National accounting rules dictate that a national government surplus equals a non-government deficit (and vice-versa). If a national government successfully achieves a fiscalsurplus through an austerity program then the private domestic sector must therefore be spending more than it is earning.
Answer: False
The answer is False.
The point is that the non-government sector is not equivalent to the private domestic sector in the sectoral balance framework. We have to include the impact of the external sector.
This is a question about the sectoral balances - the government fiscal balance, the external balance and the private domestic balance - that have to always add to zero because they are derived as an accounting identity from the national accounts. The balances reflect the underlying economic behaviour in each sector which is interdependent - given this is a macroeconomic system we are considering.
To refresh your memory the sectoral balances are derived as follows. The basic income-expenditure model in macroeconomics can be viewed in (at least) two ways: (a) from the perspective of the sources of spending; and (b) from the perspective of the uses of the income produced. Bringing these two perspectives (of the same thing) together generates the sectoral balances.
From the sources perspective we write:
GDP = C + I + G + (X - M)
which says that total national income (GDP) is the sum of total final consumption spending (C), total private investment (I), total government spending (G) and net exports (X - M).
Expression (1) tells us that total income in the economy per period will be exactly equal to total spending from all sources of expenditure.
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)).
Further, as noted above 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 (2) for GDP we get the familiar gross national product or gross national income measure (GNP):
(2) GNP = C + I + G + (X - M) + FNI
To render this approach into the sectoral balances form, we subtract total taxes and transfers (T) from both sides of Expression (3) 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 (4), (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 (4) 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 minus transfers (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 (CAB). 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.
We can re-write Expression (6) in this way to get the sectoral balances equation:
(5) (S - I) = (G - T) + CAB
which is interpreted as meaning that government sector deficits (G - T > 0) and current account surpluses (CAB > 0) generate national income and net financial assets for the private domestic sector.
Conversely, government surpluses (G - T < 0) and current account deficits (CAB < 0) reduce national income and undermine the capacity of the private domestic sector to add financial assets.
Expression (5) can also be written as:
(6) [(S - I) - CAB] = (G - T)
where the term on the left-hand side [(S - I) - CAB] 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).
The sectoral balances equation says that total private savings (S) minus private investment (I) has to equal the public deficit (spending, G minus taxes, T) plus net exports (exports (X) minus imports (M)) plus net income transfers.
All these relationships (equations) hold as a matter of accounting and not matters of opinion.
The following table shows a 8-period sequence where for the first four years the nation is running an external deficit (2 per cent of GDP) and for the last four year the external sector is in surplus (2 per cent of GDP).
| Sectoral Balance | Period 1 | Period 2 | Period 3 | Period 4 | Period 5 | Period 6 | Period 7 | Period 8 |
| (X - M) | -2 | -2 | -2 | -2 | 2 | 2 | 2 | 2 |
| (G - T) | -3 | -2 | -1 | 0 | 0 | -1 | -2 | -3 |
| (S - I) | -5 | -4 | -3 | -2 | 2 | 1 | 0 | -1 |
I have marked the cells where the government is in surplus and/or the private domestic sector is in surplus in yellow.
For the question to be true we should never see the government surplus (G - T < 0) and the private domestic surplus (S - I > 0) simultaneously occurring.
We will look for two simultaneous yellow squares for the government and private domestic sector to test that proposition.
You see that in the first four periods that never occurs which tells you that when there is an external deficit (X - M < 0) the private domestic and government sectors cannot simultaneously run surpluses, no matter how hard they might try. The income adjustments will always force one or both of the sectors into deficit.
Once we get into external surplus, we can see in Period 6 that the condition satisfied.
That is because the private and government balances (both surpluses) add up to the external surplus.
So if a national government was able to pursue an austerity program with a burgeoning external sector then the private domestic sector would be able to save overall (that is, spend less than they earn - which is not the same thing as the household sector saving from disposable income).
The injection from the external sector outstrips the drain coming from the fiscal position, which allows the private domestic sector to save overall.
Going back to the sequence, if the private domestic sector tried to push for higher saving overall (say in Period 5), national income would fall (because overall spending would fall) and the government surplus would vanish as the automatic stabilisers responded with lower tax revenue and higher welfare payments.
Period 8 shows what happens when the private domestic sector runs a deficit with an external surplus. The combination of the external surplus and the private domestic deficit adding to demand drives the automatic stabilisers to push the government fiscal position into further surplus as economic activity is high.
But this growth scenario is unsustainable because it implies an increasing level of indebtedness overall for the private domestic sector which has finite limits. Eventually, that sector will seek to stabilise its balance sheet (which means households and firms will start to save overall). That would reduce domestic income and the fiscal position would move back into deficit (or a smaller surplus) depending on the size of the external surplus.
So what is the economic understanding that underpin these different situations?
If the nation is running an external deficit it means that the contribution to aggregate demand from the external sector is negative - that is net drain of spending - dragging output down.
The external deficit also means that foreigners are increasing financial claims denominated in the local currency. Given that exports represent a real cost and imports a real benefit, the motivation for a nation running a net exports surplus (the exporting nation in this case) must be to accumulate financial claims (assets) denominated in the currency of the nation running the external deficit.
A fiscal surplus also means the government is spending less than it is "earning" and that puts a drag on aggregate demand and constrains the ability of the economy to grow.
In these circumstances, for income to be stable, the private domestic sector has to spend more than they earn.
You can see this by going back to the aggregate demand relations above. For those who like simple algebra we can manipulate the aggregate demand model to see this more clearly.
Y = GDP = C + I + G + (X - M)
which says that the total national income (Y or GDP) is the sum of total final consumption spending (C), total private investment (I), total government spending (G) and net exports (X - M).
So if the G is spending less than it is "earning" and the external sector is adding less income (X) than it is absorbing spending (M), then the other spending components must be greater than total income.
Only when the government fiscal deficit supports aggregate demand at income levels which permit the overall private domestic sector to save out of that income will the latter achieve its desired outcome. At this point, income and employment growth are maximised and private debt levels will be stable.
The following blog posts may be of further interest to you: