Skip to main content

The Sector Financial Balances Model:

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

is an accounting identity that provides a focus for macroeconomic analysis, explanation, and prediction by economists applying the Modern Money Theory (MMT) approach. It leads to a very critical line of thinking about the budget deficit projections produced for our consumption by the Congressional Progressive Caucus (CPC), Congressional Budget Office (CBO), the House, and the Senate. The US has recently had a sharp decline in its balance of trade deficit. It now stands at about 3% of GDP; which means that the rest of the world has a surplus, a balance of +3% of US GDP in its annual trade with the United States.  

Assuming that surplus is unlikely to shrink anymore, we can see from the equation that unless the Government balance is less than -3% of GDP, the Domestic Private Balance in the United States economy will not be positive (a surplus, and addition to nominal financial wealth) and is very likely to be negative (a deficit, a subtraction from nominal financial wealth). So, the private sector taken as a whole will be losing rather than gaining Net Financial Assets (NFAs), every year for as long as the situation lasts.

The Table below presents the CPC, CBO, House and Senate budgetprojections through 2023.

2013 Budget Projection Comparison

The table shows that any space for the Domestic Private Sector to accumulate Net Financial Assets would quickly disappear if any of these deficit projection plans were actually adopted and worked as advertised. The CPC projections are OK for 2013 and 2014. They provide some space for continuing repair of private sector, including household, balance sheets after the crash of 2008. But by 2015, the space for savings in the private sector would be nearly gone, and from 2016 – 2023, we see nothing but deficits small enough that the domestic government balance doesn't even cover the aggregate demand leakage due to the foreign sector balance, much less any demand leakage that the private sector desires in the form of savings. Sooner or later a budget course like that projected by the CPC would, in the absence of the banking system blowing a big credit bubble the way it did during the Clinton and Bush 43 Administrations, result in a new crash.

The CBO projections are worse than CPC's from 2013 – 2015; but thereafter, its larger deficits are less damaging to aggregate demand than the CPC's deficits. But they are not large enough to provide for anything but economic stagnation, unless, again, there's a credit bubble, which would then mean a crash from mere stagnation somewhere down the line.

Of course, the most austerity-filled plan of the four is Paul Ryan's House Budget which begins its projections in 2014 with a deficit slightly above 3.0%, and then quickly arrives at minimal deficits ending in a balanced budget projection for 2023. If these projections were enforced through an activist Government policy, and the trade balance did not move towards a US trade surplus, then we would have declines of private sector NFAs ranging from 2.3% to 3.0% of GDP every year from 2015 through 2023. There's no way that course would persist until 2023. But if it did, then nominal financial wealth in the private sector would decline by about 28% of nominal GDP over that period.

I can't predict when this continuous decline in private sector NFAs would result in another financial crash and great recession/depression, because the banking system can blow new credit bubbles sustaining “paper” growth for some years if it wants to. But eventually, without increasing private sector NFAs to sustain such a bubble, a new crash would surely occur. My guess would be that if anything like the Ryan Budget were passed, then the next crash would come within a five year time frame.

The last of the four budgets whose deficit projections are included in the table is Patty Murray's Senate Budget. It's very similar to the CBO projections for 2013 – 2015, providing little space for private savings. From 2016 – 2023, this budget projection provides less space for private sector savings than CBO's projection, which itself is far from expansionary, but more than both the CPC budget, and Paul Ryan's House budget during those years.

So, the bottom line here is that all four of these budget projections, if implemented could only correspond to a bleak, stagnating economic future for the United States, with the House Budget producing the worst result by far. I'm sure this analysis would be strongly objected to by the authors of all four budgets. But of the four, the most credible claims against what I’ve written would probably come from CPC neo-keynesian budget proponents.

They'd claim that the back-to-work 1.4 T and 1.2 T of deficit  spending their budget plan envisions for 2013 and 2014, would bring the economy back to much lower unemployment levels, so that by 2015, increasing tax revenues would support reductions in deficit spending projected for later years without austerity. In making a claim like this, however, the CPC would only be exhibiting its own lack of understanding of the Sector Financial Balances model, and the constraints on the economy it implies.

