Wednesday, July 5, 2017

Peter Cooper — Fiscal Policy, Sectoral Balances and Financial Sustainability

A bit more in-depth look at sectoral balances using some elementary algebra.

Fiscal Policy, Sectoral Balances and Financial Sustainability
Peter Cooper


Matt Franko said...

Send it over to the Vox people....

AXEC / E.K-H said...

A crash course in macro accounting
Comment on Peter Cooper on ‘Fiscal Policy, Sectoral Balances and Financial Sustainability’

You say: “PRIVATE Balance + GOVT Balance + FOREIGN Balance = 0” and “This is an accounting identity, which means it always holds true.”

This is NOT the case because you messed up the elementary mathematics of accounting.#1 In order to see this one has to go back to the MOST ELEMENTARY economic configuration, that is, the pure consumption economy which consists only of the household and the business sector.#2

In this elementary economy three configurations are logically possible: (i) consumption expenditures are equal to wage income C=Yw, (ii) C is less than Yw, (iii) C is greater than Yw.

In case (i) the monetary saving of the household sector Sm=Yw-C is zero and the monetary profit of the business sector Qm=C-Yw, too, is zero.
In case (ii) monetary saving Sm is positive and the business sector makes a loss, i.e. Qm is negative.
In case (iii) monetary saving Sm is negative, i.e. the household sector dissaves, and the business sector makes a profit, i.e. Qm is positive.

It always holds Qm+Sm=0 or Qm=-Sm, in other words, at the heart of national income accounting is an identity — the business sector’s deficit (surplus) equals the household sector’s surplus (deficit). Put bluntly, loss is the counterpart of saving and profit is the counterpart of dissaving. This is the most elementary form of the Profit Law.

The balances of the business sector, the household sector, the government sector and the rest of the world are interrelated as follows: Qm≡-Sm+Yd+I+(G-T)+(X-M), and THIS is the correct accounting identity for an open economy (X-M) with a government sector (G-T) and with business investment I and distributed profit Yd.

Your accounting blunder consist in lumping together the business sector and the household sector. This makes the crucial relation between profit, distributed profit, saving and investment invisible#3 which amounts to an intended/unintended destruction of valuable information which in turn is contrary to the very purpose of accounting.

Egmont Kakarot-Handtke

#1 See ‘The Common Error of Common Sense: An Essential Rectification of the Accounting Approach’

#2 (A0) The objectively given and most elementary configuration of the economy consists of the household and the business sector which in turn consists initially of one giant fully integrated firm. (A1) Yw=WL wage income Yw is equal to wage rate W times working hours. L, (A2) O=RL output O is equal to productivity R times working hours L, (A3) C=PX consumption expenditure C is equal to price P times quantity bought/sold X. For a start it holds X=O. Note that ALL variables are measurable. C and Yw appear in National Accounting.

#3 See also ‘How Keynes got macro wrong and Allais got it right’