A Journal for Western Man



Aren't Deficits Another Name for Saving?


Dr. Robert P. Murphy

Issue LVII- May 14, 2006



     In response to my last article on government deficits, Stefan Karlsson alerted me to an openly Keynesian analysis at National Review Online. Although Tom Nugent's surprising piece ran back in 2004, its errors are timeless and hence worth exploding even today.


Nugent commits the standard Keynesian fallacy of relying on an accounting (or sometimes statistical) result in order to "prove" causality. After describing a Wall Street Journal editorial condemning free-spending politicians, Nugent writes:

What the senators and media don't get is the basic equation that defines the role of government deficits in the economy: The federal government deficit = non-government savings (of net financial assets). That's fact, not theory, a.k.a. an "accounting identity."

Before seeing the (amazing) conclusion that Nugent draws from this, let's stop and be clear on what he's saying. At first glance, it certainly seems as if his alleged identity is downright false. After all, there are historical examples where the government deficit was zero or even negative, and yet the economy in that country had positive savings. (Indeed, one wonders: Before deficit-prone centralized governments, were people able to save, or did the accountants sadly shake their heads and explain why it was impossible?)

But surely Nugent's reasoning isn't that bad; let's give him the benefit of the doubt. I believe he is making tremendous use of the word "net" that I have placed in bold above. If a bus driver saves $1,000 of his paychecks over the course of a few months and uses it to buy, say, 50 shares of an American company at $20 each (or $1,000 worth of bonds issued by such a company), Nugent apparently wouldn't classify this as the accumulation of a net financial asset in the private sector, because the savings of the bus driver would be exactly offset by the "dissaving" of the person selling him the shares of stock (or bonds).

Beyond these types of cases, I think Nugent gets into trouble. Suppose the bus driver invests his saved funds in a new company (during its IPO); I assume Nugent would say the $1,000 investment is again completely offset by the corresponding "debit" on the books of the company. However, this move requires treating the newly issued shares as a liability on the part of the company, rather than as equity in it.

Although in certain models of financial economics issuing debt or equity is equivalent, I don't think such considerations give the result that net financial wealth can never increase in the private sector (absent government deficits). If nothing else, such an analysis seems to overlook the fact that the $1,000 of capital handed over to the company is clearly an asset now owned by the firm; if the bus driver refrains from consuming his whole paycheck week after week, that has to show up somehow.

At this point I'm just guessing, but it occurs to me that Nugent might respond in the following way: "On the contrary, if the bus driver decides to save up that $1,000 instead of spending as much as possible every paycheck, then the aggregate income of the community is down $1,000. The restaurants, movie theaters, etc., where the driver could've spent his money now have lower revenues, and this loss exactly offsets the gain of $1,000 to the company in which the bus driver invests."

If this is indeed why Nugent thinks the private sector (without government deficits) is by definition incapable of accumulating net financial assets, then his mind is truly caught in the Keynesian prison. Although in practice the transition may not be smooth, we can certainly logically imagine a successful increase in net savings (and investment) by every single member of a community.

For example, suppose everyone in the community stops going to the movies and uses the saved funds to invest in a company that manufactures drill presses. It is certainly true that the any laborer who used to work at a movie theater is now out of a job, but at the same time a new employment opportunity has opened up making drill presses (and supplying this company with all of the materials it needs).

After the necessary adjustments (which may take a significant period of time in the real world, depending on how unexpected the spending changes are), aggregate income can still be the same, since people are still "spending all of their money." But since now some of the aggregate income is spent on accumulating drill presses, rather than in viewing movies, the future income of the community will grow because its laborers can work with a growing stock of tools.

