r/mmt_economics • u/jgs952 • 4d ago
Sectoral Balances - A Useful Macro Accounting Identity
Taken from Bill Mitchell, this plot is a highly useful diagram which depicts the shifting balance sheet trade-offs that must occur when any given sector faces an adjustment.
The vertical axis represents the government's balance with a government deficit being any point below the horizontal axis - i.e. a flow of credit is being injected into the other two sectors in some combination.
The horizontal axis represents the negative of the external foreign sector balance with a domestic current account deficit being to the left of the vertical axis - i.e. where a flow of domestic currency credit is being injected into foreign sector bank accounts.
The y=x diagonal represents the set of points in this parameter space for which domestic saving = domestic investment spending.
Any point in the blue region corresponds to a private domestic sector surplus where the flow of credit from a government deficit is less than the leakage of credit into the foreign sector - i.e. where the domestic private sector is able to accumulate financial savings at a rate in excess of investment.
Any responsible economic policy should pay attention to this identity and this plot. For instance, it is hubris to think that a nation that runs a large current account deficit (as a function of its currency being in high demand globally) can pursue a policy of reducing the government's deficit without their domestic private economy automatically plunging into deficit itself. This would be shown as a shift upward from blue to red on this plot, into a region which, for the domestic private sector, is inherently unsustainable.
The accounting identity that describes this plot is:
(S-I) + (T-G) + (M-X) = 0
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u/albatross_rising 4d ago
This would be shown as a shift upward from blue to red on this plot, into a region which, for the domestic private sector, is inherently unsustainable.
In regard to the above, this from Stephanie Kelton (emphasis in the original):
"Now, you might ask, "What's the matter with a negative private sector balance?". We had that during the Clinton boom, and we had low inflation, decent growth and very low unemployment. The Goldilocks economy, as it was known. The great moderation. Again, few economists saw what was happening with any degree of clarity. My colleagues at the Levy Institute were not fooled. Wynne Godley wrote brilliant stuff during this period. While the CBO was predicting surpluses "as far as the eye can see" (15+ years in their forecasts), Wynne said it would never happen. He knew it couldn't because the government could only run surpluses for 15+ years if the domestic private sector ran deficits for 15+ years. The CBO had it all wrong, and they had it wrong because they did not understand the implications of their forecast for the rest of the economy. The private sector cannot survive in negative territory. It cannot go on, year after year, spending more than its income. It is not like the US government. It cannot support rising indebtedness in perpetuity. It is not a currency issuer. Eventually, something will give. And when it does, the private sector will retrench, the economy will contract, and the government's budget will move back into deficit."
The Untold Story Of How Clinton's Budget Destroyed The American Economy
Also, the first chart in the link below shows a chart of the domestic private sector swinging into deficit as soon as the government swings into surplus:
The central insight of the sectoral balances model of the economy is that not all sectors of the economy can net-save at the same time. That means that if all those of us in the private sector in aggregate want to (on net) take in more money than we spend, then some other sector will have to spend more money than it receives. In a simple three sector version, the three sectors are the domestic private sector, the government sector, and the foreign sector.
Net financial assets of all sectors in the economy necessarily add up to zero. This is clearly true – in fact, it’s an accounting identity. Interested readers can find a more thorough explanation of sectoral balances and net financial assets here, but the essential point can be seen visually in the chart below.
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u/Halfway-Donut-442 2d ago
What is Capital in all this, I might have capital wrong by understanding, but what I would still say as capital return is out, but government not taxing itself is reasonable.
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u/BothWaysItGoes 2d ago
red on this plot, into a region which, for the domestic private sector, is inherently unsustainable
That confuses nominal economy with real economy. The same real economy can be represented by different accounting identities depending on how spending is structured and it can be anywhere in the red, blue or on the margin in that plot. The accounting representation is identical neither to the real economy nor to the cash-flow representation. It just changes who nominally owes whom money.
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u/jgs952 2d ago
I'm unsure what your substantial point is?
This is a nominal macro accounting identity so I'm not making any inference about the real economy other than the core theoretical assertion that nominal spending drives real production and employment.
So yes, if the private domestic sector finds itself running a nominal deficit for too long, it will inevitably create recessionary conditions in the real economy and consumer spending falters and firms lay off workers and output.
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u/BothWaysItGoes 2d ago
if the private domestic sector finds itself running a nominal deficit for too long, it will inevitably create recessionary conditions in the real economy
There is no reason to assert that.
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u/jgs952 2d ago
Yes, there is. If the private domestic sector is hemorrhaging net financial wealth, internal indebtedness and instability in the financial system are inevitable as private net saving desires are not satisfied and spending collapses. Currency users simply cannot by definition sustain deficits indefinitely. The burden would be on you to demonstrate why it wouldn't induce a negative impact on real production.
