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Government budgets versus family budgets
Old 01-07-2013, 08:43 PM   #1
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Government budgets versus family budgets

I came across an interesting paragraph in a business magazine. I'm not going to provide the link because it dives straight into partisan politics, and I've had to sanitize even this excerpt.

Instead I want to talk about economics. Until now I've happily accepted the analogy that a country's budget is like a family budget. Sure, intellectually I know that governments exist to prime the pump when an economy goes into recession, even if that means running a decade or two of deficits. I know that governments are supposed to insure (or legislate against) the risks that not even Berkshire Hathaway can afford to cover.

But I never questioned the governmental family-budget analogy until I read this:
Quote:
Budgetary puritans ... view the world’s largest economy as an indebted family that needs to get back to basics. “The federal government needs to tighten its belt just like every hardworking American family has had to do during our economic recovery,” [said one Congressman].

The economy-as-family metaphor is familiar, emotionally intuitive—and incorrect. It’s a fallacy of composition: What’s true for the part is not necessarily true for the whole. While a single family can get its finances back on track by spending less than it earns, it’s impossible for everyone to do that simultaneously. When the plumber skips a haircut, the barber can’t afford to have his drains cleaned.

British economist John Maynard Keynes explained the futility of trying to shrink an economy into prosperity via thriftiness in his A Treatise on Money in 1930: “Mere abstinence is not enough by itself to build cities or drain fens,” Keynes wrote. “If Enterprise is afoot, wealth accumulates whatever may be happening to Thrift; and if Enterprise is asleep, wealth decays whatever Thrift may be doing. Thus, Thrift may be the handmaiden of Enterprise. But equally she may not. And, perhaps, even usually she is not.”

So let’s try a different metaphor. The economy is not a family but an engine that’s stuck in low gear. It doesn’t need a disciplinarian; it needs a mechanic.

The primary goal of government should be to get the economy running at full throttle once again. That will restore jobs and wealth and increase tax revenue, which narrows budget deficits.
The engine analogy may also be flawed, but it appears to make more sense than a family budget. OTOH this concept bodes badly for EU austerity measures.

Perhaps we shouldn't be making any analogies about economics. I'm just glad that "big data" is catching up to the theories and that computer processing power is finally able to put some research & analysis behind the debates.

I know that austerity during the Great Depression was not such a winner, and I know that we tested the concept again during the Great Recession. Better still, I'm happy to have a better analogy to use when I'm discussing the idea with my daughter...
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Old 01-07-2013, 08:49 PM   #2
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Google Modern Monetary Theory. It further describes how the US government spending, US Treasury actions and the Federal Reserve actions function in economic control. According this theory, there is little similarity between household finances and US government finances.
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Old 01-07-2013, 08:59 PM   #3
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And I'm sure we can all spot the logical misdirection included in the first two sentences:
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Budgetary puritans ... view the world’s largest economy as an indebted family that needs to get back to basics. “The federal government needs to tighten its belt just like every hardworking American family has had to do during our economic recovery,” [said one Congressman].
Conflating "the world's largest economy" with "the federal government" won't help understand the problem. "Budgetary Puritans" don't want Americans or businesses to slow down in their spending, they want the government to do so.

Keynes--if only governments were willing to take the medicine he prescribes when times are flush as well as when things are rough.
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Old 01-07-2013, 09:19 PM   #4
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Originally Posted by Nords View Post
I came across an interesting paragraph in a business magazine. I'm not going to provide the link because it dives straight into partisan politics, and I've had to sanitize even this excerpt.

Instead I want to talk about economics. Until now I've happily accepted the analogy that a country's budget is like a family budget. Sure, intellectually I know that governments exist to prime the pump when an economy goes into recession, even if that means running a decade or two of deficits. I know that governments are supposed to insure (or legislate against) the risks that not even Berkshire Hathaway can afford to cover.

But I never questioned the governmental family-budget analogy until I read this:

The engine analogy may also be flawed, but it appears to make more sense than a family budget. OTOH this concept bodes badly for EU austerity measures.