Despite the problems I've mentioned, I think we can at least see what Nugent is up to. The last loose end is quite simple: if it is the government issuing a new bond, then the private sector has gained a net financial asset. This is because the corresponding liability is owned by the government, not the private sector. That's why Nugent thinks the "federal government deficit = non-government savings (of net financial assets)." Let us now see what use Nugent makes of this (alleged) accounting identity:

Non-government savings include those of both residents of the U.S. and foreigners. If the federal budget deficit of $450 billion about equals the current account deficit, it means that all the net financial assets added by the deficit are being saved by foreigners, who desire to hold all those dollar-denominated U.S. financial assets and are willing to net export to us in order to get them.

We're getting close to Nugent's whopper, but before we unveil it let us again pause to understand his logic. What Nugent is arguing in the above quotation is that (in 1994) the federal deficit of $450 billion allowed the entity "the-entire-world-minus-the-US-federal-government" to accumulate $450 billion in net financial assets. But at the same time (in 1994), foreigners invested roughly $450 billion more in US assets (including government bonds) than Americans invested in foreign assets. (Do you see where this is going? We're getting oh so close now!) So if Nugent has convinced us (1) that the non-US-federal-government sector can only save as much as the US federal government borrows, and (2) that foreigners are accumulating dollar-denominated assets on net in an amount roughly equal to the federal deficit, then that means…

This data indicates … that the federal deficit is too small for the U.S. domestic sector to save anything! Domestic savings are low because the budget deficit is too low. Low and unobtainable savings means low demand, excess capacity, and low levels of employment. In other words, to get adequate demand from a healthy economy, a much larger federal budget deficit is needed.

Ta da! There you have it, folks: Because of (dubious) accounting, Nugent has reached the conclusion that it is literally impossible for the US private sector to save unless the government runs a budget deficit bigger than the trade deficit.


I have tried to show the important point that a sudden increase in savings won't necessarily plunge the economy into recession; it is certainly logically possible for all of the displaced workers (who used to make consumption goods) to find new jobs making capital goods.

But perhaps a clearer way to pinpoint the fallacy in Nugent's argument is to tweak it ever so slightly. Note that there is nothing special in choosing the US federal government as the financial entity in question. Nugent could just as easily have argued, "The Murphy household deficit = non-Murphy-household savings (of net financial assets)." Then, if the data indicate that right now the Murphy household spends $10,000 more annually than it earns in income, while my wife's Colombian relatives lend us $10,000 net this year, then US (government and private) net savings (vis-ŕ-vis my household, that is) must be zero. Clearly I need to go buy some more Big Macs and plasma screen TVs lest the nation's children find it literally impossible to put money in their piggy banks.


Ah, but Nugent has a ready response for my sarcastic argument. Government (versus Murphy household) deficits are special because of the magic of central banking:

Politicians and investors who fear budget deficits don't understand the interaction of a floating exchange rate and a central bank like the Federal Reserve…. The deficit mongers … think of the deficit in this micro-framework — in the way that a family deficit can limit our ability to spend. The government doesn't have such a constraint — it can't run out of money because it creates it. As long as government deficits do not infringe on the private sector's demand for goods and services, and in the process instigate inflation, the government deficit promotes economic growth and the related benefits to the private sector.

Nugent's argument here is roughly akin to saying that bank robbers provide employment in a community, so long as their stealing doesn't infringe on anyone else's spending. Among other problems, Nugent suffers from the monetarist belief that the printing press is only bad if it causes prices to rise. On the contrary, whenever the government expands the money supply and uses the new funds to buy things, real goods and services are siphoned out of the private sector. No appeal to accounting identities can change this obvious truth.


Tom Nugent's linking of government deficits to private savings and growth is not merely inaccurate; it is exactly backwards. When the government runs a deficit, it sucks savings out of the private sector and reduces private investment. Unless one believes that politicians spend money more wisely than investors, this practice only impoverishes the community. Notwithstanding sophistical arguments to the contrary, government deficits retard economic growth.

This article originally appeared on Mises.org.

Robert P. Murphy teaches economics at Hillsdale College. He prepared the Home Study Course in Austrian Economics, which is available for $350. See his archive. Send him mail.

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