Imagine you own a restaurant and a bunch of your customers — after watching the Suzy Orman Show — decide they need to cut their spending and pay down their credit card debt instead of eating out. That may be the wise, responsible choice for each family's bottom line, but it's terrible for your restaurant business. In response, you need to cut your spending so you lay off some of your staff. Because unemployment is high and hours are tough to get, your former employees must in turn cut their spending at the mall, the bookstore, the grocery store, the hair salon, etc. And now even fewer folks can afford to dine at your restaurant. The belt-tightening death spiral is now in full swing.Nobel Prize-winning economist Paul Krugman explains here why austerity programs are the exact opposite of what the federal government needs to do in times of dwindling demand and high unemployment. When consumers, businesses and state & local governments are cutting spending to improve their bottom lines, the economy will stagnate, or worse, continue to death spiral down from lack of demand.
As long as we are in a liquidity trap of high unemployment despite rock-bottom interest rates, the best response of the federal government is to spend (even borrowed money) to put people to work so they'll have money to buy things and keep money circulating. And unlike your family budget, every time that money changes hands, it brings in more tax revenue back to the federal government to pay for the spending.
In short, the federal government, with its ability to run deficits and borrow cheaply now, becomes the spender of last resort. It may seem counter-intuitive until you let go of the misleading "family budget" analogy. Once we do that, we can actually fix this economy rather quickly. And paradoxically, it turns out the best way to fix the deficit is to invest big now to get people back work so they are paying taxes and depending less on safety net programs.
Finally, riddle me this... Why is the kitchen table/family budget analogy only invoked for the spending side? When it comes to revenue, Republicans insist that you can cut tax rates — analogous to cutting your hourly rate — and magically bring in more money. Really? When has that ever worked in your family?
What’s more, why do the “family budget” analogists always ignore that even fiscally responsible families take out mortgages and student loans that may well exceed their annual income? Taking out debt to invest in the future or address a crisis is sometimes the prudent thing to do. Imagine, for example, your roof is falling apart and you can borrow $10,000 at 1.7% annual interest for 10 years. Do you add to your debt and fix your roof, or do you watch the next rainstorm destroy your house?