Author Archives: admin

1. From Neil, can we tell from the sectoral balances what the multiplier effect from government spending might be?

2. Jean: can you carry the graph back to look at growth of “transfers”. Yes. But of course we are an aging society and so yes you will see growing spending on Social Security since Ida May Fuller first began to collect benefits. (Yogi says: look it up)
3. Murray: many questions, most to be addressed in coming weeks and months. One response now: what about gambling. As a rough rule of thumb, it is ignored. Only the profits and wages of gambling houses show up in the data. The bets (and losses) do not.
4. Willorng: 45 mph speed limit. Mosler beat you to it—his campaign platform included a national 35mph speed limit. I did not sign on. Sorry, call me old fashioned. I’d rather drive fast and save the planet by foregoing meat—our meat consumption is far more disastrous for the environment than driving SUVs at 100mph.
5. Dale on net imports: I mostly agree. It takes two to tango so we actually have little power over the outcome, anyway. I do not imply morality on imports and exports. I would not say net imports are good or bad. They just “are”.
6. Anon: fast or slow collapse and rich vs poor savings: I do not want a collapse at all. I want debt relief and jobs creation. On the empirical evidence—who is cutting spending and increasing saving—I do not know. I suspect it is low to middle income that has cut spending but I am not sure.
7. Wh10: again, I prefer to keep morality out of this, however, I am willing to say that in the circumstances that have existed since the early 2000s, increasing private sector deficits and debts is “bad”, unsustainable, and ultimately will (did) create a crisis. And, again, it takes two to tango. The rest of the world wants dollar assets. In such a situation, given US endorsement of mostly “free trade”, we will run a current account deficit. That is not good or bad, and it is sustainable. Now most analysts believe it is both bad and unsustainable. Hence, I called them out—how can they advocate private sector savings ,and government sector balanced budget without telling us how we will bring the current account to a surplus. They have no plausible story. They are either stupid or dishonest. I simply ask them to tell us which label they prefer. Personally, I am indifferent.

In previous blogs we have examined the three balances identity and established that the sum of deficits and surpluses across the three sectors (domestic private, government, and foreign) must be zero. We have also attempted to say something about causation because it is not enough to simply lay out identities. We have argued that while household income largely determines spending at the individual level, at the level of the economy as a whole it is best to reverse that causation: spending determines income.

Individual households can certainly decide to spend less in order to save more. But if all households were to try to spend less, this would reduce aggregate consumption and thus national income. Firms would reduce output, thus, would lay-off workers, cut the wage bill, and thereby lower household income. This is Keynes’s well-known “paradox of thrift”—trying to save more by cutting consumption will not increase saving. We’ll have more to say about that in later MMP blogs.

However there is an issue of immediate interest given the deficit hysteria that has gripped the United States (as well as many other countries). In the aftermath of the global financial crisis (GFC) social spending by government (for example, on unemployment compensations) has risen while tax revenues have collapsed. The deficit has grown rapidly leading to widespread fears of eventual insolvency or bankruptcy. Those, too, are issues for later blogs. The implication of growing deficits has been attempts to cut spending (and perhaps to increase taxes) to reduce deficits. The national conversation (in the US, the UK, and Greece, for example) presumes that government budget deficits are discretionary. If only the government were to try hard enough, it could slash its deficit.

As I have argued in previous blogs (particularly in responses to questions), however, anyone who proposes to cut government deficits must be prepared to project impacts on the other balances (private and foreign) because by identity the budget deficit cannot be reduced unless the private sector surplus or the foreign surplus (flip side to the domestic current account deficit) is reduced. In this blog, let us look at the rise of the US government budget deficit since the GFC hit. We will ask whether the deficit has been, and might be, under discretionary control—if not then that raises questions about the attempts by deficit hysterians to reduce deficits.

