Final Exam Question:
1: Explain the following equation:
Govt Injections + Foreign Injections = Private Sector Surplus
2. Explain the implications of this equation in terms of the appropriate level of Government Deficit and Taxation Policy.
Students have not answered the question on previous lecture: MAC 16B
STUDENT ANSWER: -- You must start by the accounting identity for GNP, then re-arranged it into the form above and THEN interpret the terms using the names above -- this part is done correctly below, but without the equation, it is not clear and does not make sense.
This comparison shows the accounting identity for the sectoral balances. We think of it in three sectors: the rest of the world that is outside the world (foreign sector); one is the government sector in the country and the third is the private sector. So what they actually say, total private surpluses are equal to government injections and foreign injections. So to the extent that you earn money by selling exports and not spending everything on the imports, this income you get injected into the economy from outside the country is called foreign injections. You have a surplus against the world that is exactly the shortage compared to the foreign sector. And as far as the government pays money to you (income), it does not tax; this income is collected by the private sector. It is another surplus that is injected by the government into the private sector. So government injections and foreign injections or government deficit and foreign deficit are the total sum of the private surplus. One sector has a surplus on the costs of the other two sectors.
2. Explain the implications of this equation in terms of the appropriate level of Government Deficit and Taxation Policy.
Answer:This answer discusses issues which are of secondary importance (but relevant). But in the first place, the question which differentiated MMT from standard understanding is that people think we should balance the budget. We should raise taxes in sufficient amount to pay for the givernment expenditure and reduce deficit to zero. The equation should be used to explain WHY this is not a good idea. Deficit -- RENAMED to injection -- is necessary because if we have zero deficit then private sector surplus will also be zero. This is what the answer should focus on.
To achieve the right level of budget deficits, the government is likely to use a combination of policies. An important factor is the timing of plans for deficit reduction. If the country is already in a recession, it is much more difficult to reduce the deficit, because fiscal consolidation generally worsens the economic situation, leading to lower tax revenues. In some cases austerity can even beat itself. Higher taxes increase revenue and help to reduce the budget deficit. Like cutbacks, they can cause lower spending and lead to a decline in economic growth. Again, it depends on the timing of tax increases. In a recession, tax increases can cause a significant drop in spending. During high growth, tax increases will not hurt spending as much. It also depends on the type of tax that you increase. Taxes can be increased across the board for all / each entity or legislators may decide to allocate that tax burden to specific groups of people (individuals with higher incomes, businesses, etc.). Lawmakers can also decide to reduce government spending. Similar to raising taxes, changes can be made to the tax code that increases tax revenue and also closes fiscal loopholes. If governments, on the contrary, try to reduce spending and raise taxes, as they begin to do in a misguided attempt to reduce government debt, private savings will be crushed.
MMT Ch 5 Sectoral Balances and Flow of Funds — Mitchell, Wray, Watts: Modern Monetary Theory, Chapter 5