Opinion: The nation is not a household – comparing national and family budgets is nonsense

Opinion: The nation is not a household – comparing national and family budgets is nonsense

by Chris Oakes-Monger

The unnecessary damage to our wealth caused by treating government spending like a family budget.

This week a group of leading economists wrote to the BBC. In a report not untypical of the bulk of BBC news and current affairs coverage of government borrowing  during the pandemic Laura Kuenssberg had said: “this is the credit card, the national mortgage, everything absolutely maxed out” and later commented that “for the next few years there really is no money.” The economists argued that this commentary misrepresents the financial constraints we face and reproduces a number of misconceptions surrounding macroeconomics and the public finances. 

The misconceptions to which they refer all arise from the understandable temptation to reach for our own experience of household finance and budgeting as a metaphor for the public finances. We hear this kind of thinking all the time:

“But how are you going to pay for it” 

“We can’t pass on all this debt to our children!”

“There is no magic money tree!”

“Labour’s promises are unaffordable and would bankrupt the country”.

“We don’t want to go the way of Greece….”


The household metaphor is however flawed and misleading in two major ways.

The first concerns size. Decisions about individual household spending and borrowing are insignificant by comparison with the wider economy and have virtually zero impact on how the rest of the economy will function. If a family chooses not to buy a new kitchen they will save the cost of the kitchen and their income will not be affected. This is not true of government because its spending is such a significant proportion of the economy as a whole. If the government cuts its spending there is a direct impact on demand in the rest of the economy as government purchases of goods and services are reduced. If employees are laid off they too will reduce their spending. The businesses whose products are no longer required by government may in turn lay off staff reducing demand still further. As a result the government will lose the income tax and NI contributions of all of the newly unemployed and lose tax on the profits of affected businesses. VAT and other indirect tax revenues will fall as spending in the economy contracts. 

At the same time other areas of government spending will be forced up, some of them obvious like welfare spending as people claim benefits, others more hidden and longer term as the financial and other stresses on individuals, families, and communities lead to increased alcohol and substance abuse, crime, imprisonment, health costs, educational underachievement, family breakdown and so on. Large parts of Scotland and Northern England are still paying for the social damage done by mass unemployment in the 1980s. Behaving like a household and reducing government spending in other areas in a vain attempt to save money is entirely counterproductive as it reduces demand still further, stifles at birth any potential recovery, and may well end up saving nothing. 

The second problem with the household model for the national economy is that it ignores the ability of banks and the state to create money. Contrary to the household budget model, the amount of money available in the economy is not fixed. Money is best thought of as an IOU from society to the holder. Our ten pound notes carry the wording “I promise to pay the bearer the sum of ten pounds”. But any IOU in which people have confidence is effectively money. The banks create money all the time when they issue credit. For example when a house buyer takes out a mortgage the bank gives them cash in exchange for an IOU. But now the mortgage (or the IOU) can in theory be sold on to someone else and has a cash value and is effectively new money so long as people have confidence in the house owner’s ability to repay. As the banks create money in this way the money available for house purchases increases. This in turn pushes up the market values of houses which then enables banks to extend lending still further against the new “values” of houses. In the absence of adequate bank regulation this cycle of money creation and asset price inflation can generate an asset bubble. A side effect of this is a redistribution of wealth from those who do not own houses to those who do. This is of little use to owner occupiers because they are living in their asset and so cannot usually realise their profit, but for those with more than one house it is very good news. For tenants it is catastrophic as rents rise. Similar but possibly less damaging asset bubbles are created in art works, fine wines, antiques etc.

In the build up to the 2008 crash US banks irresponsibly issued low-start mortgages to people they knew would probably default when the higher rate kicked in. They then packaged and repackaged these IOUs with other sounder ones and fraudulently sold them on in the markets. All of this was creating dodgy money. When the defaults started no-one knew exactly who was holding how many of the dodgy IOUs and the whole credit market seized up as confidence in all IOUs collapsed. Many paper assets in the virtual casino of the markets became virtually worthless overnight – effectively a massive pile of money was destroyed and city gamblers lost big. However the resulting chaos spilled over and nearly destroyed the retail banking system, an outcome which would have been catastrophic for the real economy in which people trade real goods and services and in which we all have to live. 

