The Government is not a Household

One of the most damaging misconceptions in the public policy debate is the likening of the government budget to that of a household. In a modern monetary system – i.e. one involving a flexible exchange-rate fiat currency – the analogy is inapplicable. Private households and firms are financially constrained. They must earn, borrow or otherwise obtain currency before they can spend it. The government, in contrast, is not financially constrained. It faces resource and political limits, but not revenue constraints other than those voluntarily self-imposed.

This point is well recognized by MMT economists. For instance, here is a good article on the topic by Randall Wray. However, the myth is a stubborn one, so I thought it might be worth reiterating the point. I was prompted to do so after reading a post on a private message forum. I think the post is interesting as an illustration of the understandable but faulty reasoning to which many succumb. On one level, it sounds so “reasonable”, yet it is false and utterly counterproductive. It is reasoning that causes many unwittingly to vote against their own interests.

We often hear the comparison of family budgets to the federal budget. When you consider the amount of private debt in this country, it seems clear to me that our government is doing on a large scale what its constituents have been doing on a smaller scale. Most of us seem to be head over heels in debt, and now the government is falling into the same trap.

There is no awareness in this comment that the dependency of the non-government sector on private debt was exacerbated by fiscal austerity in the lead up to the crisis. As a matter of accounting:

     Government Deficit = Non-government Surplus

The non-government sector cannot be in surplus (earn more than it spends) unless the government is in deficit (spends more than it taxes). If the government reduces its budget deficit, non-government net saving is reduced by the same amount. For a more in-depth discussion of this accounting identity, see Budget Deficits and Net Private Saving.

When the government runs a budget surplus, the non-government sector is forced to run down its net savings dollar for dollar. In the article linked to above, Randall Wray points out that in the case of the US, every time the government has run a succession of budget surpluses, recession or depression has followed very soon after. It has happened seven times in the nation’s history.

Eventually, the fiscal austerity means that growth can only be maintained through the unsustainable accumulation of private debt. Private debt matters because private households and firms, as users of the currency, are financially constrained. Government, as the issuer of the currency, faces no financial constraint. It makes little sense to push the financially constrained non-government increasingly into debt just so the financially unconstrained government can avoid going into “debt”.

The poster continued:

My wife and I made the decision years ago to get out of the never-ending death spiral of personal debt and we’ve been quite happy with that decision ever since.

I share the feelings of the poster on this point. Others may feel differently. It is a position that is not dictated by MMT. But, to me, private debt spells dependency. However, the reason it does so is that, unlike the government, we are financially constrained. We can’t just create fiat money for ourselves out of thin air. If we could, I doubt we’d bother to pretend we were going into “debt” to pay for things.

I also think the attitude of the poster and his wife, to the extent that it involves a retreat from materialistic aspirations, is a sensible one in terms of environmental sustainability. I discussed my perspective on this issue in a previous post. Again, political choices such as this are not dictated by MMT, which is open on such matters, but personally I think that as a society we need to develop a deeper interest in environmentally sustainable activities. There is endless scope for intellectual, scientific, artistic, physical, sporting, social, spiritual, recreational, etc., activities that are more consistent with environmentally sustainable living than a narrow pursuit of material possessions. Our economic activities could be based more on such non-material pursuits.

But then the poster goes on to contrast his household’s choice to avoid dependency on private debt with what he sees as irresponsible government behavior:

I don’t think our politicians are capable of making the same decision on debt, regardless of their party affiliation.

In view of the accounting fact that the government deficit equals the non-government surplus, it would clearly be counterproductive for government to make the same decision as the poster’s household. If the government is determined to be in surplus, then in aggregate, and by definition, the rest of us have to be in deficit, whether we like it or not.

If, on the contrary, we decide in aggregate that we want to net save, and the government doesn’t fight this decision, the result will be income adjustments that put the government’s budget into deficit to the extent of our desired net saving.

And this latter approach to fiscal policy would be the appropriate one. Budget deficits are not a problem for governments in modern monetary systems when they are consistent with non-government net saving intentions at full-capacity output.

