Wednesday, April 22, 2009

Deficits add to private savings



All mainstream economists would gasp at the statement above, yet it is true.

A fundamental macroeconomic accounting identity is:

i = s


Which basically says that for every investor there is a saver. (We can also state it as follows: for every borrower their is a saver.)

In order for someone to "net save" someone else has to net spend or invest by the same amount.

Thus, if the United States Government is the largest debtor (we can say, investor, same thing), then the non-Federal-government sector of the U.S. and the rest of the world (ROW) are net savers.

If you don't believe it, just look at the graph below:



The graph shows that as the Federal deficit increased (gross savings of the Federal Gov't decrease), then the savings of the U.S. domestic sector (including states and localities) and the rest of the world (ROW) saw an increase in their gross savings.

I used a starting point of 1997 but the starting point is irrelevant.

Notice, too, that each time the gross savings of the government increased, the gross savings of the private sector decreased and vice-versa. In fact, the periods of rapidly declining government "savings" equated to periods of equally rapidly rising periods of private sector savings.

Lesson here is: Deficits add to private sector savings.

22 comments:

Billy said...

Welcome to Twitter - It is nice to see you there Mike!

Billy

Mike Norman said...

Thanks, Billy!

cuOnTheOtherSide said...

Reading this I must ask the following questions:


1. Is government responsible for providing private savings?

2. What would happen if the Government starts running a balanced budget (I know it’s not likely), would no one save?

3. Why would we want to depend on the Government to run Deficits to increase private savings?

4. In a $14 trillion economy why are Government deficits such a large source of private savings and not income from work or business?

The Joker said...

Mike, the concept of increased government spending leading to savings in the private sector makes good sense to me.

Why is it that most economists and Congress don't get it?

bubbleRefuge said...

1. Is government responsible for providing private savings?

The government "turns the knob" via the spending channel to regulate the level of aggregate demand in the economy. By increasing deficits ( as they are now) demand increases because the
private sector has more equity. When deficits decrease, the private sector has less equity etc.

2. What would happen if the Government starts running a balanced budget (I know it’s not likely), would no one save?
The private sector would have less equity and therefore aggregate demand would decrease which leads to slack in the economy ( aka unemployment). Since the private sector consists of both foreign + domestic USD savers, the US private sector could maintain levels of aggregate demand if foreigners began to spend their USD hoard. However, this would lead to lower US standard of living as we would become net exporters of goods and services.
3. Why would we want to depend on the Government to run Deficits to increase private savings?
Under a fiat money floating regime it is mathematically impossible to do it any other way

4. In a $14 trillion economy why are Government deficits such a large source of private savings and not income from work or business? Because the point is about aggregate savings. Income from work or business is a zero-sum game in the aggregate. One guy spends the other saves this nets to zero in aggregate. The only way for both guys to save more is for the government to consume more from both guys in exchange for money -jmccutcheon

Mike Norman said...

Bubbles:

You get an A+!

The bad news is, you are now too informed to hold any governmental policy post.

TomatoBasil said...

How does china maintain a high rate of growth during a world-wide recession with a 25% personal savings rate, almost no consumer debt, and the government only deficit spending 3% of GDP. All the while making massive investments in infrastructure. I think they defy gravity or have some of the best policy makers in the world.

Deficit: http://www.eeo.com.cn/ens/finance_investment/2009/02/24/130314.shtml

Personal Savings: http://research.stlouisfed.org/publications/iet/20080801/cover.pdf

Mike Norman said...

Tomato:

Simple: We supply the aggregate demand (savings). If you understand that then you also understand that Chin's savings do not "fund" the U.S. deficit, but rather, U.S. deficits fund Chinese savings. Without us supplying aggregate demand then China would have no savings under their current model.

Michael said...

This all makes perfect sense to me. What bothers me is that government-provided savings are financial, monetary savings and not real savings.

For real savings to occur, the act of investment must happen on the other side. I guess the question is: why do people cut consumption and save financially but not match that with an increase in "saving" via real investment? Instead of moving along the production possibilities frontier from consumption to new investment, does it just shrink?

