Households and States

In response to my claim that public understanding of fiscal policy is dominated by fallacious analogies between a national government and a household, MF asks for an explanation “Why is that analogy deceptive or misleading?”

Glad you asked. There are a number of reasons, but the main one concerns money. A household typically measures its wealth in terms of money. So many assets and so many liabilities. And it doesn’t just do this as an accounting convention. An influx of extra dollars into your bank account is a real increase in your wealth. Mo money mo purchasing power.

The United States of America also uses dollars as a unit of account for tallying up assets and liabilities, but the wealth of the United States is properly measured not by how many dollars there are but by what real production we’re engaged in and what real stock of assets we possess. We have the I-95 and the aircraft carrier Ronald Reagan and the Hollywood movie studios and Yale University and the casinos of the Las Vegas strip and the Mayo Clinic and fertile farmland and many detached single-family homes. Unlike a household, if we as a country want more dollars, we can just print more dollars. But also unlike a household, if we as a country want more stuff we actually have to make more stuff not just obtain more currency. This means that to say we’re “broke” or “running out of money” is nonsense. The relevant issue is are we running out of productive capacity? If we try to boost demand faster than we can produce, we’ll end up with inflation. But if our level of demand is well below our potential for production, then we’ll get richer (have more stuff, more production) merely by increasing our demand to something closer to our potential.

I think people get an intuitive understanding of this if they try to think about a total war situation. In World War II, the Nazi-Soviet tank balance is determined by the quantity of tank factories, the quality of tank designs, the availability of steel and rubber and trained workers, etc. If you somehow “run out of money” but have plenty of aircraft and trained pilots, you’ll find a way to get the pilots into the planes. When people look at the balance of power between North and South in the Civil War they primarily look at available manpower, railroads, industrial capacity, trained officers, etc. The American budget needs to add up in an accounting sense, but the quantity of currency available should never really be the issue.