Thursday, March 7, 2013

Government As The Homeowner, Revisited: To Scrap Or To Invest?


Consider a homeowner who owes a typical mortgage on a house and makes just enough to keep up with the bills and maybe every once in a while treat the family to something nice like a dinner out or a trip to the zoo.

Does it make sense for that homeowner to sell the car he uses to get to work in order to pay down the mortgage faster?

How about if he skips paying for the annual licensing for his field of employment (required for his career) to pay down the mortgage faster?

In order to pay down that mortgage faster, does it make sense for that homeowner to stop buying food for the kids, getting reasonable check-ups and other medical attention as needed, and keeping the house warm enough that the pipes won't freeze?

Should the homeowner cut out all trips to the library for books for the kids so as to save on gas and send bigger mortgage payments? How about toys? Should the homeowner never buy a toy again until the mortgage is payed off, even if it's a just started 30 year mortgage and he has a newborn with no toys beyond a single teething ring?

Does any of that really, truly make sense?

How about investments? Should the homeowner stop contributing a modest sum to his retirement plan and an education savings plan for his kid? Even if both of those investments are expected to have a return higher than the interest on the mortgage?

And if the homeowner can reasonably expect to get significantly higher pay from investing in his career, what then? Let's imagine this homeowner could put $1,000 on his low interest home equity line and get training and certification that on average increases a certified individual's pay by $1,000 a year. Would it be more sensible, rational, and responsible for the homeowner to get this certification or to avoid taking on a little bit more debt?

Our government is this homeowner. Our debt is this manageable mortgage.

When we're at full employment -- unlike now -- there would be no certification we could expect to be a safe bet to increase our income steadily. But we're not there. Not even close.

When we're well below full employment on account of a consumer demand shortfall -- like now -- just about any additional spending we have the government do can typically be expected to add to commerce and help push us that little bit closer to full employment. That means higher revenues. And that's without even focusing it into the most useful spending, which we can and should do to get the most bang for the buck by spending on adding to infrastructure, R&D, and other investments known to build the most revenue.

It should already be an obvious choice. But unlike the homeowner, the government gets an additional win by investing that spending in increasing revenue. Since additional employment means less unemployment, medicaid, and other liabilities, the government reduces its costs by increasing its revenue. That's not just a win-win ... it's a no-brainer. It's stunningly obvious. We should be investing in raising our revenue by engaging some short term spending (preferably including long term investments in that short term spending).

Now if only the budget cutters in Congress could see that.

4 comments:

  1. Unlike the homeowner in your analogy, the government is also operating at a deficit. You stipulate in the opening paragraph that the homeowner has sufficient income to "keep up with the bills." That means he's able to pay off, each month, what he owes in his payment plan.

    The government is currently bringing in a set income, yet is spending 30% more each month, which compounds into the total debt.

    There is no need to allocate extra funds to pay down the debt - the debt will automatically be paid down if the government stops spending more than it brings in.

    Let's say that you bring in $100 a month in income, and your bills for mortgage, utilities, etc. come up to $90 a month. Instead of saving the $10, you decide to spend an extra $40 each month on eating at restaurants. You are now $30 in debt. Next month, you'll be $60 in debt. By the end of the year, you are now $480 more in debt than when you started, and if you stopped overspending your income, it will take you four years to pay off what you spent in one.

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    Replies
    1. There's more than one way to keep up with the bills. While making all payments out of income may be the first method that comes to mind, it isn't the only method employed by homeowners, let alone by the government. Homeowners often -- in some cases quite reasonably and sustainably -- pay some bills from financing, such as home equity lines.

      Essentially, some homeowners also operate at a deficit at times. When either done in the short term to bridge a gap (which could mean a short term unemployment or car repairs) or as a means to attain higher income with a sensible investment (such as in job training), such operating at a deficit can be far more sound than sticking to the 100% non-financed method.

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    2. In the case of the government -- when faced with an output gap such as we have now -- the debt will not be paid down if the government spends less.

      Because we have a demand shortfall and are so far below full employment, any reduction in spending by the government will tend to increase unemployment (or at least slow recovery ... but the sequester's been estimated to be enough of a cut to increase unemployment). When not in a boom, budget cuts of any significant size mean more unemployment. More unemployment means higher automatic costs (unemployment, medicaid, and so on). More unemployment means lower revenue.

      Higher costs and lower revenue mean bigger deficits. Because of the greater-than-1 economic multiplier on spending, those bigger deficits resulting from spending cuts outpace any reduction in deficits from spending cuts.

      So no, cutting spending will not reduce the deficit and thus the debt. Ironically, cutting spending will increase the deficit and thus the debt.

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