Thursday, January 22, 2009

Twin deficits, Hopenchange edition 

A couple of decades ago when the world was working (successfully, alas) to scare Bush41 into a tax increase, everyone was writing about the 'twin deficits', that budget deficits and trade deficits are linked. Of course this doesn't really work out well empirically in the latter 1990s, but the basic story still has some validity.

In short, there's an identity in economics that says investment has to be paid for somehow. I.e.,

public investment + private investment = public saving + private saving + funds from foreign sources

Or, more simply, total savings and total investment from all sources should be equal.

Let's consider a couple items in that identity. Public saving is also known as budget surplus. Deficits like we have now are negative numbers. We are currently expecting, pre-stimulus and pre-SonofTARP, to have public saving from the federal government fall from -$455 billion to $1.2 trillion for FY09 (which covers the first three quarters of 2009.) How does that get paid for?

The "crowding out" story is that an increase in borrowing by government has to push up interest rates, which has a (smallish, arguably) offsetting effect to increase private savings and a larger effect to decrease private investment. The Obama administration current is arguing that interest rates will stay very low because of the state of credit markets. Do you buy that? Do you think credit-constrained banks and investment houses will swap their precautionary balances of cash for Obama Victory Bonds, pushing interest rates up?

Savings has risen, according to BEA data, with personal savings currently at $130 billion in Q3 (the Q2 number having been a tad bloated due to saving of the stimulus checks.) So where do we think this number is going to go Q4? The BEA estimates on spending and saving look to be around $275 billion. Some offset, but not enough to finance the increase.

Perhaps foreign sources, but this would mean a fastly-widening U.S. trade deficit. With the drop in oil prices, as Casey Mulligan notes, this is highly unlikely. If anything, the trade deficit would appear to be decreasing, not increasing.

So as we wait for the Q4 numbers from BEA, and start thinking about how bad this and next quarter will be, somebody has to run these numbers. (See also Federal Reserve Report Z.1, Table 8.) I've ballparked some numbers for Q4 based on reading some of the BEA data and a few forecasts, then started ratcheting up the deficit figure based on the CBO forecast. There's always a small statistical discrepancy, which I've left in. Note that most of what business saves is taken in replacement of What happens to the other numbers, is the question. Guesses are in billions of real dollars, at annual rates. I have a hard time making that data add up without either hypothesizing a massive increase in private saving, a collapse in investment, or a large run-up in trade deficits.

Twin Deficits 2008-09?
category 2008:IV 2009:I 2009:II
Residential investment 330

+Nonresidential investment 1350

+Government investment 100
equals: Total investment 1780

Household savings +275

+Business savings (retained earnings) +1500

+Government surpluses -650
+Foreign savings +700

equals: Total savings 1825

I don't know what happens here, but I think we're missing a story in the tale of economic woe for 2009.