What is prudence in the conduct of every private family, can scarce be folly in that of a great kingdom.—Adam Smith, The Wealth of Nations
Richard Feynman was once asked what he would pass on if the whole edifice of modern scientific knowledge had been lost, and all he could give to posterity was a single sentence. What axiom would convey the maximum amount of scientific information in the fewest possible words? His candidate was ‘all things are made of atoms.’ In a similar spirit, if the whole ramshackle structure of contemporary macroeconomics vanished into thin air and the field had to be reconstructed from scratch, the sentence which packs as much of the discipline into the fewest possible words might be ‘governments are not households.’ The principles of running an economy are in many crucial respects different from those of keeping your own finances in order. The example of the hypothetical tenner is part of the reason why: governments need to keep money moving around. For a household, to deposit the money in a savings account might well be the most sensible course. Governments, on the other hand, need that velocity – they need GDP. In order to get it, they sometimes have to borrow that first tenner, which they can do in a range of ways not available to ordinary citizens (who can’t, for example, just print the money). Once that first tenner is spent, the government’s hope is that it will continue to be spent many more times. [Emphasis added.]
The fundamental fallacy of Keynesian economic analysis is that it is predicated on the notion that the rules of fiscal common sense do not apply to the government. Contra Smith, the Keynesians assume that the government need not live within its means, and that it focus on attaining certain target numbers for highly abstract, generally unrealistic abstract notions of economic productivity.
The shallowness of the Keynesian worldview is apparent in many ways:
First, the Keynesian emphasis on monetary velocity is extraordinarily shallow. It is assumed that government spending increases monetary velocity by spreading money throughout the economy. Even if this assertion is true, what is often neglected is how, at least in regards to taxation and borrowing, the only way the government spreads money throughout the economy is by first taking money from the economy (of course, this is not technically the case with inflation, but since governments do not fund their budgetary expenditures solely by inflation, one must necessarily conclude that governments at least partially fund their expenses by either debt, taxes, or some combination of the two, which requires the further conclusion that, at some point, money must first be taken from the economy to later be put in to the economy). Another observation that is often neglected is that money that is not spent by the government (i.e. privately-spent money) also has some degree of velocity as well. Money does not generally sit stagnant, except among those who wish to store currency under their mattress or such-like, and so money that is spent my non-government market actors has the same velocity as money spent by government market actors, assuming that in both cases, no currency is ever removed from circulation. Thus, the assertion that government policy must needs be different from household economic policy is fallacious because the justification for the assertion that government policy is special is itself specious.
Second, Keynesians neglect to understand that money is not itself production. As was noted in the excerpted piece, households cannot print money whereas the government can. Unfortunately, the mere printing of money does not itself magically cause more products to appear in the economy. Now, inflation can draw demand forward, but only to a limited extent, because ultimately shifting production forward runs into the very serious problem of running out of demand, production materials, or both. One of the reasons why the housing market collapsed in 2008 was due in part to demand exhausting itself. To put it simply, people stopped wanting houses at the prices provided. Sure, the housing supply is at its highest, but now the demand for houses has declined, which is why housing prices remain relatively depressed. Quite simply, demand is not infinite—neither is production—which is why inflation will always fail to permanently increase production. There are limits to everything, and inflating the currency does not change that very simple fact.
Third, Keynesians fail to realize the scalability of hierarchy. The reason why the government is often compared to a household is because the household is a useful metaphor for understanding hierarchy. Every household has a head, every household has expenses, every household has members, and so on. A functioning household is one where everyone contributes to its upkeep, and one that lives within its means, and so on. Of course, the metaphor is not exactly perfect, but it is generally useful, and so it serves as a useful point of comparison, and provides people with simple heuristics for evaluating, say, the long-term reliability and stability of any hierarchical organization, such as a business, charity, church, or government. If a functioning family is one that minimizes deadweight and free riders through the proper division of labor, and manages to avoid fiscal problems by living within its means, then it is generally reasonable to expect that a state or business that minimizes deadweight and free riders, and also lives within its means, well do reasonably well and be expected to have a lot of stability.
And so, while governments are not households, the difference is more along the lines of scale than quality. Governments are similar enough in form to households that the microeconomic analysis used to evaluate the fiscal health and stability of a household should be a useful heuristic for evaluating the fiscal health and stability of a government. Furthermore, the form of government is not so radically different from the form of households that it justifies a radically different set of analysis and evaluation.