Why can’t people understand national accounting?

I was on RT’s Capital Account last night talking to Lauren Lyster about the euro zone debt crisis. At the end of the show, we came up against the deficit problem and the question about how it should be solved. I get frustrated by this topic because the whole framing of the problem presented in the media is wrong because it gets cause and effect totally backwards. The question the media asks is "how can government cut the government deficit?" The real question is "why are deficits high to begin with and what should we do about it?" And it’s this question that gets people into trouble.

I’ll let you in on a secret: before this crisis, when I thought about the budget deficit I was like everyone else in that I paid no attention to how the government budget interacted with the private and trade sector balances. This is a big error. If you do that, you treat the government budget deficit in isolation, when the reality is that the government is an integral part of an open economy with households and businesses that trade domestically and abroad. When the government balance changes, the balances for those businesses and households change too. If you are talking about deficits then, you need to know how changes in the government balance affect the rest of the economy.

Here’s the thing: when we exchange goods and services with each other, from an accounting perspective, it’s a wash; if you buy my goods, I get money and you get goods of equivalent value. If you pay for those goods with an I.O.U., with a debt, your liability, your deficit in the year we made the transaction, is exactly equal to the asset on my balance sheet and my surplus for the year. I mean this is basic accounting, folks. There’s no hocus pocus. Any person’s, any household’s, any business’s, any group’s, any government’s debt is someone else’s asset. Any person’s, any household’s, any business’s, any group’s, any government’s deficit is someone else’s surplus. Again, it’s basic accounting.

Think of it like exchange traded options and the profit and losses on the exchange. People buy and sell oil futures or soybean futures. At the end of the option period, they either have a loss or a profit and that period’s deficit or surplus is exactly offset by the deficit or surplus of the counterparties. When you sum up these deficits and surpluses they net to zero. Again, no hocus pocus. That’s how accounting works.

The same is true for national accounts. At the end of any accounting period, then, the sum of the sectoral financial balances must net to zero. The government balance – the private balance – capital account balance = 0. The government balance = the private balance + the capital account balance. See my post Economics 101 on government budget deficits for the full write-up. I credit British economist Wynne Godley for making this identity relevant to macro economics.

What does all this mean then? Put simply, the financial sector balances framework means that when the government sector runs a deficit, the non-government sector runs a surplus of equivalent size. So, to move any sector balance in an open economy, you need to move the other two balances exactly opposite in equivalent measure. To reduce the government deficit in any period, the private balance and the capital balance must increase by the exact same amount in that period.

Thinking about government deficits this way opens a whole new understanding of what cutting deficits means for the economy. What it should mean to you is that deficits are the effect and not the cause. Budget deficits are the result of the ex-post accounting identity between the sectoral balances and should not be a primary goal of public policy. Let me give you an example.

Why are deficits so high? What I have been saying is that private debt is the problem. Debt has been a substitute for income due to stagnant wages. Now that the credit bubble’s asset price inflation has turned to deflation, people, businesses and banks have found themselves saddled with debts that are not adequately underpinned by asset collateral. Businesses have done some serious heavy lifting here and debt in the corporate sector is not a problem. But households are still over-indebted. As long as household financial assets provide insufficient collateral for the debts that depend on them, the household sector will continue to maintain a reduced level of consumption and investment as a percentage of income to deal with that debt. Businesses see this and reduce their investment too. And we get stuck in a lower-investment, higher savings world that leads to deficits.

So, in that context, attempts at austerity make things considerably worse. If the government cuts back, the private debt overhang will still be there and the private sector will simply have less money to deal with it. The household sector will still attempt to keep its net saving, its surplus, high and so government cuts will be felt primarily in the form of reduced household consumption and increased private sector defaults. In the context of a still weak banking system, that could create the kind of downward spiral we witnessed during the Great Depression as banks failed. It creates the kind of paradox of thrift that makes deficit reduction harder which we are witnessing in the euro zone as many of us including James Montier predicted.