In the aftermath of the Great Recession of 2007, the US federal government budget moved sharply to large deficits. While many attributed this to various fiscal stimulus packages (including bail-outs of the auto industry and Wall Street), the largest portion of the increase in the deficit came from automatic stabilizers and not from discretionary spending. This is easily observable in the graph below which shows the rate of growth of tax revenues (mostly automatic), government consumption expenditures (somewhat discretionary) and transfer payments (again mostly automatic) relative to the same quarter of the previous year:

In 2005 tax revenues were humming, with a growth rate hitting 15% per year—far above GDP growth–hence, reducing non-government sector income—and faster than government spending, which grew just above 5%. Such fiscal tightening (called fiscal drag) often is followed by a downturn—and the downturn that accompanied the GFC was no exception. When it came, the budget deficits increased, mostly automatically. While government consumption expenditures remained relatively stable over the downturn (after a short spike in 2007-2008), the rate of growth of tax revenues dropped sharply from a 5% growth rate to a 10% negative growth rate over just three quarters (from Q 4 of 2007 to Q 2 of 2008), reaching another low of -15% in Q1 of 2009. Tax receipts quite simply fell off a cliff.

Transfer payments grew at an average rate of 10% since 2007, with the higher rate in part due to the rotten economy. Decreasing taxes coupled with increased transfer payments automatically pushed the budget into a larger deficit, notwithstanding the flat consumption expenditures. The automatic stabilizer–and not the bailouts or stimulus—is the main reason why the economy did not go into a freefall as it had in the Great Depression of the 1930s. As the economy slowed, the budget automatically went into a deficit putting a floor on aggregate demand. With countercyclical spending and pro-cyclical taxes, the government’s budget acts as a powerful automatic stabilizer: deficits increase sharply in a downturn.

The expansion before the GFC had been led (mostly) by the 2000s housing boom, during which households borrowed (and spent) on an unprecedented scale. We already visited the three balances that demonstrated the private sector taken as a whole deficit spent for almost a decade in the lead-up to the GFC. In the Clinton boom, about half the deficit spending was by firms; however in the 2000s boom it was entirely the household sector that spent more than its income. Both the Clinton boom and the 2000s boom caused the budget deficit to fall (and to actually move into a large surplus during the Clinton years).

Since the crash, the household sector has retrenched (as it always does in recession), and saving remains high. Slow growth has been the major cause of the rapidly growing budget deficit—and the slow growth, in turn, is due to a high propensity to save by the retrenching household sector. See the next graph (thanks to Dimitri Papadimitriou of the Levy Economics Institute for providing the next two graphs to me):

What we see is a rather remarkable reduction of household saving on trend since the mid-1980s. The cause is beyond the scope of this blog. But the flip-side to that has been the rise of household debt. That trend turned around sharply after the GFC, with households saving like it was 1992 all over again. Given loss of jobs, and stagnant incomes (at best) for most Americans, the notion that the household propensity to spend will sharply reverse course seems unlikely.

As we discussed above, shrinking the government’s deficit will require either that the private sector spend more relative to its income or that the US current account deficit fall sharply. But households are still heavily indebted and indeed more and more homeowners are falling “underwater”—so the likelihood that they will drop saving back down to the 2-3% range we saw in the 2000s seems unlikely. (Note that saving as a percent of disposable income is not exactly the same as the household balance that goes into our three sector balance equation. That is why although this is a small positive saving number, in the sectoral balances equation households actually spent more than their income. See the note at the end of this blog for the wonky stuff.)

Another possibility is a domestic private business sector boom. That, too is unlikely with high unemployment and depressed domestic demand and stagnant sales—investment by firms is not going to grow that much. (I won’t go into it here, but there is a lot of evidence that “investment-led booms” are really residential housing investment booms—housing construction is included in investment numbers–and there is little chance that we will see a housing construction boom in the near future.)

The final possibility is the foreign sector. The next graph shows US imports and exports on current account.

Imports are running around 18% of GDP (rebounding sharply since the GFC) and exports are at 14% of GDP—so exports are up, but imports are climbing a bit faster (this difference is mostly due to oil). While it is true that the US current account balance has become less negative in recent months, much more movement will be required to actually get to positive territory (more than 3% of GDP of adjustment would be required). Note that the last time we actually had a positive current account balance was in the Bush, Sr., recession—two decades ago.

