<p>If you think about it, there is really not much difference between a government budget constraint and a household budget constraint. </p>

<p>Both have uncertain income streams, which are labor and capital income for the household, and mostly tax revenue for the government. On the other side of the constraint, you will find consumption and saving for the household. The government will spend most of its income on (public) goods and transfers to households (social system).</p>

<p>Both can move income inter temporally using borrowing. However, neither can run a permanent deficit where it is "not expected to ever pay back", something that is typically referred to as a <a href="http://en.wikipedia.org/wiki/Ponzi_scheme">No-Ponzi-Game</a> condition. As an implication, the "life-time budget constraint" will have to hold for both:</p>

<pre><code>sum of all expected future income = sum of all expected future expenditures
</code></pre>

<p>I'm pretty informal here, you would typically rather derive "present value" of these constraints, but latex is not yet allowed here, and I'm already writing much.</p>

<p><strong>What should government debt be used for?</strong></p>

<p>We typically assume that households and governments have concave utility, they prefer consumption processes that are second-order dominating. Hence, they want to engage in smoothing of consumption over fluctuations.</p>

<p>Since all debt has to be paid back eventually, there is limited use of government borrowing. Most typically, one wants to stabilize consumption and output over business cycles, by financing consumption in busts and paying back in booms. Also, given an interest rate <code>r</code>, <code>investments</code> that promise a higher return than <code>r</code> can be financed through debt, as the government will not violate consumption smoothing.</p>

<p><strong>Potential Difference</strong></p>

<p>One potential difference is the commitment. Developed governments are typically more 
trustworthy, they are more likely to pay back there debt. Hence, they can borrow at cheaper interest than most households. As a conclusion, they can use debt more aggressively than households for the two purposes <code>consumption smoothing</code> and <code>investment</code>, as emphasized above.</p>

<p><code>tldr</code>: Besides that, they're very much alike. Note also the <a href="http://en.wikipedia.org/wiki/Ricardian_equivalence">Ricardian Equivalence</a>, which is not at the heart of this question, but very much related.</p>

CC BY-SA 3.0
2014-11-18T22:17:05.187Z
2014-11-18T22:17:05.187Z
FooBar
<p>A toy model is less useful here, as the only mathematical constraint is that both must adhere to the <em>no-ponzi condition</em> - i.e. that whilst you might be a borrower/saver in any individual period, you cannot finance your consumption merely by <em>planning</em> on borrowing more every year into the future. </p>

<p>Yet aside from this constraint, various aspects of economic theories give rise to the following differences:</p>

<ol>
<li>Since households have diminishing marginal utility from consumption within a period, households aim to smooth consumption through their life cycle. Within-household incomes generally follow a predictable hump-shaped cycle. Your income is likely to be low at the start of your life, higher in your mid 30s to 50s, then decline in your 60s and thereafter. Households will take on high debts in the early stages of their lives, then aim to become net savers in the middle of their careers, then draw down on those savings at a later stage of life. It is therefore not uncommon for a household to get into debts of up to ~5x annual incomes. </li>
<li>Following on from the point about debt in (1), households can generally finance much larger debts (proportional to annual incomes) than governments can. A rule of thumb for mortgage serviceability in many countries: a household can borrow at a level where repayments to pay down the loan over 30 years are worth approx 30% of their current income at cycle average interest rates. Governments will extremely rarely run budget surpluses worth 30% of revenues, and thus will find it harder to sustain debts that are of a similar scale relative to their revenues.</li>
<li>Household incomes are more risky than government incomes - consider that a large recession might reduce an annual income by up to 90% for 5-10% of households, though this would only be a 4-9% reduction in incomes for a government. For this reason, governments are also less likely to find themselves <em>credit constrained</em> than households.</li>
</ol>

<p>These points refute two common (though opposing) arguments made regarding fiscal policies. Firstly, it refutes the argument that governments should not run deficits. Point (3) argues that governments have dependable incomes, and therefore deficits may be appropriate. On the other hand, point (2) demonstrates that a government cannot sustainably run debts which are comparable in proportional terms to a household's mortgage - despite having a more diversified revenue base than an individual household.</p>

CC BY-SA 3.0
2014-11-19T12:43:01.853Z
2015-07-08T23:53:15.077Z
2015-07-08T23:53:15.077Z
lilster
<p>Imagine you are trying to fill a bucket with a hole in it. It's obvious you will never get the bucket filled if the hole allows more water to leave than you have power to put into it with a hose. That's your household budget. The hole = your expenditures. The hose = your income. The water level in the bucket = savings. Simple enough.</p>

