So, what are the differences between a government's budget and a household's budget? And do those differences matter? This is just a simple "teaching" post to give you my answers to those questions.

You've probably seen examples. Some poor non-economist says something like: "Governments, like households, must live within their means". And economists all point their fingers and laugh and say that's a fallacy.

1 Governments can use force (or the threat of force) to get extra (tax) revenue; households (usually) can't. That difference matters for political questions, and for microeconomic questions about the effect of taxes on the efficient allocation of resources. But it is not obvious why that difference should matter for the question at hand -- about budgets. Doesn't a criminal family that gets its income from mugging also have a budget and have to live within its means? I think the difference is that (most) governments (usually) collect a lot less in taxes than the maximum amount they could collect. (And that is especially true in the short run, because governments can confiscate assets, including refusing to pay their own debts (which amounts to a confiscation), with no outside force to stop them.) So (most) governments (usually) have a choice between cutting their spending to match their revenues and increasing their revenues to match their spending. Now some households will also have that same choice. But perhaps it is rarer for households to be able to increase their incomes to match their spending by the same amount (percentage-wise). But this is a difference of degree only.

2 Governments (usually, or are supposed to) care about the national interest when deciding how much to tax or spend; households (usually, mostly) care about their own self-interest. OK, so governments are like an altruistic criminal family -- like Robin Hood. OK, but doesn't Robin Hood have a budget, and have to live within his means, just like any other household? Yes, but if Robin Hood is altruistic in his collection of revenue (and not just in his giving to the poor) we can understand why a very powerful Robin Hood might usually choose to collect much less revenue than the maximum amount he is able to collect. Which helps us understand my point 1 above.

3 Governments are (usually) much larger than households. Sure, but why does that matter for the question of budgets? It's because of feedback effects. If you are a large fish in a small pond, you will think about how a change in your budget will affect the pond's budget, which in turn will affect your own budget. If you are a small fish in a large pond, that feedback effect will be very small. The Old Keynesian Multiplier is an example of this: if a large government doubles its expenditure, national income will rise, and the government's tax revenue will rise by enough to cover some appreciable portion of the increased spending. If a small household doubles its expenditure, its income will increase by a miniscule percentage, because nearly all the extra national spending will benefit other households, not the original household. But is the Old Keynesian Multiplier analysis right? Well, that depends. It won't work at "full employment", where national income is constrained by the supply-side, and not by the demand-side. And it won't work if the central bank controls the demand-side (as it should if it's an inflation-targeting central bank) and so adjusts monetary policy to fully offset any changes to demand coming from other sources, whether from households or from governments. The whole point of an independent central bank targeting 2% (or whatever) inflation is to do whatever it takes to make the Keynesian Multiplier precisely zero. So there won't be any feedback effects.

4 Governments can print money; households (usually) can't. OK, now we are getting to the qualitative differences; or are we? And does that qualitative difference matter quantitatively?

First off, many governments (like Canadian provincial governments, and Eurozone national governments) can't print money. And some households (those which own banks, or bank shares) can print money (except it's "printed" electronically, which doesn't matter a jot).

But there is nevertheless a difference between money printed by the central bank and money printed by commercial banks. Actually, there are two differences:

The first difference is that the central bank (usually) has a (de jure or de facto) monopoly in printing currency; commercial banks (usually) face more competition from other commercial banks in "printing" demand deposits. And monopolies can (usually) earn monopoly profits (which get given to the government if the government owns the central bank). Competitive firms, disciplined by entry of new firms, (usually) can't.

The second difference is that commercial banks (usually) peg the exchange rate of their money to the money issued by the central bank (they promise to redeem at par); the central bank does not peg the exchange rate of its money to the moneys issued by the commercial banks. The central bank is the alpha leader, that can choose to make its money more valuable or less valuable; the commercial banks are the beta followers, that just follow the central bank in making their moneys more valuable or less valuable. So the government can always order the central bank to inflate away the value of its money, and so inflate away the value of government debts which promise to pay fixed amounts of that money; and the commercial banks just follow along. Commercial banks (and the households that own them) can't do this.

Sure, that's a qualitative difference between a government's budget and a household's budget. But does it matter in practice? And does it matter quantitatively in practice? No, not if the central bank sticks to its 2% inflation target, because that means it will not exercise its power to inflate away (a de facto confiscation) of the government's debts. That 2% inflation target has presumably already been factored into expected inflation and the nominal interest rate paid on government (and household) debt. And the government's revenue from the central bank's monopoly profits from issuing currency aren't that big either. For a back-of-the-envelope calculation: assume a 5% currency/GDP ratio, and a 5% growth rate in Nominal GDP (3% real plus 2% inflation), so 5% x 5% = 0.25% which means the government revenue from printing money is 0.25% of GDP. A nice little Magic Money Tree of monopoly profits, but no biggie. Other sources of government revenue are much bigger.

But in an extreme emergency, when the 2% inflation target can be cast aside? Maybe. But the government could also just confiscate stuff.

5 Governments have (potentially) infinite lives; households have finite lives. That's what economists usually say, but is it true? And why should it matter?

Governments sometimes fall to revolutions which restart everything from scratch, and nations can disappear. And people have kids, and grandkids, or can "adopt" them if they want to continue their business after they die. Or set up trusts and corporations. What's the difference?

Let me cut to the chase: ignore 5, and let's go straight to 6:

6 Governments can (usually) bequeath net liabilities; households (usually) can't. I can bequeath my assets to my kids, and I can also bequeath some of my liabilities to my kids, like a house and the mortgage that goes with it. But my kids can always refuse to accept my bequest, and they presumably will refuse to accept my bequest if they figure the assets are worth less than the liabilities. I can't make my kids accept a negative bequest. (Though commenters on an old post once told me it used to be the law in some countries, and maybe still is in others, that kids are responsible for their parents' debts.) But governments can force my kids (as future taxpayers) to accept a negative bequest of the national debt. (Though even then, my kids might emigrate if they figure it's too negative.)

Economists who say "the national debt is not a burden on future generations of taxpayers, because they inherit both the bonds and the tax liabilities inherent in those bonds, and so owe it to themselves" don't get this. They are playing fast and loose with the word "inherit". Now it's true that if the kids literally do "inherit" the bonds from their parents, as a freebie, then there is no net negative bequest (distortions from taxation to finance the bonds aside). Because the positive bequest from their parents' bonds offsets the negative bequest from the government debt. But if instead we sell the kids the bonds, they are paying us for an asset which is their own liability. It's like buying an IOU, and then seeing your own signature on that IOU. They have inherited a liability, which makes them worse off, unless they can palm it off to the grandkids in turn.

Which is where things get weird. Because if the interest rate on government bonds is always less than the growth rate in the economy, it is possible for them to palm it off to the grandkids, and the great-grandkids, forever. It's a Ponzi scheme, where you borrow more to pay the interest on the debt, and so the debt grows at the rate of interest. But unlike the real Mr Ponzi's scheme, there is no reason it should ever end, provided the economy always grows faster than the debt. You can actually borrow more than is needed to pay the interest on the debt, to keep the debt/GDP ratio from falling over time. And some government bonds do in fact (usually) have interest rates lower than their growth rates.

But why can't a dynastic household do the same thing? "OK kids, you get to inherit my debts. But at the same time you inherit my name and reputation that keeps the interest rate on my debts below the growth rate of the economy, so you can make a nice living from issuing more debt to cover your reasonable living expenses." Dunno. Maybe they can, if the stars line up right, and they never break the chain.

I think I will stop there.