The “Household Fallacy” fallacy
11 August 2017
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Economic Theory
Government and Institutions
Trade, Development, and Immigration
8 November 2024
Several economists have claimed that “austerity” is not only cruel but based on faulty economic theory. They accuse its supporters of committing the Household Fallacy. Writing in The Guardian earlier this year, Ann Pettifor, director of Policy Research in Macroeconomics, claimed that it is a “fallacy that government budgets conform to ‘the household analogy’: that, as with family budgets, a state’s outgoings cannot exceed its income.”
Or as advocate of People’s Quantitative Easing and inspirer of “Corbynomics”, Richard Murphy, puts it:
“… the assumption that the government behaves like a household with regard to debt is just wrong. Households can’t create their own money out of thin air to repay debt but governments with their own currency and central bank (as the UK has) can … Governments and households are not the same at all because households may be constrained by the need to repay debt but governments are not.”
Alas, governments are not magical entities that transcend the borrowing constraints faced by households. Those who talk about a ‘Household Fallacy’ are committing a fallacy.
For a start, households do not need to balance their budgets in every period. They often spend more than they earn, borrowing to make up the difference. And they can do this for as long as creditors believe they will be able to pay it back, with interest. A household whose income keeps increasing can keep increasing its debt.
The real problem with the Fallacy fallacy, however, isn’t that it underestimates households’ ability to borrow, but that it overestimates governments’. Of course, governments can meet interest payments in a way that households cannot: namely, by confiscating money from citizens through taxation. This means the government can usually borrow more than any household in the country. If I had the right to confiscate my neighbours’ property, I would also be able to borrow at lower interest rates. But it doesn’t remove the constraint that households face when borrowing. Like households, governments can keep borrowing only if creditors continue to believe they will be able to meet the interest payments – only, that is, if creditors believe the borrower’s future income will suffice to meet its obligations. Call this the income constraint.
Just as a household’s ability to increase its income to meet extra interest payments is not unconstrained, a government’s ability to increase its tax revenues is not unconstrained. Among other constraints, high tax rates are a deadweight drag on the economy that reduce the output that can be taxed. If the government tried to collect 90% of GDP, for example, it would find itself collecting far less than it does now because GDP would be so much smaller.
“Then the government can simply print money to meet its obligations!”, comes the reply of the Fallacy alleger. Alas, a government that responds to its inability to raise tax revenues by instead paying its bills with freshly printed money will soon find itself being charged very high rates of interest. Who wants to receive interest payments in a currency that is rapidly losing its purchasing power, as currencies do when governments behave in this way? To make these higher interest payments, the government would then need to print yet more money, thereby creating an inflationary spiral which would destroy the currency. Witness Germany in the early 1920s, Zimbabwe in the 2000s and now Venezuela, where inflation is 750%.
The U.K. government has recently been paying some of its bills by printing money. Its central bank has created £435 billion of new (base) money since 2009, with which it has bought U.K. government debt. As Richard Murphy is keen to point out, this amounts to meeting debt obligations by printing money. But it doesn’t prove his point that governments lack the income constraint faced by households. If creditors believed that the U.K. government’s future tax revenues would not suffice to meet its obligations, and that they would always receive nothing but freshly printed money, they would demand dramatically higher rates of interest and an inflationary spiral would begin.
The point of the austerity policy is to make sure that this day does not arrive. You can sensibly argue that this day is farther off than austerity advocates believe, or that deficit spending will help push it farther away by stimulating economic growth and, thereby, increasing tax revenues. But you cannot sensibly claim that the government’s ability to print money means that, unlike households, it faces no income constraint on its borrowing.
Richard Murphy and his ilk are right that the government has a money tree. But there’s nothing magical about it. The money tree is not a wealth tree.
Or as advocate of People’s Quantitative Easing and inspirer of “Corbynomics”, Richard Murphy, puts it:
“… the assumption that the government behaves like a household with regard to debt is just wrong. Households can’t create their own money out of thin air to repay debt but governments with their own currency and central bank (as the UK has) can … Governments and households are not the same at all because households may be constrained by the need to repay debt but governments are not.”
Alas, governments are not magical entities that transcend the borrowing constraints faced by households. Those who talk about a ‘Household Fallacy’ are committing a fallacy.
For a start, households do not need to balance their budgets in every period. They often spend more than they earn, borrowing to make up the difference. And they can do this for as long as creditors believe they will be able to pay it back, with interest. A household whose income keeps increasing can keep increasing its debt.
The real problem with the Fallacy fallacy, however, isn’t that it underestimates households’ ability to borrow, but that it overestimates governments’. Of course, governments can meet interest payments in a way that households cannot: namely, by confiscating money from citizens through taxation. This means the government can usually borrow more than any household in the country. If I had the right to confiscate my neighbours’ property, I would also be able to borrow at lower interest rates. But it doesn’t remove the constraint that households face when borrowing. Like households, governments can keep borrowing only if creditors continue to believe they will be able to meet the interest payments – only, that is, if creditors believe the borrower’s future income will suffice to meet its obligations. Call this the income constraint.
