Its Accounting Identities, Stupid

I ran across this nice little cartoon video in the blogosphere that explained the “Three Sectors’ Financial Balances”. The video below describes how its impossible for all three sectors of the economy (The Government, Private, and Foreign Sector) to all run Surplus accounts. One sector has to be in the deficit if the other two are in the surplus. This is not a matter of opinion, rather, it is an accounting identity (fact).

 

 

In the US we have a current account deficit, which means the foreign sector is in a surplus. That means one of the two other sectors has to run a deficit. As we know, the US Government is the one that runs the deficit (which is the only thing stopping us from falling into another recession). The US private sector is running a surplus, which means the Net Savings (Savings – Investments) of the sector is positive.

Just take a look at the chart below of the Sector financial Balances as a % of GDP. They balance out.

Below is how you can replicate the chart of Net Private Savings and the Government Deficit on FRED. As you see, it is nearly identical, with the the foreign sector being the only thing missing. The Private sector cannot net save (note difference from net save and save) if the government does not run a deficit (unless the foreign sector is running a deficit, which means Net positive exports). This is crucial to understanding basic monetary system in which we operate in. So to preach that the Government needs to ‘tighten its belt’ just like the ‘people’ (private sector) do is hoping for a recession (as shown by this chart).

Note: How the government runs the deficit (Tax cuts, Spending, or both) is up for debate because that is a discussion of policy decisions, and not fact.

 

 

 

 

 

 

 

 

 

 

 

 

 

Tags: $MACRO

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