In my view, austerity is a failed paradigm. Clearly, government shouldn’t have wasteful programs to begin with. So there should be no need to cut them to cut a deficit. Moreover, the deficit is the result of an ex-post accounting identity between private savings, and capital account and government balances. It makes zero sense to target the effect (deficits) instead of the cause (excess credit growth and malinvestment). In plain English that means the policy prescriptions are the economic input and the deficit is the output. Focus on the policy and policy goals, not deficits.

The way I look at this crisis puts me into Ray Dalio’s camp. The right narrative for what has happened is that the depression has been the result of significant malinvestment that was built up during the so-called ‘Great Moderation’ as a result of loose monetary policy at the Fed and other central banks in a world awash in fiat money. The real policy question should be how to eliminate the malinvestment and reallocate capital investment to useful productive enterprises without creating a deflationary spiral. When credit is written down, GDP drops and people are thrown out of work. That can be mitigated. It is bank runs that create deflationary spirals. So the answer is to write down assets and recapitalise the banking system quickly rather than dragging it out. The goal should be to allow increased savings and debt and debt interest reduction to combine with increased income to accelerate the deleveraging process without causing runs.

I named my blog “Credit Writedowns” because I anticipated an historic wave of credit writedowns in the global banking system which would lead to a wave of deleveraging, systemic risk, and bank failures — in short, a massive financial and economic bust to rival the Great Depression. My hope had been to draw attention to the systemic risk associated with the deleveraging process necessary to purge these excesses. But since I began writing here four years ago, it has become clear to me that the goal of most policy makers is to avoid the pain of deleveraging by any means necessary. Their goal has been to extend and pretend, dragging it out, resisting credit writedowns and resisting recapitalising the banking system.

But debts that can’t be repaid, won’t be. Rather than resist this process, policy makers should embrace it and mitigate the downside.

UPDATE 6/3 2012: I should have noted from the outset that the first two thirds of this post are fact and the last third contains an Austrian-styled interpretation of the origins of the crisis. See my post "Ludwig von Mises on Austrian Business Cycle Theory" for a write-up of why the part on malinvestment and Fed policy is Austrian.

Tom Hickey at Mike Norman Economics, an MMT blog, writes a reminder from the MMT perspective that:

folks like Bill Black, Michael Hudson, and Randy Wray, all of UMKC, Yves Smith of Naked Capitalism, and Janet Tavakoli of Tavakoli Structured Finance have documented that the problem arose from what Bill Black calls a criminogenic environment in the financial sector, both the mortgage market and the securitization process. It continues in the foreclosure debacle.

Yes I agree that the deregulation as crony capitalism was a major factor. See my post on Corporatism masquerading as Liberty for example. Nonetheless, I am sticking to my Austrian interpretation here about artificially low rates after the tech bubble as the most significant factor in housing’s parabolic move higher and the attendant malinvestment from capital misallocation. At a later juncture, I might try to synthesize or compare and contrast to give you a more balanced perspective. I have added this update in part for this reason.

  1. guest says

    Never notice that a woman looks confused. A good way to spend the night on the couch or never have your calls returned. Great article.

  2. The Mays Report says

    What can I say, this is an absolutely brilliant piece. Well thought out and articulated. You always write well but this is one of your best and the timing could not be better. Great Job!!! 

  3. Dave Holden says

    Haven’t seen the RT piece but in a world where Nobel prize winning economists don’t understand how banking works I think it’s only fair to cut people some slack on this issue. I’m not sure I really get it. 

    Isn’t the point that its how the government runs a deficit that matters? Clearly austerity isn’t helping but isn’t there a concern about gradually replacing private malinvestment with government malinvestment?

    1. Edward Harrison says

      That’s certainly what I have been saying. See:


      This is why you want to write down the debt quickly and get on with it. The longer this thing drags out, the more deadweight loss and misallocation you’re likely to get.

      The core issues are private debt and undercapitalised banks. Once we deal with those, there will be a lot less need for stimulus.

      1. Dave Holden says

        OK thanks. Tbh I think I’m in total agreement with you on this. 

        Thanks also for those links they look very useful –  I’ve put them on my instapaper for further pondering offline. 

        And “Arbeitsbeschaffungsmassnahmen” what a great word!

