Wednesday, April 17, 2013

Financial Sector Balance - Updated

In previous blog posts, we have discussed aspects of Financial Sector Balance here, here and here. We are now well into a slow recovery from the economic shock brought about by the housing bubble of 2007. This post is an update on data presented earlier and a few remarks.

Recapping, we recall that the FSB is an important macroeconomic relationship showing how financial flows balance among the Public, Private, and Foreign financial sectors. It could just as well be between Blondes, Brunets, and Red Heads, but we have no data on those sectors. Fortunately, the Bureau of Economic Analysis (BEA) has the pertinent data in its National Income and Production Accounts (NIPA).

By merely observing that when money flows between sectors an account in one sector must be debited and credited in the other sector by the same amount. So the sum of debits and credits will be zero, zip, nada, and we can write.

Public (Net Surplus) + Private (Net Saving) + Foreign (Net Imports) = 0

Alternatively, we can equate two expressions for GDP or national income 

GDP = C + G + I + NX

where C = household consumption, G = government spending, I = business investment in means of production, and NX = net exports, often written as (X - M).

Because all income devolves to households, we can write another expression as

GDP = C + T + S

where C is the same, T = household taxes, and S = household saving. Equating the two expressions for GDP and collecting terms we have

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

This expression conveys the general idea, but is oversimplified as it ignores some accounting conventions. For example, household "investment" in stocks is considered to be saving. Because business taxes are costs of production, they are included under consumption. We can assume that the BEA accountants get it right.

The figure below shows a stacked bar graph of the top-level NIPA data. This presentation shows that the terms of the FSB equation do balance to zero.

There are some interesting observations that become readily apparent.
  • Net saving in the private sector requires a public deficit as long as there exist net imports.
  • In the presence of large net imports and small public deficits the private sector must reduce savings and net borrow.
  • As of the end of FY 2012 (September) private saving and public deficits are still abnormally high. Further, the rapid decline of saving and deficit has leveled out. 
Because the government has no direct control over imports and private saving desires, it follows that government has no direct control over the deficit. Evidence from around the world shows that austerity measures do not reduce deficits, but only make them worse. 

Finally, it must be clear that in the US a public deficit is a necessary for private net saving.

Revised April 18, 2013.


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