Historically high budget deficits will be required for the next decade | Bill Mitchell – billy blog

If you also know that the current account deficit is consistently draining growth (loss of spending in the domestic economy) and you understand how dramatic this recent shift in private sector behaviour has been then you would immediately ask – who is going buy the goods and services that provide the demand for labour services and produce incomes for Americans.

Then you do a simple calculation which only requires 3 fingers of one hand – the steps in the calculation go like this (yes, we have to spell it out):

1. How many sectors are there that can spend? Answer: three.

2. What are they? External sector, private domestic sector, and government sector.

3. Firms will layoff workers if they cannot sell the goods and services that they have produced (in expectation that they will be sold).

4. A current account deficit means that some income produced in the local economy is lost to the foreign sector – that is, is not recycled back into domestic demand. This creates a drain on growth.

5. A massively rising private sector balance (S > I) means that the private sector (households and firms) are spending less than they are earning (much less in this case and the transition was very quick).

6. There is only one sector left to spend and keep the economy from recession.

This is the theme of Richard Koo’s work as well. He writes that:

The key difference between an ordinary recession and one that can produce a lost decade is that in the latter, a large portion of the private sector is actually minimizing debt instead of maximizing profits following the bursting of a nation-wide asset price bubble. When a debt-financed bubble bursts, asset prices collapse while liabilities remain, leaving millions of private sector balance sheets underwater. In order to regain their financial health and credit ratings, households and businesses are forced to repair their balance sheets by increasing savings or paying down debt. This act of deleveraging reduces aggregate demand and throws the economy into a very special type of recession.

via bilbo.economicoutlook.net