<p>National economies are not like buckets, though. It doesn't make sense for a national economy to have "savings", or "income". If I spend money at Wal-Mart, that's an expense for me but income for them. If someone else buys one of my paintings on Ebay, that's an expenditure for them but income for me. Everyone is better off presumably, but as far as the amount of money goes, it's zero sum. A better analogy for a national economy is an interconnected series of pipes where no water enters the system and no water leaves the system. In this completely closed system, we can't add any water, but what we can do is make the water flow faster. Then everyone gets the water that they need with a fixed supply. Because mild inflation allows the real GDP of an economy to grow at a faster rate than it would otherwise be able to, in this analogy, inflation is like widening the pipes.</p>

<p>Incidentally, there IS a pretty good counterpoint at the national level for the household analogy, but it's not government spending. It's actually the aggregate trade imbalance with other countries, as that money leaves and enters the system in a way that government spending does not.</p>

CC BY-SA 3.0
2014-11-18T22:33:18.400Z
"It's actually the aggregate trade imbalance."

I was about to argue about the balance of trade (with regards to exports/imports), but you mentioned that towards the end! On a side note,
rosenjcb
CC BY-SA 3.0
2014-11-23T07:30:50.697Z
Yeah, I really wish our politicians understood the difference between domestic debt financing and international trade balances. We'd be all better off.
Nate Vomocil
CC BY-SA 3.0
2014-11-18T22:11:11.580Z
2014-11-18T22:11:11.580Z
Nate Vomocil
<p>We are often told by pundits that "Country X cannot spend more than they take in in revenue, because a house that makes A and spends B will always collapse if B>A". Essentially the siren calls of a balanced budget as promulgated by the talking heads.</p>

<p>Sadly, despite even conservative economists like Friedman citing a <em>k-percent rule</em> and the necessity of inflation (since the number of people demanding money seems to continue rising), many entry level students get hung up on this concept. </p>

<p>Essentially, what I'm asking is: </p>

<blockquote>
  <p>What are the key functional differences between a household budget (or other simple toy model) and a national budget and what's the best way to communicate this to people with only a passing familiarity with economics?</p>
</blockquote>

<p>I'm looking for a way to effectively communicate to group of first year students that beyond just the ability to control the supply of money (monetary policy), and control income and spending more readily than an individual or household (fiscal policy), economic policy really has nothing in common with the ability to balance a checkbook, and the dramatic oversimplification is a disservice to the dismal science.</p>

<macroeconomics><fiscal-policy><monetary-policy><teaching>
How does a national budget differ from a household budget?
Jason Nichols
# How does a national budget differ from a household budget?

(Asked by: username_0 on 2014-11-18)

We are often told by pundits that "Country X cannot spend more than they take in in revenue, because a house that makes A and spends B will always collapse if B>A". Essentially the siren calls of a balanced budget as promulgated by the talking heads.

Sadly, despite even conservative economists like Friedman citing a *k-percent rule* and the necessity of inflation (since the number of people demanding money seems to continue rising), many entry level students get hung up on this concept.

Essentially, what I'm asking is:

> What are the key functional differences between a household budget (or other simple toy model) and a national budget and what's the best way to communicate this to people with only a passing familiarity with economics?

I'm looking for a way to effectively communicate to group of first year students that beyond just the ability to control the supply of money (monetary policy), and control income and spending more readily than an individual or household (fiscal policy), economic policy really has nothing in common with the ability to balance a checkbook, and the dramatic oversimplification is a disservice to the dismal science.

**Tags:** macroeconomics, fiscal-policy, monetary-policy, teaching


---

## 3 answers

### Answer by username_1 on 2014-11-18. Score: 6

If you think about it, there is really not much difference between a government budget constraint and a household budget constraint.

Both have uncertain income streams, which are labor and capital income for the household, and mostly tax revenue for the government. On the other side of the constraint, you will find consumption and saving for the household. The government will spend most of its income on (public) goods and transfers to households (social system).

Both can move income inter temporally using borrowing. However, neither can run a permanent deficit where it is "not expected to ever pay back", something that is typically referred to as a [No-Ponzi-Game](http://en.wikipedia.org/wiki/Ponzi_scheme) condition. As an implication, the "life-time budget constraint" will have to hold for both:

```
sum of all expected future income = sum of all expected future expenditures

```

I'm pretty informal here, you would typically rather derive "present value" of these constraints, but latex is not yet allowed here, and I'm already writing much.