Let's grant that the back-to-work budget works to create enough new jobs by the end of 2014 to bring the U-3 unemployment rate down to 5%, so that tax revenues have made a big comeback by 2015. Then the SFB model still applies, so that if the deficit goes down to 3.3% as projected for 2015, and given the foreign balance of 3%, then there will be only a fraction of a percent in overall addition to private sector nominal financial wealth, which taking even a low rate of inflation into account, would actually represent a decline in inflation-adjusted nominal financial wealth.

There might well be less than that if increasing demand in 2013 and 2014 leads to a growth in the foreign balance to 4% in 2014 – 2015. If that happens, then private sector savings would be underwater by 2015, and way underwater if the CPC budget course were somehow maintained into later years. Again, we could expect domestic private sector savings losses from 2016 on, and even perhaps in 2015. We could not have too many years of those without hitting another great recession. So, the CPC budget may be better than the others for a couple of years, but the danger in it is that the CPC will take it seriously and, assuming its success in the first two years, would then push forward on the budget course projected, deterred eventually only by the inevitable crash, which hopefully would occur in very short order, rather than being postponed by another credit bubble, only to be even more severe later on.

Moving to all four budgets, I want to emphasize that apart from the above macroeconomic considerations and their significance for declining domestic private sector wealth over time, the situation looks even worse when we take economic and political power considerations and their likely effect on the economy into account. The history of the US since 1970 shows clearly that when the private sector gets a cold, the household sector gets pneumonia.

Big businesses, the financial sector, and wealthy oligarchs will use their economic and political power to see to it that their nominal financial wealth will continue to increase even as the private sector as a whole is losing 20% - 30% of its financial wealth. Over the period of a decade, that will exacerbate the already ridiculous level of inequality we see in American society, and accelerate the movement toward plutocracy in America if we allow any of these austerity plans, or any variations between the CPC proposal and the House proposal to be passed and implemented.

So, where are we with these budgets? I think they’re all illustrations in fiscal fantasy, or perhaps I should say, in fiscal science fiction using bad fiscal science. In taking a fiscal approach based on reducing budget deficits, all the budgets are doing the wrong thing for the economy and the wrong thing for America. The right approach to take to fiscal policy is to design and implement programs that will guarantee full employment at a living wage for everyone who wants to work full time and is able to do so.

If the government does that, then it will let the domestic private sector determine what both the foreign balance and the domestic private sector balance should be. Then these sector balances would drive the government balance. That balance could be a surplus or a deficit of a particular size, though in the case of the United States it would probably be a large deficit, or, as I prefer to call it, a large Government addition, to domestic private sector wealth, for some years to come. But it would be determined by the wishes of those in the domestic private sector, with the Government's role being one of accommodating the surpluses or deficits.

Seeing this conclusion, I'm sure that some of my readers will ask: how can the United States afford to run deficit after deficit while continuing to accumulate its national debt? Well, first, it doesn't have to accumulate and can even pay off its national debt without inflation. I've explained how it can do that in my new e-book on Fixing the Debt without Breaking America. But second, even if the US does the politically unwise thing of continuing to accumulate a larger and larger national debt, it can do that without either solvency or inflation problems. Scott Fullwiler has done a very good job of explaining how that can happen in a recent series of his, which concludes here.

So, it turns out that deficits can be run indefinitely by nations with non-convertible, fiat currencies, with floating exchange rates, and no external debts in currencies not their own, without either solvency or inflation problems as long as the Government doesn't deficit spend beyond full employment. That's the kind of fiscal policy we should be making, not fiscal policy deliberately aimed at deficit reduction. So, to all the fiscal budgeteers in Washington looking to implement long-term plans for deficit reduction: a plague on all your budgets. You’re ending America, as we’ve known it!

(Cross-posted from New Economic Perspectives.)

