Lecture 3. THE ACCOUNTING MODEL OF THE GDP

Consider the GDP as national income that come only from 
three sources: (For the present, we will assume that
exports = imports and thus ignore foreign trade balance 
effects.)

C = Consumer Spending
I = Investment by Individuals
G = Govenment Spending

The nation disposes of this income by three types of 
expenditures:

C = Consumer Spending
S = Savings
T = Taxes

Since, over time, income must equal expenditure, the 
following equations are valid:

C + I + G = C + S + T, or, subtracting C from both sides:

I + G = S + T, or, transposing S and G:

(1) I - S = T - G 

The left side of equation (1) represents the private 
sector. If the difference is positive, the private sector
is a net borrower and, otherwise, a net saver.

The right side of equation (1) represents government. If 
the difference is positive, government has a surplus budget
and, otherwise, a deficit.

Let us emphasize that this is not economic theory but
rather straight forward, uncontesable accounting, where the
numbers must "add up".

If either side of equation (1) is positive, so is the 
other. In that case, when the government has a surplus 
budget, the private sector is a net debtor. However rarely 
this happens, and no matter how many billionaires there 
are, there are many others in debt.

If either side is of equation (1) is negative, so is the 
other. In that case, when the government budget has a 
deficit, the private sector has a surplus balance. No 
matter how many people are unemployed, there are, on 
balance, trillions available for spending. This is our 
current situation.
The Role of Trade Balance in the Model
When the foreign trade balance is considered,
the logic does not change. There is simply an additional 
factor:

    Exports minus Imports = X - M
                          = Net Exports                 

A positive balance in this account (also called the 
the "Current Account") means that the private sector
has a net claim on foreign assets.  Unfortunately,
this account  has been negative for two decades.
It deficits are private sector debits.

The symbols above (from the blog:"New Economic 
Perspectives", an excellent web site from which to learn 
economics) portrays the flow of money between all three 
sectors: private, public (government), and foreign.

Each sector has in-flows and out-flows to the other 
sectors. Each transaction has two entries. For every 
transaction, money goes in one direction and its value in 
goods and/or services goes in the other direction.

If, by chance, all three sectors have "Net Exports" 
balances equal to zero, the sum of the three balances will 
be zero.

Otherwise, if only one sector has a "Net Exports"
balance equal to zero, the other two sectors will have 
equal and opposite balances so that the sum of the three 
balances will still be zero.

It would be impossible for only two of the sectors to have
a zero balance. The remaining sector would have a non-
zero balance but no debtor or creditor.

If two of the three sectors jointly have either a positive
balance or a negative balance, the remaining sector must
have a balance equal and opposite to the sum of both of
the other balances. Thus the the sum of the three balances
will still be zero.
 
That covers all possible cases. Thus, the economy of the
three sectors really is a zero-sum game! In the above
circuit, the sum of all balances is always zero. This
gives rise to an identity:

  Private Sector Savings (S - I) 
+ Public Sector Surplus  (T - G)
+ Foreign Sector Surplus (M - X)
= zero 
The Complete Accounting Model
Re-writing the above identity:

(2) (S - I) + (T - G) + (M - X) = 0

and multiplying by -1 yields:

(3) (I - S) + (G - T) + (X - M) = 0

and transposing (G - T) yields our final equation:

(4) (I - S) + (X - M) = (T - G)

Thus, from an entirely different concept,
we have again derived equation (1) above
with the addition of "Net Exports"
as a Private Sector claim on foreign assets.
Consequences
It is important to recognize that,
because of the zero sum of balances,
with Foreign Sector Surplus relatively stable,
Public Sector Surplus growth (less government spending)
implies Private Sector Savings decline (more consumer 
debt).

Conversely, with Foreign Sector Surplus relatively stable,
Public Sector Surplus decline (more government spending)
implies Private Sector Savings growth (less consumer debt).

The government’s deficit is someone else’s surplus
and the government’s debt is someone else’s asset.

If we want the government to pay off its entire debt,
then we must want every single private portfolio
to lose its Treasury securities.

Since all of us agree that the private sector should save,
we must also agree that the government should borrow.

Now we can see why the attempt to balance the budget
in the early 1930s brought on the Great Depression
and why the same policy in 1937 caused another recession.

Reducing government spending during a recession is lunacy.
The Proof is in the Pudding
Having explained the model and stated our conclusion, 
let us now verify the model with data.

It is interesting to confirm our accounting principles
by examining data from the NIPA (National Income and 
Product Accounts) file in their Sectorial Balances 
Data. (A hat tip to Scott Fullwilir and Stephanie 
Kelton from the "New Economic Perspectives" blog for this 
link.)

Please note: The data below is copied exactly from the 
file, where the data is given in negative quantities so 
that equation

(4) (I - S) + (X - M) = (T - G)

 becomes:

(5) (S - I) - (X - M) = (G - T)
 
or in the terminology of the file heading:
 
(5) Domestic Private Surplus (S - I)
     - Current Account       (X - M) (Net Exports)
     = Government Deficit    (G - T)

But if you look at the data in the NIPA file you will see 
that it is given (in the last three columns on the right)
with Current Account transposed so that the file heading 
reads:

(6) Domestic Private Surplus (S - I)
     = Government Deficit    (G - T)
     + Current Account.      (X - M) (Net Exports)  

The file data is listed as percentages of GDP.
(Use algebraic addition/subtraction!)

In 1998 Q3, (file line 190) we had:

  Domestic Private Surplus: -2.55%.
= Government Deficit:       +0.01%
+ Current Account:          -2.56% (Net Exports)
             
In this case,
 with Government Deficit almost zero,
 Domestic Private Surplus almost equals Current Account.

In 1988 Q1, (file line 148) we had:

  Domestic Private Surplus: +1.61%.
= Government Deficit:       +4.20%
+ Current Account:          -2.59% (Net Exports)

In this case, the Current Account is almost the same as in
1998 Q3, but a large Government Deficit overcame the 
Current Account, yielding a positive Domestic Private 
Surplus.
Conclusions:
1. A government deficit is a private sector surplus.

2. The numbers "add up".
    This is not economic theory.
    This is simply Accounting 101.

3. Anyone who doubts the validity of the Accounting Model
    should have an alternate explanation
    for over 240 quarters of NIPA data such as given above.


Q: What happens when government reduces spending
    during a recession?

A: Money necessary for consumer spending
   or business investment is removed from the economy. 


Q: What happens when government balances the budget?
               
A: If T - G = 0,

    then (I - S) + (X - M) = 0 and

    S = I + (X - M) or

    Savings = Investments + Current Account

    Since the Current Account is seriously negative and,
    during a recession, the Investments account is         
    pitifully small, the Domestic Private Sector is a net   
    debtor.

    These consumers will not be in a consuming mood.
    Indeed, with our inequality of income and wealth,
    the average consumer will be in serious debt.


Q: Why would politicians call for less government spending
    or even a balanced budget during a recession?

A: They are either fools or charlatans
    seeking votes from foolish or ignorant voters.

    Government deficits are due to reduced tax revenue,
    and necessary relief spending.

    To increase consumer spending,
    government deficits must be increased.
     
    During a recession,
    federal government austerity
    is a recipe for a depression.
Proceed to:
Lecture 4. THE MONEY SUPPLY
Thanks for your interest.
  Marvin Sussman, retired engineer

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