Governmental Budget Constraint

You want to take a Caribbean vacation. It costs $3,000. However, you only have $200 in the bank, your credit cards are already maxed out, and all of your friends refuse to loan you any money. Guess you'll be taking your vacation at the local Motel Sleazo. Hope you enjoy vibrating beds.

That's budget constraint. You reach the end of your financial resources and can't buy what you want.

Just like you, governments can reach the end of their budget possibilities. Governments have more cash flow than you do, plus they can usually borrow more (U.S. federal government debt: $22 trillion...now, that would pay for a heck of a vacation).

Governments can also raise taxes to bring in more money. The ability to borrow and the ability to raise taxes means that government's don't run into the same hard constraints as you do. They rarely have their credit cards embarrassingly denied trying to buy a $0.79 donut.

But a government reaching its constraints can have wider impacts. When you run out of money, it just means you have to economize on your vacation. When a government does...it can impact entire economies.

Raising taxes too much cuts into economic activity. Meanwhile, excess debt used to fund government spending (especially on the federal level) can impact inflation.