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Sectoral Balances

As an engineer exploring MMT, I have a sectoral balance question you may be able to answer. The sectoral balance equation is frequently used in MMT writings to explain transactions between the government and non-government sectors, but appears to be mathematically incorrect. Rather than copying the equations from one of the MMT writeups, I'll pull them from http://en.wikipedia.org/wiki/Sectoral_balances .

"(1) Y = C + I + G + (X – M)"   <= the NIPA GDP equation

"(2) Y = C + S + T"             <= the NIPA GDI equation

"You can then drop the C (common on both sides) and you get:

 (4) S + T = I + G + (X – M)"   <= the sectoral balance equation

But the NIPA definition of C in equation (1) is "Compensation of employees, paid" and its definition of C in equation (2) is "Personal consumption expenditures" - and mathematically the C can be drapped only if the two values are equal, which they're clearly not.

What am I missing here?

It's not uncommon to drop the C in these consolidations. I see no real problem with these over-simplifications when they're put in the right context. But MMT mangles the sectoral balances in a deeply misleading way.

What they do is consolidate the equation down to (S-I)=(G-T). This implies that the private sector can only "net save" when the govt deficit spends. This is horse shit. First, they're treating the govt like it's an external entity. The govt is logically our liability. Printing money isn't the same as printing "net worth". That govt spending really does get "financed" in real terms. Second, the MMT equation is showing the domestic sector balance which is saving net of investment. Of course, investment is the thing that makes the whole economy work so netting it out is absurd.

For instance, in the Wiki page the problematic conclusion is this:

"Thus, when an external deficit (X – M < 0) and public surplus (G - T < 0) coincide, there must be a private deficit. While private spending can persist for a time under these conditions using the net savings of the external sector, the private sector becomes increasingly indebted in the process."

All they did here is describe the paradox of thrift as if it's a new thing. Yes, if the govt runs a surplus in substantial quantities it could cause economic problems. This is true for any sector of the economy.

Further, they imply that all new debt is bad. This is terribly misleading. If the govt runs a surplus and we are investing and borrowing in a way that offsets this saving then we aren't worse off. In fact, we are probably better off because our debt is sustainable and our real wealth is growing.

But by netting out investment they miss the whole key to the chain of production and viable debt dynamics. When we invest within the private sector we create real savings which makes balance sheet expansion MORE viable, not less. You don't need the govt to spend money to make the economy viable so we can save. All you need is productive investment. It sure helps when the govt adds some productive investment (and they often do), but MMT creates this depiction where the deficit is necessary "by accounting identity".


"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche

It took me a while to see the light, but one of the most useful things I've learned on this website is how MMT is just an excuse for government involvement in the economy. In the MMT world the government causes unemployment and therefore needs to fix it. In the MMT world the government causes a lack of money and saving therefore needs to fix it. If you believe MMT then you can blame the government for virtually anything related to the monetary system and build up a strawman for how they need to fix it.

I really enjoyed your Odd Lots podcast on MMT. They have some useful insights, but they "overreach" on many things.

I think what MMT does is explain why govt isn't necessarily bad, which is what a lot of people believe. But they go a little overboard in their explanation and try to claim that govt isn't just a helpful entity, but an entity we are entirely dependent on to succeed. This distorts reality and leads people to believe that we NEED job guarantees and NEED deficits and NEED all this other govt intervention.

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche

MMT gets many things wrong in part from extrapolating from things it gets correct.   However the great flaw in MMT, as well as much of economics, is focussing on money (which economically is not real) rather than on real values (Thermodynamic values).    In reality money is just a one type of financial asset which exists in a dynamic relationship will all other financial and real assets.   As Cullen has said (paraphrased) "money has a high degree of moneyness".   Yes, the ability of the government to tax and spend in a sovereign currency increases the value of this money,  but it still exists with all other financial assets.    There is nothing in real economics which can't exist in perpetuity with the constraint of zero government debt.   However, if the real economy grows, overall debt must increase under the constraint of constant or increasing prices, but this debt can be entirely private sector debt.  The critical flaw in MMT is that this very real possibility is rejected.