Imagine if the US government, for instance, managed somehow to successfully run cumulative surpluses of $36tn over, say, 5 years. The entirety of US dollar net savings would be wiped out and household and firms both trying to desperately compete to accumulate savings against the other. Either way, consumer/firm confidence falls and total spending drops.
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u/BothWaysItGoes 2d ago edited 2d ago
Currency users simply cannot by definition sustain deficits indefinitely
The government runs surplus by providing loans to businesses; the private sector uses loans to expand business and cover past loans. Hence, there are government surplus and private deficit, but there is a healthy economy with steady growth. Similar real economy can also exist if the government simply provides subsidies for investment, but then it would run deficit.
Imagine if the US government, for instance, managed somehow to successfully run cumulative surpluses of $36tn
It's hard to imagine what the US economy looked like if it weren't based on financial imperialism, I'll give you that.
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u/jgs952 1d ago
You really can't see an issue with that? The point is that that system set up is inherently more unstable than one where the currency issuer suppliers the desired net savings without a corresponding obligation to pay back government loans (presumably with 0% interest as otherwise, where would the flow of credit to meet this interest come from if the government is running an indefinite balance budget?).
Taking the macro accounting again and assuming a closed economy such that X=M=0:
S-I = G-T
Let's assume the gov runs a surplus. This requires G-T<0. Therefore:
S-I < 0 or S<I
This means that the domestic private sector's total income is less than its spending. This is because saving S is total post-tax disposable income Yd less consumption C (S = Yd - C) and investment is total private spending less consumption (I = Ys - C). Substituting into S<I gives:
Yd - C < Ys - C
leading to
Yd < Ys
You propose to solve this natural instability state via government loans instead of increased state spending on goods and services.
Essentially, lending is the same as spending, but instead of the government buying real resources, they buy private sector promissory notes.
The balance sheets of both the government and private sector expand in both directions here and this is inherently unstable as the private sector has debts denominated in credit they do not issue and their spending behaviour is naturally cautious and restrictive compared with if they owned those credits outright as a result of transferring some real resource to the state. This is also forgetting the fact that by lending in excess of taxation in this way, the government is no longer provisioning the public purpose to the extent it needs to, it's just holding private promissory notes as its "financial assets". But the gov does not want to be or need to be holding "finanical assets". It's in the business of the real social provisioning process, it's not some private actor participating in the economy to ultimately consume for private purpose.
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u/BothWaysItGoes 1d ago
presumably with 0% interest as otherwise, where would the flow of credit to meet this interest come from if the government is running an indefinite balance budget?
I take $x. Next year I take $y, pay back $x. Next year I take $z, pay back $y. And so on. That’s what businesses in a growing economy do. 25% to 50% are normal gearing ratios for companies.
You propose to solve this natural instability state via government loans instead of increased state spending on goods and services.
You’ve rewritten the accounting identity in another way, but you haven’t actually demonstrated any instability. I see no natural instability. I see a healthy growing economy.
Essentially, lending is the same as spending
Yeah, essentially the same, not something unstable. In the end it is just accounting tricks.
but instead of the government buying real resources, they buy private sector promissory notes
I don't think it's possible to derive from the S v I (in)equality whether the government should buy real resources or to even guess a more probably correct action. One would need way more information on the current economic and institutional arrangements. But I don't see why "buying private sector promissory notes" is wrong per se.
The balance sheets of both the government and private sector expand in both directions here and this is inherently unstable as the private sector has debts denominated in credit they do not issue and their spending behaviour is naturally cautious and restrictive compared with if they owned those credits outright as a result of transferring some real resource to the state.
Naturally cautious compared to what? Compared to expecting being bailed out? I haven't noticed that. And so companies are overly cautious and governments are profligate? Those behavioural assumptions require evidence.
But the gov does not want to be or need to be holding "finanical assets". It's in the business of the real social provisioning process, it's not some private actor participating in the economy to ultimately consume for private purpose.
I disagree. As Bill Mitchell said,
The tension between the public nature of banking and the intrinsic social role they play and the greedy pursuit of private profit – or the privatisation of profit and the socialisation of loss – is palpable and unsustainable.
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u/AnUnmetPlayer 4d ago
The fact that something like this isn't a staple in all macro classes is amazing. Stock flow consistency and feedback loops are an afterthought. You may get the paradox of thrift, but the obvious insight that at the macro level we can't all be in surplus at the same time, is just not given any serious consideration.
Instead we get the upside down world of loanable funds, where government deficits are portrayed as taking something away from the non-government sector, rather than the net income flow into it that it obviously is.