Date: 21 August 2022
The New Financial Model proposes an important change in the relationship between consumption, saving, investment, income and output. Under the present financial model, the income equation at individual level is:
Income (Y’) = Consumption (C) + Saving (S) ----- (Equation A)
At the aggregate level, in a simplified closed economy framework without government, saving is available for investment. Therefore, S = I’.
Output (Y’) = Consumption (C) + Investment (I’) ----- (Equation B)
Income-Output Equation in the New Financial Model
Under the New Financial Model, consumers receive Future Money claims linked to the consumption of eligible final goods/services. These Future Money claims represent financial assets of consumers. At the aggregate level, the Present Value of Future Money deposited into FM accounts constitutes consumption-linked financial saving that becomes available for financing investment.
Therefore, under normal economic conditions, the amount available for investment (I’’) under the New Financial Model is:
Investment (I’’) = Saving (S) + Present Value of Future Money (PV FM)
Substitute the value of PV FM from Equation (1):
Investment (I’’) = Saving (S) + C * f / (1 + r) ^ N ----- (Equation C)
If the Present Value of Future Money finances additional investment and the corresponding investment expenditure contributes to additional economic activity and output, the resulting output Y’’ under the New Financial Model will be:
Output (Y’’) = Consumption (C) + Investment (I’’)
Substituting the value of I’’ from the above equation:
Output (Y’’) = C + Saving (S) + C * f / (1 + r) ^ N ----- (Equation D)
Output (Y’’) = C (1 + (f / (1 + r) ^ N)) + S ----- (Equation E)
Y’’ = C * Consumption Multiplier + S
So, above is the income-output equation in the New Financial Model.
In the New Financial Model, the term (1 + (f / (1 + r) ^ N)) is defined as the NFM Consumption Multiplier. Its value depends on the FM rate (f), the prevailing interest rate (r), and the maturity period (N).
Consumption Multiplier (CM) = (1 + (FM rate / (1 + r) ^ N)) ----- (Equation F)
As Y’ = C + S in the present financial model (Equation A), Equation D can also be written as:
Y’’ = Y’ + Present Value of Future Money (PV FM)
Y’’ = Y’ + C * f / (1 + r) ^ N ----- (Equation G)
Thus, under the assumptions of the New Financial Model, eligible consumption generates Future Money claims whose present value creates consumption-linked financial savings. At aggregate level, when these funds finance additional investment and corresponding economic activity, the resulting output Y’’ under the New Financial Model can exceed the initial output Y’ under the present financial model.
Let’s take an example (Example 2):
Suppose an individual has an initial income of $100, of which $80 is allocated to consumption and $20 to saving. The individual purchases an eligible final good worth $80. Let the FM rate (f) be 5%, the maturity period (N) be 30 years, and the interest rate (r) be 3%.
Under the present financial model:
Y’ ($100) = Consumption ($80) + Saving ($20)
Under the New Financial Model:
On consumption of $80, the consumer will receive Future Money at an FM rate (f) of 5% = $4. Only the present value of $4 needs to be deposited in the FM account.
Present Value of FM from Equation (1) = C * f / (1 + r) ^ N
PV FM = $80 * (0.05 / (1 + 0.03) ^ 30) = $1.65
Under normal economic conditions, the Present Value of Future Money becomes available for financing investment. Therefore, according to Equation C:
Investment (I’’) = Saving (S) + Present Value of Future Money (PV FM)
Investment (I’’) = $20 + $1.65 = $21.65
If these additional investable funds finance additional investment and corresponding economic activity, the resulting output under the New Financial Model is:
Y’’ = C + I’’ = $80 + $21.65
Y’’ = $101.65
Thus, under the New Financial Model, the amount available for investment increases from $20 to $21.65, an increase of $1.65 compared with the present financial model. The initial income of $100 at the individual level generates aggregate output of $101.65 under the New Financial Model.
Emergency Future Money Release
Now suppose during an extraordinary economic emergency, such as a financial crisis, severe inflationary shock, energy crisis, pandemic, war, or natural disaster, the government or Future Money Council may implement an Emergency Future Money Release and all or part of the accumulated Present Value of Future Money may be released to consumers for immediate consumption.
Reconsider the above Example 2:
C = $80, S = $20, f = 5%, r = 3%, N = 30, Present Value of FM = $1.65
Suppose the entire PV FM is released to the consumer. The consumer's immediate consumption capacity becomes:
Ce = C + Present Value of Future Money (PV FM)
Ce = $80 + $1.65 = $81.65
Because the entire PV FM has been redirected from investment to immediate consumption, the amount available for investment becomes:
Ie = S = $20
The resulting output allocation under the emergency mechanism is:
Ye = Ce + Ie = $81.65 + $20
Ye = $101.65
This example illustrates an important feature of the New Financial Model. Under normal economic conditions, the Present Value of Future Money becomes available for investment. However, during an economic emergency, the Future Money Council or government may authorize the release of some or all of these funds to consumers. In such a case, the economic role of the Present Value of Future Money shifts from supporting investment to supporting immediate consumption. Thus, the NFM provides a mechanism through which consumption-linked long-term financial savings can be redirected toward household consumption during extraordinary economic circumstances.
Under normal conditions: Y’’ = C + (S + PV FM)
Under emergency conditions: Ye = (C + PV FM) + S
For detail please read the Chapter 6th of New Financial Model.
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