The “Household Fallacy” fallacy
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.