the corporate sector, the household sector and the overseas sector ( the counterpart to the external balance of payments ). each sector may be in financial surplus or deficit, but the surpluses and deficits must, in accounting terms, sum to zero ( although in terms of available statistics they may not, because of errors and omissions ) ; every piece of deficit is necessarily matched by a piece of surplus. typically, one might envisage the savings surplus of the household sector being channelled through the banks and financial markets to fund a deficit in the corporate sector, arising from its capital investment and working capital needs. in this context the deficit in the corporate sector seems perfectly acceptable. why, then, should a deficit in the public sector raise particular anxiety? isn't the situation where the public sector has a funding need analogous to that where private sector corporate entities have such needs? not necessarily so. a number of factors may differentiate the two situations. what are these factors and what are the special considerations which may apply in the case of the public sector deficit? • first, when assessing the impact of different deficits one may need to look behind them, to associated developments in the real economy. for example, a financial deficit may reflect, at one extreme, spending on current consumption, and particularly on imports with no resulting benefit to domestic employment ; or it may reflect, at the other extreme, investment which generates jobs and greater efficiency within the domestic economy. if there is a suspicion – whether or not well founded – that a public sector deficit is inclined to the former category, it will be judged less helpful to the long - term health of the economy and thus tend to weaken financial confidence. a sizeable underlying public sector deficit may anyway be regarded as a sign of fundamental weakness in an economy, if it signifies too heavy an involvement of government in the running of the economy. it is these types of consideration which have led to the emergence of various recommendations and rules about fiscal deficits. there is, for example, the " golden rule " of the uk finance minister, gordon brown, which he first espoused in 1997, stating that, over the cycle, spending of a current ( as opposed to capital ) nature should be balanced by revenues, and borrowing should only be countenanced to cover capital expenditure. in europe there is the supposedly sacrosanct cap on the fiscal deficit of each of the member countries of the euro - zone, at 3 % of gdp. and in hong

to unravel acutely. foreigners take fright and don't wish to roll forward their lending, or will only do so at a much higher margin. the country can ’ t afford higher foreign currency interest payments, still less to make net repayments of principal on foreign borrowing. domestically the only means left by which to cover the deficit is for the central bank to fund it. this means that the central bank lends to the government virtually on demand by, effectively, crediting the government ’ s bank account – resort to the printing press in all but name. whether this lending carries an interest rate or not is largely immaterial, since the central bank can continue at the stroke of a pen to create the money to pay the interest. this procedure will inevitably be inflationary, but a wayward government may welcome this as a means of reducing the real value of its outstanding domestic debt. it may even feel that inflation will aid its current financial position, if its revenues inflate faster than its outgoings. all of this is a clear recipe for disaster, including, probably, an exchange rate crisis. between these two extremes – the us and the no - hoper – there are of course many cases where the situation is less clear - cut or less predictable. euroland provides an interesting example. given the careful steps which were taken before the advent of the euro to ensure the insulation of monetary from fiscal policy and to outlaw monetary financing of budget deficits, we might wonder why the news of impending budget overruns should cause the euro to weaken. it seems that not only do credit spreads faced by individual deficit countries widen ( presumably for fear, however slim, of sovereign default ), but also the currency weakens for fear of governments conspiring with the central bank to abandon its mandate against inflation or to break the rules against monetary financing. a rather different interpretation could be that foreign exchange markets are merely exhibiting a pavlovian reaction : having been brainwashed to the effect that a deficit is inherently bad if it surpasses certain preannounced limits, the reaction when such a breach does occur is bound to be negative, even if analysis of the substance underlying the breach provides little or no justification for such a reaction. in the context of trying to identify a relationship between the fiscal position and the exchange rate, these examples demonstrate that there is no simple, pre - ordained relationship. the outcome depends on a wealth of factors, including the nature of the disturbances affecting public finances