William Dudley on Budget Deficits

New York Fed Chief William Dudley gave a speech yesterday called “U.S. Economic Policy in a Global Context” (hat tip Yves Smith). Dudley’s overall aim was to show that one must regard US policy in an international context and not based on domestic factors alone. I think the whole Speech is worth reading but I wanted to highlight this section below on macro accounting identities. I have bolded he relevant parts:

we all have to bear in mind that current circumstances put stress on the support for open global markets in the developed world.

On the U.S. side, the recovery remains distinctly subpar in spite of aggressive monetary and fiscal stimulus. On the monetary policy front, short-term rates remain near zero and the Federal Reserve is just about to complete its $600 billion Treasury purchase program. On the fiscal policy front, the U.S. government has engaged in large stimulus program. This supported demand and employment while the private sector shifted its saving balance into surplus in an effort to repair balance sheets.

However, the large size of the fiscal deficit and the rapid increase in the country’s federal debt-to-GDP ratio means that this is not sustainable for much longer.

Ultimately, the composition of economic activity in the United States needs to be rebalanced. There are two issues here. First, the consumption share of GDP may still be too high. Second, the need for U.S. fiscal consolidation implies that there will have to be offsetting increases in investment and the U.S. trade balance as the recovery proceeds.

To illustrate this second point consider the following accounting identity:

The public sector balance + the private sector balance = the current account balance

Right now the identity holds as roughly:

-10 percent of GDP public sector balance + 7 percent of GDP private sector balance = -3 percent of GDP current account balance.

If the public sector balance must over time move from around -10 percent to around -3 percent to stabilize the federal debt-to-GDP ratio at tolerable levels, then the private sector balance and the current account balance must move by roughly 7 percentage points of GDP to take up the slack.

Assuming that the consumption share of GDP still needs to fall over the medium term, the adjustment in the U.S. private balance will have to occur primarily in terms of rising residential or business fixed investment.

There does seem to be room for business investment to expand significantly when firms become more confident in the economic outlook, provided that the United States remains a competitive location for investment. But residential investment is unlikely to climb very much for some time given the chronic overhang of unsold homes.

If these two sectors cannot take up all the slack created by necessary fiscal retrenchment in the years ahead—as seems likely—then the U.S. trade balance will need to improve as well. This implies that EMEs will no longer be able to rely on expanding U.S. demand as a key driver of their own economic growth.

I said last month:

“I wouldn’t poo-poo these accounting tautologies. They are real. They have value and they help you understand what’s happening in the economy. The reality is the non-government sectors cannot net save unless the government is deficit spending. The only way the private sector can pay down it’s debt burden is through a net negative shift in trade or government balances. The other way to reduce debt burdens is through debt forgiveness and default. With the U.S. household sector highly indebted, these are the choices”


Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty five years of business experience. He has also been a regular economic and financial commentator on BBC World News, CNBC Television, Business News Network, CBC, Fox Television and RT Television. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College.


  1. Wynne Godley must be smiling in his grave. So now, what is the plan to either a) turn the trade deficit around or b) increase corporate reinvestment of profits in the US because this cannot be done through c) household sector returning to deficit spending given demographics, housing price deflation, etc.? That is the corrolary discussion that must go on whenever fiscal deficit cutting is on the table – yet it does not, because few policy makers, economists, and institutional investors realize that double entry book keeping applies to macroeconomics as well. That is what 3 decades of micro based macro theory has accomplished. Good to see Dudley is able to state openly that fiscal deficits cannot be analyzed while ignoring other sector financial balances. Maybe more people will start to get it.

  2. The problem I had with the Dudley comments go to causality – and your comments highlight this. The causality goes from the external variable of public policy to internal variables of changes to the national accounting identities. What I mean is that public policy acts like an exogenous economic shock. So to the degree that you have policy designed to reduce gov’t spending, the right way to think of the effect is regarding the reaction to that reduction in the private sector. Unless we see a capital spending boom or an unrelated reduction in household savings, I don’t see how this will work.