Here’s a useful explanation of the GDP equation:
John T. Harvey — Why government needs to spend money
To get a better idea of what’s going on, have a look at the numbers. As every intro macro student knows, GDP is the sum of consumer spending (C), physical investment spending (I; note that this is not financial investment, but firms adding productive capacity and inventory), government spending (G), and net exports (exports minus imports or X-M). We usually write this in class as:
GDP = C + I + G + (X-M)
Which leads to the sectoral balances equation.
(S – I) = (G – T) + (X – M)
Paraphrased (to improve clarity) from the above link:
The sectoral balances equation says that net private savings (private savings (S) minus private investment (I)) has to equal the public deficit (government spending (G) minus taxes (T)) plus net exports (exports (X) minus imports (M)), where net exports represent the net savings of non-residents.
A note on “net private savings” even though it probably seems obvious–it’s the money you have left after “investment” which is a catch-all term for all expenditures in this case. That includes debt to private banks, taxes, and everything else you spend money on, since one person’s debit is another person’s credit in any given sector.
And on the national accounts scale, a debit on the government’s balance sheet, is a credit to the rest of the world.
Another way of saying this is that total private savings (S) is equal to private investment (I) plus the public deficit (government spending (G) minus taxes (T)) plus net exports (exports (X) minus imports (M)), where net exports represent the net savings of non-residents.
Thus, when an external deficit (X – M < 0) and public surplus (G - T < 0) (government takes more in taxes than it spends into the private sector--zap) coincide, there must be a private deficit. While private spending can persist for a time under these conditions using the net savings of the external sector, the private sector becomes increasingly indebted in the process.
I like Dr. Kelton’s annotated sectoral balances graph better than the one in the wiki.
It’s especially easy to see where the Clinton surplus went positive (the red patch above the line) the private sector went negative to the exact extent that the current account went positive! You can see that the amplitudes (blue and green) are almost mirrors of each other, because there was no offsetting outflow from the government to mitigate the borrowing that people did to purchase the imported goods that we no longer produce ourselves. At the end of the graph, private savings has again gone positive, and government debt negative, as it should be with a large foreign balance, but we are now grappling with inequality. These equations do not show the distribution of income within a sector, so the case where 90% of the population is in hock to the rest is invisible.
And that private sector debt is precisely what we’re grappling with now, with governments all over the world mired in the destructive myth that government spending is somehow taboo. Suppressing government spending, however, vastly benefits the financial sector, since debt is their only “product”, obviously. Government spending is the *enemy* of Wall Street. It competes, not with private sector production, but private sector *credit*. When government spends enough so that no one has to borrow to survive, the vampire squid goes hungry.
See Dr. Keen for just how disastrous letting the financial sector dictate public policy is.