Debate Magazine

Economic Myths: The Government Needs to Run a Deficit to Enable Private Saving.

Posted on the 21 May 2015 by Markwadsworth @Mark_Wadsworth

Caveat: I whole heartedly agree with the basic tenant of Modern Monetary Theory i.e. that there is no real direct link between government spending, taxation, borrowing and debt repayments; in the very long run they sort of match up in accounting terms is all.
But then they go off on a complete tangent e.g. here:
It may not be apparent from perusing mainstream newspapers or watching the evening news, but the private sector’s capacity to save and pay off debt is inextricably linked to the government’s use of fiscal policy.
Attempts to slash budget deficits will actually work against private-sector efforts to get debt under control. By directly subtracting from demand, fiscal contraction will have a negative impact on output, employment, income and therefore private saving, frustrating private-sector attempts to pay off debt.
The following accounting identity shows an aggregate relationship that must hold by definition for a closed economy, such as the global economy as a whole:
(G – T) = (S – I)
In this identity, G is government expenditure, T is tax revenue, S is private saving and I is gross private investment.

Somehow or other, government deficits are spun as being a good thing as they enable private saving or enable the private sector to pay off debts.
This is all robbing Peter to pay Paul; if you allocate government debt back to the individual taxpayers who have to pay the interest and principal, it all cancels out. Admittedly, government debt is usually never paid off, it is just rolled forward indefinitely, that's the key to all this but a separate topic.
More importantly, if the government is running a balanced budget, then G-T = 0 and we are left with...
S-I = 0
Hence S=I
In other words, private (i.e. household) saving = Private (i.e. business) investment.
(The distinction between 'saving' and 'investment' should not be under-estimated, see my earlier post).
Overall, the optimum savings ratio for each individual and hence the population as a whole is zero but the overall optimum amount of business investment is positive.
So that means that S-I could be a negative number; if we want the equation to balance, then the government has to run a surplus i.e. G-T<0, i.e. T>G.
This strikes me as complete nonsense, ergo the original equation must also be nonsense; common sense tells us that lower taxation would, all things being equal, lead to more business investment (as long as it doesn't spill over into higher land prices - let's assume a sane tax system which taxes production less and land more).


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