Philip Arestis and Malcolm Sawyer University of Cambridge and University of Leeds

Introduction  The well-known relationship  G- T = S - I - NX = S – I + FA  G: government expenditure; T tax revenue; S private savings; I private investment; NX net exports including net income (= -FA: financial account)

 Why are there budget deficits? excess of savings intentions over investment intentions;  Sustainability of deficits and sustainability of private sector surplus (e.g. UK’s position circa 2007);

 Sustainability of what?  Primary or total deficit?  Debt or net asset position?  Private surplus or public deficit?

 The reverse causality argument;  Low investment --low growth of the capital stock -- need for budget deficit;  Leading to low growth--high public debt relationship.

 The 'functional finance' idea  The sustainability of the 'functional finance' deficit  As interest payments on outstanding debt rises, stimulates demand, lowers required budget deficit, and debt reaches sustainable level

 The role of structural budget positions, and requirements for balanced structural budgets.  The problematic nature of ‘potential output’ (y*).  The link of ‘potential output’ and the Phillips curve: p = pe + f(y); f(y*) = 0.

 Budget deficit = Private sector net savings plus financial account  A balanced structural budget requires a balanced structural private sector position  Hence it requires that:  S* - I* +FA* =0; where * signifies ‘average’ or ‘structural’ level of the variable concerned

 Calculations of structural budget position require a consistency check: that is does  SBP = S* - I* +FA* ?  A shift in the structural budget position (SBP) would entail a corresponding shift in a combination of savings, investment and current account behaviour

 Reducing the structural budget position does not make sense unless there is reason to believe that there is corresponding shifts in private behaviour.

 What should the structural budget position look like?  Question: what levels of output and employment to use in the calculations?  Structural budget position should be set to ensure the desired levels of output and employment reached

 Structural budget position would be sustainable (provided that the private sector behaviour is sustainable)  However, average budget deficit likely to be larger than structural budget.

 The UK and EMU (through ‘fiscal compact’) aim to balance their structural budgets;  This has in general not been previously attained and little reason to think that it would be achievable in future;  ‘There is no alternative’ to a substantial budget deficit;

 The need for UK policy makers to recognize that a sustainable high employment budget position involves a significant deficit;  Arguments against budget deficits on grounds of not being sustainable are in general flawed.

 The reduction in the scale of structural budget position requires some combination of rise in ‘structural’ investment, decline in ‘structural savings and rise in net exports;  Limits on rise in ‘structural’ investment  Limits on rise in net exports

 An egalitarian shift in the distribution of income would help reduce the structural budget deficit;  So perhaps there is a partial and progressive alternative to structural budget deficit.