      2. David_Lazarus says

        That debt writedown could come as a beneficial side effect of a run on the banks which collapses them.

    2. David_Lazarus says

      By 1933 the private malinvestment had been cleared out of the economy. We cannot try Keynesian stimulus now because we have not cleared out the malinvestment. All that will happen is that it will be transferred to the taxpayer like the banks did with their MBS to the Fed. All that was achieved by the “stimulus” was it maintained the previous private mal-investment. That is more true in countries that had big domestic credit binges, like the US and the UK. All it is extend and pretend, but on a longer scale. We will have another crisis very soon because we did not clear out the problems in the financial sector. Only once we have cleared out the mal investment can the economy grow on a more stable footing, that might require more private defaults as well. 

      1. Edward Harrison says

        David, I am with you there. The runs and associated deadweight loss made things worse but at least the writedowns were taken.

        The problem with stimulus is that it can be a blunt instrument if not done in a targeted way. In the US the deficits are offset by some increased household savings but a lot of business retained earnings. The ‘stimulus’ has done nearly nothing to reduce the household debt. We still have a long way to go but there is no way politically people are going to accept years and years of deficit spending without trying to raise taxes or cut spending growth. Eventually recession will come because of it. I think it’s inevitable.

        1. David_Lazarus says

          Had politicians allowed the banks to collapse and effectively write down trillions of debt then the impact  of the stimulus would have been far more effective. 

          As to the stimulus I would have concentrated it in welfare spending which flows almost immediately back into the economy. Next an energy conservation plan, which would mean free insulation and draught proofing for homes, that could be paid for in part by a hike in energy taxes. Though with the objective of having no net impact on the economy. In the long run it would significantly reduce energy use and imports. You could infrastructure spending which has lower leakages to overseas suppliers, which reduces the effectiveness of stimulus. 

          I would have had a substantial capital gains tax and elimination of loopholes. While many might criticise this as anti capitalist it only highlights how little many realise who are the real targets are the banks. Until you clear that mortgage you only are effectively renting from the bank and they get most of the gains from a property bubble. If the property bubble is killed off then businesses will find less capital is needed to expand. If rents are held high to support reckless borrowers then the capital available for actual job creation is less. Ordinary businesses could have a rollover of capital gains for those that sell a business and keep all the proceeds for reinvestment in a new businesses. That will not penalise small businesses that create jobs. Raising taxes on energy could help eliminate the deficit but until the economy is growing can be used to boost training and pay for welfare programs. As unemployment falls the surplus could be paying down government debt and reducing the deficit.

          The people need to feel the impact of a depression to appreciate the need for years of deficits. So one way or another they will get that depression. All the inactivity by congress has actually been beneficial for the US. A GOP dominated White house and congress will mean austerity and depression, for most yet ever bigger tax cuts for the 1%. 

          The UK has even more debt to pay down and is doing so very slowly. Most will probably pay it down via bankruptcy as the crisis continues. 

  4. David_Lazarus says

    I think that a major part of the problem goes back to the simplistic analogies used by Reagan and Thatcher years ago that described the economy like a household budget. Merkel used the Swabian house frau equivalent only last week. Most leaders now use the same inaccurate model so no wonder the public are confused. Yes they understand simple budgets but are not told about the interplay between one persons deficit being another entity’s surplus. When you aggregate the simple household model you get the Keynesian Paradox of Thrift. Keynesianism seems to be a dirty word now in economics and thought of as discredited, because the last stimulus was seen as a failure. 

  5. Seth2077 says

    Who’s to say what is malinvestment? One man’s waste of capital is another’s well deserved luxury. There is no need to go down this road in order to explain what has happened to our economy the past few years because a much more plausible explanation is at hand: income disparities. Through a number of channels (trade, financialization, mechanization, etc) aggregate demand supported by earnings (equity) dropped among the majority of Americans. To keep pace and maintain their quality of life, aggregate demand supported by debt grew. This obviously could not go on forever and we are now dealing with the inevitable result. No resorts to value or morality required.  

