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.
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.
It's not obvious to me that there really are differences that are both qualitatively and quantitatively important.
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.
Worthwhile Canadian Initiative 
Frank,
“In terms of private contracts, one man’s loss is not always another man’s gain. Both men can lose under certain conditions.”
This is obviously true, but that wasn’t the original argument, was it? Nick wasn’t saying that government debt is bad because of crowding out, inflation, suppressed exports, etc. That is a totally different kettle of fish. So that’s a discussion for another day.
But it’s good that you brought up mortgages! Those liabilities are not limited to a certain set of assets – they might eat them all! So (practically) the household debt is a burden along with the government debt? All of those evil credit cards? And so are by the way our beloved notes and coins?
Come on.
Jussi,
I am trying to answer your original question (November 2, 2017) – “Or what are the differences between government debt and corporate debt?”.
With corporate debt (or mortgages), the transfer of real resources can be a condition of the debt contract.
With government debt (these days anyway) that is rarely if ever the case.
And again (November 3, 2017) – “So I ask again: what are the differences between government debt and corporate debt in terms of being burden on future generations?”
As far as a burden on future generations, I as a citizen bear the burden of taxation and thus am liable for the interest payments on the sovereign debt (including the accumulated debt). I bear no such burden to buy a Ford truck or a Sony television in helping these corporations pay off their debt.
And finally again (November 4, 2017) – “IMO, this seems rather simply, so I don’t understand why some smart economists like Nick and many others are saying that there can a burden (through debt = financial liability) without a corresponding (financial) asset?”
One answer is that the central bank can make loans and retain those loans. This creates a liability in the private sector with no corresponding asset (bond).
Another (alluding to what I have already said) is that the value of the asset and liability can change independently of each other.
This is especially true when the transfer of real goods is included in the contract.
“Yes, if you are a lawyer. No, if you are an economist. Owners of a corporation are liable up to the corporate’s assets (for a limited corporation anyway) and if assets do not cover the liabilities it’s the creditors who bear the losses.”
I believe you are describing a reduction in corporate equity here. I would not call that liable.
“One man’s debt is another man’s asset. Net of financial agreements is always zero, all the time. So there cannot be any kind of time travelling”
If I am reading that right and a bank is involved, I do not agree with that at all.
Frank,
Nick argument: “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.”
So it is not about real resources directly. That’s another discussion.
“As far as a burden on future generations, I as a citizen bear the burden of taxation and thus am liable for the interest payments on the sovereign debt (including the accumulated debt). I bear no such burden to buy a Ford truck or a Sony television in helping these corporations pay off their debt.”
Some people (“you”) pay taxes to pay off debt and some not. Similarly, some people are shareholders and some (“I”) are not. So it is a distributional question. No, it doesn’t change the aggregate.
“One answer is that the central bank can make loans and retain those loans.”
It doesn’t work like that (for an economist). If true the government could create infinite wealth (printing assets without corresponding liabilities).
“Another (alluding to what I have already said) is that the value of the asset and liability can change independently of each other.”
No they cannot (yes, if you are an accountant).
TMF,
“I believe you are describing a reduction in corporate equity here. I would not call that liable.”
Yes, corporate debt means lower shareholders’ equity value. So that’s a burden for the shareholders, regardless what you call it.
“If I am reading that right and a bank is involved, I do not agree with that at all.”
Give us an example! But keep in mind that it is easy to create financial assets, if their net value is not zero it would be easy to create infinite amount of wealth.
Jussi: “Give us an example! But keep in mind that it is easy to create financial assets, if their net value is not zero it would be easy to create infinite amount of wealth.”
TMF is right. See my old post. But it does not follow that you can create an infinite amount of wealth by creating financial assets, just like you cannot create an infinite amount of wealth my creating any individual good. Because demand curves slope down, so if you create too much the price drops below the costs.
And Tel is right that the shareholders of a corporation can and will walk away from the liabilities of that corporation, if the assets are less than the liabilities.
Nick, the old post is about money and liquidity. How is it relevant to this question? Are you saying that the government debt is a burden and other type of debt is not because money might have some value due to the network effect?
“And Tel is right that the shareholders of a corporation can and will walk away from the liabilities of that corporation, if the assets are less than the liabilities.”
Nick, no one said they couldn’t. But again is this the reason why government debt is a burden and corporate debt is not? Are you saying that “walking away” will magically create value for the kids? Where does that wealth come from? Are you REALLY saying that whether or not a corporate is a limited company will have intergenerational consequences?!
Jussi: “Give us an example! But keep in mind that it is easy to create financial assets, if their net value is not zero it would be easy to create infinite amount of wealth.”
I think Nick is agreeing with me for a different reason.
I save $10,000 in demand deposits. I start a bank by selling $10,000 in stock to myself. The reserve requirement is 10%. The capital requirement is 10%. The bank creates $100,000 in demand deposits (creating a reserve requirement of $10,000). Borrowers create $100,000 in new bonds. There is an asset swap of demand deposits for bonds. The bonds purchased by the bank now create a capital requirement of $10,000. The demand deposits are spent in the real economy.
There is a saving flow of $10,000. There is a dissaving flow of $100,000. NGDP (a flow) increases by $90,000 in the present.
My saving decreases NGDP by $10,000 in the present. When I spend it, NGDP increases by $10,000. So, I consider saving spent to be “past” “money” brought to the present to increase demand.