But it is not only banks that can create money. States which control their own currency can too (which is why we could never have been like Greece). When governments borrow they issue IOUs called gilt edged securities. Private individuals, banks and institutions buy them for cash, receive interest on them and can trade them in the markets. Because they are backed by the government they are generally seen as a safe investment compared with shares. However in addition to this process in which other participants in the economy lend to the government there is an alternative option called quantitative easing or QE. The Bank of England can provide pounds to the government in exchange for the governments IOUs (gilt edged securities). This can be done direct or the Bank of England can buy up existing gilt edged securities held by other banks, issuing them with pounds in exchange. So the Bank of England is now holding the IOUs But the Bank of England is really just another arm of the state and there is no real reason why the debt should ever be repaid. Effectively extra money has been printed which has the effect of diluting slightly the value of all the existing currency.

So there are money trees which are not magic both in the private banking sector and at the Bank of England, and we have seen QE in use during the Covid crisis where suddenly huge amounts of government money have appeared as if from nowhere. 

After the 2008 crash Cameron and Osborne used QE to push money into the banks. This had the effect of reflating share values thus restoring the wealth of those who had lost money in the crash. This was a political choice, which protected the rich at the expense of the rest of us. They combined this by taking a torch to the rest of the public sector during a recession, calling on the entirely spurious household model as a justification for what was an opportunist chance to roll back the state and slash corporation tax and other taxes on the rich.

As a result any recovery in the real economy was seriously delayed for the reasons outlined earlier. Keynes would have said don’t give the QE to the banks; spend it on government investment in the real economy where it will benefit everyone by restarting growth immediately.  Instead we flat-lined for two and a half years as the rich watched their shares recover.

When money is created by QE the real question is who benefits from it? If it goes to the rich as it did under Cameron and Osborne then it is a redistribution upwards. If it goes to the poor it is the opposite. If it goes to those with no unmet needs it will most likely find its way into a useless and potentially dangerous asset bubble. If it goes to someone who needs the money to spend, or if it is directly invested by the state in the real economy, it will create new wealth for all of us to share.

Perhaps an illustration would help. When we first had our children we started a baby-sitting circle. I printed about 240 vouchers – 24 for each couple in the circle which were exchangeable for baby-sitting. All went well for about eighteen months but unfortunately there was one couple who were always happy to sit but who never went out. They gradually accumulated nearly all the vouchers and left the rest of us with none to exchange. People were having to lend and borrow vouchers – the baby-sitting economy was seizing up. The voucher wealth of the couple who never went out was creating a voucher debt problem for the rest of us. 

The solution was to print 120 new vouchers – 12 per couple – voucher QE. Note that this reduced the value of all the existing vouchers and was a huge redistribution of “baby-sitting” wealth from the couple with all the vouchers to the rest of us, but as they had no real need of sitters they were not too distressed, and baby sitting in the rest of the economy restarted immediately. Had I modelled my plan on George Osborne’s handling of the economy I would have given most of the new vouchers to the couple who never went out. Fortunately I wasn’t that stupid!! 

Government finance is not the same as a household budget and thinking that it is damages all our wealth. Some at the top may believe it is worth propagating the myth that they are the same in order to justify policies designed primarily not to create new wealth but to redistribute existing wealth upwards, but that cannot be true for the rest of us.


About the author:

Born in St Albans in 1953 and raised in Radlett I attended Watford Grammar School and then studied Mathematics at Southampton University. On graduating I took a PGCE at the University of London Institute of Education and taught for twelve years in Hertfordshire comprehensives before moving to Alton Sixth Form College in 1987.

From then I taught mostly A level Mathematics full time and then part time until my final retirement from teaching last year. I still live in Alton but am a regular visitor to Southampton. I am married with three children the youngest of whom is at Liverpool University.

I have a wide range of interests including Theology, Geology, Politics and Economics and a huge enthusiasm for music of all sorts. I love walking, particularly in the Lake District and when we are not in lockdown I dance several times a week.