8/2/2019 Macro Accounting

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Macroeconomic Accounting

The closed economy - no government model

Ys=GDP is our national income should be understood to be the supply of funds to spend. It is paid to

households who either spend it on consumption or save it. Hence Ys=C+S. The final demand for goods is

consumption plus investment i.e. Yd=C+I. If there is to be any investment to add to the capital stock, it must befinanced out of the savings of the households. Hence, if Ys is to equal Yd then, it must be that S=I. If household

savings are low, then investment must be low as well. This is the problem that traps poor nations in poverty. They

are poor so they cannot save. Since they cannot save, they cannot invest in productivity enhancing plant, equipment

and technology, and thus they remain poor.

The open economy - no government model

In an open economy households can spend national income (Ys) on either consumption (C) or imports (M)

or save it. Hence, Ys=C+M+S. In the open economy, in addition to investment goods, a nation can produce exports

(X). So the final demand for goods in an open economy is Yd=C+I+X. If I=S, it follows that X=M. In short, the

nation finances it investment with domestic savings and pays for its imports with exports. Of course, it is not

necessary that I=S and X=M. To equate Ys=Yd all that is necessary is that S+M=I+X or (I-S)=(M-X). In short,

investment can exceed domestic saving if the shortfall is supplied by an excess of imports over exports. When thelatter occurs there is said to be a trade deficit; as foreigners have supplied the nation with more goods than they

bought, they have in effect loaned the nation the difference - the nation is a debtor. Which is not necessarily bad. In

the early days of its development the United States grew far faster than its domestic saving allowed. Much of the

capital for railroads and canals and factories was borrowed through merchandise trade deficits.

A trade deficit will result in foreigners holding stocks of a nations currency. These currency holding could

also be used to purchase assets on the capital account. This currency may simply be invested in the short-term

treasury debt of a nation and interest payments flow back. Alternatively, other assets such as land, or companies

could be purchased. If the deficit is financed by short-term credit then the only cost is interest payments to

foreigners. On the other hand, as foreigners come to own a nations companies and land the nation may lose some of

its economic independence. If a nation wanted a certain level of I, and to avoid a trade deficit, it would have to

finance I by reducing C and, thereby, increasing S.

The open economy with government model

In this model the nations income Ys can be consumed, saved, used for imports or collected as taxes (T) so

Ys= C+S+M+T. The demand for government goods (G) is added to the list of other final demands so we get

Yd=C+I+G+X. Using the logic developed earlier it follows that if Ys=Yd then S+M+T=I+X+G. It follows that a

government deficit (G-T) must equal (M-X) + (S-I). In short, a government deficit can be financed with a trade

deficit or by crowding-out private investment, that is, using some of the nations saving to finance G. For example,

in 1991 (G-T) accounted for 3% of GDP. It was financed primarily by crowding-out some I. While S was 15.65%

of GDP, I was only 12.41% of GDP. A trade deficit of -.3% made up the difference. In 1989, on the other hand the

deficit accounted for 1.6% of GDP, but S was virtually equal to I at 15.8% and 16.0% respectively. A trade deficit

of -1.8% carried the bulk of the financing burden.

In the 1980s the United States once again became a debtor nation. The reason was the huge federal deficits

that followed from Reagans supply-side tax cuts and the increase in expenditures, most especially on defense.

Rather than becoming a debtor, as in its earlier years, to finance investment, the US became an international debtor

to finance an orgy of consumption spurred by tax cuts and defense spending. As a consequence the foreign

ownership of US land, companies, hotels, office buildings etc increased dramatically to rather alarming levels.

Moreover, the percentage of the national debt held by foreigners also increased. As a consequence trade

negotiations with Japan were compromised by the fear that Japan might dump its US treasury securities and throw

US capital markets into chaos. The process is now being repeated as the Bush Administration runs huge tax cut and

war deficits. The US trade deficit is now at record breaking levels resulting in the US being heavily dependent on

credit from Asia, and especially China.