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32 thoughts on “The Government is not a Household

  1. This point – that the govt. deficit = non-govt. surplus – seems so self-evident once you think about it that it keeps amazing me how on earth anybody could dispute it. Can you identify what exactly prevents people from appreciating this point?
    And it is not only laymen. I am not an economist, but the sectoral balances identity
    G-T=S-I+M-X
    is supposedly taught in any introductory macroeconomics course, is it not? If so, how could economists fail to understand this? Is there something we are missing?

  2. Very interesting question. I started to compile an answer, and it kept getting longer, so I have decided to make it the next post. 🙂

    I don’t think it’s possible to know the definitive answer for why people think the way they do, but I do think there are identifiable reasons why orthodox economists tend to adopt a different (in my view, incorrect) interpretation of the identity. I’ll give my take in the post, but I would be interested in reading alternative explanations others may have.

  3. vimothy: Planned net saving as opposed to actual. There is no mention of government’s real income.

    There is a suggestion that government expenditure can be used to activate idle resources that would otherwise remain unused and taxing can be used to remove some private spending power that otherwise might compete for resources. If there are idle resources, deficit expenditure can be used to effect a net increase in resource usage. There is a suggestion that the government’s capacity to net spend is not constrained by a lack of money but by its ability to transfer resources from the private to public domain. The latter depends on the availability of resources and tax-driven demand for the currency.

  4. Peter: but nobody plans to “net save”: it is a residual term at the aggregate level.

    Real income comes in in terms of the neoclassical derivation of budget constraints for different economic agents (households, firms, governments), which you refer to in your post.

  5. vimothy: Actual (ex post) saving comes out as a residual, but it may differ from planned (ex ante) saving. Likewise, actual net saving (saving minus investment) can differ from planned net saving.

    For example, if the private sector attempts (plans) to cut back expenditure (increase saving) to pay off debt/repair balance sheets, it will only succeed to the extent desired if the budget deficit is sufficient to support this higher intended level of saving. If the government cuts expenditure or raises taxes, this will partly defeat the private-sector saving efforts. The attempt to increase net saving will partly fail, and plans will be unrealized.

  6. Peter D,

    “This point – that the govt. deficit = non-govt. surplus – seems so self-evident once you think about it that it keeps amazing me how on earth anybody could dispute it. Can you identify what exactly prevents people from appreciating this point?”

    My theory is that many people are aware of this but that they don’t want to have it widely understood because the people who now understand it are people with money; who also believe in the quantity theory of money. So, they think that any more Government creation of net financial assets will devalue their own financial assets. On the other hand, the people who don’t understand it are working people, who are being fooled by the Household analogy. And if they begin to understand the truth then they’ll want more Government spending then now; and, the people with money fear, that will result in inflation and losses in the real value of their own financial position.

    So, in my view, this is about greed, as much as it is about lack of understanding.

  7. Peterc:

    No one plans to “net save”! Just think about it: how often have you ever planned to “net save”? When you planned to net save, did you succeed or fail?

    It is literally impossible for you personally to “net save”, just as it is impossible for any individual household or firm to net save. Therefore it is obviously impossible for any individual economic actor to plan to net save. This concept (“planned net saving”, desired net saving”) gets knocked around Neo Chartalist blogs a fair bit and is leaky as hell.

    Net saving is a residual at the aggregate or macro level—you guys cancel the private nominal flow of investment against the private nominal flow of saving to produce something you call “net saving”. It is not clear to me that the difference between these two nominal flows is especially significant, but regardless it’s obvious that we can’t plan to “net save”.

    Now, what happens when (for example) households try to save on aggregate? Output that would have been consumed is invested in capital goods and the potential productive capacity of the economy is increased. Aggregate intertemporal trade, baby! There is no other way for the economy as a whole to save (saving = intertemporal trade = lower current consumption & higher future consumption).

