... At the end of any accounting period, then, the sum of the sectoral financial balances must net to zero. The government balance – the private balance – capital account balance = 0. The government balance = the private balance + the capital account balance. See my postEconomics 101 on government budget deficits for the full write-up. I credit British economist Wynne Godley for making this identity relevant to macro economics.
What does all this mean then? Put simply, the financial sector balances framework means that when the government sector runs a deficit, the non-government sector runs a surplus of equivalent size. So, to move any sector balance in an open economy, you need to move the other two balances exactly opposite in equivalent measure. To reduce the government deficit in any period, the private balance and the capital balance must increase by the exact same amount in that period.
Thinking about government deficits this way opens a whole new understanding of what cutting deficits means for the economy. What it should mean to you is that deficits are the effect and not the cause. Budget deficits are the result of the ex-post accounting identity between the sectoral balances and should not be a primary goal of public policy....
...the deficit is the result of an ex-post accounting identity between private savings, and capital account and government balances. It makes zero sense to target the effect (deficits) instead of the cause (excess credit growth and malinvestment). In plain English that means the policy prescriptions are the economic input and the deficit is the output. Focus on the policy and policy goals, not deficits.Read it at Credit Writedowns
Why can’t people understand national accounting?
by Edward Harrison
Good summary overall.
However, I disagree that the problem arose from central banks keeping interest rates too low for too long, thereby fueling massive malinvestment that eventually imploded. I think that folks like Bill Black, Michael Hudson, and Randy Wray, all of UMKC, Yves Smith of Naked Capitalism, and Janet Tavakoli of Tavakoli Structured Finance have documented that the problem arose from what Bill Black calls a criminogenic environment in the financial sector, both the mortgage market and the securitization process. It continues in the foreclosure debacle.
While low rates may have played a role in fomenting the crisis, they were neither the proximate nor the principal cause of it. These crisis can be laid square at the feet of the financial sector, and the next crisis or the further devolution of this one, however one wishes to view it, is already baked in because the behavior hasn't changed, nor have the institutional arrangements.