    1. Edward Harrison says

      Who’s making the morality play? You’re talking about income inequality as unjust and you’re saying that calling excess credit and a housing bubble malinvestment is a morality play? OK, right.

      I agree though that income stagnation played a big part in the accumulation of debt in the US.

    2. ChrisBern says

      Seth–  income and employment have been fine and even “strong” for relatively educated/skilled Americans.  Where it’s faltered is for relatively uneducated/unskilled Americans.  Why?  Because in an unprecedented way, uneducated/unskilled Americans are competing against uneducated/unskilled people from all around the world.  And the ones they’re competing against often work twice as hard but for a fifth of the pay/benefits!  

      At a personal level, the clear conclusion is to build oneself up with **skills that employers are looking for**.  i.e. don’t drop out of high school, do learn a marketable trade, don’t go to college and major in Art Appreciation while borrowing $80K in student loans, and don’t expect any handouts in life because moreso than at any point in our lifetimes, it’s the skills that pay the bills!!

  6. Ida Pagnottella says

    Edward, I know that what you write is correct, look at Italy. The private sector doesn’t have debt on a whole, the public sector in fact sells its debt (BTPS) mainly to Italian private savers, mostly 50 and 60 year olds. you are correct that now, after 30 years of high debt the problem is exploding because YOUNG people you make very little because there is no growth have private debt and so Italy will not be able to finance its growing debt in the future. However, the real cause of Italy’s problem is how the public sector spent that money. If the public sector had created useful infrastructure, efficient public services, I think that debt would n’t have grown out of control. since Italy is very corrupt and has spent badly the money it has spent, not only do we have debt, but our schools and roads fall apart, and we have a very burocratic anti business public sector, which has not permitted the creation of jobs. also, with this excess of debt, people forget that you need a growing private business sector to finance the public sector. so it is not just the equation, it is the fact that when the private sector had savings, the deficits were made by wasting money, so you have a bankrupt public sector, a private sector who is getting poorer everyday, and outdated infrastructure. a total mess. in this debate i believe we must consider corruption and short sightedness a cause of the Euro zone mess. the problem is that the voters do not realize that it is their fault, as long as everything was fine, nobody complained about the waste, now that it hurts, everyone blaims the Troika, I don’t see many blaming ourselves for our bad choices.

    1. David_Lazarus says

      Italy is also in a better situation than some other countries in that it has some export markets that are holding up well like luxury goods, and high levels of savings. Italy could clearly benefit from some reforms especially towards some labour flexibility and business regulation, though the lack of private debts really should be applauded. In some respects Italy is like Japan in that its government spending can be financed out of domestic savings but the long term issue is improving efficiency in the use of those funds, and towards infrastructure. One thing that Italy could so with immediately is a slashing of politician wages and benefits. Italian MP’s are among the best paid in the world and their pensions are very generous after only a short period in office. Italy is very fixable but do its leaders have the political will power to do so?

    2. Edward Harrison says

      I have a lot of sympathy for the Keynesian desire to spend government money to jumpstart the process. The problem though is as you elaborated that some or much of that spending can be wasted.

      Italy doesn’t really ha e a deficit problem at this point but given the existing large government debt stock and low growth, there’s no way to bring the debt down.

  7. ChrisBern says

    Edward–  you said that austerity is a failed paradigm, and I definitely agree during recessions/depressions, austerity only makes things worse.  

    But the flip side to all of this is that when governments build up significant deficits and therefore debt **during healthy economic times**, they then put themselves in a weaker position to deal with economic downturns when they inevitably happen.  

    Specific to America I think many citizens are weary of the government spending a lot of money when the economy is good, and then when the economy is bad, hearing proposed solutions that involve, ahem, spending more money.  To put it differently, I think the vast majority of Americans would welcome stimulus spending and avoiding austerity during economic downturns IF the government wasn’t such a big spender during healthy times.  As it is it’s difficult for someone like President Obama to push for more proactive spending and fewer cuts now–even if it’s the proper solution from a pure economics perspective–because people don’t trust that the spending will ever get reduced after the economy inevitably rebounds!