Remember, to reduce the government sector deficit from the current 9% or so of GDP toward balance will require some combination of a private sector movement toward deficit and a current account movement toward surplus amounting to a total of 9% points of GDP. That is huge. The problem is that actually trying to balance the budget through spending cuts or tax increases could reduce economic growth (I think it will actually cause a sharp downturn, but I do not need to make that case). Lower economic growth could conceivably reduce our current account deficit—by making Americans too poor to buy imports, by lowering US wages and prices to make our exports more competitive, and by reducing the value of the dollar. Note that all of those are painful adjustments for Americans. And it might not work, because it requires the US to slow without that affecting the global economy—if it also slows, US exports will not increase.

Now, deficit warriors insist that cutting government will induce faster growth of the private sector. If that were true, it actually makes it easier to reduce the budget deficit—as the private sector’s balance worsens toward deficit. On the other hand, more rapid growth will probably cause deterioration of the current account deficit (our imports will rise; our wages and prices will not fall; and the dollar could gain strength). That in turn must be matched by some combination of private sector and government sector movements toward deficits. The US has a higher propensity to import than do our trading partners—what that means is that if we grow at about the same rate as the rest of the world, our imports grow faster than our exports.

So, to balance the government’s budget we need to grow faster, but faster growth will probably increase our current account deficit so that the three balances identity will imply either that our private sector returns to excessive spending (as it did for the past decade) or that the government’s deficit cannot be reduced. It is something of a Hobson’s choice—with no morality implied—because what appears to be a “free choice” of reducing the budget deficit through faster growth means we actually are accepting bigger household debts and a bigger current account deficit.

That is the problem with analysis and policy recommendations that do not take account of the three balances—they ignore what is implied for the other balances.

Let us summarize the points. First, the three balances must balance to zero. This implies it is impossible to change one of the balances without having a change in at least one other. Second, at the aggregate level, spending (mostly) determines income. A sector can spend more than its income, but that means another spends less. While we can take government spending as more-or-less discretionary, government tax revenue (its equivalent to its income) depends largely on economic performance. Chart 1 above showed that tax receipt growth is highly variable, moving pro-cyclically (growing rapidly in boom and collapsing in slump).

Government can always decide to spend more (yes, it is politically constrained), and it can always decide to raise tax rates (again, given political constraints), but it cannot decide what its tax revenue will be because we apply a tax rate to variables like income and wealth that are outside government control. And that means the budgetary outcome—whether surplus, balanced, or deficit—is not really discretionary.

Turning to our foreign sector, exports are largely outside control of the US (we say they are “exogenous” or “autonomous to US income”). They depend on lots of factors, including growth in the rest of the world, US exchange rates, trade policy, and relative prices and wages (US efforts to increase exports will almost certainly lead to responses abroad). It is true that economic outcomes in the US can influence exports (as discussed, slower US growth can slow global growth)—but impacts of policy on exports are loose.

On the other hand, US imports depend largely on US income (plus exchange rates, relative wages and prices, and trade policy; again, if the US tried to reduce imports this would almost certainly lead to responses by trading partners that are pursuing trade-led growth). Imports are largely pro-cyclical, too. Again, our current account outcome—whether deficit, surplus, or balanced—is also largely nondiscretionary.

What is discretionary? Domestic spending—by households, firms, and government—is largely discretionary. And spending largely determines our income. Sectoral balances, however, should be taken as mostly nondiscretionary because they depend in very complex ways on the discretionary variables plus the nondiscretionary variables and on the constraints imposed by the macro identity. It makes most sense to promote spending that will utilize domestic resources close to capacity, and then let sectoral balances fall where they may. As we will argue in coming months, the best domestic policy is to pursue full employment and price stability—not to target arbitrary government deficit or debt limits, which are mostly nondiscretionary, anyway.

Note 1: The main differences between the personal saving rate and the household net saving as a % of GDP are the following (thanks to Scott Fullwiler):

1. Household net saving is as a % of GDP, whereas personal saving rate is as a % of disposable income
2. Household net saving subtracts all household spending, including consumption and residential investment, whereas personal saving only subtracts consumption spending

A few additional smaller differences for the really wonky:

1. Household net saving adds an allowance for household capital consumption (i.e., depreciation), personal saving doesn’t,
2. Household net saving imputes insurance and pension reserves to households from govt sector, personal saving doesn’t, and
3. Household net saving includes wage accruals less disbursements from businesses to households, personal saving doesn’t.

