« In defence of bonuses | Main | Stalinist companies vs market forces »

February 19, 2009

TrackBack

TrackBack URL for this entry:
http://www.typepad.com/services/trackback/6a00d83451cbef69e2011278fbd69528a4

Listed below are links to weblogs that reference Public borrowing & the credit crunch:

Comments

Feed You can follow this conversation by subscribing to the comment feed for this post.

Luis Enrique

oh man, this confuses me. I'm not disputing your conclusion, but I'd like to understand how what you argue here differ from what Krugman calls: "one of the most basic fallacies in economics — interpreting an accounting identity as a behavioral relationship"?

(Krugman quote from here: http://krugman.blogs.nytimes.com/2009/01/27/a-dark-age-of-macroeconomics-wonkish/ )

Andrew

Luis, it differs because Krugman's complaint basically boiled down to people using an accounting identity to claim that government can't boost GDP because anything the govt spends comes from somewhere. Krugman says yes it does come from somewhere, but that doesn't mean we can't make GDP bigger in the process.
Chris is saying that the total investment comes from somewhere, but nothing about how big it is. Notice he's got % of GDP on his graph.
In short, the De Long-Krugman/Fama blog war is about whether GDP can be increased by govt spending going up, Chris's point is about govt spending having to go up anyway.

Leigh Caldwell

I wish Chris was right, but I think Luis is more accurate.

Let's take a simple example. ABC plc revises its estimates of future economic growth downward and thus decides to cut investment, keeping income and consumption fixed. It accumulates savings which it keeps in the bank. It is not incumbent on the government to borrow this money from the bank if it doesn't want to.

In exchange for the company's savings increasing, the bank's savings decrease (because it has accumulated a liability to the company).

[Incidentally: the bank should, in a functioning monetary market, reduce interest rates to encourage people to borrow their money (and consequently decrease private non-bank saving to offset the temporary increase caused by ABC). But the monetary market hasn't been functioning normally.]

So the increase in private saving (assuming the financial sector is included) is as much a consequence as a cause of government deficits. We can have a debate about the causality of this change and what decisions or behaviour led to it, but it doesn't arise spontaneously from the accounting relationship.

A separate phenomenon is the drop in national income which results from ABC's cut in investment (or equivalently, from the reduction in velocity of money). This in turn will reduce ABC's income and it may soon start drawing on some of those savings. But that isn't directly a factor in this argument.

chris dillow

@ Leigh - the drop in national income caused by ABC's cut in investment is central to the argument. This drop is what causes tax revenue to fall, which is the mechanism through which a higher private financial balance leads to a government deficit.
It's for this reason that I'm not making the error of mistaking an accounting identity for a behavioural relationship.

Ian Hislop

Chris has to be wrong. His comment about national accounts is only valid in a closed economy. In a global economy where savings can be placed anywhere there is no necessary correlation between savings and a national government deficit. A government can run as large a deficit as it wishes provided it can find someone to finance it.

Keith

I don't understand this idea of private public sector accounts being locked together to sum to a constant. Government debt has shot up in no small part because the Government has spent a lot on bail outs. They were not forced to do that by 'arithmetic', it was a political choice. If they had not done it, where would the arithmatic be then? Am I not getting something here?

tbrrob

I'm lost by this why if the private sector runs a surplus does the state have to run a deficit?

I don't see the relationship there is no have to about it.

Luis Enrique

Ian,

I think the open economy thing is not a problem - it could be that the counterparty of UK private sector surpluses is overseas deficits, but as Chris mentions, if anything the opposite is the case.

Chris, I didn't suppose you'd made that mistake, I just wanted to understand how not. I think I do now, but I still get in a muddle.

Looking at:

I(G)+I(P)=S(G)+S(P)

we have I(G) going up (govt stimulus spending) and S(G) going down (fiscal expansion) and I(P) going down (companies not investing), and S(P) up (private sector lending to govt) - that's a behavioural story that adds up. Whereas just saying I=SG+SP so if SP up, SG down, is the sort of error Krugman is getting at, I imagine.

I just find it all very confusing when I start thinking about mechanisms. For example, I'd have thought it would be possible for the private sector to hold investment I(P) constant and increase lending to the govt. Say S(P) goes up by 1 and S(G) down by 1, that means net invest can't change ... but why can't the govt have invested the money it just borrowed? I know the sort of error I'm making here, and could prob figure it out if I sat down with pen and paper, it's just easy to get confused, is all.

Luis Enrique

Ian,

I think the open economy thing is not a problem - it could be that the counterparty of UK private sector surpluses is overseas deficits, but as Chris mentions, if anything the opposite is the case.

Chris, I didn't suppose you'd made that mistake, I just wanted to understand how not. I think I do now, but I still get in a muddle.

Looking at:

I(G)+I(P)=S(G)+S(P)

we have I(G) going up (govt stimulus spending) and S(G) going down (fiscal expansion) and I(P) going down (companies not investing), and S(P) up (private sector lending to govt) - that's a behavioural story that adds up. Whereas just saying I=SG+SP so if SP up, SG down, is the sort of error Krugman is getting at, I imagine.

I just find it all very confusing when I start thinking about mechanisms. For example, I'd have thought it would be possible for the private sector to hold investment I(P) constant and increase lending to the govt. Say S(P) goes up by 1 and S(G) down by 1, that means net invest can't change ... but why can't the govt have invested the money it just borrowed? I know the sort of error I'm making here, and could prob figure it out if I sat down with pen and paper, it's just easy to get confused, is all.

Andrew

Was that THE Ian Hislop?

Ian Hislop

One of them

Bob B

Surely, the fundamental national accounting identity is:

S+C+T = Y = C+I+G+X-M

where: S=Current saving; C=Consumption spending; T=Taxes paid on income, goods and services;
Y=GNP; C=Consumption spending; I=Business investment; G=Public spending on goods and services.

On rearranging in the fsmiliar way:

X-M = (S-I) + (T-G)

The counter-part of an improvement in a country's Current Balance of International Payments, it's necessary to increase the private sector surplus of Current saving over Business investment and/or increase the Public sector surplus of Tax revenues over Public spending on goods and services.

Btw for a particularly bleak assessment of where the global economy might be headed as the result of the credit crunch, try Martin Wolf in Wednesday's Financial Times (17 Feb), where he argues we could repeat the experience of Japan's economy in the 1990s after the breaking of its asset-price bubble in 1992:
http://www.ft.com/cms/s/0/ae540b20-fd5e-11dd-a103-000077b07658.html?nclick_check=1

chris dillow

@ Luis - for the private sector to increase its savings for a given level of investment requires it to cut spending - say the wage-bill for companies. This leads to lower tax revenue and a government deficit. Of course, if the government invests the money it borrows, its deficit (I-S) rises further.
@ Ian - it is possible that a rise in private domestic saving causes a fall in foreigners' saving (that is, the UK's current account deficit) and hence no impact upon the government's balance. But given that imports fall only slightly as spending falls, this is only a small part of the story. Empirically, it's the government balance that bears most of the adjustment.

Luis Enrique

Ta. I thought that might be it, but got hung up on wondering whether it would be one for one (i.e. private sector lending to govt decreases tax revenues one for one) and whether it would need to be.

Robert Prime

Typically, with large amounts of borrowing such as in a remortgage, they will carry out credit checks through the services of a credit reference agency. This is part of how they work out the potential risk to them of giving you the borrowing, and is fed into the deals that they offer you.

scoremore

Government debt has shot up in no small part because the Government has spent a lot on bail outs...great lens will credit this and save.

The comments to this entry are closed.

Why S&M?

Blog powered by Typepad