August 25, 2011
National income accounting is really basic stuff. It is taught in every intro economics class. It would be a really great thing if only the people who wrote about and implemented economic policy understand it.
Starting at the beginning, we know that we can add up GDP on the output side by summing its components, consumption, investment, government, and net exports. This must be equal to the incomes generated in production. This gives us a basic identity that:
1) C+I+G+(X-M) = Y
where Y stands for income. This identity must always hold, it is true by definition.
We can then divide Y into disposable income, which is total income, minus taxes. This gives us:
2) Y = YD + T
We can then divide disposable income into savings and consumption, since by definition any income that is not consumed is saved. This gives us:
3) YD = C+S
since we now know that Y = C+S+T, we can rewrite equation 1 as,
4) C+I+G+ (X-M) = C+S+T
we then eliminate consumption from both sides and we get:
5) I+G+(X-M) = S+T, rearranging terms gives:
6) (X-M) = (S-I)+(T-G)
This one actually has a clear meaning. X-M is exports minus imports, or the trade surplus, S-I is private saving minus private investment, and T-G is taxes minus government spending, or the budget surplus. This identity means that the trade surplus is equal to the sum of the surplus of private savings over investment and the government budget surplus. Remember, this is an accounting identity, it must be true.
Now, let’s bring this back to the concerns that the Post and Samuelson raise today. Both are very concerned about inflation (I’ll beat up on them for this is another post), but they also hold out the hope that the economy will get back to full employment once consumers and firms are more confident about the economy.
But consider the accounting identity. The country has a large trade deficit, which means that X-M is a large negative number. It’s currently around 4 percent of GDP (just under $600 billion), but would certainly be much larger if the economy were near full employment. Imports rise with income, so that with a higher level of GDP the trade deficit would expand.
If X-M is negative, then either or both (S-I) or (T-G) MUST be negative. This means either or both that we have negative private savings or we have a budget deficit.
We can have the former with a very low private saving rate, as we did during the stock and housing bubble. In both periods there was aa consumption boom driven by transitory wealth created by the bubbles. It is difficult to understand why anyone would want a low private saving rate.
It means that people reach retirement with very little to support them other than their Social Security or Medicare, which both the Post and Samuelson want to cut. So no one can consistently want both low private saving and cuts to Social Security and Medicare, unless they want the elderly to be very poor. (It is in principle possible to raise investment, but in practice very difficult. The equipment and software investment share of GDP is already almost back to its pre-crash levels, so the prospects of further increases are very limited.)
The other possibility is that we can have a large budget deficit, making T-G a big negative number. But, we know the Post and Samuelson hate budget deficits, they complain about them all the time.
For those who believe in accounting identities and evolution there is only one other place to go, we must get our trade deficit down. We need X-M to be a much smaller negative number. The best mechanism for getting the trade deficit down is reducing the value of the dollar.
A lower dollar would make imports more expensive for people in the United States, leading them to buy fewer imports. It would also make our exports cheaper for people living in other countries, leading them to buy more of our exports. Fewer imports and more exports translates into a smaller trade deficit.
So we should want a lower dollar, right? Not so fast, Samuelson explicitly warns that a falling dollar could be a bad consequence of higher inflation. The Post editorial never mentions a lower dollar as a possible benefit of more expansionary monetary policy.
What can we conclude from this? We can conclude that Samuelson and the Post do not know national income accounting.