November 3, 2017

The Law of Interdependent Balances

Comment on Nick Rowe on ‘So, what ARE the differences between a Government’s Budget and a Household’s Budget?’


Nick Rowe’s analysis suffers from the Fallacy of Insufficient Abstraction and therefore gets lost in observations of irrelevant country-specific historical accidents.

The correct perspective is, of course, macro and this means to compare the household SECTOR and the government SECTOR and NOT the individual household to the government sector, i.e. the molehill to the Himalaya. And, most important, the analysis has to be TOTAL and NOT PARTIAL, that is, it has always to INCLUDE the business sector.

At first, we have only the business- and the household sector.#1The two sectoral balances are given as follows:
Qm≡C−Yw      profit Qm is household sector’s spending C minus wages Yw,
Sm≡Yw−C      saving Sm is wage income Yw minus consumption expenditures,
Qm+Sm=0 or Qm≡−Sm.

At the heart of the monetary economy is an identity: the business sector’s budget surplus (= profit) equals the household sector’s budget deficit (= dissaving). Put bluntly, loss is the counterpart of saving and profit is the counterpart of dissaving. This is the most elementary form of the macroeconomic Profit Law.

Now, the government sector GS is added. The three sectoral balances are given in the most elementary case as follows:
Qm≡C+G−Yw      profit Qm is HS and GS spending C+G minus wages Yw,
Sm≡Yw−T−C       saving Sm is wage income Yw minus taxes T and expenditures C,
Bm≡T−G            budget surplus Bm is taxes T minus government expenditures G,
Qm+Sm+Bm=0 or Qm≡−Sm−Bm.

The business sector’s monetary profit Qm is equal to the household sector’s budget deficit (= dissaving) and the government sector’s budget deficit. For the economy as a whole holds that all budget deficits and surpluses add up to zero. This is the Law of Interdependent Balances a.k.a. Law of Interdependent Budgets a.k.a. Fundamental Law of Macroeconomic Accounting.#2

Now, one has to logically distinguish between the three phases that make a complete cycle: (i) origination of the budget deficit = credit creation = money creation, (ii) duration of the debt/interest payments, (iii) compensatory budget surplus = debt repayment = money destruction.

From the macro perspective, there is, in principle, no difference between the household sector’s and the government sector’s growth of debt, interest burden, and eventual repayment.

In the case of private debt, the household sector pays interest to the banks, in the case of public debt it pays interest in the form of taxes. In the case of full securitization, the interest goes in both cases ultimately to the bondholders (= business sector and creditor households). As long as private or public debt exists and the interest rate is greater than zero, income is redistributed between debtor/taxpayer- and creditor households.

Egmont Kakarot-Handtke

#1 The pure production-consumption economy is defined with the macro axiom set: (A0) The objectively given and most elementary configuration of the economy consists of the household and the business sector which in turn consists initially of one giant fully integrated firm. (A1) Yw=WL wage income Yw is equal to wage rate W times working hours. L, (A2) O=RL output O is equal to productivity R times working hours L, (A3) C=PX consumption expenditure C is equal to price P times quantity bought/sold X. For a start X=O.
#2 For details see cross-references MMT