to function, just as they need staff and premises.  We just don't need to factor in any of those things to get the complete set of book entries for a monetary circuit.

The Circuit

I've used a monetary circuit based on that used by Steve Keen and others for this exercise.  Specifically, this involves the following steps:

On day 1, the firm borrows 100 and pays the worker 100 of wages.

At the end of the month on day 31, the worker buys 109 of goods and the bank buys 3 of goods.  The bank pays 9 of interest to the worker on his deposit, the firm pays 12 of interest and repays the loan.

To illustrate the relationship between ledgers and balance sheets, I've assumed that the bank closes an accounting period part way through the circuit at day 10, when 1/3rd of the interest has accrued..

The Ledgers

I've set out each ledger as a series of columns, rather than T accounts (mainly because of formatting issues in blogger).  Counterpart refers to the ledger where the offsetting entry appears.

I've included separate ledgers for the loan interest and deposit interest.  This allows us to recognise accruals of interest without actually debiting or crediting them to the borrower's or depositor's account

Each ledger is closed off at the end of the period with a balancing item to bring the total of credits on the ledger equal equal to the total of debits on the ledger.  This item represents the balance carried forward to the next period, and appears as an offsetting credit or debit at the start of the next period.  The carried forward balances also tells us what appears in the closing balance sheet.  We also need to calculate amounts of accrued but unpaid interest.  Each of these involves a double-entry - to the relevant interest account and to the P&L account.

For the period up to the bank's reporting date, the ledger entries would look like this:

Loans
Day	Transaction	Counterpart	Dr	Cr
1	Make loan	Firm's deposit	100
10	Balance c/f			100
Total			100	100
Firm's Deposit
Day	Transaction	Counterpart	Dr	Cr
1	Make loan	Loans		100
1	Wages	Worker's deposit	100
10	Balance c/f		0
Total			100	100
Worker's Deposit
Day	Transaction	Counterpart	Dr	Cr
1	Wages	Firm's deposit		100
10	Balance c/f		100
Total			100	100
Loan Interest
Day	Transaction	Counterpart	Dr	Cr
10	Interest income	Profit & loss	4
10	Balance c/f			4
Total			4	4
Deposit Interest
Day	Transaction	Counterpart	Dr	Cr
10	Interest expense	Profit & loss		3
10	Balance c/f		3
Total			3	3
Profit & Loss
Day	Transaction	Counterpart	Dr	Cr
10	Interest income	Loan interest		4
10	Interest expense	Deposit interest	3
10	Balance c/f		1
Total			4	4

Collecting all the ledger balances gives the balance sheet as follows:

Balance Sheet at Day 10
Assets
Loans		100
Interest receivable		4
Total assets			104
Liabilities
Deposits		100
Interest payable		3
Total liabilities			103
Shareholder funds
Profit & loss		1
Total shareholder funds			1
Total liabilities and shareholder funds			104

The ledgers for the next period would then look like this:

Loans
Date	Transaction	Counterpart	Dr	Cr
10	Balance b/f		100
31	Loan repaid			100
Total			100	100
Firm's Deposit
Date	Transaction	Counterpart	Dr	Cr
10	Balance b/f			0
31	Bank purchases	Purchases		3
31	Worker purchases	Worker's deposit		109
31	Loan interest	Loan interest	12
31	Loan repaid	Firm's deposit	100
Total			112	112
Worker's Deposit
Date	Transaction	Counterpart	Dr	Cr
10	Balance b/f			100
31	Worker purchases	Firm's deposit	109
31	Deposit interest	Deposit interest		9
Total			109	109
Purchases
Date	Transaction	Counterpart	Dr	Cr
31	Bank purchases	Firm's deposit	3
31	Purchase expense	Profit & loss		3
Total			3	3
Loan Interest
Date	Transaction	Counterpart	Dr	Cr
10	Balance b/f		4
31	Loan interest	Firm's deposit		12
31	Interest income	Profit & loss	8
Total			12	12
Deposit Interest
Date	Transaction	Counterpart	Dr	Cr
10	Balance b/f			3
31	Deposit interest	Worker's deposit	9
31	Interest expense	Profit & loss		6
Total			9	9
Profit & Loss
Date	Transaction	Counterpart	Dr	Cr
10	Balance b/f			1
31	Purchase expense	Purchases	3
31	Interest income	Loan interest		8
31	Interest expense	Deposit interest	6
Total			9	9

The interest ledgers now include the actual payments of interest.  Note however, that when we say payments, all we mean is that there is a double-entry where the counterpart is one of the deposit ledgers, as opposed to the P&L ledger.  There is no "payment" beyond this.

We now also have entries in the purchases ledger.  As there are typically no balance sheet items for purchases (as opposed to items purchased), this ledger is balanced to zero by taking everything to P&L.

As we have assumed a complete monetary circuit, the final balance sheet for the bank would just be a collection of zeros.