There is much that is debatable in macroeconomics but some facts are beyond dispute. One such fact is that the flows of money between three different sectors of any economy with a given currency have to add up to zero. Understanding this and its implications is incredibly important.
These sectors are the domestic government sector, the domestic private sector, and the external sector or 'rest of the world'. The reason that the balance of these sectors must add up to zero is simply that there is nowhere else for the money to go. If any one sector has a surplus then at least one of the two sectors must have a deficit.
We often hear references to the balances of two of these sectors, namely the government sector and the external sector. When people discuss the government deficit or surplus they are referring to the difference between the amount of money flowing out of the public sector (through spending) and the amount flowing in (through tax revenue). Government debt is just the sum of the accumulated past annual deficits (minuses surpluses).
When people discuss current account deficit or surplus with the external sector they are referring to the difference between the money received from exports or remittances and money spent on purchasing imports. Saying there is a current account deficit is equivalent to saying that the external sector has a surplus.
What is seldom, if ever, explicitly discussed is the financial balance of the third sector, which is the domestic private sector, comprising individuals, households, and companies. This can obviously also have a surplus or deficit.
As noted a key fact is that financial flows between the three sectors will always balance each other.
What this means is that if a country is a net importer (i.e. the external sector has a surplus) then at least one of the other two sectors must run a deficit. Either the government must have a budget deficit or the private sector has to run a deficit.
Since it is widely felt that it is bad for the government to run a deficit and accumulate debts, when there is a government deficit policymakers frantically try to reduce it by increasing taxes or cutting government spending. The problem with this is that, because of the sectors must balance, this forces the private sector to run a deficit.
This is potentially dangerous. It is not sustainable for the private sector to run deficits as it will eventually lead to insolvency and financial collapse.
This contrasts with government deficits, which are sustainable indefinitely in modern economies since the state issues its own currency and, unlike the private sector, can never run out of it. That is the defining feature of modern fiat currency systems. Indeed it seems logical that if the government creates money then it needs to run a deficit as this is the only way for the private sector as a whole to accumulate money (i.e. save).
Unfortunately there is widespread belief that public sector deficits are not sustainable and have to be eliminated. That is simply not the case. Indeed most governments run deficits most years. Surpluses are rare. On the rare occasions when the US government has tried to run surpluses for several years they have always precipitated financial collapse of the private sector and depressions. It is repeated public sector SURPLUSES that are not sustainable, as this forces the private sector to run repeated deficits.
The only way that they government sector can avoid deficits and the private sector simultaneously run surpluses is for the country to be a net exporter. In other words for the government and the private sector to have surpluses the external sector has to run a large deficit. The problem with that approach is that not all countries can be net exporters. Globally exports and imports have to balance to zero as, until we connect with alien life, there is nowhere else for exports to go! So if some countries are net exporters that forces other countries to be net importers. Because many countries (e.g. China, Germany, Koreas, and until recently Japan) actually have policies committing themselves to being net exporters this forces other countries to be net importers. Most large developed countries (Germany excepted) are net importers. It follows that in these countries, which include the USA and the UK, it is necessary essay for governments to run deficits to match the external sector surplus. If they don't they will be forcing their domestic private sector into deficit.
In summary, the requirement for money flows between sectors to balance means that in countries that are net importers governments need to run deficits in order to ensure that the domestic private sector does not become insolvent.
These sectors are the domestic government sector, the domestic private sector, and the external sector or 'rest of the world'. The reason that the balance of these sectors must add up to zero is simply that there is nowhere else for the money to go. If any one sector has a surplus then at least one of the two sectors must have a deficit.
We often hear references to the balances of two of these sectors, namely the government sector and the external sector. When people discuss the government deficit or surplus they are referring to the difference between the amount of money flowing out of the public sector (through spending) and the amount flowing in (through tax revenue). Government debt is just the sum of the accumulated past annual deficits (minuses surpluses).
When people discuss current account deficit or surplus with the external sector they are referring to the difference between the money received from exports or remittances and money spent on purchasing imports. Saying there is a current account deficit is equivalent to saying that the external sector has a surplus.
What is seldom, if ever, explicitly discussed is the financial balance of the third sector, which is the domestic private sector, comprising individuals, households, and companies. This can obviously also have a surplus or deficit.
As noted a key fact is that financial flows between the three sectors will always balance each other.
What this means is that if a country is a net importer (i.e. the external sector has a surplus) then at least one of the other two sectors must run a deficit. Either the government must have a budget deficit or the private sector has to run a deficit.
Since it is widely felt that it is bad for the government to run a deficit and accumulate debts, when there is a government deficit policymakers frantically try to reduce it by increasing taxes or cutting government spending. The problem with this is that, because of the sectors must balance, this forces the private sector to run a deficit.
This is potentially dangerous. It is not sustainable for the private sector to run deficits as it will eventually lead to insolvency and financial collapse.
This contrasts with government deficits, which are sustainable indefinitely in modern economies since the state issues its own currency and, unlike the private sector, can never run out of it. That is the defining feature of modern fiat currency systems. Indeed it seems logical that if the government creates money then it needs to run a deficit as this is the only way for the private sector as a whole to accumulate money (i.e. save).
Unfortunately there is widespread belief that public sector deficits are not sustainable and have to be eliminated. That is simply not the case. Indeed most governments run deficits most years. Surpluses are rare. On the rare occasions when the US government has tried to run surpluses for several years they have always precipitated financial collapse of the private sector and depressions. It is repeated public sector SURPLUSES that are not sustainable, as this forces the private sector to run repeated deficits.
The only way that they government sector can avoid deficits and the private sector simultaneously run surpluses is for the country to be a net exporter. In other words for the government and the private sector to have surpluses the external sector has to run a large deficit. The problem with that approach is that not all countries can be net exporters. Globally exports and imports have to balance to zero as, until we connect with alien life, there is nowhere else for exports to go! So if some countries are net exporters that forces other countries to be net importers. Because many countries (e.g. China, Germany, Koreas, and until recently Japan) actually have policies committing themselves to being net exporters this forces other countries to be net importers. Most large developed countries (Germany excepted) are net importers. It follows that in these countries, which include the USA and the UK, it is necessary essay for governments to run deficits to match the external sector surplus. If they don't they will be forcing their domestic private sector into deficit.
In summary, the requirement for money flows between sectors to balance means that in countries that are net importers governments need to run deficits in order to ensure that the domestic private sector does not become insolvent.
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