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More National Income Accounting

GDP data are important by themselves. However, by deriving a series of other measurements, one can compute how much of GDP is left as spendable income in the private and government sectors, which allows one to construct a "budget constraint" for the economy as a whole.

To get from National Income to Disposable Income (DI), which is the income that people can either spend or save, a number of adjustments must be made. First, that part of corporate profits that never reaches households, retained earnings and corporate taxes, must be deducted. Next, adjustments must be made in interest so that it includes only and all interest payments reaching households. Then, payments to the government for social security and related programs must be subtracted, and transfer payments from the government for these programs and other programs must be included. Finally, business transfer payments, which include donations to non-profit organizations and the write-off of bad debt, are added. This gives what is called Personal Income. Some of Personal Income must be paid as taxes. What is left, Disposable Income, is either spent or saved.

There is a point to all these computations. In deriving disposable income from GDP, we separated amounts flowing to households from the rest of GDP. In the process, we can see where the rest goes. Some stays in the business sector as business savings. Retained earnings and depreciation are important parts of this sum. Some income ended up with the government. The amount left in the government is the total of taxes less all transfers. Finally, somewhat lost in the numbers are some transactions involving foreigners. They pay us interest, we pay them interest, and there are also transfers in the form of aid. Let us call this total "Foreign Transfers (Tf).

This separation allows us to write GDP in a way that shows how much each sector (household, business, government, and foreign) is left with:

(2) GDP = DI + Business savings + (Taxes - Transfers) + Tf

Disposable income is either consumed (C) or saved (S). If savings by households is combined with business savings to get savings by the private sector (S), equation 2 can be written:

(3) GDP = C + S + (Taxes - Transfers) + Tf

Since equations 1 and 3 are both ways of arriving at GDP, we can combine them as:

(4) C + I + G + Xn = C + S + (Taxes - Transfers) + Tf

Reorganizing, and letting consumption cancel from both sides, gives:

(5) (I - S) + (G + Transfers - Taxes) + (Xn - Tf) = 0.

Equation 5 is a constraint that the economy as a whole faces. It may not mean a great deal to you when you first look at it, but in fact it is an important equation. Consider what the contents of each set of parentheses mean. The first term tells us about the private sector. If investment is greater than savings, the private sector must borrow to finance the extra investment. If savings is greater than investment, the private sector will lend to other sectors.

The middle term, (G+Transfers-Taxes) is the government deficit or surplus. Total government expenditures equal its purchase of goods and services plus its transfers. If these are larger than tax receipts, the government has a deficit, and must borrow to cover it.

The last term indicates the borrowing or lending of foreigners to finance foreign trade. When foreigners buy from us, they must have a source of funds. One source is selling to us. If they sell less than they buy, they must borrow the difference from us. If we buy more from them than we sell to them, we must borrow the difference from them.

We have arrived at a simple result in a complex way. In any market the purchases of buyers must equal the sales of sellers. Equation 5 shows this for the market for loanable funds. If someone borrows $100, then someone else must lend $100. Equation 5 divides up all transactors in this market into three groups, the private sector, the government, and the foreign sector and says that not all sectors can borrow at the same time. When one borrows, another must be lending. Financial markets link the decisions of people who may have no idea that their decisions are in fact connected.

The table below puts some numbers from the U.S. economy into this equation. Notice how dramatically foreign borrowing changed in just two years. In 1984 the United States had a huge deficit in its balance of trade--it bought much more from foreigners than it sold to them. The table says that the dollars that foreigners earned on these sales were returned to the U.S. government and businesses in the form of foreign loans.

The U.S. Budget Constraint



Investment - Savings


Government Deficit


Foreign Borrowing


Statistical Discrepancy


Sources: Survey of Current Business, Nov. 1984, 1985. Amounts are in billions of dollars; a negative represents lending to credit markets and a positive represents borrowing. The "statistical discrepancy" occurs because there are errors in measuring the components.

It would be nice if the table could tell us why the large amount of foreign lending to the U.S. suddenly occurred. However, neither the table nor the equation on which it is based can do that. They simply tell us that there are connections among the sectors of the economy. If the government sector runs a larger deficit, for example, other sectors must finance the deficit and thus they will be affected. Although the equation clearly shows that a change in the government's deficit will affect other sectors, it does not tell us what the effects will be. For this we need economic theory, and in this we do not find consensus among economists. On one hand, Keynesian economists (those who draw inspiration from the writings of John Maynard Keynes) have argued that an increased deficit may increase savings by more than the increased deficit, and thus actually increase investment. On the other hand, non-Keynesians have usually argued that the increased deficit will have little effect on savings and will crowd out investment. Explaining these theories is the major task of a course in macroeconomics.

We have saved the best for last. There is another way to see the interconnections among sectors.

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