Perhaps we shouldn't be making any analogies about economics. I'm just glad that "big data" is catching up to the theories and that computer processing power is finally able to put some research & analysis behind the debates.

I know that austerity during the Great Depression was not such a winner, and I know that we tested the concept again during the Great Recession. Better still, I'm happy to have a better analogy to use when I'm discussing the idea with my daughter...
Re the engine analogy, I read somewhere that nobody thought about the human heart as a pump until mechanical pumps were common.

Both internal combustion engines and economies are self-sustaining cycles. Keynes certainly was aware that automobile engines didn't start themselves, they needed somone/something to run them through a couple cycles before they would "catch". He probably hand-cranked some himself. Furthermore, it's not enough to get them to turn over slowly. If you don't turn them vigorously enough, they don't catch.

I wonder if that mechanical experience influenced his economic theory.
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Old 01-07-2013, 09:24 PM   #5
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I read the same article over the weekend, with a similar reaction.

gsparks2, Samclem, please elaborate. Some of the engineers here took sociology, not economics, to get our social science credits.

I'm inclined to agree with Samclem's theory that the body politic gets complacent when times are good, preferring rhetoric suggesting that the economy needs a sustained (or even endless) period of high growth to "make up" for the last recessionary period.

But what is the medicine that Keynesian theory would suggest for good times?
Is the opposite of stimulus an anti-stimulus? Should economic actions be given in alternating doses of opposite polarities that seek to moderate a real-world sine wave of economic growth rates back toward a flat +3% slope? I know the fed tries to do this by manipulating interest rates, but what else do the theories suggest?
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Old 01-07-2013, 10:04 PM   #6
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I think a better analogy might be to a corporation rather than a family. A corporation raises funds by issuing debt (or equity) and then invests those funds principally in things that provide long term benefits (plant, new products, etc).

I don't so much mind government debt to fund infrastructure (roads, bridges, etc) that will last a long time and provide long term benefits to citizens and I understand the benefit of temporary deficit spending during time of financial distress - but what the government has been doing is issuing debt to fund current operations and IMO that is specifically the type of spending that a government should not be issuing debt to fund.
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Old 01-07-2013, 10:10 PM   #7
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In what way IS a government budget and a family budget similar?
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Old 01-07-2013, 10:23 PM   #8
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I think a better analogy might be to a corporation rather than a family. A corporation raises funds by issuing debt (or equity) and then invests those funds principally in things that provide long term benefits (plant, new products, etc).

I don't so much mind government debt to fund infrastructure (roads, bridges, etc) that will last a long time and provide long term benefits to citizens and I understand the benefit of temporary deficit spending during time of financial distress - but what the government has been doing is issuing debt to fund current operations and IMO that is specifically the type of spending that a government should not be issuing debt to fund.
To get it closer to a corporation analogy, we'd have to imagine that the corp's only customers are it's own employees.
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Old 01-08-2013, 07:10 AM   #9
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The Keynesians (e.g. Krugman, et al) have been arguing that the European austerity route is deadly throughout the recession. That doesn't mean that we can simply continue spending at whatever level we want and continue cutting taxes willy nilly. It simply means that drastic austerity in the face of low growth is problematic. Seems like everybody got a touch of Keynesianism when faced with the fiscal cliff. Otherwise, why not just go over it and solve the problem.
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Old 01-08-2013, 07:33 AM   #10
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In what way IS a government budget and a family budget similar?
How about when either spends more than income?

I did that when I bought a house for example. But I only spent twice my annual income once, when I bought a house. And when I did that, my future options were limited by the amount of the debt and the interest I was then committed to pay on it.

But I just don't see a sustainable future for any entity, be it household or government, that spends more than its income for decades.

Doesn't there eventually and inevitably come a time when The Piper Will Be Paid?