**What should government debt be used for?**

We typically assume that households and governments have concave utility, they prefer consumption processes that are second-order dominating. Hence, they want to engage in smoothing of consumption over fluctuations.

Since all debt has to be paid back eventually, there is limited use of government borrowing. Most typically, one wants to stabilize consumption and output over business cycles, by financing consumption in busts and paying back in booms. Also, given an interest rate `r`, `investments` that promise a higher return than `r` can be financed through debt, as the government will not violate consumption smoothing.

**Potential Difference**

One potential difference is the commitment. Developed governments are typically more
trustworthy, they are more likely to pay back there debt. Hence, they can borrow at cheaper interest than most households. As a conclusion, they can use debt more aggressively than households for the two purposes `consumption smoothing` and `investment`, as emphasized above.

`tldr`: Besides that, they're very much alike. Note also the [Ricardian Equivalence](http://en.wikipedia.org/wiki/Ricardian_equivalence), which is not at the heart of this question, but very much related.


---

### Answer by username_2 on 2014-11-19. Score: 4

A toy model is less useful here, as the only mathematical constraint is that both must adhere to the *no-ponzi condition* - i.e. that whilst you might be a borrower/saver in any individual period, you cannot finance your consumption merely by *planning* on borrowing more every year into the future.

Yet aside from this constraint, various aspects of economic theories give rise to the following differences:

1. Since households have diminishing marginal utility from consumption within a period, households aim to smooth consumption through their life cycle. Within-household incomes generally follow a predictable hump-shaped cycle. Your income is likely to be low at the start of your life, higher in your mid 30s to 50s, then decline in your 60s and thereafter. Households will take on high debts in the early stages of their lives, then aim to become net savers in the middle of their careers, then draw down on those savings at a later stage of life. It is therefore not uncommon for a household to get into debts of up to ~5x annual incomes.
2. Following on from the point about debt in (1), households can generally finance much larger debts (proportional to annual incomes) than governments can. A rule of thumb for mortgage serviceability in many countries: a household can borrow at a level where repayments to pay down the loan over 30 years are worth approx 30% of their current income at cycle average interest rates. Governments will extremely rarely run budget surpluses worth 30% of revenues, and thus will find it harder to sustain debts that are of a similar scale relative to their revenues.
3. Household incomes are more risky than government incomes - consider that a large recession might reduce an annual income by up to 90% for 5-10% of households, though this would only be a 4-9% reduction in incomes for a government. For this reason, governments are also less likely to find themselves *credit constrained* than households.

These points refute two common (though opposing) arguments made regarding fiscal policies. Firstly, it refutes the argument that governments should not run deficits. Point (3) argues that governments have dependable incomes, and therefore deficits may be appropriate. On the other hand, point (2) demonstrates that a government cannot sustainably run debts which are comparable in proportional terms to a household's mortgage - despite having a more diversified revenue base than an individual household.


---

### Answer by username_3 on 2014-11-18. Score: 3

Imagine you are trying to fill a bucket with a hole in it. It's obvious you will never get the bucket filled if the hole allows more water to leave than you have power to put into it with a hose. That's your household budget. The hole = your expenditures. The hose = your income. The water level in the bucket = savings. Simple enough.

National economies are not like buckets, though. It doesn't make sense for a national economy to have "savings", or "income". If I spend money at Wal-Mart, that's an expense for me but income for them. If someone else buys one of my paintings on Ebay, that's an expenditure for them but income for me. Everyone is better off presumably, but as far as the amount of money goes, it's zero sum. A better analogy for a national economy is an interconnected series of pipes where no water enters the system and no water leaves the system. In this completely closed system, we can't add any water, but what we can do is make the water flow faster. Then everyone gets the water that they need with a fixed supply. Because mild inflation allows the real GDP of an economy to grow at a faster rate than it would otherwise be able to, in this analogy, inflation is like widening the pipes.

Incidentally, there IS a pretty good counterpoint at the national level for the household analogy, but it's not government spending. It's actually the aggregate trade imbalance with other countries, as that money leaves and enters the system in a way that government spending does not.

> **Comments:**
> **username_4**: "It's actually the aggregate trade imbalance."  I was about to argue about the balance of trade (with regards to exports/imports), but you mentioned that towards the end! On a side note,  
> **username_3**: Yeah, I really wish our politicians understood the difference between domestic debt financing and international trade balances. We'd be all better off.  

---

