Voters Prefer Deficit Reduction Rhetoric to Action

The deficit is just an accounting identity. It represents the difference between saving and investment in the private sector (plus imports) because what the public sector spends the private sector is able to save. Here's a simple explanation based on the work of Keynesian economist Wynne Godley on the dynamics of sectoral balance within a national economy;

"Let’s divide the economy into three sectors: private, government,

and external. If one sector spends less than its income (i.e.,

saves), one or both of the other sectors must be spending more

than their income (i.e., dissaving or running a deficit). The aggregate identity looks like this: (S – I) + (T – G) + (M – X) = 0

We can rearrange the equation as (S – I) = (G – T) + (X – M) where (S – I) is the net saving of the combined private sector households plus firms. The second term, (G – T), is the overall

government balance, including federal, state, and local governments. When the government is running a deficit (G > T), this

term is positive. And finally, (X – M) is the current account balance. When the current account is in surplus, this term is positive. In a closed economy without a government sector, saving

always equals investment. If the private sector is to save more than domestic investment, then there must be other sectors willing to run deficits. A government deficit, for example, is an injection

into private income, and hence generates saving in excess of

investment. The rest of the world is in a deficit position relative to a country with a current account surplus, which, again, is an injection into the domestic income flow. Therefore, the public and external sector deficits are what allow, or “finance,” the private sector’s saving in excess of domestic investment...When the government sector goes into deficit, the shortfall equals the additional private sector saving (or reduction of private sector deficit), plus additional net imports."

http://www.levyinstitute.org/pubs/ppb_113.pdf

Because we have a large current account deficit, which represents a leakage of private sector savings, government deficits must rise by the same amount or private sector saving will fall (unless exports rise). The twin demand leakages of the trade deficit and the growth of private sector saving must be balanced by increased government deficits not lower ones. If surpluses occur in the public and private sector simultaniously along with big trade deficits, the US economy will come to a halt due to a total collapse of effective demand.

Government spending is just one aggregate of total effective demand in the US economy; so long as the twin leakages of a trade deficit and private sector savings increases reduce overall effective demand, the government must run a deficit to sustain economic growth. Failing to do so will not only result in economic stagnation but in even bigger federal government deficits than would be the case with more, mostly nondiscretionary, federal spending.

steve of IL 1:07PM August 18, 2010