Thread by @David_Charts

THREAD:
So you're running the U.S. economy.
Q: How big should the U.S. budget deficit be?
A: Bigger than the trade deficit, to avoid crises.
Not expecting that answer? Wondering why? Learn about one of the coolest economic concepts, the sector balances. 1/

There are 3 sectors described by CBO:
1. Govt: The federal budget balance.
2. Foreign: The current account, roughly equal to the trade balance plus some investment-related $ flows.
3. Private: Household savings minus business investment. 2/
cbo.gov/publication/54…

Government sector: CBO uses the federal budget deficit as its measure. In 2020, the U.S. ran a 15% GDP budget deficit; it had been 2.4% in 2014 (about historical average) and increased to 4.6% in 2019. 3/

The foreign sector is the U.S. current account balance (mostly trade plus some investment flows) multiplied by -1, as we view it from the foreigners' perspective. A U.S. trade or current account deficit is a foreign surplus. It has been about 3% GDP for a decade. 4/

The third sector is the private sector, saving minus investment.* It was in deficit from 2002 to 2008, then reversed dramatically in the Great Recession.

*CBO includes state & local government budget balances here, as they use federal budget as government to simplify. 5/

Putting them all into one graph, we see the first graph in the thread again. Note that the 3 balances in 2020 add to zero, as they do each and every year. This is a mathematical identity (equation that must hold true) based on how the sectors are defined. 6/

Yes, you read that correctly. The sum is always zero. Here is the data table used to create the chart, and a handy FRED link for the chart and data. 7/
tps://fred.stlouisfed.org/graph/?graph_id=549449

Looking at the equations in the table in graphic form, you basically have the federal government spending $ into the private sector and removing $ via taxation. You don't want the private sector in deficit (i.e., accumulating debt) for very long; bad things happen... 8/

...like the GR in 2008. Private sector ran sizable deficits in the decade prior, borrowing via foreign surplus and was forced to stop borrowing suddenly and deleverage. Note this drove the government deficit up to maintain the identity. 9/
levyinstitute.org/publications/s…

Trump's goal of lowering the trade deficit and increasing the budget deficit via tax cuts were not compatible. If the red line moves farther from zero, the sum of the blue and green lines must shift up; people spend extra money injected by government on imports too. 10/

Here is a quiz you can use to see if you got it; solutions on next tweet. 11/

Quiz solutions: 12/

So why should the U.S. run a budget deficit larger than the trade deficit (foreign surplus)? Because that's what it takes to have a private sector surplus. You want government steadily injecting money into the private sector, at a level that doesn't create inflation. 13/

If the U.S. takes its trade deficit (~foreign surplus) of 3% GDP as a given, then the budget deficit has to be at least 3% GDP so private sector in surplus. That's the floor. The goal is not a budget surplus.

14/THE END.

Fixed: The link to the CBO method sector balances.
fred.stlouisfed.org/graph/?graph_i…