Macro 101 – Sectoral balance

You may not know that much about economics, and possibly even less about macro-economics. But if there is one formula you should know, it is the equation for sectoral balances.

Don’t get overwhelmed by the look of it. What it basically says is that there is a direct and unbreakable relationship between the government budget balance, the national trade balance and the private sector budget balance.

So what! Why is that important?

Well what it also tells you is that total change in private savings over a period are equal to private investment plus the government budget balance plus net exports over that period, and that this is always true. Although at first this formula may seem relatively unimportant, once you understand its consequences it becomes very powerful. 

Here is the reason;

If in an accounting period there is a trade deficit and a government budget surplus then there MUST be a private sector deficit. By private sector deficit I mean a period where there is a net loss of savings from the private sector. If this situation continues for a period of time then it leads to increasing indebtedness.

The reason this is formula is so powerful is that it allows you to make a very quick analysis about whether macro-economic decisions actually make sense and, at a high level, determine the likely outcomes of those decisions. That does not mean that this is the “magic” formula, because there may exist some other compensating factors in the economy that you are unaware of, but it certainly is a good place to start.

It also provides input into the comparative "money centric" vs "GPECS centric" view of economic policy as discussed in another post.