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National Income Accounting 101 for everyone

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  • Strongly Liberal Democrat
    Democrat
    Dallas, TX
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    Understanding National Income Accounting 101 is absolutely essential for Democrats to be Democrats, or even Republicans to be Republicans. Issues of government spending and taxation are fundamental to our political debates. None of what I'm about to speak on involves any so-called "economic" theory. It is all based on basic accounting conventions. This is what is actually taught in the mainstream of macro-accounting and none of this should be controversial. Unfortunately, political ideology in America on the left and right has totally ignored the indisputable facts I'm going to describe. It is not all of their faults. Millions of macro and political economy introductory textbooks have been printed with algebraically incorrect equations to describe national savings or the national surplus. (For more on this point and that which follows in this post please see bilbo.economicoutlook.net/blog/?p=20536...

    First off, there is a basic accounting equation you need to understand, and you need to remember this towards the end of the discussion: Assets = Liabilities + Equity or A=L+E. This is always true and cannot be disputed. A firm's assets are always equal to the debts that the firm owes and the funds supplied by the owners of the firm. The same is true for an individual. And the same is true at the national income accounting level.

    For brevity, you need to recognize something in the aggregate I will describe and explain as the "non-government."

    The "non-government" is the aggregation of the private domestic US economic sector + the foreign economic sector.

    Here is a simple algebraic deconstruction of GDP accounts:

    Gross Domestic Private (S) urplus = GDP (Y) - (T)axes - (C) onsumption = S = Y - T - C

    Government (B)udget (S)urplus= T - (G)overnment spending = BS=T-G

    S + BS= Y - T -C + T- G= S + BS= Y- C - G

    Since GDP equals Y=G + C + Domestic (I)nvestment Spending + (N)et E(x)ports= Y=G+C+I+NX

    Consolidating the previous equation,

    S + BS=G + C + I + NX - C - G =

    S + BS= I + NX

    Rearranging,

    BS=I + NX - S

    As you may notice, from the above, in order for the government to run a budget surplus, the gross domestic private surplus has to be less than Investments and Net Exports.

    Rearranging for clarity,

    BS=(I-S) + NX

    Now if the Budget Surplus is a actually a deficit and thus a negative number and we want to keep the left hand side of this algebraic equation clean, we will multiply the entire equation by -1.

    We now have,

    Government Deficit (GD)= (S - I) - NX

    If Net Exports are actually a negative number, and thus Net Imports, we now have,

    GD=(S-I) + NI

    If we can describe (S-I) as the Domestic Private Sector Net-Surplus and NI as the Foreign Sector Net-Surplus, we now have,

    Government deficit=Domestic Net-Surplus + Foreign Sector Net-Surplus

    Hence,

    Government Deficit = Non-Government Net-Surplus

    You can easily just call this Government Deficit= Non-Government Surplus, since we are dealing from gross amounts of aggregate entities.

    Below is a recent and most up to date version we have of a graphical reconstruction of sector balances, courtesy of Professor Scott Fullwiler of UMKC, as appearing in theweek.com/articles/625515/hillary-cli...

    Remember, Assets=Liabilities+Equity. This is always true.

    ASSETS = LIABILITIES + EQUITY

    Gross Non-Government Surplus= Total Non-Government Deficits + Government Deficit

    Government Deficits are the source of "paid in" equity into the aggregate Non-Government.

    Government Deficit= (Gross Non-Government Surplus - Total non-government deficits)=

    Government Deficit=Non-Government Surplus.

    The accounting and algebra described above holds no matter what type of monetary regime and/or trade regime you have.

    You could have a gold-standard regime or a fixed foreign exchange regime or a floating currency, and the above is always true.

    There all kinds of policy and political implications from what I'm talking about, but I'm leaving that alone for this post.

    The Government Deficit is always equal to the Non-Government Surplus. This is just a matter of basic accounting.

  • Strongly Liberal Democrat
    Democrat
    Pensacola, FL
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    In A=L+E, is money in savings accounts in banks considered equity? I assume it is and is it considered the same as cash? The reason I ask this is because savings are at risk and the same money in banks is owed to multiple accounts. Doesnt that produce a problem when multiple accounts are counting the same money as equity? Realising that there is only a problem if there is a run on banks, but doesn't that compromise the purity of A=L+E ? I believe that assumptions like this are prevalent causing multiple problems.
  • Strongly Liberal Democrat
    Democrat
    Dallas, TX
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    You assume that banks lend deposits. Bank lending create deposits in the banking system. Loans create deposits in the banking system. Lending deposits is not what "banks" do, that's "shadow" banking and anyone can participate who can acquire or possesses deposits to lend. If I lend you $10 that I otherwise held in savings; my savings has shifted from cash or deposits to your IOU. Presumably, you will spend this $10, and thus my savings that I have lent to you will then be "transferred" into the economy and held in savings by someone else. In the instantaneous accounting without taxes considered, the $10 dollars would now be in the possession of someone else in the economy. So the existing deposits in the banking system simply changed ownership, from me to you to a third party and so on.