My degree is in criminal justice, not economics, so perhaps I'm missing something.
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Old 01-08-2013, 08:01 AM   #11
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The latest news about the IMF economists "apologizing" for being wrong about austerity in Europe and causing needless damage is really quite mindboggling.
IMF economists apologize for austerity forecasts - Salon.com
BBC News - Today - Ngaire Woods: 'IMF have learnt lessons of austerity'
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Old 01-08-2013, 08:33 AM   #12
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[QUOTE Keynes--if only governments were willing to take the medicine he prescribes when times are flush as well as when things are rough.[/QUOTE]

This becomes an enormous problem as any additional spending to prime the pump becomes a permanent part of inefficient government utilzation of capital which is then not available to the private sector. To make matters worse, it also becomes part of the budgeting process where government assumes ridiculously high spending growth rates. Further, government is far from like a family because only in government can reductions in the growth rate of spending, while actually spending significantly more than the preceding years, be considered "cuts".
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Old 01-08-2013, 09:26 AM   #13
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One difference between a family budget and a government budget is that if a family tightens its belt, spends less and saves more, their employers won't usually cut their pay because they didn't spend everything they were given.

And in reality, as I see it the "paradox of thrift" never would have been so much of a concern if we never allowed the economy to be dependent on 2-4% economic growth above population growth and inflation year after year. That's a house of cards that will fall as soon as people stop spending more than they need to spend.
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Old 01-08-2013, 11:00 AM   #14
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I don't so much mind government debt to fund infrastructure (roads, bridges, etc) that will last a long time and provide long term benefits to citizens and I understand the benefit of temporary deficit spending during time of financial distress - but what the government has been doing is issuing debt to fund current operations and IMO that is specifically the type of spending that a government should not be issuing debt to fund.
+1. And even in the selection of infrastructure projects the government often does poorly (e.g. the "Bridge to Nowhere" and the John Murtha Airport), and accomplishes others with very poor efficiency. Still, since only the government is in a position to accomplish some of these things (e.g. highway construction requires use of "eminent domain" laws available only to government), even the government's wasteful methods are better than the alternative (no highway).
But much of the government spending we've seen of late has merely had the objective of employing people irrespective of the value of the work performed. In general, the best way to know if a particular bit of work is worth paying for is to see if customers in a free market will pay someone to do it. If not, that's a red flag. But there are market failures and "tragedy of the commons" situations in which work must be paid for by the government. The emphasis should be on the intrinsic value of the project itself, not on the number of people hired.

Those favoring "priming of the pump" often claim a "fiscal multiplier effect" or a "Keynesian multiplier": that every dollar spent by the government generates some greater amount of total spending (pick a number: some claimed 1.5, some 2+). It's fair to say this idea has gained many more critics since the widescale implementation of the US fiscal stimulus provided more data on the relative ineffectiveness of this spending. Wikipedia gives evenhanded coverage of the topic of fiscal stimulus.
From that article:
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More recently three economists with the NBER and IMF have published a working paper examining economic features that impact fiscal multipliers. They found that the output effect of an increase in government consumption is larger in industrial than in developing countries, the fiscal multiplier is relatively large in economies operating under predetermined exchange rate but zero in economies operating under flexible exchange rates; fiscal multipliers in open economies are lower than in closed economies and fiscal multipliers in high-debt countries are also zero.[9]
A Timeless (and painless) short work that may be relevant:
"What is Seen and What is Not Seen" (Bastait). (Includes the oft-cited "Fallacy of the Broken Window")

