What is the sectoral balances framework?

The sectoral balances framework, developed by British economist Wynne Godley, is a powerful accounting identity that shows the relationships between government, private sector, and foreign sector finances.

The framework states that: Government Balance + Private Sector Balance + Foreign Balance = 0

In other words, if the government runs a deficit (spends more than it taxes), the private sector and/or foreign sector must run equivalent surpluses. And if the government runs a surplus, the private sector and/or foreign sector must run deficits.

For the United States, which typically runs a trade deficit (meaning the foreign sector is in surplus, accumulating dollars), the equation means that government deficits are necessary for the private sector to save in aggregate. If the government tried to balance its budget while the trade deficit continued, the private sector would have to go into debt or run down savings.

This framework helps explain why attempts to balance the federal budget often lead to recessions. When the government cuts deficits, it forces the private sector to reduce savings or increase debt. Eventually, this becomes unsustainable and the economy contracts.

The sectoral balances approach grounds economic policy in accounting identities - not theory or ideology, but mathematical relationships that must hold true. It's one of the key analytical tools MMT economists use to understand macroeconomic dynamics.