Note 2: Thanks to the MMT gang. You know who you are.

There were a large number of relevant comments and questions. I have done some cut and paste here and will deal with them in order.

Question: Is there any material difference between the sectoral balances in a currency and the sectoral balances issued in the national accounts for GDP purposes?

Answer: Here is my understanding: for the US there would be no (significant) difference as we use dollars in our stocks and our flows. Even if we buy foreign made output, we provide dollars that are exchanged for foreign currency. In other countries there could well be a significant portion of the economy that is denominated in a foreign (dollar) currency. Much of that could go unrecorded, of course. In that case the official accounts would be in domestic currency but if it were feasible we could also keep some accounts in dollars. All the macroidentities for this country would still apply for transactions that take place in dollars.

Q: Several comments were made about this statement: “No matter how much others might want to accumulate financial wealth, they will not be able to do so unless someone is willing to deficit spend.”

1. So do you consider inventory run up to be in the category of ‘willing’?
2. I’m thinking optimist makes perishable goods that in the end nobody wants to buy having somehow managed to persuade a bank to create the necessary money (possibly by having large valuable real thing to offer as collateral).
3. I also find it very confusing. A desire to accumulate wealth is very easy to realize – do not spend your income. Whenever anybody gets a paycheck technically the whole amount is saved. So saving or accumulation is realized by definition while spending requires action.

A: If a firm is producing “widgets” it does so to “realize” them in the form of money things—it wants to sell them to get a credit to its bank account If it cannot sell them, they are added to inventory and count in the GDP accounts (technically NIPA) as investment. There will be an offsetting flow which is saving. Within the private sector, the increase to investment equals the increase to saving—this activity has no impact on the overall private sector’s balance. But let us imagine that foreigners order those widgets; in that case, the firm gets to sell them (receiving a credit to its bank account); there will be no increase to domestic investment. Instead, exports have increased—there is a positive entry to the current account balance. Ignoring all other entries, the US domestic private sector gets a surplus on its balance (saving) while the foreign sector “deficit spends”.

I know this will not answer all possible questions that follow on from this. After we look at the “circuit approach” later in the MMP we will see how the firm financed its production of widgets and what the implication is for the firm if it fails to “realize” them in the form of sales for money things. You can think of the “saving” of the household sector as the counterpart to the undesired inventory accumulation by the widget manufacturer. The manufacture of the widget produces household income that can be consumed or saved; of course the firms hope workers never save—because that means lost potential sales. If households do save, widgets go to inventory as investment. The firm can then be in trouble—not able to cover its costs. But foreigners or the government can step in to fill the demand gap.

Q: I wonder about “a) Individual spending is mostly determined by income.” Is this important/necessary/useful for you exposition?

A: Of course, it is true that wealthier people can fairly easily spend even if their flow of income is zero—they can sell off assets or borrow against them. But for many households, it is “mostly” true that income determines spending. And it is common sense to most people. My bigger point, however, is that at the aggregate level we need to think about reversing the causation. My household’s income is mostly determined by my employer’s decision to spend on my wages and salaries. So household consumption really depends to a great extent on its income (so consumption is called “induced spending) but its income in turn comes from somewhere—largely spending by firms and governments on wages, profits, and interest. At that spending by firms is undertaken on the expectation of sales (expenditures by households or other firms). We then also have government and investment and exports that are at least to some extent “autonomous” to income (don’t depend on today’s income). Yes these are important issues both for explanation and for projections of economic performance. There is also a logical angle: a society can decide to spend more but it cannot decide to have more income (unless it spends more). Spending is thus logically prior.

Q: When somebody hands you a five dollar bill, you can’t spend (create an outflow) out of that instantaneous inflow. You can only spend out of your stock — whether it’s a Swiss bank account or the buck and a quarter you have in your pocket. Flows are strings of instantaneous events; stocks have existence and duration. You can only spend out of wealth, not out of income. Obvious, but a point of confusion out there in the world.

