The Circular Flow and National Accounts
Circular Flow &
National Accounts.
Every sector’s financial surplus has a counterpart elsewhere. Learn to derive sectoral balances, distinguish stocks from flows, and read deficits without abandoning accounting logic.
Observe
Find the counterpart.
One sector cannot accumulate
a financial surplus alone.
If households and firms together receive more income than they spend, they acquire financial claims. Those claims must correspond to liabilities or deficits elsewhere—in government, the foreign sector, or both.
A government deficit is simultaneously non-government net financial income; this identity alone does not tell us what caused the deficit or whether it is desirable.
Think
Derive the balances.
Rearrange national income into
three financial positions.
Begin with the expenditure and income identities. Equating them and rearranging reveals the private domestic balance, the government balance and the foreign balance. Their sum must equal zero.
S − I
Saving minus investment: net lending when positive.
T − G
Taxes minus spending: public surplus when positive.
M − X
Imports minus exports: foreign surplus against the domestic economy.
Analyse
Make every balance add up.
Construct a
sectoral-balance ledger.
Choose private saving, investment, taxes and government spending. The foreign-sector balance adjusts as the accounting counterpart required for the three balances to sum to zero.
National-accounts laboratory
STOCK–FLOW CONSISTENT
Sector balances (€bn)
The foreign sector records a €10bn surplus against the domestic economy.
Apply
Connect flows to balance sheets.
Today’s flow changes
tomorrow’s stock.
A deficit or surplus is measured over a period; debt and wealth are measured at a point in time. Repeated deficits can add to debt, but valuation changes, defaults and asset-price movements can also alter stocks.
Income, saving, deficit
Measured over a month, quarter or year. Saving is a flow that adds to wealth.
Wealth, debt, capital
Measured on a particular date. A stock is the accumulated result of past flows and valuation changes.
Identity
If the private sector and foreign sector are both in surplus, government must be in deficit.
This follows from accounting.
Causal interpretation
The government deficit caused the external deficit.
This cannot be established by the identity alone.
Decide
Reason from the identity.
Which balance must
complete the system?
The private domestic sector has a surplus of €40bn and government has a deficit of €25bn.
MACROECONOMICS · MODULE 03 COMPLETE
You can now make
the accounts speak.
Sectoral balances reveal the financial counterparts connecting private, public and foreign positions. Accounting consistency is the beginning of macroeconomic explanation—not its conclusion.
