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Bad Economic Analogies Never Die

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Maybe you heard the analogy between managing household finances and government finances in an Intro to Economics class? Or maybe you heard it on talk radio or saw it spewed out on cable? Perhaps you remember Reagan referring to the federal government while stating, "...if you've got a kid that's extravagant, you can lecture him all you want to about his extravagance. Or you can cut his allowance and achieve the same end much quicker."

In general, analogies are useful in helping to paint a more vivid picture of a situation but become useless, and sometimes even dangerous, when people confuse the analogy for reality to draw false conclusions and support bad policies.

The U.S. government is a far cry from a household. Households or families don't have the option to print money, for example, or to issue bonds on their own behalf, or to create inflation or deflation. Governments need to ensure that their debts grow more slowly than their tax base, so that the revenue they receive from future taxes can pay off both the principal and interest.

Moreover, and unlike a household, the government doesn't always have to balance its budget -- in fact, it's not always desirable that it does. In weak economic times, the government needs to play a larger role by stimulating the economy and supporting those most in need; naturally it will run a deficit in those years. Government spending is sometimes the only thing that can prevent the economy from going into a freefall.

The differences between what a family and a government can and should do during economic hard times are often the source of a disconnect that many people feel intuitively. When families experience a drop in revenue, they usually reduce their expenditures. When governments experience a drop in revenue due to economic crises, its expenditures often increase because of the need to provide more social support. With high unemployment and low demand, tax receipts fall off significantly in recessionary times. But rather than economizing as a household would, this is precisely when the government has to open its wallet. It needs to provide basic support for those most in need, the elderly, the poor and the increasing masses of unemployed. Government spending can stabilize and stimulate the economy.

Fifty years ago, in his essay "Pseudo Conservatism Revisited," the historian Richard Hofstadter observed that "deficit spending is an affront to millions who have been raised to live (and in some cases have been forced by circumstances to live) abstemious, thrifty, prudential lives.... when society adopts a policy of deficit spending, thrifty small-businessmen, professionals, farmers, and white-collar workers who have been managing their affairs by the old rules feel that their way of life has been officially and insultingly repudiated." This same dynamic fueled the rise of the Tea Party in our own day.

Legitimate concerns about government debt arise in situations where the overall economic growth is not fast enough, and tax receipts are not substantial enough for the government to make its debt payments while handling the day-to-day expenses of running the government and the long term investments that are vital for our future.

The weaknesses in the analogy between government and household finances are too often lost yet this misleading analogy persists, creating confusion, prompting poor decisions and is some of the stimulant underneath the Congressional behavior we see today.

Some of the text from this posting was take from the recently release ebook, "A Modest Proposal for America"


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