In a pecuniary economy, households' spending is limited by the stock of state money and the flow of income received in the form of state money. Thus, households are subject to liquidity constraint as they incur debts in the established unit of account, and consequently need to obtain the widely accepted medium of exchange (Wray 1998; Bell 2001). Even when households' borrowing is unlimited, there is liquidity constraint to the extent that various interest rates and fees are administered by banks and business enterprises upon different households. Consequently, households are concerned with sound finance--or balancing their budgets at some point (albeit not at all times). The state's spending, on the other hand, is not limited by a stock of money, since the state spends by issuing its own IOU (Knapp 1924). Thus, there is no instrumental reason why a sovereign state should follow "sound finance" (Lerner 1943; 1947; Wray 1998).
The idea that a sovereign government or nation faces financial burden due to federal deficits is based on a state-household budget analogy, according to which, in much the same way a household goes bankrupt if its debt continuously exceeds its income flow, continuous government deficits are also unsustainable. The view of government "sound finance" holds that there is some "prudent" government deficit-to-GDP ratio in the same fashion that there are sensible household debt-to-earnings ratios that are used in reasonable lending practices. Under such an analogy, in the same manner that households have a time line for repaying their debts (even if they are rolled over) the state eventually will have to face the retirement of government debt. Thus, according to this view continuous government deficits are wasteful and constitute a "burden" for future generations.
The household-state analogy does not differentiate households and the state as distinct institutions with specific characteristics, powers and liabilities. An Institutionalist discussion of this analogy with reference to household and government deficits would reveal some questions of importance for theorizing about households and the state as institutions in a pecuniary culture.
Government Deficits and Households' Financial Positions
The state-household deficit analogy is not merely a rhetorical device and an example of fallacy of composition; it is a habit of thought. The analogy enters the process of valuation in policy analysis and formulation, and is engrained in common everyday "understanding" of public finance and the relation between state and households. The following main issues emerge as a result of the household-state analogy with respect to deficits. First, the special place of the state as a monopoly issuer of money is ignored, which obscures the importance of households' place at the bottom of the "debt pyramid" (Bell 2001). In addition, the way in which the state deficit spends and "prints" money is misconstrued (Wray 1998; Bell 2000). Furthermore, the household-state debt analogy obscures the effect of government deficit on the household sector, as well as its role in generating household sector net savings. We are going to focus on the last point.
The government budget deficit offsets the private (business and households) sector's surplus. This means that the private sector as a whole can save only when the government runs a deficit. Alternatively, while it is true that one household can spend less than its income, and thus can save, another would have to go in debt. Thus, the government deficit represents private sector saving. The private sector saving equals the sum of the government sector deficits, which equals the outstanding government debt (assuming a balanced foreign sector). In such a case, if the government runs a surplus, the private sector will be deficit spending and reducing its net financial wealth at the aggregate level (although some households may still be able to save) (Wray 2006; Galbraith 2006). Consequently, the household-state analogy that undergirds the doctrine of sound finance results in a paradox. Concerns about sustainability of government debt necessary assume that households can run indefinitely deficits, as balancing the government budget would mean that household wealth decreases. On the other hand, in order for the economy to grow, the household sector must become indebted. Yet, when it is argued that the government should balance its budget just as a prudent household, there is a presumption that households indeed are not indebted.
In the case of the U.S. economy, where recent borrowing by the household sector has reached unprecedented levels and debt-service burden has reached record heights, there are warnings that household borrowing relative to income cannot continue indefinitely. Furthermore, these studies show that current economic growth is driven by consumer borrowing, and thus is vulnerable to a decrease in consumer spending (Papadimitriou, Chilcote, and Zezza 2006; Galbraith 2006...