Monday, December 24, 2012

Making an Analogy

You'll often hear people say something like "Households have to balance their budgets - the federal government should too."  And the reply, "The government isn't like a household - you can't equate them."

I think both views are wrong:  households do not in fact have to balance their budgets every single month, and one can make an analogy between the federal budget and a household budget - though I'll imagine a household that lives in a stylized and simplified world for the analogy to be easily followed.

Suppose you work for the only employer there is.  (The federal government has only one economy, after all.)  Continuing our supposition for this hypothetical household, you have good credit, though you rashly allowed your relatives Ronald and George to run up your credit card debt irresponsibly.

Now you lose your job and there is no other. (Analogous to recession/depression hitting the national economy.  Again, for ease of simplification, I'm positing no income at this point.)  Here's what the future looks like:  after a wait of some time, it's pretty certain you'll get your job back when the employer's business has improved - perhaps in 4-5 years. (Analogous to the economy recovering - eventually.)   A couple more wrinkles:  if you invest in some training courses during this period of being unemployed, you'll improve your chances of being hired back at a higher salary, and if you invest in sprucing yourself up a bit - e.g. a new wardrobe to replace your worn-looking one - you'll improve your chances of being hired back sooner - perhaps in 1½ -2 years.   (Analogies to national investments in education and infrastructure.)  And oh yes: interest rates are really low, so you can borrow money essentially for free.

So you have three choices:

Option 1. "Balance your budget" by giving up your home and eating out of dumpsters while your increasingly shabby appearance makes the chance of your being rehired more and more remote;

Option 2. Accept that you're going to have to go into debt to maintain your household, adding to the debt already run up by your irresponsible relatives, but knowing that in a few years, before your credit has run out, you'll be rehired, and can then start paying off the accumulated debt;


Option 3. Take a deep breath, and invest in the education and sprucing up - and maybe some other useful things you were thinking of buying on credit in the future, but figure now is the time while interest rates are so low.  Yes, it means taking a deep credit plunge, but because you get your job back so much sooner, you in fact lay out no more (and probably even less) than you would have by just coasting on credit for a longer time without making the investments (option 2). You're also ahead on those future planned purchases you make now, as interest rates are going to go up once the only company in town is back to hiring everybody. And once you're hired back at that higher salary, you can pay off the debt more quickly than you would if you followed option 2.

Which option would you choose?

(Yes, yes, yes, it's very simplified, and not a true representation of an actual household, but I believe it's a perfectly valid analogy for the situation we found ourselves in back in late 2008.  Since then we've been coasting mostly on option 2, a little bit of option 3 back in 2009, and have been harangued by Ronald's and George's closer relatives to "act responsibly" by adopting option 1.)

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