One of the most enduring metaphors in public discussions of government finance is the comparison between the federal and household budgets. The argument goes like this: “Just as households must balance their budgets and live within their means, so must the government.” While this analogy may seem intuitive, it is based on several misunderstandings about household and government finances.
The Mortgage Fallacy: Do You Really “Own” Your Home?
Many people who say that the government should “live within its means” are homeowners. However, most homeowners still need to own their homes free and clear; they are still making mortgage payments. Essentially, they are in debt, but they manage this debt responsibly by making regular payments while hoping the asset (the house) will appreciate over time.
Similarly, governments take on debt with the expectation that investments in infrastructure, education, healthcare, and other public services will yield economic growth, outpacing the cost of borrowing.
Interest Payments: The Real Yardstick
For households and governments alike, the critical issue is not eliminating debt but managing it responsibly. A household can sustain a mortgage if it covers monthly payments, including interest. Similarly, governments must manage their debt to cover interest payments. In this sense, carrying debt is not intrinsically irresponsible or problematic; what matters is the ability to service that debt.
Money Does not Grow on Trees, But It is Not Just Printed, Either
The notion that central banks merely “print money” is a simplification that obscures the complex mechanisms of monetary policy. When a central bank creates money, it is generally loaned into existence, meaning interest must be paid. The aim is that the loaned money will facilitate economic activities that yield a rate of return higher than the interest rate on the borrowed money.
Investment vs. Expenditure: The Case of the Savvy Homeowner
Imagine a homeowner with five properties worth $5 million but $4 million in outstanding loans. Although his net worth is only $1 million, he is not in financial trouble. His assets are investments expected to appreciate, yielding a return more significant than the cost of his loans. Governments operate on the same principle when they invest in projects that boost GDP growth.
Apples and Oranges
The household budget analogy needs to capture the nuances of government financing. Governments, unlike households, have a much longer timeframe for their investments and the ability to influence economic conditions directly, affecting their income (tax revenues). The primary goal should not be a blind reduction of debt but strategic management of debt to maximize public benefit and economic growth. Thus, next time someone says, “The government should balance its budget like a household,” remember that the two are not as similar as they may seem at first glance.
