Accounting Identities in Macroeconomic Theory

Wolf (2012) explains how Wynne Godley used the accountant’s articulation of flow accounts—income and cash flow statements—on the one hand, with the stock account—the balance sheet—on the other. Godley focused on the financial balances in the accounts of the various sectors of the economy (personal, corporate, government, and overseas) governed by the principles of double-entry bookkeeping. In Wolf’s words:

The essential idea is that since income has to equal expenditure for the economy, as a whole (which is the same as saying that savings equal investment), so the sums of the differences between incomes and expenditures of each of these sectors of the economy must also be zero. These differences can also be described as ‘financial balances’. Thus, if a sector is spending less than its income it must be accumulating (net) claims on other sectors. The crucial point is that, since sectoral balances must sum to zero, a rise in the deficit of one sector must be matched by an offsetting change in the others. It follows that if the fiscal deficit is increasing, the sum of the surpluses of the other sectors of the economy must be increasing in a precisely offsetting manner

This framework of accounting identities, developed, for example, in Godley and Lavoie (2007), has been deployed to analyse the recent recession. In the wake of the banking crisis, the private sector in leading Western economies has been paying down debt rather than spending; the increase in net private sector saving has not been matched by the increase in government borrowing, and this, it is argued (e.g. by Koo 2011) contributes to ‘balance sheet recession’.

The accountant in Godley is not just evident in his models being disciplined within an accounting framework. Some of his colleagues told me at the time that what gave Godley his ‘edge’ in forecasting, leading to some of his famously prescient predictions, was his intimate understanding and knowledge of the national accounts (the data he had pored over in his work at the Treasury).