Just as a household’s ability to increase its income to meet extra interest payments is not unconstrained, a government’s ability to increase its tax revenues is not unconstrained. Among other constraints, high tax rates are a deadweight drag on the economy that reduce the output that can be taxed. If the government tried to collect 90% of GDP, for example, it would find itself collecting far less than it does now because GDP would be so much smaller.
“Then the government can simply print money to meet its obligations!”, comes the reply of the Fallacy alleger. Alas, a government that responds to its inability to raise tax revenues by instead paying its bills with freshly printed money will soon find itself being charged very high rates of interest. Who wants to receive interest payments in a currency that is rapidly losing its purchasing power, as currencies do when governments behave in this way? To make these higher interest payments, the government would then need to print yet more money, thereby creating an inflationary spiral which would destroy the currency. Witness Germany in the early 1920s, Zimbabwe in the 2000s and now Venezuela, where inflation is 750%.
The U.K. government has recently been paying some of its bills by printing money. Its central bank has created £435 billion of new (base) money since 2009, with which it has bought U.K. government debt. As Richard Murphy is keen to point out, this amounts to meeting debt obligations by printing money. But it doesn’t prove his point that governments lack the income constraint faced by households. If creditors believed that the U.K. government’s future tax revenues would not suffice to meet its obligations, and that they would always receive nothing but freshly printed money, they would demand dramatically higher rates of interest and an inflationary spiral would begin.
The point of the austerity policy is to make sure that this day does not arrive. You can sensibly argue that this day is farther off than austerity advocates believe, or that deficit spending will help push it farther away by stimulating economic growth and, thereby, increasing tax revenues. But you cannot sensibly claim that the government’s ability to print money means that, unlike households, it faces no income constraint on its borrowing.
Richard Murphy and his ilk are right that the government has a money tree. But there’s nothing magical about it. The money tree is not a wealth tree.
12 thoughts on “The “Household Fallacy” fallacy”
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Many commentators on this topic quote Keynesian economic theory to support their opposition to so called “Austerity”. In some respects there is merit to their argument. Restricting or significantly curtailing government expenditure at the start of or during a recession is only likely to make matters worse, as evidenced by the Great Depression or more recently the EU’s (aka Germany’s) spending constraints on Greece. However, a great deal of these commentators miss or conveniently ignore the other side of the Keynesian equation. Keynes only advocated a budget deficit as a tool for assisting a government to blunt the social and economic impact of a recession. Keynes expected a government during normal or boom times to be running a surplus. The problem in the UK is that during the boom years of the 00s, i.e. during the New Labour administration, the government did not run a surplus. In fact after the New Labour administration’s first term they went from a surplus to an increasingly large deficit. Many on the left will argue this deficit was not particularly large by historical standards, but what they are missing is those were boom times. A sensible government should have been running a surplus. Globally banks and markets were drunk on cheap credit and that is when the government should have got it’s house in order. Instead when the crisis struck we went from deficit to record deficit. It is at that point, as you so rightly identify, there comes a tipping point when even a government can’t just keep borrowing without the creditors starting to question whether they will get their money back.
Donald Trump said that governments don’t need to default on their debts because they can ‘print the money’.
This is what people have concluded from central banks’ ‘quantitative easing’. The less government does to balance the books, the less the public thinks it needs to do, and the harder it gets.
I entirely agree with the article above, which makes it a rare piece of commentary indeed in today’s times.
One thing I find peculiar however is why investors seem to continue to believe in the soundness of the UK’s economy. I think this was one of Ann Pettifor’s arguments in a recent radio programme, where she noted that the most recent gilt auctions had been many times oversubscribed – implying that we, as a nation, are nowhere near the danger identified above (higher interest rates because investors demand a premium for taking the UK’s credit risk). Is this because we are witnessing a ‘race to the bottom’ in the sense that all the major economies are engaging in QE (ie so investors may not like the fact that the sterling they are being given when the gilts are repaid is “printed” but they would be getting “printed” dollars/Euros/etc so it becomes more a question of which economy is less poorly managed than the next)?
Ah. “The Household Fallacy Fallacy” Fallacy. Utter neoliberal claptrap.
Go on then, Luke.
Presumably believers in the Household Fallacy live in a state of constant rage or bafflement. If governments are able to spend with impunity and keep enriching the lives of all their citizens without negative consequences, why hasn’t a single administration ever been able to figure this out and go on to prove the point? It’s not as if they have lacked the incentive, so perhaps every single government in world history has been fooled by this fallacy!