  8. vimothy: Just to be clear we are on the same page, actual investment includes planned and unplanned investment, the latter referring to unanticipated buildups or rundowns of inventories. Take a two-sector closed economy model. Actual saving equals actual investment by definition in such a model, but there will be impetus for behavioral change if planned investment differs from planned saving. Actual net private saving must be zero, but planned net private saving need not be. If it’s not, there will be output or price responses. The notion of a macro equilibrium requiring realized plans is not specific to MMT.

  9. “actual investment includes planned and unplanned investment, the latter referring to unanticipated buildups or rundowns of inventories. Take a two-sector closed economy model. Actual saving equals actual investment by definition in such a model, but there will be impetus for behavioral change if planned investment differs from planned saving.”

    Agreed. All of that makes sense.

    “Actual net private saving must be zero, but planned net private saving need not be.”

    Woah there–does not follow from the preceding para. What just happened? Where does this “planned net saving” come from?

  10. People plan to save and they plan to invest, but no one plans to “net save”, where “net saving” is the difference between the nominal flow of private saving and the nominal flow of private investment.

  11. There is a further problem with this idea. Let’s posit an aggregate unit who can, in fact, plan to save nominal income net of nominal investment. Why, exactly, would this hypothetical aggregate unit (aggregore!) want to acquire these non-productive financial assets? Saving net of investment is saving that does not increase future potential output by definition, and so is not saving that facilitates intertemporal trade.

  12. vimothy: Thanks for your clarification.

    Saving net of investment is saving that does not increase future potential output by definition …

    It also results in unemployment and idle capacity unless net exports and the budget deficit are sufficient in combination to maintain full employment. Leaving resources idle provides no benefit for the future. That is just foregone output that can never be got back. There is also nothing to stop the government using its expenditure to invest productively in whatever degree it deems appropriate, subject to resource and political constraints.

    People plan to save and they plan to invest, but no one plans to “net save”, where “net saving” is the difference between the nominal flow of private saving and the nominal flow of private investment.

    In aggregate, there is a level of (monetary) investment planned, and a level of (monetary) saving planned. Planned net saving is just short hand for aggregate planned saving minus aggregate planned investment. Both these planned magnitudes cannot be realized unless net exports and the budget deficit in combination enable them to be realized.

  13. Peter,

    “In aggregate, there is a level of (monetary) investment planned, and a level of (monetary) saving planned. Planned net saving is just short hand for aggregate planned saving minus aggregate planned investment. If aggregate planned saving exceeds aggregate planned investment, both these planned magnitudes cannot be realized unless net exports and the budget deficit in combination enable them to be realized.”

    So what you mean is not that individuals want to “net save”, but that their (the consolidated non-govt sector) planned saving on aggregate is greater than their planned investment, and that this reduces nominal income and increases unemployment.

    But observe that this “net saving” is totally unproductive (in terms of increasing potential output in the future—conditional on the caveat below). What the consolidated private sector desires is not “net saving”, but real investment equal to their planned saving.

    “There is… nothing to stop the government using its expenditure to invest productively in whatever degree it deems appropriate”.

    Agreed. Govt spending can represent investment (gross capital formation), consumption (government consumption expenditure) or straight transfer payments.

  14. “But observe that this “net saving” is totally unproductive (in terms of increasing potential output in the future—conditional on the caveat below). What the consolidated private sector desires is not “net saving”, but real investment equal to their planned saving.”

    Because to the extent that “net saving” really is saving net of investment, it’s not actually saving.

  15. “Because to the extent that “net saving” really is saving net of investment, it’s not actually saving”

    Of course its saving. It simply shows that investment precedes saving. Saving is the residual of investment. One cannot save their way to prosperity but they can invest their way to prosperity and have some saving left over.

  16. “real investment equal to their planned saving”

    real investment is a little bit of a trick as investment is way of labelling consumption.

    If I buy a car it is consumption, but if I decide to use it for a business a week on Tuesday it magically becomes investment.

    When Pret a Manger make a sandwich at 8am it is real investment, but if it remains unsold at 5pm it becomes consumption when it is thrown away.