    Agree with you and everyone that credit write downs are the ultimate answer, which would mean that a lot of equity holders and some bondholders would take massive hits to their wealth.  Which is perfectly fine with almost everyone, except for those who would get affected and apparently except for the politicians who keep propping those malinvestors up.

    1. Edward Harrison says

      My general take on recessions is that government should allow automatic stabilizers to do the heavy lifting of mitigating the downturn and leave the added discretionary stimulus alone.

      Instead we get the Fed manipulating rates lower and allowing private debt to build. What would we expect to happen? Of course this leads to a massive deleveraging.

      Our political masters often seem to think perpetual growth is the goal even if that growth is based on unsustainable asset inflation and leverage. For me, the lesson here is that it was allowing debt to stay high during and after repeated business cycles that was the mistake.

      1. David_Lazarus says

        “For me, the lesson here is that it was allowing debt to stay high during and after repeated business cycles that was the mistake.”It is now why the policy levers are restricted to keeping that leverage high. Though what it does do is lower the jobs growth from every extra dollar spent. So much is siphoned off to feed the banks. 

  8. MGK says

    “The real policy question should be how to eliminate the malinvestment and reallocate capital investment to useful productive enterprises without creating a deflationary spiral.”

    Edward, I agree in principle with what you say, but I can’t help thinking that it’s the malinvestment issue that has produced the debt problem and that solution is the political intactable issue that is prolonging the agony. Government doesn’t “invest” any more, rather, most “spending” is either targeted towards reducing taxes largely for immediate consumption or directly goes for consumption. As such, there is little or no “investment” going on that yields long term ROI for the nation as a whole.

    Few people seem to understand that investment in NASA during the 60’s directly led to the microelectronics, broadcasting, telecommunications, GPS, etc. industries of today, yet at the time that “spending” was  regarded as either “keeping up wit the Soviets” or wasteful, unnecessary endeavors. No one anymore looks to teh long term and so the majority of government spending is mrely malinvestment.

    1. Edward Harrison says

      I agree with you. I wish it were different. But it’s what Jamie Galbraith calls the Predator State.

      Clearly as short term oriented as the 2009 stimulus was, without it we risked a Great Depression. But the goal wasn’t about reallocating resources or reducing debt. So I believe the US economy is still fragile as a result.

      Frankly I don’t know what you do given the lack of will on solving the core issues of debt and financial leverage. As soon as the spending prop is taken away we’ll be right back in recession.

  9. bernd says

    Im not quite sure I get your
    line of argument. What you state is that:”the
    sum of the sectoral financial balances must net to zero.The
    government balance – the private balance – capital account
    balance = 0.”
    , which is absolutely correct, it´s an accounting identity after
    all! Given that model I do not however understand how you could
    come to this conclusion: “What
    I have been saying is that private debt is the problem.” Within
    the model you use to advance your conclusions, this shouldn´t be a
    problem, if anything it´s a distributional problem within the
    private sector; its a wash. It would seem to me, that either
    there is no private debt problem or the level of abstraction you
    employ in your model leads to a significant loss of relevant
    information.Your model does not seem to be in line with the
    analysis you provide.

    1. Edward Harrison says

      Bernd, the question is what occurs using the sectoral balance tautology if private debts are high. I am explaining my assumption is that household debt is so elevated that any household net dissavings is constrained by debt service for holders of underwater mortgages. If households that were underwater could take on more debt – and they can’t now because the collateral to refinance is insufficient – then they could net dissave. But this isn’t the case.

      So again the question is, given this constraint, what happens when you attempt to push the government deficit balance lower. You get debt distress and lowered consumption and defaults.

      1. ChrisBern says

        Since “The government balance – the private balance – capital account balance = 0” by accounting identity, then how does look in an accumulated sense?  i.e. the U.S. currently has a national debt of something like $15 trillion.  And its citizens have personal (non-government) debt of something like $16 trillion.  How does this happen given, “when the government sector runs a deficit, the non-government sector runs a surplus of equivalent size.” Mathematically the answer must be $31T worth of capital account deficits I suppose, but what does that mean in layman’s terms…$31T of net outflows leaving our borders since the inception of the country?  Evidently somehow there’s a way to grow both government and personal debts at the same time–as our current debt balances show–so why couldn’t they both shrink at the same time, which is the question an austerity advocate would ask?

