One of the first things an economic student learns is the basic national income definitions. The best known simple definition of the aggregate components of national income is: Y = C+I+G+(X-M) and the disposition of income is Y=C+S+T. I shan’t bore you with the specific meanings since you can look them up in any basic macro textbook. Suffice to say that simple substitution yields:
(S-I) + (T-G) = (X-M)
This definition really is important! (S-I) is the ‘private savings balance’ or the difference between private sector savings (S) and investment (I); (T-G) is the ‘government balance’ or the difference between tax receipts (T) and all government expenditure (G); (X-M) is the difference between exports (X) and imports (M) and is usually called the simple ‘current account balance’. Why is the above bit of mumbo-jumbo so important? Because it shows the inter-related nature of the government deficit and other key components of national income.
To understand the principle involved, let’s suppose that at the current level of national income and employment the current account is in balance; ie, (X-M) = 0. Let’s assume too that there’s a private sector savings surplus of 10 units, or (S-I) = 10. Substituting into the above, the ‘government balance’ must be negative, or (T-G) = -10. If the private savings balance increases to 15, ceteris paribus the government balance or ‘the deficit’ must also widen to -15; this is precisely what happens when firms and households try to rebuild their savings after over-leveraging. But if simultaneously the external account improves by 5 units, or (X-M) = 5, the government account (T-G) can remain at -10.
In short, the ‘deficit’ cannot be cured simply by cutting expenditure (G) and raising taxes (T) as some politicians would have us believe. Any attempt to do so will have repercussions on other variables—including on the level of national income itself. This in not ‘Keynesian economics’; rather, it follows from basic national accounting principles.