The problem with identities in economics


Obviously, George Osborne's plan to make budget deficits illegal is just a piece of politicking. For it's only "illegal in certain circumstances" and being in a recession is a special circumstance. So, actually, it's really just a restatement of the Keynesian orthodoxy, that there should (can be if you prefer) be fiscal stimulus in a recession and there should also be fiscal austerity in the boom so as to reduce the white hot heat of that technological revolution. Shrug. But it's got all the right people het up as this letter to The Guardian tells us:

Economies rely on the principle of sectoral balancing, which states that sectors of the economy borrow and lend from and to each other, and their surpluses and debts must arithmetically balance out in monetary terms, because every credit has a corresponding debit. In other words, if one sector of the economy lends to another, it must be in debt by the same amount as the borrower is in credit. The economy is always in balance as a result, if just not at the right place. The government’s budget position is not independent of the rest of the economy, and if it chooses to try to inflexibly run surpluses, and therefore no longer borrow, the knock-on effect to the rest of the economy will be significant. Households, consumers and businesses may have to borrow more overall, and the risk of a personal debt crisis to rival 2008 could be very real indeed.

This is true, in one model, because that's how we set that one model up. Indeed, it's how we define that model. But we must not confuse the model with the economy, nor the map with the territory. For there's no particular reason why there has to be inter-sectoral lending or borrowing at all. There can, obviously, be intra-sectoral such. Some companies are cash rich at present. Some households are at that stage of life where they have significant savings and or assets. Some companies desire borrowing, as do some households. There's no reason at all why there must be lending or borrowing across those sectoral boundaries, nor why government should be taking any part in any that does happen. It's simply a construct of our model that we think it must. And, again, models are not reality.

Our economists are getting rather carried away by the constraints of the models they're using. But then, a group letter to The Guardian signed by Andrew Simms, Richard Murphy and Howard Reed. We knew it was going to be wrong, didn't we?