The household analogy is an absolutely great way to describe government debt
Much tutting over a reporter using the “household analogy” to describe government debt. The thing is, for all the squealing that no, no, it’s really different, it isn’t. The size of the governmental credit card is much larger, the constraints appear at a much higher level of debt but they’re still there and in the same way.
In a recent edition of the Newscast programme Kuenssberg, the broadcaster’s former political editor, suggested government borrowing was like a mortgage or taking out a credit card. She said: “One of the differences that is very important is the limit on borrowing for different kinds of spending. And just to give people some context, and I know some people object to trying to use metaphors to explain this stuff, I think actually it is quite important so you understand that borrowing for capital spending is a bit like if you took out a mortgage to buy a house or for day-to-day spending you buy loads of new frocks on your credit card: they are not the same kind of spending.”
Apparently this is terrible because:
Households have a limit on how much they can borrow because banks and other lenders put a cap on the amount. It means that once they have hit borrowing limits and can no longer afford to pay the interest bill, they tend to fall into arrears and before long creditors call in the debt. Thousands of households declare themselves bankrupt each year for this reason.
A review of the BBC’s economics coverage by Andrew Dilnot, a former head of the UK Statistics Authority, said in 2022 that countries also do not “tend to retire or die, or pay off their debts entirely” like households, which is why comparisons with household debt – and suggestions the government must ‘pay off’ or ‘pay down’ the debt – “can cause intense debate”.
Banks and lenders put a limit because they think there’s an amount that a household will not be able to repay. And as that limit is approached the more staid institutions refuse to lend and the wilder shores of the system are approached. That’s how moving from 3% over base for a mortgage (“investment!”) rises to 49% on a credit card with a guarantor (a recent offer from a non-traditional lender in the UK market).
Exactly the same happens with a country. The income is the amount that can be squeezed out of the populace over time in taxation. As the lenders think that’s getting closer to that upper limit then so does perceived risk and the interest rate at which anyone is willing to lend. This is how the Russian government ended up paying 300%.
Yes, obviously, a government can print money. But so can a household. Getting the pub to run a tab is money printing - debt creation is an increase in the money supply after all and there’s nothing that says that only banks can do that. But willingness to do that also rises as lenders - creditors - assess that risk of repayment. Until, at the limit, no one thinks promises of repayment are credible so no one lends. This is what happened to both Venezuela and Zimbabwe. To the point that both countries should, really, have started printing the money on larger pieces of paper - perhaps in rolls - so that it could be used for more fundament and valuable purposes.
The household analogy for government finances really does work. The limitation is different, sure it is. For the household, what income can be brought into it, for the government that income that can be squeezed out of everyone else. But it’s still a limit. And as that limit is approached interest rates charged on loans rise and the value of promises to pay become worth less - not worth the paper they’re written upon.
There’s only the one thing wrong with all of the above. The limitation upon government is actually lower than that upon a household. Lenders will, entirely happily, lend 4 or 5 times annual income to a household for an investment - say a mortgage. Currently the UK government takes 40% of GDP in taxation. 5 times that would be 200% of GDP as an outstanding debt. Who thinks that the markets will be happy to lend to a government with a debt to GDP ratio of 200%?
Governments face lower credit limits than households, that’s what makes them different.
Tim Worstall