The United States is not a household

I’ve often lamented the common confusion of many folks who attempt to apply the economic principles of their household (“times are tough, so we need to tighten our belts,” or, “we can’t just continue to spend more that we take in,”) to the country as a whole. The United States, as an economic entity, behaves quite differently than your household.

Here is Slate’s Matt Yglesias (@mattyglesias) railing on the following commentary from Daniel Mitchell:

GDP numbers only measure how we spend or allocate our national income. It’s a very convoluted way of measuring economic health. Sort of like assessing the status of your household finances by adding together how much you spend on everything from mortgage and groceries to your cable bill and your tab at the local pub.

Wouldn’t it make much more sense to directly measure income? Isn’t the amount of money going into our bank accounts the key variable?

The same principle is true – or should be true – for a country.

Essentially, Mitchell is trying to make an analogy to measurement of economic activity of the U.S. and measuring the economic activity of a household. In doing so, he is forgetting a basic principle of the macroeconomy – expenditures must equal income.
So, measuring spending (gross domestic product, or GDP) is exactly equivalent to measuring income. Yglesias:

This, dear readers, is a great illustration of the perils of the household analogy. Your household’s expenditures and incomes don’t necessarily sum up to zero. In fact, it’s extremely unlikely that they sum up to zero. In any given year, your family is going to be either borrowing money (I took out a mortgage in late 2012, for example) or else saving money (this year I’m making payments on the mortgage).

The American economy isn’t like that. The sum total of income earned by firms and households net of taxes and subsidies has to equal the total amount of money spent by firms, households, the government, and foreigners. There’s no other way for it to work. If you earn $1,000 someone else has to spend $1,000. On a quarter-by-quarter basis, Commerce Department estimates of GDP and Mitchell’s preferred Gross Domestic Income sometimes diverge, but that’s measurement error—as any good Cato scholar should know, the government isn’t perfect. On a conceptual level, GDP = GDI by definition. This isn’t some kind of Keynesian conspiracy, it’s just what the figures mean.

Or, as Matt suggests: Beware the household analogy!

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