1 Ikus http://bilbo.economicoutlook.net/blog/?p=32268.

2 Ikus http://bilbo.economicoutlook.net/blog/?p=32396.

3 Ingelesez: “First, we can measure the sources of spending that flow into the economy over a given period. Economists use the shorthand expression:

(1) Ingelesez: “GDP ≡ C + I + G + (X – M)

which says that total national income (GDP) is the sum of total final household consumption spending (C), total private investment including inventory accumulation (I), total government spending (G) and net exports (X – M).

Note the use of the mathematical symbol ≡ which denotes an Identity which is true by definition and the “equivalence … does not depend on the particular values of the variables”.

We often replace it with an equals sign (=) but we always know that this National Accounts Identity is an accounting statement which must always be true.

As it stands, the National Accounting Identity is not a theory.

(…)

The central role played by the principal of effective demand provides the causal link between expenditure and income.

It tells us that total income in the economy per period will be exactly equal to total spending from all sources but also the process involved that bring that equality into line.

We also have to acknowledge that financial balances of the sectors are impacted by net government taxes (T) which includes all taxes and transfer and interest payments (the latter are not counted independently in the expenditure Expression (1)).”

4 Ingelesez: “Further, … the trade account is only one aspect of the financial flows between the domestic economy and the external sector. We have to include net external income flows (FNI).

Adding in the net external income flows (FNI) to Expression (1) for GDP we get the familiar gross national product or gross national income measure (GNP):

(2) GNP = C + I + G + (X – M) + FNI

At this stage, we could get quite complicated and consider things like retained earnings in corporations and the like, but here we assume that all income generated ultimately comes back to households (after all the distributions are made).”

5 Ingelesez: “To render this approach into the sectoral balances form, we subtract total taxes and transfers (T) from both sides of Expression (2) to get:

(3) GNP – T = C + I + G + (X – M) + FNI – T

Now we can collect the terms by arranging them according to the three sectoral balances:

(4) (GNP – C – T) – I = (G – T) + (X – M + FNI)

The the terms in Expression (4) are relatively easy to understand now. The term (GNP – C – T) represents total income less the amount consumed less the amount paid to government in taxes (taking into account transfers coming the other way).

In other words, it represents private domestic saving.

The left-hand side of Equation (2), (GNP – C – T) – I, thus is the overall saving of the private domestic sector, which is distinct from total household saving denoted by the term (GNP – C – T).

In other words, the left-hand side of Equation (2) is the private domestic financial balance and if it is positive then the sector is spending less than its total income and if it is negative the sector is spending more than it total income.

The term (G – T) is the government financial balance and is in deficit if government spending (G) is greater than government tax revenue (T), and in surplus if the balance is negative.

Finally, the other right-hand side term (X – M + FNI) is the external financial balance, commonly known as the current account balance (CAD). It is in surplus if positive and deficit if negative.

In English we could say that:

The private financial balance equals the sum of the government financial balance plus the current account balance.

Note that by re-arranging Expression (4) we get the familiar sectoral balances equation:

(5) (S – I) – (G – T) – CAD = 0

Following our earlier discussion of the flow-of-fund approach made popular by the New Cambridge economists, we can re-write Expression (5) in this way:

(6) (S – I) = (G – T) + CAD

which the New Cambridge economists interpreted as meaning that government sector deficits (G – T > 0) and current account surpluses (CAD > 0) generate national income and net financial assets for the private domestic sector.

Conversely, government surpluses (G – T < 0) and current account deficits (CAD < 0) reduce national income and undermine the capacity of the private domestic sector to add financial assets.

Expression (6) can also be written as:

(7) [(S – I) – CAD] = (G – T)

where the term on the left-hand side [(S – I) – CAD] is the non-government sector financial balance and is of equal and opposite sign to the government financial balance.

This is the familiar MMT statement that a government sector deficit (surplus) is equal dollar-for-dollar to the non-government sector surplus (deficit).”

6 Ingelesez: “In summary, our interpretation of the sectoral financial balances is as follows:

1. (S – I) is the private domestic financial balance or the NAFA of the private domestic sector. If it is in surplus, then that sector is lending funds to the other sectors. If it is in deficit, then the private domestic sector is borrowing from the other sectors.

2. (G – T) is the government sector financial balance. If it is in surplus then the government sector is spending more than it is taking out of the economy in taxation and undermining the capacity of the two other sectors to accumulate net financial assets and vice versa.

3. CAD is the external sector financial balance. If it is in deficit then the national economy is borrowing from abroad and foreigners are accumulating financial asset claims and vice versa.

These are accounting statements. So in one sense, the claim that the sectoral balances is about accounting is factual. But of course it also is a highly limited conclusion.

At this stage, we know nothing about the state of the economy that would be associated with bringing these balances into line, nor do we know anything about where the economy has been and where it might be heading.

Further, we don’t know what motivates each of the financial balances accounted for.

At this point, to give traction to analysis we need to add theory. As noted above, once theoretical conjectures are included in the framework then we can start to explore causality, adjustment, and understand the state of the economy more fully, including the policy options that might drive the economy to where we want it to go.

The theoretical dimension of the sectoral balances framework takes this well beyond the accounting.”

7 Ingelesez. “So the income-expenditure model is a theoretical structure that conjectures that changes in these financial balances are driven by national income flows, which in turn, are driven by changing expenditure flows.

For example, there are various theories of household consumption expenditure but all of them suggest that consumption is determined positively by changes in disposable income. The response of consumption to a change in income is called the Marginal Propensity to Consume (MPC). It is normally hypothesised that the MPC will be less than one, so that the residual of disposable income not consumed will be positive. That constitutes saving.

So the private domestic financial balance (S – I) will increase, other things equal, when national income rises.

Similarly, taxation revenue (net of transfers) is considered to be a positive function of national income. So, other things equal, the government financial balance (G – T) falls when national income rises, and vice versa.

Imports are also considered to be a positive function of national income – so when national income rises we buy more locally- produced goods and more imported goods. So the external balance falls when national income rises, and vice versa, other things equal.

We could add more complex theoretical propositions to explain private domestic investment, exports, government spending, and net foreign income transfers. And indeed, larger macroeconomic models do just that.

But the point is that these theoretical conjectures allow us to hypothesise what will happen to the financial balances if there is an external event that leads to income changes.

For example, we might assume the government decides that the level of income is too low because spending is too low relative to full capacity spending and as a result unemployment is too high.

It introduces a discretionary increase in the deficit such that G – T rises. This stimulates national income via the expenditure multiplier process which increases disposable income, consumption expenditure, and household saving. It also stimulates increased import expenditure.

If nothing else changes, Private domestic net financial asset acquisition will increase and the external deficit will increase somewhat. The relationship between the sectoral balances will be maintained but national income will be higher and the net financial assets in the non-government sector will have changed.

More complex theoretical reasoning is obviously possible.

The accounting structures that underpin the sectoral balances framework allows to check logic. For example, if a politician says that the government and non-government should simultaneously reduce their debt levels (assuming neo-liberal public debt issuance strategies) then we know that is not possible. We don’t have to resort to theory to make those sort of conclusions.

But the accounting structures do not allow us to determine the validity of a political statement that says that austerity will stimulate growth. At that point we need theory and we can use the sectoral balances framework to draw inferences about which sectors will respond in which way when austerity is imposed.”