A: When my boss pays me my $5 wages, that is indeed an income flow—ie: $5 per hour, per week, per month, or per year. Flows occur over time (even if the time is short). I can accumulate my income (wages) flow in the form of green paper dollar notes—the flows accumulate to a stock of dollar bills. (Stocks are measured at a point in time. Now!, for example.) If instead I spend the wages as I receive them, that is a consumption flow financed out of wages flow. But if I save all my wages as accumulated stacks of dollar bills for a period of a year, and then at the end of the year I choose to run down my wealth by splurging on a new BMW, then I am dissaving (reducing stock of wealth) to finance consumption.

Note that if I accumulated BMWs as my wealth (rather than dollar notes) then I would first have to sell the BMWs before I could finance consumption. That is of course the advantage of accumulating “cash”—I don’t have to sell it before spending. So my exposition was not confused. You could say that it is rather arbitrary whether to count hoarding of $5 notes as a saving flow into my stock of wealth, that I then run down to finance consumption versus spending the $5 income flow to finance consumption. That is to say, as we collapse the time period toward an “instant” then the distinction between flows and stocks disappears. That seems to be what you are saying. An instantaneous flow reduces to a stock as time approaches zero. And that of course is correct, too.

Note that income can be received as a flow of claims (rather than green paper). I work all month long, accumulating wage claims on my employer. (Legally enforceable in court.) Then I finally get my paycheck and deposit it in my bank account. Now I spend down my deposit until my next paycheck. If we want to be technically wonky we would say you are receiving an income flow every day of the month that finances a consumption flow every day of the month. But as you say, the “payment” of the wage actually takes place on a single day as a credit to your bank account (increasing your stock of wealth). (Technically, the claim on your employer is converted to a bank deposit—usually a debit to your employer’s account and a credit to yours.) You could not “really” spend your wages (claims on your employer) until you got your paycheck—except by borrowing against the claims.

Q: My understanding of domestic government budget surpluses is that they merely destroy the dollars that earlier spending created. Isn’t it meaningless to suggest that a sovereign government “saves” its own fiat currency?

A: In practical terms, yes. In the US during the Clinton boom there was a projection that all outstanding US Treasury debt would be retired. This led to a mad rush at the Fed to figure out how the federal government could continue to run surpluses if there were no government IOUs out there to “destroy”. If we ever did get to that point, the only way the private sector could continue to run deficits against the government would be to surrender assets (not government IOUs) in payment. You’d have to turn over your car, house, bank account, and children to the government to pay taxes!! That is the logical result of a government surplus carried to infinity—government would accumulate infinite claims on you. And yes you are correct that sovereign government does not—cannot—“save” its own currency!

Q: “It is impossible for every individual in the private domestic sector to net save at the same time if that sector’s aggregate balance is zero” Sure, but the logic is not the one you and this post claim. It is savers who force deficit spending and not the other way. This is the reason why.

A: Takes two to tango, of course. I think I made that clear. But carrying on from above, at the aggregate level (at least) it makes more sense to say that spending “causes” income which in turn “causes” saving. Here is why. If I am credit worthy I can always decide to spend more (the bank takes my IOU, gives me its IOU, and I deficit spend). I cannot (easily) decide to have more income. I need income to save more. Still, it takes two to tango. Yes, if I have income I can decide to consume less and save more. That will have an implication on someone else’s income flow (since I am not buying her widgets). And that means undesired deficit spending (and perhaps inventory accumulation—as above).

Q: Could you provide an algebraic description of MMT and its prescriptions as part of the MMP?

A: I did.

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

That is pretty much all the math(s) you need to become a good macroeconomist! If you understand that, you are way ahead of most Nobel winners. (More seriously, where math helps, we will use it.)

In Blog #2 we introduced the basics of macro accounting, and in Blog #3 we took a break from accounting to take a look at the rise and fall of the Goldilocks economy in the US. Thus, we applied our sectoral balance identity to the case of the US. In today’s blog we will go a bit deeper into the accounting, looking at the relation between flows (deficits) and stocks (debts). To avoid making mistakes we need to make sure that we have “consistency” between our flows and our stocks. We want to make sure that all spending and saving comes from somewhere and goes somewhere. And we must make sure that one sector’s surplus is offset by a deficit in another sector. This is a lot like keeping track of the scores in a baseball game, and in fact most financial “scores” really are electronic entries in the modern world.