When we hear of the employment or economic stimulus provided by government spending, rather than the actual value of the project itself, that's a sign of trouble. A famous story told by Milton Friedman comes to mind:
Quote:
At one of our dinners, Milton recalled traveling to an Asian country in the 1960s and visiting a worksite where a new canal was being built. He was shocked to see that, instead of modern tractors and earth movers, the workers had shovels. He asked why there were so few machines. The government bureaucrat explained: "You don't understand. This is a jobs program." To which Milton replied: "Oh, I thought you were trying to build a canal. If it's jobs you want, then you should give these workers spoons, not shovels."
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Old 01-08-2013, 11:12 AM   #15
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Government could act as a balancing counterweight to an economy, tempering the extremes of both overexuberance and depression. Government spending during a downturn can help an economy right itself, but in order to have the funds to do so government needs to save up during good times.
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Old 01-08-2013, 11:26 AM   #16
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Better still, I'm happy to have a better analogy to use when I'm discussing the idea with my daughter...
I think on this often. How to explain.
My thinking is that the cause-effect of logical budgeting no longer exists in governments, and that history has no precedent to learn from. I would agree that the quantum leap in technology has stalled the mechanisms that have been sacrosanct to monetary theorists. Perhaps technological science is catching up, but it is certainly not there.... yet.... and may be never?

As we look at the almost straight-up curve of learning on a historical basis, since the 1950's, I'm reminded of this:

My dad was a loomfixer in a textile mill in Rhode Island as I was growing up.
At age 10, in 1946, he brought me into the mill where he was working, to show me the latest advance, a primitive rope-chain-pulley mechanism that adjusted the warp and woof of the textile fabric automatically, to produce fine lace, in 1/10th the time of previous technology.
He worked 50 to 60 hours a week to support us. On this day, he was excited to show off the new loom and... like it was yesterday, I can hear him saying.
"Bobby... Very soon we'll have big changes in efficiency that will mean that I'll only have to work 25 hours a week, so we'll be able to spend more time together. When you grow up, you may only have to work 20 hours."

That stuck with me... even to this day. It was so logical. Now, I'm not sure. How do we explain away the fact that the growth of technology hasn't resulted in the elimination of want?

Strangely enough, Keynes died at just about the same time, and neither Marshall, Pigou or Hayek ever had to deal with that technology aberration.
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Old 01-08-2013, 11:53 AM   #17
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With my very limited knowledge of economics, It seems to me that the main difference between the government and family budgets is that I know of no family that can (legally) print its own money and have it accepted by everyone else...
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Old 01-08-2013, 11:56 AM   #18
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How do we explain away the fact that the growth off technology hasn't resulted in the elimination of want?
Technology (and free markets) have surely made major progress in this regard.


What happened in 1820? I highly recommend "The Birth of Plenty" by William Bernstein (yes, that William Bernstein) for those interested in a quick, non-technical read on the root factors that caused world prosperity to increase (and why it doesn't take hold everywhere)

And, of course, poverty is a very relative concept, isn't it? While I'm sure others will disagree, I'd argue that we have no true poverty in the US when viewed in either a contemporary worldwide understanding of what it means to be "poor" or even a historical US perspective. In this place, and in ones like it, an observer from 19th century US or from Ghana today would conclude that we have no poverty. There are those with mental issues, drug addiction, etc (and those people who depend on them) who may be very short of resources, but that's not a problem caused by a shortage of wealth.
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Old 01-08-2013, 12:12 PM   #19
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Economics and politics are inextricably interlinked.

I find that when people start talking politics they seem to get dumber and dumber. Yours truly is included in this group.

Economics is just one step removed from this situation. But I do try to understand some of the better thinking on this. I've got the following reserved at our library:
End This Depression Now!: Paul Krugman: 9780393345087: Amazon.com: Books

Chapter 8 is titled: But What About the Deficit?
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Old 01-08-2013, 12:52 PM   #20
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But I do try to understand some of the better thinking on this. I've got the following reserved at our library:
End This Depression Now!: Paul Krugman: 9780393345087: Amazon.com: Books

Chapter 8 is titled: But What About the Deficit?

I'll be curious what you think of that book. I recently read another by Krugman (well, skimmed it after ~ 1/3 of the way through), and my impression of Krugman was:
I am an award winning economist.
I have certain 'beliefs'.
When I talk economics, I make connections to my 'beliefs', and infer cause/effect.
I expect you to accept my inference of cause/effect w/o any attempt at proof, because I am an award winning economist.
At least that was my take on it, curious what others may think.

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