Election season has begun, which means that we're probably going to start seeing one of my least favorite analogies being used again. This analogy has circulated social media during every election I have paid attention to (which is admittedly few). The analogy I’m talking about is the comparison of federal funds to family funds, typically comparing the federal budget to a family budget, or the federal debt to family debt.
I like analogies a lot, and I think they are really useful, but I think this one is overly simplistic, mostly useless, and one of the most misleading analogies out there. It isn’t entirely useless, but close to it. You can perform a google search and in about three and a half seconds find a bunch of articles about why this analogy isn’t very good. However, since I like analogies so much I would instead prefer to come up with a more accurate analogy. This more clearly illustrates the differences, and also is a nice way to describe the ridiculously complex way that US and world economics works. My understanding of this kind of stuff is not the best, but analogies are fun so it’s worth a shot.
My analogy family started out as a bunch of children living with their parents in Britain. The children didn’t really like their parents and felt like they were being mistreated, so they moved away to live with their Uncle Sam. Uncle Sam had lots of land that he let the children use, and each of the children used the land to make a living. Eventually, the children decided that they needed an independent body to settle disputes and provide for the common good, so they gave this responsibility to Uncle Sam. Uncle Sam was now able to settle disputes between the children, and was also able to provide services that had little incentive for any of the children to provide. Uncle Sam also established a family currency to use, to provide a more convenient way to trade. In order to fund these services Uncle Sam levied a tax on the children, to be paid in the established currency.
One of the children, named Fred, was good with money and established a bank, which provided a safe place for the other children to keep their currency. He used some of the deposited money to loan money to the other children, and charged interest on these loans. By gaining this interest he was able to pay interest for the deposits he received from the other children, as well as make a living for himself.
Sometimes one of the other children would run into problems, and their business would struggle. This would have a ripple effect on the other children, since they all depended on each other for goods and services. When one of the businesses struggled, businesses that it sold goods to would face higher prices, and businesses that it bought goods from would have lower sales. This would then spread throughout all the children, and was usually made worse because the children would become afraid that things were going to get worse, so they would purchase less goods. In this way, small fluctuations in the children’s business could create tough times for everyone. During tough times the children would become afraid that the bank would lose the money it had loaned out, and thus lose some of their deposited money. So they would all try to withdraw money from the bank at once. The bank does not hold all of the money that is deposited, so the bank would run out of money. This is known as a run on the bank. So the bank would have no money to invest, and the children would have lost much of their savings, and their businesses would be performing poorly. Uncle Sam would see what was happening to his adopted children and get depressed, so these occurrences were called depressions.
Uncle Sam wanted to avoid depressions as much as possible, so he worked with Fred to establish rules for how his bank should operate, and ways to avoid the depression. Fred got someone else to run the normal bank, and he instead became an independent central bank, which would set rules for how much money the normal bank had to keep in reserve, in order to try to prevent future runs on the bank. Additionally, Fred has the ability to control interest rates and inflation, by buying and selling bonds to the bank. This adds additional money to the bank or removes money from the bank. This controls the interest rate through supply and demand. When the bank has more money it wants to make more loans, loans are easier to come by so the interest rates go down. Fred operates independently of Uncle Sam, since Uncle Sam can't make decisions as quickly as Fred can, but ultimately he answers to Uncle Sam. After he received his new job title his siblings started referring to him as "the Fred".
So Uncle Sam taxes the children and uses that tax money to provide services for the children, and uses the Fred to try and prevent the children from panicking and tanking their economy. However, the Fred often isn't enough, since the misfortune of some of the children can still negatively impact the rest and can lead to a depression. To avoid this, Uncle Sam spends more than he takes in in taxes when the economy begins to look bad. This extra spending on services can ease the children's fears and get them to continue spending again. In order to spend more money than he takes in, Uncle Sam sells promises. His promises guarantee that he will repay what the promise was purchased for, with interest. Uncle Sam can sell promises because it is widely recognized among the children and other families that Uncle Sam's word is good and that his family is strong.
As it turns out, over the years Uncle Sam has been in debt for the vast majority of the time. The demand for his promises has stayed strong, and he can continue to sell new promises to pay old promises, in a way paying off the children's and other families owed debts by selling them new ones. In this way future generations fund past ones, and on and on as long as the children and other families value Uncle Sam's promises. The children own most of Uncle Sam's debt, and other families own a smaller portion of it. Even though his debt has grown, Uncle Sam's family is widely considered strong, and demand for promises stays high. Additionally, Uncle Sam issues his own currency, and could create more to pay back his promises, if necessary. Although this runs the risk of making the currency less valuable, which could reduce the value of his promises.
I think the analogy I have described is still a simplistic version of how things really work, but like I said, world economics is tough to understand. I think this just illustrates that there is far more going on than a simple family budget. Families are not a mostly self reliant economy, they do not issue their own currency, they don't tax their children, and they don't sell securities to their children. The topic is commonly just written off as having an easy solution: don't spend more than you make. But if economics were that simple it wouldn't be something you need a college degree to research. As far as I can tell, many economists disagree on monetary policies, and many disagree on whether the US drastically needs to reduce its debt or not.