We will also try to say something about causation. It is not sufficient to say that at the aggregate level, the private balance plus the government balance plus the foreign balance equals zero. We would like to be able to understand why the private sector balance was negative during the Clinton Goldilocks years while the government balance was positive—how did we get to that point, and what sorts of processes did it induce. Obviously that is necessary before we can really analyse the situation and formulate policy. Unlike the macro accounting identity (which must be true), it is not possible to say with certainty what causes a particular sector’s balance. It is quite easy to say that if the government runs a surplus and if the foreign balance is positive (foreign sector spends less than its income) then the domestic private sector must by accounting identity be negative (running a deficit). It all must sum to zero.

Explaining why the private sector had a deficit during the Goldilocks years is harder; it is even harder to project if and for how long that deficit would continue. I already made clear in Blog 3 that I got the timing wrong—private sector deficits continued for about 4 years longer than I expected. Projections are darned hard to get right—if they were easy, MMTers would all make lots of money placing bets on outcomes. Another way of stating this is to say that a good understanding of MMT does not give one any monopoly on explanations of causation. We must not be overly confident. As the late and great Wynne Godley used to put it, he did not make forecasts, rather, he made contingent projections.

For example, carrying on with the work of Godley, the Levy Economics Institute (www.levy.org) makes such projections. Typically it begins with CBO (Congressional Budget Office) projections of the path of government deficits and of economic growth over the next few years. CBO projections are largely determined by current law (ie: laws determining government spending and taxing, as well as mandates over deficit reduction). However, the CBO’s projections are not stock-flow consistent and do not adopt the three sector balances approach (this used to drive Godley crazy). In other words, they are incoherent. But given projections over the government balance and GDP growth as well as empirical estimates of various economic parameters (propensity to consume and import, for example), one can produce a stock-flow consistent model that produces the implied sectoral balances as well as path of debt. The Levy Institute often finds that economic growth rates (for example) plus government deficit projections used in CBO forecasts imply highly implausible balances in the other two sectors (domestic private and foreign) as well as private debt ratios. To do that kind of analysis, you must go beyond the simple accounting identities.

Deficits -> savings and debts -> wealth. We have established in our previous blogs that the deficits of one sector must equal the surpluses of (at least) one of the other sectors. We have also established that the debts of one sector must equal the financial wealth of (at least) one of the other sectors. So far, this all follows from the principles of macro accounting. However, the economist wishes to say more than this, for like all scientists, economists are interested in causation. Economics is a social science, that is, the science of extraordinarily complex social systems in which causation is never simple because economic phenomena are subject to interdependence, hysteresis, cumulative causation, and so on. Still, we can say something about causal relationships among the flows and stocks that we have been discussing in the previous blogs. Some readers will note that the causal connections adopted here follow from Keynesian theory.

a) Individual spending is mostly determined by income. Our starting point will be the private sector decision to spend. For the individual, it seems plausible to argue that income largely determines spending because one with no income is certainly going to be severely constrained when deciding to purchase goods and services. However, on reflection it is apparent that even at the individual level, the link between income and spending is loose—one can spend less than one’s income, accumulating net financial assets, or one can spend more than one’s income by issuing financial liabilities and thereby becoming indebted. Still, at the level of the individual household or firm, the direction of causation largely runs from income to spending even if the correspondence between the two flows is not perfect. There is little reason to believe that one’s own spending significantly determines one’s own income.

b) Deficits create financial wealth. We can also say something about the direction of causation regarding accumulation of financial wealth at the level of the individual. If a household or firm decides to spend more than its income (running a budget deficit), it can issue liabilities to finance purchases. These liabilities will be accumulated as net financial wealth by another household, firm, or government that is saving (running a budget surplus). Of course, for this net financial wealth accumulation to take place, we must have one household or firm willing to deficit spend, and another household, firm, or government willing to accumulate wealth in the form of the liabilities of that deficit spender. We can say that “it takes two to tango”. However, it is the decision to deficit spend that is the initiating cause of the creation of net financial wealth. No matter how much others might want to accumulate financial wealth, they will not be able to do so unless someone is willing to deficit spend.

