Sectoral balances and Clinton’s budget surplus

A sectoral balances analysis starts with the recognition that the U.S. economy, like any national economy, is roughly comprised of three sectors. There’s the government sector: the federal government, the Federal Reserve, and the state and local governments. There’s the private domestic sector: individuals, households, businesses, the banks, all the major industries, etc. And then there’s the foreign sector: i.e. the rest of the world, or every entity outside the U.S. national border that we trade with.

Each of these three sectors are in a state of surplus or deficit at any given moment. The government is either taxing more than it spends (surplus) or spending more than it taxes (deficit). Households and businesses in the private domestic sector are either saving more than they’re spending (surplus) or vice versa (deficit). And the rest of the world is either exporting more to America than it imports (surplus), or importing from the U.S. more than it exports (deficit). (Perhaps confusingly, the foreign sector balance is the inverse of the U.S. trade balance; i.e. a surplus in the foreign sector actually means a U.S. trade deficit.)

And because of the way we calculate gross domestic product (GDP), the sum of the deficits or surpluses of these three sectors will always be zero. So if the domestic private sector is running a surplus of 4 percent of GDP, for instance, then the government and foreign sectors might each run a deficit of 2 percent. …

The lesson here is that it’s much more sustainable for the government sector to be in deficit, because — unlike the other two sectors — it isn’t cash-constrained. The U.S. government sector controls the supply of U.S. dollars, so in a pinch it can always print more to pay off whatever debt obligations it has stocked up. This carries inflationary risk, but it also means it’s basically impossible for the government to suffer a debt crisis. And you can see that in the chart: The government has been in deficit basically forever, and we’ve yet to have a debt crisis.

Meanwhile, the private domestic sector is cash-constrained, and can suffer a debt crisis quite easily. It only went into deficit a little bit for short periods in the late 1990s and 2000s, and that was enough to blow up the entire economy.