The national accounting equation is an accounting of this year’s composition of national income as caused by the different actors of the economy. The GDP/Income equation by itself doesn’t tell us anything about what will cause income or savings or consumption to rise or fall, and it’s wrong to assume we can infer anything other than this year’s composition. The equation also does not tell us anything about what makes people desire more consumption or investment. All we know is what cleared, i.e., what goods were bought/sold.
1. Y = C + I + G + X - M
Income = Consumption + Investment +Government spending + exports - imports
2. S = Y - T - C
Savings = income -tax - consumption
do not answer the question 'What causes Y to rise or fall?' or 'What causes S to rise or fall?' We need completely new tools that better describe about flow and causation. We cannot infer flows from one factor going to other factors of the equation, and hence cannot infer from the equation which factor creates new money and hence increase general income level.
This is why many economists are in disagreement and each tends to use the equation to bolster his belief of what is needed to improve the current economic environment. Some believe that it is private sector C and I that increases Y, and that G, which drains money via T, lessens private sector S and therefore their C and I.
But it is equally believable, and in fact, a more compelling explanation, that it is G that increases Y and therefore helps induce more private sector C and I. If you have no government deficit spending, there is no new currency to go around, nothing to save, no money people can use to spend, no money to buy Government treasuries with.
Why is the concept that money should be existing first before government can borrow it more believable than the concept that government has to issue money first by spending before people can have money to lend back to government? Did some people create the first money before government decided it can take some away via T? How then did those people decide when to stop creating money? Why can't anyone just create money now as he likes? What mechanism made everyone at that time stop creating together? In other words, why is the framework that people created money easier to accept than the framework where government created it?
Equation 2 above for example leads some people to make this statement: “if you like, you could define S as “national saving” to include both private saving plus government saving.” Why claim that national saving is government plus private saving? Doesn’t a flow from one lead to an increase in stock of the other? I.e., ‘Private saving’ increases with more government spending, and ‘government saving’ increases with private dis-saving (greater taxation), and at an extreme (forgetting foreigners) adding both together results in zero.
Now let's think beyond the domestic system, to get to the X and M of national accounting equation. If there is more M than X, then money is getting out of the domestic economy. This by itself would mean that in the next period, there would be less domestic Y to fund that period's C and I. G will have to increase, such that it may need more funds than what it can get via T. If there is less money now in the economy, how does G fund itself? Where would the Government Treasury buyer's money come from?
Well, if money is getting out of the system, someone outside is getting more money than he wants to consume. That person now has excess reserves of money. In the extreme that everyone in the domestic system is short money, therefore cannot fund G, perhaps because in the last period they all spent their last cent buying the latest gadget from Mr foreigner, then those dollar reserves now owned by Mr. Foreigner is brought back into the domestic system via G, funded by treasury sales to Mr Foreigner.
Those excess reserves could not have gone to Mr Foreigner's bank account unless they were issued into existence first. That's why there's most often a buyer when the government issues a treasury, because the previously issued and spent dollar eventually gets to someone who just needs to save it for future consumption.
In short, G enables Y not to fall even when X-M is a negative number. G also creates the Y that enables both domestic and foreign investors to fund future G that is funded by borrowing.