        I believe that question encapsulates why I personally don’t understand national accounting….perhaps a brief answer of that question would help others understand as well, or at least me if I’m the dense one in the room.   :)

        1. Edward Harrison says

          I think you need to keep it simple.

          Using the option clearinghouse example may help. If you think of one really big counterparty as the government, then you still have all the other counterparties transacting, accumulating liabilities and assets with each other.

          You need to set that bigger picture aside though. What we are talking about here is only the flow of assets in one period between one counterparty and all the others. That’s what a government deficit is. Forget about the aggregate stock of assets and liabilities and concentrate on just the flow between government and non-government and that keeps it simple.

      2. bernd says

         Edward, I don´t disagree with your analysis, nor do I disagree with
        your policy conclusions. I do believe both are broadly correct. As they
        have been ever since I started reading your blog, you definetely have a
        track-record of being spot on in terms of your analysis. The only thing I
        was trying to point out is that your analysis is not consistent with
        the 3 sector model(Goverment,private, external) which you use. You even make
        precisely this point yourself: “Businesses have done some serious heavy
        lifting here and debt in the
        corporate sector is not a problem. But households are still
        That´s at least a four sector model right there; In
        which case saving by households can occur(via corporate(business) bonds
        or shares) without an increase in government debt, which pretty much
        gets you back to the crowding out discussion and the question of who is a
        better steward of investment, government or the private sector.

        I don´t disagree with your general analysis nor do I disagree with your conclusions, they just don´t fit your model.

        1. Edward Harrison says

          Bernd, of course they fit the model. I am being more granular by disaggregating the private sector. I could be more granular still by separating business into financial and non-financial as is normally done got the NIPA. Bernd, before you make claims about what fits or doesn’t fit the ‘model’, you need to spend time with the data. The NIPA consists of three broad categories, the ones I used. But clearly even those broad categories can be disaggregated. I am amazed you don’t understand this.

        2. Edward Harrison says

          Btw, the reason disaggregating the private sector matters is because the key indebtedness, household debt, is not coming down very fast despite high government deficits. It tells you that the offsetting private net savings to government deficits is somewhere else. It demonstrates that government deficits alone are a poor tool to effect a deleveraging without more mortgage debt targeted solutions.

          1. David_Lazarus says

            All the private sector gains are being offset in the corporate sector, in the record cash pile that corporations are reporting. Households have stopped saving again because property prices are not going down as fast in many areas, so appear to have bottomed out. Also they lack bargaining power in raising their wages to enable them to save more. 

    2. Edward Harrison says

      Rob Parenteau has suggested you could effect a corporate tax offset by a household tax rebate to better target how the private surplus offsetting increased government deficit is represented. That gets to your distribution problem.

      The problem right now is that for all the saving the private sector is doing, it is mostly business retained earnings and not household net savings. This is why a payroll tax rebate is much more targeted than a corporate tax rebate when the problem is household debt. Even so, it won’t be targeted enough to guarantee deleveraging. Better to have real mortgage relief programs and writedowns, because that is the most targeted. This is my point.

  10. Tip Parker says


    Overall, I agree with you and thank you for the explanation .  But I have trouble stating the case in my own terms.  This is partly because the signs in the equations and inherent in the terms confuse me and perhaps others.  I think you are discussing net flows, but the term “balances” brings to mind balance sheet amounts as of specific dates, or what are called “levels” in the Flow of Funds Accounts.  

    Starting with the two person model, it is easy to see that the flow of cash or an IOU from A to B must cancel out.  The equation would  be:

    A + B = 0.  

    If we used the same flow terminology for the government/privatge sector/international model, then it seems to me that the equation should be:

    government net flow + private sector net flow + international net flow = 0.  

    But your equation uses minuses, not plusses.  I don’t understand why, and while my algebra is rusty, it seems unlikely that the government balance [or flow which is now heavily negative] – the private sector balance [or flow which may now be positive] – the capital account balance [or international net flow which is negative] can equal zero.       

