When Will CBO and the House Budget Committee Ever Learn About Sector Financial Balances?

It never ceases to amaze me that those who offer budget plans and projections never take into account the reality that their projections must be consistent with implications of trends in sector financial balances for their projections. This is a simple lesson that those playing the fiscal responsibility game never seem to learn. Certainly this is true of the Republican House Budget Committee, as we’ll see.

The Sector Financial Balances (SFB) model is an accounting identity, and these are always true by definition alone. The SFB model says:

Domestic Private Balance + Domestic Government Balance + Foreign Balance = 0.

The terms refer to balances of flows of financial assets among the three sectors of the economy in any specified period of time. Why must there be flows? Because the three sectors trade financial assets with one another. So, the equation says that the sum of all the balances of flows for the three sectors of the economy is zero, because, since there’s only so much in assets traded in any time period, the positive balance(s) of one or more sectors relative to the others must be matched by the negative balance(s) of the other two sectors.

So, for example, when the annual domestic private sector balance is positive, more financial assets are flowing to that sector, taken as a whole, than it is sending to the other two sectors.

Similarly, when the annual foreign sector balance is positive, more financial assets are being sent to that sector than it is sending to the other two sectors.

And when the annual government sector balance is positive, then it is getting more in financial assets from the other two sectors combined than it is sending to them.

Conversely, when the private sector balance is negative, the private sector is sending more to the other two sectors than it is getting from them, and so on for each of the other two sectors.

Now let’s apply this to the House Republicans’ Federal budget projections from 2016 – 2025, as in Table One, just below.

Table One: Sector Financial Balance Projections 2016 – 2025

 SFBprojections20152025 Assuming House Budget
From Table One you can see that if things go according to the Republican plan, the private sector as a whole will have a small surplus of 0.7% of GDP in 2016, but that every year thereafter the Republican projections imply an increasing private sector deficit from year to year ending with a deficit of 1.7% of GDP in 2025. These increasing losses of net financial assets for the private sector would be serious enough if the losses represented by the negatve flows were equally distributed across the private sector.

But we know that they won’t be. We know that our nation’s economy is structured so that some parts of the foreign sector and some parts of the private sector have sufficient economic and political power to direct financial flows from outside and inside their sectors disproportionately into their coffers. So, this means that the sub-sectors with lesser economic and political power will suffer the burden of the losses.

Which ones? We know from various studies of inequality (see here and here), that over the past 35-40 years, the American economy has delivered its financial growth disproportionately to large corporations, especially in the FIRE, energy, information technology, defense, and health care sub-sectors of the economy, and also to households either already wealthy, or deriving their income from large companies in these sub-sectors. The vast majority of households have been either barely holding their own or are losing ground economically. These trends have accelerated since the crash of 2008, since most of the gains from the “recovery” have gone to the already wealthy, the bailed out FIRE sub-sector, and the other sub-sectors and types of households just listed.

The implications of this are that the remainder of the private sector, small and large companies not in the sub-sectors just listed and households in the 99% will get poorer and poorer year after year if the Republican projections should be realized. Eventually, unless there’s a credit bubble providing money and corresponding debt liabilities to these sub-sectors, consumer demand will gradually decrease until it finally collapses because net financial assets cannot be drawn upon to maintain it.

In other words, the implications of the Republican budget projections are another economic crash during the coming decade probably sooner rather than later.

What can delay this process leading to collapse. Well, paradoxically, it will be the failure of the Republican deficit projections. This will certainly occur because the projections based on this budget plan don’t accurately project the effects of the automatic stabilizers resulting from those parts of the safety net, their budget plan hasn’t completely eviscerated. The automatic increases in automatic stabilizer spending caused by rising unemployment insurance payments, food stamp spending, early retirements and disability spending will create larger deficits than the Republicans plan.

Like the Tories and Liberals in the UK before them, the political pressures will be too great for them to follow through on their deficit projection plans. The more they try, the more likely it is that they will lose control of all or part of Congress, and not be in a position to implement their austerity plans. But whether or not they lose control, deficit spending will be greater than they plan and it will ease the pressure on the private sector because government deficits in the realm of automatic stabilizer spending mean private sector surpluses and gains in consumer demand that will boost the economy.

Of course there are “good deficits” and ‘bad deficits.” As Bill Mitchell says “bad deficits” are those “. . . which arise from a government not taking responsibility for filling the spending gap. . . .” “Good deficits” are those “. . . designed to support the saving desires of the non-government sector.” The Republican “accidental” deficits will be “bad deficits” because they won’t provide much basis for creating full employment on a continuing basis, and because they will support only economic stagnation. But, nevertheless, they will still alleviate suffering enough to “boil the frog” more slowly.

In upcoming posts, I’ll look at the White House Budget, and the CPC budget and perhaps others and see if anyone else offering budget projections has learned the lesson, to put it kindly, that projections that don’t take sectoral financial balances into account must always be way off the mark.

