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During a pandemic, private sector financial behaviour becomes more risk-averse would like to move into surplus....

During a pandemic, private sector financial behaviour becomes more risk-averse would like to move into surplus. Suppose that the foreign sector also runs a surplus. What does this imply for the government financial balance? Under what circumstances is it possible for a country to run a government surplus and a domestic private sector surplus at the same time?

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Expert Solution

The government fiscal balance is one of three major financial sectoral balances in the national economy, the others being the foreign financial sector and the private financial sector. The sum of the surpluses or deficits across these three sectors must be zero by definition. A surplus balance represents a net savings or net financial asset building position (i.e., more money is flowing into the sector than is flowing out), while a deficit balance represents a net borrowing or net financial asset reducing position (i.e., more money is flowing out of the sector than is flowing into it). Each sector may be defined as follows, using the U.S. as an example:

  • Private sector: A surplus balance means U.S. households and businesses together are net savers, building their financial asset position. In other words, savings by households exceed the amount borrowed and invested by businesses. There is a net inflow of money into the private sector. The private sector had a 4.4% GDP surplus in 2019.[3] A deficit would mean households and businesses together are net borrowers, reducing their financial asset position.
  • Government balance (all levels, e.g., federal, state and local in the U.S.): A surplus balance represents a government collecting more tax revenue than it pays in outlays, building its net financial asset position. This would mean the government is a net saver, removing funds from the private sector. A deficit balance means government outlays are greater than tax revenue and it is reducing its net financial asset position (i.e., increasing its debt position), providing funds to the private sector. Another interpretation is that a government surplus reduces private sector financial assets, while a government deficit increases private sector financial assets. The U.S. government at all levels ran a 7.2% GDP deficit in 2019.

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