More Creationist Economics: When the Foolishness of Austerity Collides With the Balance of Accounts

A while ago, I linked to a Financial Times op-ed by economist Martin Wolf about how the balance of accounts (the government deficit equals the trade deficit plus net private savings) means we can’t cut our way to prosperity. Wolf has another piece which has a very clear graph demonstrating this phenomenon in the U.S.:

Wolf-US-balances1
(from here)

Let’s look at 2011. The government deficit, as a share of GDP, is a bit larger than 9% (it’s negative to reflect the deficit). Now sum up the foreign sector balance (a broad measure of the trade deficit), the household savings and corporate holdings, and you get…about 9% plus a bit. Shocking. Anyway, Wolf (boldface mine):

Finally, some people note that the sectoral balances are identities: they must add up to zero. This is correct. But there are many different ways they can add, both in terms of the relative sizes of the surpluses and deficits and levels of economic activity. This sectoral way of thinking can be easily converted into standard macroeconomic models, in which interest rates and income jointly determine the equilibrium outcome. The important contribution of this way of thinking is that it forces one to ask how one expects the economy to add up.

At a time when monetary policy is ineffective, it seems sensible to assume that the offsetting adjustment to attempts to eliminate fiscal deficits will occur via a weak economy. As income falls, profits and household savings will also decline. Evidently, this is an unpleasant way to achieve the desired outcome. Indeed, the required slump will itself worsen the fiscal outcomes. That will necessitate still greater fiscal tightening.

To put the point in another way, a structural deficit in the fiscal accounts implies a structural surplus in the offsetting private accounts. How is that private sector structural surplus going to disappear?

Of course, since the U.S. is a currency issuer and also has a major employment deficit (i.e., idle workers), it could ignore worrying about federal deficits, except as they result in either inflation or poor public policy. But I digress.

If we want to lower the federal deficit, we can, but ask yourself this: when the private sector takes the hit–and it must–who is going to get hit the hardest and the least? If recent history is any guide, it will be the 99%….

Aside: Krugthulhu, using a similar argument, points out that Germany was able to cut its public deficit because it ran a massive trade surplus. A related set of phenomena enabled the Clinton ‘miracle.’ Unfortunately, we can’t all be exporters…

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