Econ 101 Fail

OK, folks.  It’s time for a refresher on basic national accounts.  Treasury Secretary Tim Geithner is interested in reducing current account surpluses around the world without devaluing the dollar.  Good luck with that.

Even worse, Geithner reiterated that the U.S. “will bring our fiscal position back to a sustainable balance.”

Loosely speaking, our national income is equal to what we produce in any given year — that is, GDP (Y).  GDP may be broken down into private consumption (C), private investment (I), government consumption and investment (G), and trade surplus — exports minus imports (X-M).

If we take national savings (S) to be income which is not consumed, then S=Y-(C+G)=I+(X-M).  If “we haven’t saved enough” then by definition we have insufficiently invested or we have too large a trade deficit.  There is no escape from the iron grip of elementary mathematics.

In turn, national savings may be private or public, where public savings is taxes minus government spending.  If the private sector suddenly decides to save more — as they did with the collapse of the housing bubble — then the public sector must save less.  That is, budget deficits must rise.

As a matter of pure accounting, there are exactly the two ways to avoid large government deficit.  One is for private investment to rise.  Unfortunately, unemployment is at 9.6 percent and capacity utilization is low.  Businesses have no incentive to invest in more capital when they have existing capital already going to waste.  The only other way to avoid increasing government deficits is to increase net exports.  Econ 101 says the dollar must fall relative to other currencies in the world.

So when unemployment is high, capacity utilization is low, and devaluation is unprincipled, what is left to do to increase national savings?  Declare war on algebra?

As for Geithner, he has a little more wiggle room, reportedly declaring that the fiscal consolidation will wait until the recovery strengthens.  Currently, CBO projects unemployment to average 9 percent next year and finally fall below 8 percent . . . sometime in late 2012.

David Rosnick is an economist at the Center for Economic and Policy Research in Washington, DC.  This article was first published in the CEPR blog on 12 November 2010 under a Creative Commons license.

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