Tuesday, 16 June 2015
Beware of using sectoral balances to reveal the flaw in Osborne’s budget surplus idea.
A number of people, e.g. Richard Murphy, Bill Mitchell and John Eatwell argue that sectoral balance analysis is helpful in revealing the flaw in the budget surplus idea recently advocated by the UK’s finance minister, George Osborne. This approach is dodgy.
Of course there is no denying the obvious point that a public sector surplus must be matched by a private sector deficit (assuming for the sake of simplicity we ignore the foreign sector). But that point apart, sectoral balance analysis has nothing to offer here. To see why, let’s consider Richard Murphy’s ideas, and we’ll start with a quote from his article, as follows.
“The principle is simple and is that there are just four sectors in the economy. They are:
1.Consumers = C
2. Government = G
3. Business, whose investment = I (their current trading is of course part of the flip side of C, and we must not double count).
4. The rest of the world, represented by the balance of trade = E”
Murphy continues (to quote):
“Now as a matter of fact the surpluses and deficits run by these groups must arithmetically balance in monetary terms, because double entry does work: every debit does indeed have a credit.
So if we use the same letters C, G, I and E to represent the net savings or borrowings of these groups in a period then:
C + G + I + E = 0
So, if consumers borrow someone else must lend.”
Well there’s something wrong there and as follows. If consumers borrowed ONLY FROM entities in one or more of the other sectors, then Murphy’s point would be true. But of course that’s nonsense.
The reality is that much of consumer borrowing is from OTHER CONSUMERS. That is, typically, what happens when a consumer gets a loan is as follows. 1, Consumer gets a loan from a bank, 2 the borrower spends the money, 3, the money is deposited on sundry other consumers’ bank accounts.
Now assuming the latter don’t spend the money (i.e. assuming they put it in a deposit or term account), then effectively the latter consumers have loaned money to the borrower mentioned at the outset above. The loan of course goes via a bank or banks.
It is thus quite untrue to say that if consumers borrow more, sundry entities in other sectors must LEND MORE.
In fact the latter point can be put in more general terms and for the following reasons.
Merging the consumer and business sectors.
Murphy’s sectors are unusual in that he splits the private sector into consumers and business. It’s more normal to split the domestic economy just into the private and public sectors. I.e. consumers and businesses are merged into one sector: the “private sector”.
But nothing useful is added to the analysis by splitting the private sector into consumers and businesses as Murphy does.
So returning to the point about borrowing, we can say that given an increase in borrowing by the private sector (consumers plus businesses) some of that borrowing will come from entities IN THE PRIVATE SECTOR.
In short, Murphy is completely wrong to say later on that:
“The government surplus or deficit is, in other words, the opposite of what is happening with consumer debt…”
Murphy needs to go back to the drawing board.
In his letter to the Financial Times, John Eatwell (Cambridge economist) says amongst other things that where there is a persistent surplus “the accumulation of debt by the private sector will be a recipe for serious economic instability — an indebted private sector is very vulnerable to economic shocks.”
Well not necessarily. The reaction of the private sector to a withdrawal of central bank money (base money) may to some extent be to replace it with private bank created money, i.e. the private sector non-bank entities may borrow more from private banks. And that extra borrowing COULD BE on a totally responsible basis. Though to be realistic there is bound to be SOME IRRESPONSIBLE borrowing mixed in there. So Eatwell has a point.
Certainly the latter phenomenon, namely borrowing so as to maintain living standards seems to have been going on just prior to the 2007 crunch. On the other hand, as a general rule, private bank lending is PRO-CYCLICAL rather than anti-cyclical. It is thus debatable whether private banks, as a general rule, expand lending when there is a withdrawal of base money from the private sector.
To the extent that private banks DON’T react in the latter counter-cyclical way then effect the reaction of the private sector as a whole to a budget surplus is to accept the cut in demand, produce less, and consign a portion of the workforce to the dole queue.
In the event, the actual response of the private sector will doubtless lie somewhere between the above two extremes (1, replacing ALL the central bank money lost with privately created money with no consequent drop in demand, and 2, complete failure by the private sector to borrow more.)
As to Bill Mitchell’s analysis, I couldn’t see much wrong. However he goes into too much detail about sectoral balances. That is (to repeat) the only insight that sectoral balances have to offer when it comes to identifying the flaw in Osborne’s budget surplus idea is that a public sector surplus must be matched by a private sector deficit.
As to the size of the deflationary effect or “unemployment increasing effect” of that surplus, sectoral balance analysis has nothing to offer.