    The $10 in my savings that I lent to you equals your debt to me. You have $10 in cash or deposits as an asset and a $10 liability owed to me. Presumably, you are going to spend that $10 dollars and acquire $10 dollars of assets. So some other third party entity is going to acquire the deposits I shadow lended to you in exchange for their assets that they sold to you for $10. So in the end, the economy still has $10 still in it, but instead of being held in my possession, I hold an IOU from you, you owe me the IOU, and someone else holds the $10 that I lent into the economy to shadow lend to you.

    Nothing can defile or overturn A=L+E. It is a simple accounting identity that is always true. It can never be "imbalanced."

    As Newton said 'for every action there is an equal reaction,' so is absolutely true of accounting.

  • Strongly Liberal Democrat
    Democrat
    Pensacola, FL
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    Gross Domestic Private (S) urplus = GDP (Y) - (T)axes - (C) onsumption = S = Y - T - C

    Carlitos, I am OCD and like I did in College with professors in calculus and Differential Equations and cannot proceed until I understand all variables clearly and can't assume anything no matter how menial.

    Is Y the Gross Domestic Private Investment

    What is Gross Domestic Private ?

  • Strongly Liberal Democrat
    Democrat
    Pensacola, FL
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    Carlitos, In the fields I am familiar with there are mathematical remedies to account for effects applied to systems. Like gravity and temperature etc. How does economics deal with things like risk of repayment of debt, influence of profit or positive effects on equity and negative effects on liability. Like in A=L+E . How is the risk of non payment of loans and IOU' s in the equity column as well as the hesitancy in paying out liabilities dealt with. In 2008 they obviously excluded risk. Is there a developed math to deal with these potential outcomes. If there is then why dont they apply it to hiring guidlines?
  • Strongly Liberal Democrat
    Democrat
    Dallas, TX
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    Chet Ruminski Wrote:

    Gross Domestic Private (S) urplus = GDP (Y) - (T)axes - (C) onsumption = S = Y - T - C

    Carlitos, I am OCD and like I did in College with professors in calculus and Differential Equations and cannot proceed until I understand all variables clearly and can't assume anything no matter how menial.

    Is Y the Gross Domestic Private Investment

    What is Gross Domestic Private ?

    Y is GDP and GDP=G + I + C + NX

    That's National Income for the Domestic Private Sector.

    The DPS is all the businesses and households in the United States of America.

    Remembering that GDP = Gross Domestic Income, as sales=incomes,

    the Gross Domestic Private Sector Surplus is National Income earned but not spent by businesses and households in the United States of America. For all the income earned but not spent, there are amounts spent but not earned by businesses and households or some other sector.

    But let's hold that thought for a moment and just work more through the algebra:

    Gross Domestic Private Surplus=National Income - Taxes - Consumption or S=Y-T-C

    Plugging in Y in the equation we have,

    S=G+I+C+NX-T-C which reduces to S=G+I+NX-T

    Government Budget Surplus=T-G and Government Budget Deficit=G-T

    So you got,

    S=I+ NX +(G-T) which is S=I+NX+Government deficit

    Government Deficit= S-I-NX

    Government Deficit=(S-I) - NX

    S-I = Domestic Private Sector Net-Surplus and remembering that if Net-Exports are a negative number and actually Net-Imports, we can arrange this to

    Government Deficit=(Domestic Private Sector Net-Surplus)+Foreign Sector Net-Surplus

    Because we are talking about aggregate level surpluses, term Net is irrelevant.

    Government Deficit=Non-Government Surplus

  • Strongly Liberal Democrat
    Democrat
    Dallas, TX
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    Chet Ruminski Wrote: Carlitos, In the fields I am familiar with there are mathematical remedies to account for effects applied to systems. Like gravity and temperature etc. How does economics deal with things like risk of repayment of debt, influence of profit or positive effects on equity and negative effects on liability. Like in A=L+E . How is the risk of non payment of loans and IOU' s in the equity column as well as the hesitancy in paying out liabilities dealt with. In 2008 they obviously excluded risk. Is there a developed math to deal with these potential outcomes. If there is then why dont they apply it to hiring guidlines?

    You probably need to go outside "economics" per se to find those answers. I would start with Finance and Accounting.

    Most mainstream economics in American schools is simply an extension of the mathematics department.

    The business schools' finance and accounting departments are where real economics is done.

    To start with government debt:

    In finance, there's a basic concept of a risk free rate of return provided by government securities.

    In the mainstream finance textbooks, the government is assumed to not have any risk. The textbooks may not explain this, but that's ONLY possible if the government government is the issuer of the currency and always willing to pay its debts.

    Note, when the credit agencies downgraded the Federal Government, they did not cite the government's inability to pay, they basically cited the psychotic Republicans' refusal to pay.

    With non-government debt:

    Accounting has the conservatism principle: losses are realized as soon as recognized, yet gains are not until realized.

    Accounting is about reporting accurate financial statements, not manipulating reality.