    So consumption and investment are labels, and they can be switched dynamically. Relying on real investment as somehow concrete and unchanging is a modelling abstraction – and therefore it can be incorrect or inaccurate.

  17. Greg,

    It’s certainly not saving. Macroeconomic saving must increase future potential output to facilitate intertemporal trade. On aggregate how can households consume less now and more in the future? Only by investing.

    Neil,

    This is something of a digression, but the distinction between investment and consumption goods is quite straightforward. Consumption is that part of the flow of output that is consumed to meet current living standards and investment is the part of the output flow that is used to increase future production. Quite a bit can indeed depend on the time period under consideration but it’s not really all that difficult. Note that this has nothing to do with the distinction between nominal and real per se.

    Not sure what your final sentence means.

  18. Greg,

    “It simply shows that investment precedes saving. Saving is the residual of investment.”

    What do you mean? I can’t make sense of these sentences.

  19. vimothy,

    It’s not straightforward at all, because previous real Consumption can become current real Investment and vice versa. That is particularly the case in a Service economy.

    “Not sure what your final sentence means.”

    Precisely my point. The assumptions on which the models are based are not crystal clear, nor is the size of the deviation those assumptions incur when compared to the real world they are attempting to model.

  20. Vimothy

    One does not need to consume less now to consume more in the future, that is a fallacy. One can consume at the same rate for a year and then up their consumption the next year, as a result of investment. There is no need to curtail current consumption for a period in order to raise consumption next period.

    Especially now when there is idle productive capacity.

  21. Neil,

    Those are measurement issues (if a good lasts for longer than the period in question it counts as investment). I don’t see how they are relevant.

    Greg,

    Still confused by these statements: “It simply shows that investment precedes saving. Saving is the residual of investment.” Can you explain?

  22. “if a good lasts for longer than the period in question it counts as investment.”

    Most goods last longer than a period, therefore most things are an investment and there is little consumption.

    “investment is the part of the output flow that is used to increase future production”

    How is my buying a sofa going to increase future production?

    A bed perhaps 😉

  23. “Most goods last longer than a period, therefore most things are an investment and there is little consumption.”

    Come on, why do you guys assume that everyone else working in this area is really stupid?

    “Most goods last longer than a period” is a meaningless statement unless you specify the length of the period in question. Then we can evaluate whether the statement is true or false. Most final goods (and services) produce a flow of consumption in the future IFF you specify a short enough time period. For instance, a nanosecond would do it. Mostly, we’re interested quarters and years.

    “How is my buying a sofa going to increase future production?”

    It’s going to produce a flow of future consumption services—somewhere comfortable to place your ass—until it depreciates—your ass wears it out—and you replace with a new one (the sofa that is, not your ass).

  24. vimothy,

    “Come on, why do you guys assume that everyone else working in this area is really stupid?”

    Not stupid, but captured by the base assumptions and the limits of the model abstractions you are relying on. Which makes its value in prediction suspect – particularly if it hasn’t been tested well against the real world.

    A real world where the data has likely been classified incorrectly.

  25. I think the statement “investment precedes savings” is self explanatory. There is nothing to save until an investment is made.

  26. Greg,

    That’s nonsensical. You can either consume your resources, or invest them. If you consume them, you cannot invest them by definition. It’s either or.

  27. “If you consume them, you cannot invest them by definition. It’s either or”

    I’ve already pointed out that they can change state after the event.

    Either that or everything that lasts more than a reasonable accounting period is by definition investment.

    In which case there is a heck of a lot of latent investment in the economy.

  28. Neil,

    You did, but it’s quite a silly argument, so I thought it best to ignore it.

    But let’s give it some thought.

    If (measured) investment is zero (i.e. no new capital is being formed), is this problematic in any sense, or not?

  29. Vimothy,

    Accounting frequently restates previous periods.

    Which why economics that is based on sound accounting principles is the way forward.

  30. Okay then, you tell me–what are the implications of this for the neoclassical analysis?

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