Your Email has been sent.
You must add at least one tag to this diary before publishing it.

Add keywords that describe this diary. Separate multiple keywords with commas.
Tagging tips - Search For Tags - Browse For Tags


More Tagging tips:

A tag is a way to search for this diary. If someone is searching for "Barack Obama," is this a diary they'd be trying to find?

Use a person's full name, without any title. Senator Obama may become President Obama, and Michelle Obama might run for office.

If your diary covers an election or elected official, use election tags, which are generally the state abbreviation followed by the office. CA-01 is the first district House seat. CA-Sen covers both senate races. NY-GOV covers the New York governor's race.

Tags do not compound: that is, "education reform" is a completely different tag from "education". A tag like "reform" alone is probably not meaningful.

Consider if one or more of these tags fits your diary: Civil Rights, Community, Congress, Culture, Economy, Education, Elections, Energy, Environment, Health Care, International, Labor, Law, Media, Meta, National Security, Science, Transportation, or White House. If your diary is specific to a state, consider adding the state (California, Texas, etc). Keep in mind, though, that there are many wonderful and important diaries that don't fit in any of these tags. Don't worry if yours doesn't.

You can add a private note to this diary when hotlisting it:
Are you sure you want to remove this diary from your hotlist?
Are you sure you want to remove your recommendation? You can only recommend a diary once, so you will not be able to re-recommend it afterwards.
Rescue this diary, and add a note:
Are you sure you want to remove this diary from Rescue?
Choose where to republish this diary. The diary will be added to the queue for that group. Publish it from the queue to make it appear.

You must be a member of a group to use this feature.

Add a quick update to your diary without changing the diary itself:
Are you sure you want to remove this diary?
(The diary will be removed from the site and returned to your drafts for further editing.)
(The diary will be removed.)
Are you sure you want to save these changes to the published diary?

Comment Preferences

  •  Another great diary! (2+ / 0-)
    Recommended by:
    cynndara, jellyyork

    Lately I've been hearing a lot about how the US is positioning itself to become a net energy exporter vis a vis the massive shale oil deposits now being exploited in the Dakotas, Texas and elsewhere. I wonder if we are embarking now on a scheme to improve our trade balance at the expense of the environment and ever-increasing climate chaos. Apparently the fossil fuel industry has already priced in the new reserves. I understand that these resrves constitute a five-fold increase over the assumed maximum to exceed the 350 ppm that scientists tell us should be the upper limit. Perhaps it is the "wisdom" of our "leaders" to fix the economy while breaking the earth.

    •  I think that's part of their insanity (0+ / 0-)

      Thanks, OS. If we reverse the balance of trade; then we need to run a smaller deficit to compensate for savings. But, at what cost? The environment; the earth; poisoned air and water for our children and grandchidren?

  •  Might be the plan (0+ / 0-)

    But don't worry about it being fulfilled.  They're building castles in the air.  Those shale fields play out so quickly that they've already become more of a Ponzi scheme than real production; it's just another bubble.   It will burst within a decade or so, and the price of fossil fuels will continue to rise unabated.  Oh, and don't forget the increasing number of earthquakes related to fracking.  As long as they occur out in the wilderness beyond the Mississippi, officials and the Investor Class will ignore them.  Until one shakes the New Madrid, even just a little.  It wouldn't take The Big One to remind people of what The Big One would do.

    No, this chart just adds weight to my hunch that we're right on schedule for the growth curve to turn over permanently, as long predicted, right around 2030.  I'll be 72.  With luck, my fruit trees will be producing, and I'll have gotten used to eating my own veggies and chickens by that time.  Ya'll are welcome to come up to the Mountain.  I could use some company.

  •  Great work as usual, Letsgetitdone (1+ / 0-)
    Recommended by:

    and congratulations on the book!

    I don't negotiate grand bargains with deficit terrorists!

    by priceman on Thu Mar 28, 2013 at 07:04:50 AM PDT

Subscribe or Donate to support Daily Kos.

Click here for the mobile view of the site