0 responses to “When Will CBO and the House Budget Committee Ever Learn About Sector Financial Balances?

  1. Senator Mark Warner of Virginia, a member of the Senate Budget Committee, has sent a letter to the CBO asking them to explain the history of federal deficits and surpluses in relation to depressions; to explain how the sectoral balances are used by people such as Jan Hatzius, the chief economist of Goldman Sachs, Paul McCulley, recently the chief economist of PIMCO, and Martin Wolf, the chief economics writer of the Financial Times, use the sectoral balances in their work; and to explain why the CBO should not use the sectoral balances for projecting the effects of legislation and federal budgets.

    • Tip, please let us know how that turns out. Is Warner “on board” with MMT, or looking for ways to rebut it?

    • Tim,

      Would you post a link for the letter?

      I’ve been sending the Sen and my Rep email on this very topic. I’d like to know what prompted the letter to the CBO.



  2. Matt McOsker

    Joe, I 100% agree that the CBO ignores any SFB model. The CBO is not even a macro projection to begin with. But I cannot pin it all on the Republican party by any stretch.

    The Republicans ignore SFB, but have been pretty good at running deficits overall since 1980.

    But, so do the Democrats. I mean Obama cut Social Security increases, and I hoped he would know better.

    Neither party will come out and say we need to run higher deficits, and spend more on projects that put money in the pockets of the working class, and that we do not need to raise taxes to do it – nor kill any bill by adding a tax increase provision. For Example, a job guarantee or massive infrastructure spending. Better yet just give $500 per capita to the states to use on whatever. We should have been running higher deficits in the amount of 2-5% of GDP from what we were actually running the past 10 years.

    Regarding inequality. I feel Jamie Galbraith’s research is getting this right. Inequality is a worldwide phenomenon, is finance driven, and boom driven (tech, high oil prices of the last decade, real estate). The only policy response is to increase program spending that is directed at lower classes, and run adequately high deficits.

    The funny part is that higher deficits will benefit the rich too. As they own many of the businesses that will work on these project types that benefit from the spending. As the lower classes get more money to spend they higher classes will benefit from what they sell to the masses. The rich should actually be behind such a proposal.

    The reason all this happens is both parties believe we have a debt and deficit problem – its just like a household. Even Bernie Sanders only partially gets it.

  3. Arliss Bunny

    Hey, Joe! Excellent as usual. I covered the various budgets for Netroots Radio last week and it really is frustrating. I just keep telling myself that Stephanie has barely had time to unpack and her arrival in DC IS good news. I do wish there was a way to corner a group of key progressive Senators (Jeff Merkley, Sherrod Brown, Elizabeth Warren, Bernie Sanders and the like) for an MMT in one hour speed course. The basic elements aren’t all that hard to understand, it’s letting go of the old memes that is hard. Anyway, I’ll soon have a regular show on Netroots, instead of my current guest spot. I’ll co-host with the very bright Will McLeod. I’ll bring the macro/MMT/economics news to the party and he’ll have the politics. (Greece has been fun for both of us.) The tentative show title is, “Hopping Mad with Will McLeod and Arliss Bunny”. I will be knocking on your door to “guest” on topics like the budget and I hope you will be able to participate. I sincerely believe that with Stephanie in DC, the Levy influence and Varoufakis in Greece, and the JG program in Scotland MMT IS finally starting to get visibility it never had before. We all need to keep making noise in our own ways. When I read the Progressive Caucus budget using “pay for” language I thought – NOOOOOO! And THAT’s where we need to start. If we can get the people who are already part way down the road to take those last few steps, that’s how we change the meme. BTW, if you noticed your ears burning I also did a show two weeks ago on the HVPCS and strongly recommended your book. 😉 Carrots!

  4. David Chester

    This equation for balancing is only one of 6 that apply to the whole of the national economy. They are based on the idea that what rate of money flows in to an entity must also flow out from it. When our overall social system or macro-economy is reduced to what functions it performs (that is to all of them), there are only 19 different things that it does and these flow between 6 idealized entities. The associated model can be found on Wikimedia as: DiagFuncMacroSyst.pdf This is the starting point of the analyses to be found in my latest book “Consequential Macroeconomics” which is described in Amazon Books etc. Write to me for more details. [email protected]

  5. Both Democrats and Republicans are equal opportunity offenders when it comes to ignoring SFB.
    My friends, everybody here knows that balance the budget for balancing’s sake is a fools errand, and is not something to be lauded or put on a pedistal. My question is how do we change people’s minds across the country.

    For better or worse, the tired, worn out, idiotic analogy of comparing Uncle Sam’s spending and income to a household’s income holds tremedous politcal sway because it is what people know. How can we change mind? I just don’t know….

  6. Pingback: When Will the White House and OMB Ever Learn About Sector Financial Balances? - New Economic PerspectivesNew Economic Perspectives