Yes, that's precisely right John. You could have a perfectly healthy economy with the govt as a regulator and establisher of the unit of account without ever issuing a single financial asset. MMT makes this crazy case of overreach where the govt not only sets the unit of account, but HAS to issue financial assets, HAS to provide full employment, etc. It's all a bit misleading.

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche

Cullen, Being grounded in physical science, I find it objectionable to drop a variables just because someone chooses to call them the same letter (although I'm finding that economists do that regularly). What's implicitly being said is that the difference between the value of the two variables is negligible. So I went to BEA's NIPA tables and picked up 2018 Q4 values (shown below). I don't find the difference between the two C's at all negligible (68% - 53% = 15% of GDP), so there's still a problem with the use of sectoral balances that I'm not understanding (especially when you're critical of MMT for dropping (X-M) which is only 3% of GDP).

(1) Y = C + I + G + (X – M)


C = Personal consumption expenditures = 68% of GDP

I = Gross private domestic investment = 18%

G = Government consumption expenditures and gross investment = 17%

(X-M) = Net exports of goods and services = 3%

(2) Y = C + S + T


C = Compensation of employees,paid = 53% of GDP

S = Net operating surplus plus consumption of fixed capital = 40%

T = Taxes on production and imports less subsidies = 7%

(4) S + T = I + G + (X – M)   <= the sectoral balance equation

I'm suspecting your problem with (S-I)=(G-T) has more to do with NIPA than MMT, probably in the meaning you're attributing to the variables, contrasted with their NIPA definitions (and I'm suspecting at this point that MMT is attributing even different definitions to the variables), hence my post.

I may be in a straight-jacket of my own making but I find any equation with variables that can't be accurately defined and measured to be pretty useless. That's why I've focused on the NIP accounts in trying to get a realistic grasp on macroeconomics. (There, BEA is trying to compile real data to real definitions.) I'm now finding myself faced with three different definitions of the same equation and am more confused than when I posted. Can you help?

Hi Ed,

You're using different measures. GDP can be measured in three different ways using the NIPAs. See the NIPA handbook for details.

My critique of MMT has nothing to do with them dropping or adding (X-M). In MMT they often describe a closed economy where private sector saving is equal to (G-T). So, think of the flow of funds in an economy, where, for instance the govt spends a bunch of cash and no other activity takes place (no taxes, no banks, etc). MMT will argue that we "net save" by the quantity of that spending. I am telling you that this is technically right if you don't think of the govt as part of the private sector's liabilities. And it is very wrong if you do (which you should because our govt is very much an asset/liability of our private sector in the same way that our corporations are assets/liabilities of our private sector).

The thing that MMT misconstrues is that in depicting the economy in this way they are netting Investment via (S-I). This is absurd. Investment is the thing that literally adds to our net worth and our real wealth. This can and is done all the time whether (G-T) is positive or not. There is absolutely no need for (G-T) to be positive in order for I to be positive or sustainable, but MMT creates this whole false narrative where you come away believing that we absolutely NEED (G-T) in order for the private sector to save. It's crazy in one sense and wrong in a very basic sense.


"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche

This just explained to me why I wasn't quite comfortable with MMT. Their description of how endogenous money operates always made a lot of sense, but it wasn't clear how they moved from their definitions of how things work to policy prescriptions.

Cullen explained it perfectly - they fall prey to the usual "politics masquerading as economics" disease that afflicts so many, if not most, economists.

MMT is an incorrect "description" of the monetary system that allows its proponents to try to convince people that the government needs to do certain things. For instance, in the context of this discussion MMT leads us to believe that the government needs to spend in order for us to save because the government is the issuer of currency and "net financial assets".

It took me a long while to realize how wrong all of this is. It's been educational watching Cullen learn MMT and slowly pick it apart piece by piece over the years.