Posted Friday, Dec. 7, 2012, at 12:08 PM
Here's a neat little chart tracking both federal government debt as a share of GDP and household debt as a share of GDP. As you can see, the increase in federal borrowing offsets a decline in household borrowing.
The intertwining of these issues is not properly understood in the conventional political debate about federal borrowing. But when the household sector tries to reduce its indebtedness it needs to do something to make that happen. Stacking up huge piles of money in the closet is not a very sound method. As an individual, you don't really need to think about this. You save by either lending money to your bank or else by purchasing a financial asset (stock, ETF, mutual fund, bond) from someone else. But that just puts the money in the bank fault or in someone else's closet. Ultimately the money saved has to go to something.
One possibility is it could be a loan to someone else. Your retirement savings are my mortgage. But the household sector can't deleverage on net like that. So it could be corporate borrowing. But corporate borrowing for what? If households are spending less, businesses don't want to borrow money to invest in expanded capacity. What we need to do is lend the money to the government. The government can do two things with it. One is invest. The merits of a public sector investment don't stand or fall on the short-term demand situation the way a business investment does. The other is boost the incomes of citizens, either by cutting taxes or by boosting transfer payments to those in need.