The Deficit Obsession is Costing Us a Clear View of the Economy

The UK chart shows a government almost permanently in deficit, with the exceptions being the brief Lawson boom of the late 1980s and the dot-com era around 1999-2001, both of which coincided with private sector borrowing rather than saving. In 2008-2010 the government deficit widened sharply as the private sector moved rapidly into surplus following the financial crisis, and the same dynamic repeated again during Covid in 2020.

The austerity programme pursued by the Conservative/Lib Dem coalition from 2010 led to a sharp fall in the private sector’s surplus, which briefly turned negative around 2015-16 as the adjustment fell on output and incomes rather than on the deficit itself, and UK growth remained anaemic throughout the decade. The Rest of World (red) is consistently positive, reflecting the UK's structural current account deficit, that is, we import substantially more than we export, so the rest of the world accumulates sterling assets.

Both the current account deficit and the private sector's desire to save are structural features of the UK economy, which means the government deficit is not primarily a political choice: it is the arithmetic residual of those two other positions.

The IMF is forecasting that the private sector surplus narrows considerably in coming years as the Chancellor tightens fiscal policy. On the sectoral balance arithmetic, that adjustment has to land somewhere, and the historical record suggests it lands on growth and employment rather than on the deficit itself.

The US chart also shows a government (green) almost permanently in deficit and following roughly the same pattern. One notable feature of the pre-2008 period is that the US private sector (blue) was itself in deficit, and here it was households that were net borrowers: that was the credit-fuelled consumption boom that ended in the financial crisis.

Post-2008, the private sector has returned to surplus and has remained there, with the government deficit providing the net financial assets that underpin that saving. The Rest of World position (red) stays persistently positive, reflecting the US current account deficit: the world accumulates dollars and dollar-denominated assets, which is part of what sustains demand for US government debt. The world's exporting nations are, in effect, choosing to hold US government liabilities as the price of access to the American consumer market.

What the chart also shows, with rather more clarity than any political speech, is that successive Republican and Democratic administrations have denounced the deficit, promised to eliminate it, and then watched it persist regardless. This is not a failure of political will. It is the accounting asserting itself. As long as that arrangement holds, and as long as the US private sector wants to run a surplus, the government deficit is the residual that makes both positions possible. The theatre of deficit reduction has real costs: it shapes spending priorities, constrains public investment, and generates genuine anxiety among voters. The deficit itself, in a country that (for now) issues the world's reserve currency, remains stubbornly and necessarily present.

Germany presents the mirror image of the standard deficit-panic narrative. The private sector (blue) has been in substantial and growing surplus since the early 2000s, often exceeding 8% of GDP. But unlike the US or the UK, it is not the government that supplies most of those net financial assets: it is the rest of the world.

Germany's persistent current account surplus means the RoW (red) sits deep in deficit, financing German private sector saving through trade. The government (green) was in deficit through the 1990s post-reunification, then tightened toward balance and even surplus during the "schwarze Null" era of the 2010s, before Covid forced it back into deficit in 2020.

Not every country can run a current account surplus simultaneously: for every Germany accumulating claims on the rest of the world, there must be a corresponding deficit somewhere else. Germany's private sector wealth, in this sense, is built on its trading partners' deficits.

This is worth considering as surplus countries are often held up as models of fiscal virtue. If Germany's approach were adopted universally, the arithmetic would collapse immediately: there is no rest of the world for the entire world to run a surplus against. The virtue, such as it is, depends entirely on other countries absorbing the corresponding deficits. When a large economy pursues a persistent surplus through wage suppression, domestic consumption restraint, and export-led growth, it is not simply being prudent: it is exporting demand destruction to its trading partners and forcing their private sectors deeper into debt or their governments into larger deficits to compensate. The language of responsibility tends to only flow in one direction in these debates. It rarely reaches the surplus countries.

Japan is the most striking chart in the set. Since the mid-1990s, the private sector has run a surplus of between 8% and 13% of GDP virtually without interruption, reflecting an economy in which households and corporations have had an extraordinarily strong desire to save and accumulate financial assets.

The government deficit (green, below the line) has mirrored that almost exactly across the same period. Japan's Rest of World position is modestly negative, meaning Japan itself runs a current account surplus: the rest of the world borrows from Japan, which slightly offsets the private sector saving desire.

The chart demolishes the claim that large persistent deficits inevitably trigger bond market crises or runaway inflation. Japan has run government deficits of this scale for three decades; its private sector has the net financial assets to show for it.