Government Deficits Translate into Surpluses for the Non-Government Sector

by L. Randall Wray

In recent months, the nation’s pundits have been whipping up deficit hysteria in a mass public mis-education campaign funded by billionaire Pete Peterson. In this blog I will explain why we should not be misled. First, most of the growth of the deficit can be attributed to the rotten economy–which destroyed jobs and thus tax revenue. Second, and more importantly, a sovereign government deficit is nothing to fear. It is simply the mirror image to the non-government sector’s saving. As the US private sector retrenched to rebuild its balance sheet, the government’s balance moved toward deficit. There is an unrecognized identity at work.

One sector’s deficit equals another’s surplus. If we sum the deficits run by one or more sectors, this must equal the surpluses run by the other sector(s). Following the pioneering work by Wynne Godley, we can state this principle in the form of a simple identity:
Domestic Private Balance + Domestic Government Balance + Foreign Balance = 0

For example, let us assume that the foreign sector runs a balanced budget (in the identity above, the foreign balance equals zero). Let us further assume that the domestic private sector’s income is $100 billion while its spending is equal to $90 billion, for a budget surplus of $10 billion over the year. Then, by identity, the domestic government sector’s budget deficit for the year is equal to $10 billion. Since flows accumulate to stocks, we know that the domestic private sector will accumulate $10 billion of net financial wealth during the year, consisting of $10 billion of domestic government sector liabilities.

As another example, assume that the foreign sector spends less than its income, with a budget surplus of $20 billion. At the same time, the domestic government sector also spends less than its income, running a budget surplus of $10 billion. From our accounting identity, we know that over the same period the domestic private sector must have run a budget deficit equal to $30 billion ($20 billion plus $10 billion). At the same time, its net financial wealth will have fallen by $30 billion as it sold assets and issued debt. Meanwhile, the domestic government sector will have increased its net financial wealth by $10 billion (reducing its outstanding debt or increasing its claims on the other sectors), and the foreign sector will have increased its net financial position by $20 billion (also reducing its outstanding debt or increasing its claims on the other sectors).

It is apparent that if one sector is going to run a budget surplus, at least one other sector must run a budget deficit. In terms of stock variables, in order for one sector to accumulate net financial wealth, at least one other sector must increase its indebtedness by the same amount. It is impossible for all sectors to accumulate net financial wealth by running budget surpluses.

Finally, note that none of this is theory. It is an accounting identity. Note also that it is not limited to the hegemonic issuer of the world’s reserve currency. It applies to every nation.

Let us turn to recent data. The following chart was prepared by Professor Scott Fullwiler, the James A. Leach Chair in Banking and Monetary Economics at Wartburg College.

sector financial balances

This chart shows the sectoral financial balances for the US, using the identity from above. The government balance is shown as a mirror image of the private balance (that is, above 0 percent means a positive balance, and below 0 percent is a negative balance). The capital account is the negative of the current account, so a positive balance there is a negative trade balance.

We see from the chart that the "normal" situation in the US is a private sector surplus, and a (growing) current account deficit. These are offset by a government budget deficit. The exception was the Clinton years, when government ran a surplus and the private sector ran unprecedented deficits. That private sector deficit continued for almost a decade (with a reprieve during the Bush recession), and led to the mountain of private sector debt that helped to bring on the financial crisis. When the crisis hit, the private sector retrenched and the government budget deficit grew–to 10% of GDP.

A few things are readily apparent from this figure.

First, one sees that the private and government balances are nearly the reverse of one another, as the accounting identity requires. If the current account balance were zero, the private and government balances would be exact mirror images.

Second, reliance on domestic private sector net dissaving (that is, private deficit spending) during the 1998-2008 period for economic expansion to offset trade deficits and small government deficits (or surpluses during 1998-2001) is clear. This is in sharp contrast to most of the post-WWII period which saw government deficits and trade surpluses (at least until the 1980s) while the private sector was virtually always in surplus.
Third, the return of large government deficits in 2008 enabled a return to a substantial domestic private sector surplus position.

Fourth, note how throughout the postwar period, economic recessions correspond to an increase in both private net saving and government deficits, while the opposite occurs during expansion. Indeed, it is this increase in private sector net saving during economic slowdowns that is in itself the recession. Reduction of private sector net saving occurs in expansion.

And, in conclusion, the government sector deficit will remain high–no matter what the deficit hysteria crowd does–until the economy recovers and the US private sector reduces its net saving. The only other alternative is for the US to turn to current account surpluses–something that is not going to happen. But that is a topic for another day.

L. Randall Wray is a Professor of Economics at the University of Missouri-Kansas City and Research Director with the Center for Full Employment and Price Stability as well as a Senior Research Scholar at The Levy Economics Institute and author of Understanding Modern Money.

Professor Wray also blogs at New Economic Perspectives, and at New Deal 2.0.

This article originally appeared at

Randall Wray


L. Randall Wray is a professor of economics and research director of the Center for Full Employment and Price Stability at the University of Missouri–Kansas City. His current research focuses on providing a critique of orthodox monetary policy, and the development of an alternative approach. He also publishes extensively in the areas of full employment policy and the monetary theory of production. Wray received a B.A. from the University of the Pacific and an M.A. and a Ph.D. from Washington University, where he was a student of Hyman Minsky.