The continuing challenge of consumer debt

Jon Hilsenrath and Conor Dougherty have an article (see here) over at the Wall Street Journal that argues that one of the significant challenges to a solid economic recovery is the high levels of consumer debt.  They say:

The biggest problem may be household indebtedness. At the peak of the economic boom in the third quarter of 2007, U.S. households collectively had borrowed the equivalent of 127% of their annual incomes to fund purchases of homes, cars and other goods, up from an average of 84% in the 1990s. The money used to pay off that debt means less available for new spending. Households had worked their debt-to-income levels down to 112% by the first quarter, in part because banks have written off some debt as uncollectible. 

Let me take a moment here to address a fallacy that I often hear.  People often make the following claim:  I have to live within my means and pay my bills at the end of the month, so should the government.  Let's set aside the ambiguities that are contained in the premise of the claim (the data on consumer debt would appear to contradict the premise) and note that a government (a country) is not a household.  The fallacy here is one of false comparisons.  A family budget and the budget of a nation are not the same thing.  Let me state that I am not making an argument for reckless government spending.  I am saying that the standard analogy often used by people is just logically fallacious.  Note that even President Obama recently committed this fallacy and the economist Jared Bernstein "takes him to school" for it (see here).  The relevant points of Mr. Bernstein's rebuttal are shown below:

Here’s the gist: “The federal budget is just like a family budget, and we in government must tight our belts and live within our means just like families do.”

There are similarities which I’ll note below, but it’s almost always used as an argument for cutting everything to the bone right away, and in that sense it’s wrong.

First of all, it’s bass-akwards: when families are tightening their belts, the federal government is the one institution that can actually help the economy—and these belt-tightening families—by loosening its belt and running a deficit.

That deficit should be temporary and should come down when the private economy climbs up off the mat—which again tweaks the analogy: when families start to loosen, gov’t should eventually start to tighten (“eventually” because these transitions can be fragile and if gov’t tightens too soon, it can reverse the early gains).

But there’s another fundamental way in which this family budget analogy gets misused.  Families borrow to make investments and to get over rough patches.  They run deficits too.  I went into pretty deep debt to finance college and grad school and I’m glad I did.

The whole credit system is based on the fact that if we had to pay cash-as-we-go for everything, we’d seriously underinvest.  And that’s true for families and governments—and yes, you can overdo the borrowing thing.  But to flip too far the other way is equally dangerous.

So, while it sounds good and has some merit, I’d use the “gov’t budget=family budget” argument with care and I’d discount those who want to use it as a hammer to insist on instant cuts.