Maybe its because the investment in capital and labor restructuring will take time, but consumption cuts can happen immediately. Purdue college of technology is offering an expedited 2-year degree to people from the auto/manufacturing sectors to make that go faster: http://news.uns.purdue.edu/x/2009a/090415BozicDegree.html

My head is spinning! Fascinating, though. What a great time to be an econ nerd

The Joker said...

I've learned several things from reading this blog:

1. American's think of government spending the way they think of their personal finances.

2. American's have a gold-standard mentality.

2. The government is not doing more to support the economy because of political agendas on both sides of the aisle.

Mike, thanks for teaching the few of us who are willing to learn.

Mike Norman said...

Joker: You got it!!

Michael: Gov't spending adds to aggregate demand, which is part of the economy's total output or GDP, which is exactly equal to national income. Therefore, spending does not only raise the net worth of the non-governmental sector in the form of a larger holding of financial assets, it also adds to national income if the amount of spending is higher than the amount of money the gov't collects in taxes (otherwise known as a deficit).

If people consume less ("save" more) because they are forced to do so (lack of sufficient income, loss of a job), by definition they are getting poorer and national savings is declining. (Keynes's "Paradox of Thrift.")

As BubbleRefuge explained so well, only government can provide the additional aggregate savings so that ALL people can purchase the real assets they need to live quality lives and obtain sufficient amounts of the financial assets they need for retirement.

If some people are without food, shelter, clothing, education, health care, etc. and lack adequate amounts of financial assets to provide for their retirement, it is because the government has not provided enough aggregate savings.

This is purely a political and ideological constraint. It is capable of being rectified by a keystroke on a computer, if the political and ideological will is there.

bubbleRefuge said...

How does china maintain a high rate of growth during a world-wide recession with a 25% personal savings rate, almost no consumer debt, and the government only deficit spending 3% of GDP. All the while making massive investments in infrastructure. I think they defy gravity or have some of the best policy makers in the world.
China deficit spends in order to keep the value of their currency relative to the dollar low. Hard to believe its only 3%. China has lower living and work standards than they could otherwise have in order to support our American lifestyle. Thank you China.
-jcmccutcheon

Michael said...

Omg this is making sense. If output falls below the PPF between Consumption and Investment, I was worried that the government is "propping up" consumption that is "unnatural."

However, that move toward investment, if its going to occur at all, still requires the government, if they are the sole provider of net solvency. No one will take those investment risks without the padding of equity, which in a floating FX nonconvertible world comes from the government.

Mike Norman said...

Michael: You got it! Now YOU, too, are overqualified to hold a top policy post!!

Michael said...

LOL

I should also welcome you to twitter, I just started following you

Ronald Doan said...

How does the growth in the private secter fueled by bank loans fit into this anylisis?

Mike Norman said...

Bank loans are merely a type of private sector money. The expansion of this money (i.e. the desire to acquire it to purchase goods and services) was coincident with decent to strong growth in the economy from 2003 to 2006, when the Federal deficit was high. When the gov't started to reign in the deficit, it siphoned strength out of the economy and we went down.

Michael said...

banks wont lend unless firms want to borrow. businesses don't want the debt/equity ratio they used to, risk premiums have gone up. now IS the time for profits, so that they'll be more comfortable borrowing again.

Mike Norman said...

Yes, if the economy stabilizes then businesses and households will begin demanding credit and banks will start to lend. Lending is pro-cyclical, a concept that appears lost on policymakers in Washington and mainstream economists.

Michael said...

Since the supply of loanable funds comes from banks only constrained by capital and risk premia, maybe connected to some aggregate of debt/equity ratios. I'm wondering what the correct model for the market in loanable funds looks like.

Traditionally it would be savings and investment and the clearing price is interest rate. Now I don't know how I'd draw it out.

Michael said...

Maybe something like this:

http://www.emeraldinsight.com/fig/3520010106002.png

Where price is set by banks, incorporating their risks, tolerance for defauts and so on, and no real supply curve. Volume of credit is purely determined by shifts in the demand for credit.

Mike Norman said...

I would draw it as follows:

Replace R-zero with "Y" (Which equals GDP and national income.) Then I would reverse the demand curves to go from the lower left to the upper right. The graph would then show that as GDP (national income) increased, the demand for credit would, too. The interest rate would be fixed.