Tuesday, March 12, 2013

Our House Burned Down, So Let's Worry About Our Electric Bill

Pundits love framing discussion about the deficit in the same terms as household budgets. And while I don't find that framing very useful and at times purposefully obtuse, here's my stab at it.

About four-and-a-half years ago your family's house was on fire. Your neighborhood fire department took the necessary steps to contain and eventually put out the fire. But your house suffered severe damages that were in need of repair. So you borrowed some money to make minimal repairs and got the house back to the point that you could sort of live in it again.

But it still needs a lot of work, including repairing a leaky roof. You have some debt, but it's manageable debt. In fact, the bank at the corner is still willing to lend you a lot of money and will do so at practically 0% interest because you are such a sure bet to repay it. So would you borrow some more money to finish fixing up the house now?  Or...would you spend 2-3 years singularly focused on reducing your electric bill and food expenses, and cutting junior's weekend art and music expenses, in hopes of slightly improving your debt holdings over the next 20 years?

And you'd be doing this because you are worried about how much debt you will have 15-20 years from now, even though the biggest driver of your debt happens to be your mortgage and education costs - neither of which are addressed in any of your household budget plans.

That in a nutshell is what has happened with the financial crisis/Great Recession and the ensuing fiscal debate that has been taking place in Washington the past 3 years. Our house was on fire (financial meltdown, over-leveraged household debt) and the fire is out and we still have a lot of work to do (economic growth, high unemployment). But we're focusing on debt instead and ignoring the biggest drivers of debt (health care costs, particularly Medicare).

This week both Paul Ryan and Senate Democrats both plan to release balanced budget plans, as if balancing the budget is an end unto itself. If balancing the budget in 10-20 years would lead to huge economic growth and job creation, it'd make more sense. But almost every economist predicts that any attempt at drastic spending reductions now would hurt economic growth and probably send us back into recession.

Here was Ben Bernanke a few weeks ago explaining Economics 101 to everyone else in Washington:

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