Still, it is true that the household or firm will not be able to deficit spend unless it can sell accumulated assets or find someone willing to hold its liabilities. We can suppose there is a propensity (or desire) to accumulate net financial wealth. This does not mean that every individual firm or household will be able to issue debt so that it can deficit spend, but it does ensure that many firms and households will find willing holders of their debt. And in the case of a sovereign government, there is a special power—the ability to tax–that virtually guarantees that households and firms will want to accumulate the government’s debt. (That is a topic we pursue later.) We conclude that while causation is complex, and while “it takes two to tango”, causation tends to run from individual deficit spending to accumulation of financial wealth, and from debt to financial wealth. Since accumulation of a stock of financial wealth results from a budget surplus, that is, from a flow of saving, we can also conclude that causation tends to run from deficit spending to saving.

c) Aggregate spending creates aggregate income. At the aggregate level, taking the economy as a whole, causation is more clear-cut. A society cannot decide to have more income, but it can decide to spend more. Further, all spending must be received by someone, somewhere, as income. Finally, as discussed earlier, spending is not necessarily constrained by income because it is possible for households, firms, or government to spend more than income. Indeed, as we discussed, any of the three main sectors can run a deficit with at least one of the others running a surplus. However, it is not possible for spending at the aggregate level to be different from aggregate income since the sum of the sectoral balances must be zero. For all of these reasons, we must reverse causation between spending and income when we turn to the aggregate: while at the individual level, income causes spending, at the aggregate level, spending causes income.

d) Deficits in one sector create the surpluses of another. Earlier we showed that the deficits of one sector are by identity equal to the sum of the surplus balances of the other sector(s). If we divide the economy into three sectors (domestic private sector, domestic government sector, and foreign sector), then if one sector runs a deficit at least one other must run a surplus. Just as in the case of our analysis of individual balances, it “takes two to tango” in the sense that one sector cannot run a deficit if no other sector will run a surplus. Equivalently, we can say that one sector cannot issue debt if no other sector is willing to accumulate the debt instruments.

Of course, much of the debt issued within a sector will be held by others in the same sector. For example, if we look at the finances of the private domestic sector we will find that most business debt is held by domestic firms and households. In the terminology we introduced earlier, this is “inside debt” of those firms and households that run budget deficits, held as “inside wealth” by those households and firms that run budget surpluses. However, if the domestic private sector taken as a whole spends more than its income, it must issue “outside debt” held as “outside wealth” by at least one of the other two sectors (domestic government sector and foreign sector). Because the initiating cause of a budget deficit is a desire to spend more than income, the causation mostly goes from deficits to surpluses and from debt to net financial wealth. While we recognize that no sector can run a deficit unless another wants to run a surplus, this is not usually a problem because there is a propensity to net save financial assets. That is to say, there is a desire to accumulate financial wealth—which by definition is somebody’s liability.

Conclusion. Before moving on it is necessary to emphasize that everything in this blog (as well as Blog #2) applies to the macro accounting of any country. While examples used the dollar, all of the results apply no matter what currency is used. Our fundamental macro balance equation,

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

will strictly apply to the accounting of balances of any currency. Within a country there can also be flows (accumulating to stocks) in a foreign currency, and there will be a macro balance equation in that currency, too.

Note that nothing changes if we expand our model to include a number of different countries, each of which issues its own currency. There will be a macro balance equation for each of these countries and for each of the currencies. Individual firms or households (or, for that matter, governments) can accumulate net financial assets denominated in several different currencies; vice versa, individual firms or households (or governments) can issue net debt denominated in several different currencies. It can even become more complicated, with an individual running a deficit in one currency and a surplus in another (issuing debt in one currency and accumulating wealth in another). Still, for every country and for every currency there will be a macro balance equation.

OK that is enough for this week. Can I remind commentators and questioners that this is a Primer. We will collect questions and comments until Wednesday and then post a response. We appreciate comments and questions directly related to this blog. We really do not want comments from those who have already examined and rejected MMT.