Economic Reform Australia Blog

A pivotal formula in macroeconomics

An article by Cullen Roche <http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1905625> recently posted on ERAInf contains some informative data on sectoral balances. These sectoral balances can be established according to GDP:

GDP = C + I + G + (X – M)

C = consumption

I = investment

G = government spending

X = exports

M = imports

Or stated differently;

GDP = C + S + T

C = consumption

S = savings

T = taxes

From there we can conclude:

C + S + T  =  GDP  =  C + I + G + (X – M)

Cullen has indicated that the key to understanding modern monetary theory is to recognise the significance of the zero net sum of (a) the private sector balance, (b) the public sector balance and (c) the foreign sector balance. Thus, rearranging the above we have:

(I S) + (G T) + (X M) = 0

(I – S) = private sector balance

(G – T) = public sector balance

(X – M) = foreign sector balance

One can see this in a fascinating visual form by viewing the sectoral balances in the USA going back to 1952:

John Hermann