The dissaving increases NGDP by $100,000 in the present. So, I consider dissaving spent to be “future” “money” brought to the present to increase demand.
The “money” is time traveling around to different time periods (most likely) relative to what would happen if there was no saving and dissaving.
Finally, nobody is probably going to agree with me about that.
I can see most of the “monthly budgeting” discussed here is about the currency denominated debt.
I would say the right questions are:
1) Is the debt/bonds bought by a bank or non-bank?
2) What entity is supposed to make the principal payments and interest payments and when?
3) What happens if there is a default?
In general, gov’t bonds and household bonds can be bought by a bank or non-bank.
In general, household bonds have dates when principal and interest payments are supposed to be made. Most of the time, the gov’t budget is run so that the bonds are interest-only.
In general, household defaults mean the lender takes some kind of financial loss. If the gov’t borrows in its own currency, it is expected that the currency printing entity would bail out the lenders (make the bonds whole).
I have to say that I still don’t get. Why government debt is a burden but e.g. corporate is not? Maybe the answer is obvious like Tel said but I just don’t see it (wouldn’t be the first time)? Nick would you have time to also for this one? Or anyone else who gets it?
On other subjects:
“But keep in mind that it is easy to create financial assets, if their net value is not zero it would be easy to create infinite amount of wealth.”
Nick and TMF, the backdrop here was that there is wealth creation by “refuse to accept” or “walking away”. If that is the case, we truly can create an infinite amount of wealth.
Note that from financial asset > liability it follows that economic “total wealth” > “total real wealth”. Is this a useful starting point? And also if assets == liabilities it doesn’t follow that money couldn’t have liquidity value.
And Nick, coming back to the old post, you started it by saying:
“Take Bitcoin for example. It’s a financial asset to whoever holds it.”
Why do you say Bitcoin is a financial asset? Wikipedia: “A financial asset is a non-physical asset whose value is derived from a contractual claim, such as bank deposits, bonds, and stocks.”. Is Bitcoin “a contractual claim”?
Jussi, how do you define wealth creation?
Also, let’s try this scenario.
The gov’t issues some 200 year bonds. The central bank buys the gov’t debt. A corporation issues some 200 year bonds. Some, but not all, of the people buy the corporate bonds. The corporation also has stock. The corporate bonds are interest-only for 140 years. The gov’t runs its budget/bonds as interest-only for 140 years. At year 100, everyone dies and there is a new generation. The new generation inherits the corporate stock. The new generation inherits the corporate bonds. At year 141, the gov’t and corporation start making principal payments.
Where is the burden?
I have tried to summarize below the discussion on this matter:
Nick is saying that government debt is a burden, some economists (e.g. Krugman) are saying it is also an asset, meaning it is a wash – therefore the debt level itself doesn’t matter. I think that Nick is right given his assumptions because if it is sold and not bequeath (in any form!) it has to be consumed by “the parents”. But that is a big assumption because it means that more debt always means more consumption!
So, IMO, this is not “a biggie” or anything new – if debt is used to increase current consumption, it is a burden on future generations. Either the parents eat the apples or they bequeath them. So Nick’s argument collapses back to the fact that it only matters whether the additional debt means higher consumption. And this applies to any debt class (e.g. corporate bonds). That is what Brad DeLong also said (2012 – answer to Nick): “What causes the burden is not that government debt is issued, but rather that the issuance of government debt crowds out the formation of useful capital.” (http://delong.typepad.com/sdj/2012/10/the-intergenerational-burden-of-the-debt-nick-rowe-tempts-fate-weblogging.html).
Nick has said that Simon Wren-Lewis agrees with him. E.g. SWL: “Government debt can be used to redistribute income to current generations from future generations, even if the aggregate level of consumption in each period remains the same.”. (https://mainlymacro.blogspot.fi/2015/02/the-burden-of-government-debt-again.html). The latter part, “even if “, should be highlighted as I’m not sure his comment is actually compatible with Nick’s assumption that the debt is not bequeath in any way (meaning higher consumption). In other words SWL assumes here the kids are not worse off as their consumption is unaltered. So this is not a biggie. Sure enough he promptly continues: “The size of government debt is not a good indicator of any burden.”.
Also Noah wrote that he and Nick “agree on everything now” (after disagreement): “These past government transfers can be accomplished by government borrowing and spending…This is the upshot of Nick’s model.”. Yet, Antonie Fatas (2012) seems to think that this is not a biggie: “My reading of the debate is summarized well by Noah Smith long list of updates to his blog entry. In particular the following question: is government debt an indicator of the (fiscal) burden we are imposing on the next generations? And the answer is a clear no. Debt does not matter. What matters is taxes and spending, debt is just a vehicle to deal with imbalances between the two. Debt is not a burden per se but it can be the outcome of tax and spending decisions that lead to redistribution of resources.”. Read them yourself but I think both Noah and Fatas think that this is not a biggie.
Nick (2015) himself later agrees with Fatas: “(Antonio Fatas, by the way, is correct in saying that if the government issues debt to buy real assets, and if future generations inherit (as a freebie) those real assets as well as the tax liabilities inherent in the debt, it can all cancel out.)” http://worthwhile.typepad.com/worthwhile_canadian_initi/2015/02/debt-does-have-intergenerational-distributional-implications.html. I think that “buy real assets” covers all public investments (e.g. roads).