Interest payments on the national debt are running at 3% of GDP, and investors are willing to pay the govenment to borrow from them at maturities up to 20 years. Is the same true of households?
Pettifor & Murphy are right. Households experience pressure to reduce gearing the older they get because of debt write-off risk faced by their counterparty if they die. This is not true of governments, as their income is from current and future households, and they can’t go bankrupt.
No sensible investor cares about the repayability of all government debt for the same reasons debt is tolerated on mature company balance sheets. In the long-term, stabilising debt/GDP is acceptable, as tranches of debt stock can be refinanced by new households. There is then an impressionistic investor assessment to be made of whether borrowing is going to increase the denominator enough to offset the numerator.
Our current debt is not so scary if you consider in 1950 it was about 250% of GDP: http://www.ukpublicspending.co.uk/uk_national_debt_chart.html
The real value was largely inflated away, not repaid. The economy did not suffer lasimg consequences – we were not ‘punished’ by investors demanding higher rates of return.
@MXM – If inflating away debt was such a good idea, why did we suffer stagflation by the 1970s? How did having higher inflation over a long period benefit us relative to (say) Germany? Since we attained control of inflation our economy has performed relatively better.
@MXM – It is obviously easy to demonstrate that governments are not completely analogous to households. It is also easy to show that incurring a debt and paying it off later can be a wise move. Or that operating with a certain amount of debt on the books is normal and healthy for a wide range of economic entities.
However, the argument is over whether governments can continuously spend more than they receive without dire consequences. Are they somehow immune from good financial management? The answer is they are not. You admit this when you say that ‘in the long-term stabilising debt/GDP is acceptable’.
@MXM – banks (and by association depositors and investors) are willing to lend to households for 20 years plus it’s called a mortgage. Cataclysm aside there will always be some form of government in the UK, but that doesn’t mean that investors will always be willing to invest in Gilts maturing in 20 years at 3% per annum. Investors invest in Gilts because the UK has a track record of honouring its debts. If the government defaults or there is a debt write-down or even any hint of a debt write-down then the economic consequences for the UK would be dire. Investors are likely to demand significantly higher interest rates or will just not invest in Gilts full stop. If the latter occurs and the IMF or some other global organisation doesn’t bail us out (on their terms see Greece current day) then the only options are to decrease government expenditure or print money, which is likely to lead to an inflationary spiral. So in essence like people governments can go bankrupt. Would any sensible investor buy Greek government bonds? Venezuelan bonds? Zimbabwean bonds?
The comparison with the 1950s is disingenuous as the ratio of debt to GDP resulted from the costs of fighting a lengthy war. The costs were a one off and investors knew that. In addition at the time the UK like America was a safe haven in an uncertain world. If as a nation we are seen to be increasing our borrowing just to cover the ever increasing day to day costs of government and welfare state then that is a long term structural issue and I doubt investors would be so forgiving. Particularly as we have an aging population with absolutely no reserves to pay the spiralling costs of pensions and health care.
‘governments can keep borrowing only if creditors continue to believe they will be able to meet the interest payments.’
The article has no validity, as summed up by the above quote. A government spends money into existence and taxes it out. Spending is logically anterior to taxation/borrowing. A government issuing its own fiat currency under floating exchange rates has no operational need to borrow. Debt sales are purely voluntary and provide the non-government sector with an interest-bearing risk-free asset as opposed to a non-interest bearing one.
When the government spends it adds reserves to the banking system, when it taxes it drains reserves- you can’t drain before you add! The central bank could leave the reserves in the system and allow the overnight rate to fall to zero if it wished to.
‘Free market’ advocates clearly consider that the private sector uses resources more efficiently than the govt. I don’t agree but at least this forms the basis for a valid argument. However, to say that a government which issues its own fiat currency under floating exchange rates is somehow revenue constrained like a household is economic illiteracy.
Well Household fallacy works at two levels, and it is a fallacy.
First, a middle-class family can usually cut their spending to a great level without significantly affecting its income. I don’t have anything but an estimate of my own situation, but I can say that perhaps 30% would be still bearable and not affect my ability to earn. It’s not true of governments: if they cut spending, especially if they do this in hard times, this usually means layouts, lowering public expenditure, investments and so on, and this almost directly affects govt income, making things worse.
Second, most of the time a government can simply default on their debts without really much consequence. Yes, it will suffer a “bad credit” for a time, but it will keep pretty much all of its assets and income base (i.e. taxes). Not so a family/household. In many countries a household can’t go bankrupt at all and creditors can go after insolvent debtors all the time they want, and even in countries with a debtor-friendly bankruptcy laws, bad credit often means or with a great probability leads to homelessness, which in turn takes away almost all ability to earn.
But yes, what Murphy said *is* bullshit, if nobody wants to lend to a govt, it will not be able to borrow, and if someone thinks that it can be overcome with printing money, well, they can visit Zimbabwe or Venezuela.