    Similarly, the statement, “The government balance = the private balance + the capital account balance” seems unclear.  If the government balance is the largest number and negative, I don’t see how can it equal the private balance which is mildly positive and the capital account balance which is mildly negative?


    Tip Parker

  11. Pr729 says

    Thanks Ed.  On the RT interview you said that the private sector was usually in surplus.  How can that be true when we have record levels of private sector debt?

    1. David_Lazarus says

      The surpluses are within corporates who have cash piles above $2 Trillion. Households in general are in debt. Yet the private sector is in overall surplus. There is also the current account deficit or balance of payments deficit which is also funded by the government deficit. 

    2. Edward Harrison says

      Savings can be positive even while aggregate debt levels can increase. Remember, savings is just an aggregate of net financial flows into and out of one particular sector of the economy. It describes what is happening in aggregate with respect to other sectors and doesn’t reflect intra-sectoral distributions.

      And it is NOT the corporate sector doing the saving. The norm is for households to save. See here for the US:


    3. Edward Harrison says

      Also see this post for a discussion of reducing US deficits using sectoral balance analysis:


      1. Pr729 says

        Thanks very much, interesting posts.  A few follow ups, the crux of which is trying to understand how creating broad money fits into the sectoral balance analysis and the current themes of household and government deleveraging:

        – You say that households can have a positive savings rate but also increase borrowing.  In order to do this though, you either decrease someone else’s surplus or the bank creates money to lend to you.  The way I see it, the increase in borrowing by the household increases their surplus but it doesn’t necessarily mean that another sector went into deficit if the money was created (printed).
        – QE2 in the US and QE in the UK are aimed at increasing broad money (M3) and therefore increasing the bank balances of the private sector and in turn will increase their surplus. 
        – As households delever, they pay down debt and decrease M3 (assuming the banks also use it as a chance to delever as is happening at the moment).  The household sector surplus is decreasing but other sectors are not decreasing deficits. (Is the savings rate quoted after paying down debt?).
        – You said in one post that the best way to decrease the government deficit would be to reduce reserve currency status.  Well, isn’t monetising your deficits actually a better way of doing that.  Deficits are around 5-8% p.a., which would be a healthy rate of growth for M3 (given the deleveraging in the economy, M3 growth wouldn’t actually grow much faster than that).  Reducing the reserve currency status would result in massive deflation for the US as the non-financial sector would be required to buy the government bonds resulting in a reduction in M3 versus the status quo (of China buying US treasuries).

        There is a good chance I have made your blood boil with this entry, so I apologise in advance, but it is crucial for me to try and understand and I feel the link between money creation and sectoral balances is where I have the most uncertainty (and hopefully the same for your other readers).

        thanks again,

  12. Isidore Fitch says

    The Media always asks, in essence:
    “How can the brave progressive arsonists stop these horrible fires?”

  13. Jayarava says

    This is great stuff, thanks. However when you say that business has done some heavy lifting and that the problem is personal debt, you mean the USA right? Because as far as I can see what you are saying is not true in the UK – the private sector still owes a huge amount. Particularly the finance sector, but across the board our private debt is massive.

    BTW What I’m reading here is consistent with the Post-Keysian stuff I’ve been reading.

    1. David_Lazarus says

      The US and UK households are still heavily indebted though US households have made more effort to reducing that debt. That seems to have stopped but the debt levels are still too high for US households. There maybe an element of taking a breather to see which way the economy turns before resuming household spending cuts. The UK however for many is at the point that cuts are going to be imposed on families because of the inflationary impact of QE and recent price rises. The governments policy is to devalue the debt burden through inflation. Though with stagnant wages this will only end up lowering living standards for most even further and increasing the divergence between the rich and the poor. Long term this increases the risk of social unrest. In the UK house prices have not had rapid falls that would force people to reevaluate their net worth. So we have slow falls in value which means that people are still paying mortgages and while home prices are falling they are only slowly approaching negative equity. Add to that the UK mortgage is typically recourse so debts cannot be walked away from like in the US.

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