    Finance tells us that the terms of loans and interest rates reflect lenders' assessment of risks + required returns.

    On the non-government side, if borrowers don't repay and go thru bankruptcy, both equal amounts of non-government debts and savings are "destroyed."

    Without debts, there are no savings.

    Total debt=Total Savings

    So if equal amounts of non-government debt and savings are destroyed thru the bankruptcy process, that has no bearing on the non-government surplus, except thru secondary effects on the economy.

  • Liberal Democrat
    Democrat
    Colorado Springs, CO
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    Carlitos Wrote:

    Understanding National Income Accounting 101 is absolutely essential for Democrats to be Democrats, or even Republicans to be Republicans. Issues of government spending and taxation are fundamental to our political debates. None of what I'm about to speak on involves any so-called "economic" theory. It is all based on basic accounting conventions. This is what is actually taught in the mainstream of macro-accounting and none of this should be controversial. Unfortunately, political ideology in America on the left and right has totally ignored the indisputable facts I'm going to describe. It is not all of their faults. Millions of macro and political economy introductory textbooks have been printed with algebraically incorrect equations to describe national savings or the national surplus. (For more on this point and that which follows in this post please see bilbo.economicoutlook.net/blog/?p=20536...

    First off, there is a basic accounting equation you need to understand, and you need to remember this towards the end of the discussion: Assets = Liabilities + Equity or A=L+E. This is always true and cannot be disputed. A firm's assets are always equal to the debts that the firm owes and the funds supplied by the owners of the firm. The same is true for an individual. And the same is true at the national income accounting level.

    For brevity, you need to recognize something in the aggregate I will describe and explain as the "non-government."

    The "non-government" is the aggregation of the private domestic US economic sector + the foreign economic sector.

    Here is a simple algebraic deconstruction of GDP accounts:

    Gross Domestic Private (S) urplus = GDP (Y) - (T)axes - (C) onsumption = S = Y - T - C

    Government (B)udget (S)urplus= T - (G)overnment spending = BS=T-G

    S + BS= Y - T -C + T- G= S + BS= Y- C - G

    Since GDP equals Y=G + C + Domestic (I)nvestment Spending + (N)et E(x)ports= Y=G+C+I+NX

    Consolidating the previous equation,

    S + BS=G + C + I + NX - C - G =

    S + BS= I + NX

    Rearranging,

    BS=I + NX - S

    As you may notice, from the above, in order for the government to run a budget surplus, the gross domestic private surplus has to be less than Investments and Net Exports.

    Rearranging for clarity,

    BS=(I-S) + NX

    Now if the Budget Surplus is a actually a deficit and thus a negative number and we want to keep the left hand side of this algebraic equation clean, we will multiply the entire equation by -1.

    We now have,

    Government Deficit (GD)= (S - I) - NX

    If Net Exports are actually a negative number, and thus Net Imports, we now have,

    GD=(S-I) + NI

    If we can describe (S-I) as the Domestic Private Sector Net-Surplus and NI as the Foreign Sector Net-Surplus, we now have,

    Government deficit=Domestic Net-Surplus + Foreign Sector Net-Surplus

    Hence,

    Government Deficit = Non-Government Net-Surplus

    You can easily just call this Government Deficit= Non-Government Surplus, since we are dealing from gross amounts of aggregate entities.

    Below is a recent and most up to date version we have of a graphical reconstruction of sector balances, courtesy of Professor Scott Fullwiler of UMKC, as appearing in theweek.com/articles/625515/hillary-cli...

    Remember, Assets=Liabilities+Equity. This is always true.

    ASSETS = LIABILITIES + EQUITY

    Gross Non-Government Surplus= Total Non-Government Deficits + Government Deficit

    Government Deficits are the source of "paid in" equity into the aggregate Non-Government.

    Government Deficit= (Gross Non-Government Surplus - Total non-government deficits)=

    Government Deficit=Non-Government Surplus.

    The accounting and algebra described above holds no matter what type of monetary regime and/or trade regime you have.

    You could have a gold-standard regime or a fixed foreign exchange regime or a floating currency, and the above is always true.

    There all kinds of policy and political implications from what I'm talking about, but I'm leaving that alone for this post.

    The Government Deficit is always equal to the Non-Government Surplus. This is just a matter of basic accounting.

    Good discussion Carlitos. But your first line says it all. "Understanding National Income Accounting 101 is absolutely essential for Democrats to be Democrats, or even Republicans to be Republicans."

    No disrespect, but the dialogue that follows is hardly the stuff that any politician is going to insert in his or her stump speech. Americans are into soundbites...not this nuanced stuff. You, of course, know that.

  • Strongly Liberal Democrat
    Democrat
    Dallas, TX
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    Hi Schmidt,

    Have to make it safe for the politicians!

    To that end, we have to start with the public and policymakers.

    And while the American public could stand to hear a stump speech that was more like a college lecture, it doesn't need to be quite like this, but the resources need to be there to educate voters and pundits who need that deeper understanding.