We have been witnessing a somewhat muted round two of the debate over the intergenerational effects of fiscal deficits. Paul Krugman got the ball rolling by enunciating the conventional economic wisdom that “no, debt does not mean that we’re stealing from future generations.” This incensed Nick Rowe, who insisted that, through the vehicle of debt, “we can take apples out of the mouths of yet unborn future generations, and eat them ourselves.” And Roger Farmer chimed in even more strongly: “An increase in government debt always places a burden on future generations.”
I should emphasize that this is not about what use government money is put to; everyone understands that government investment, if it’s productive, can make future people better off, debt or no. And it’s not about Keynesian countercyclical policy, which in a world of hysteresis can also have long-lasting positive effects. No, this debate abstracts from all of this and asks, taken by itself, does a fiscal deficit impose costs on future generations? Krugman says no, that debt is money we owe to ourselves in every generation; the payments and receipts cancel out. Rowe and Farmer say Krugman is confusing time periods with people: the transfers obviously offset at each moment in time, but the payers and recipients can be from different generations.
So let’s sort this out. First, we should frame the question just as Rowe and Farmer do: it’s not about time periods, which is trivial, but generations that overlap within time periods. And let’s also take the issue of what the money is spent on off the table too, since it could be financed either out of taxes or bond issues. Just examine debt’s effects on intergenerational distribution in an economic test tube.
Consider a world that functions like this: (1) All people are economically indistinguishable except for their age. There are no economic classes, nations, or any other categories of significance. (2) People buy bonds for income-smoothing in an uncertain world. The present value of the bond is its price which is equal to the discounted stream of future payments. (3) When they circulate in the secondary market, bonds are always purchased from older people by younger people, never the other way around. (4) People cleverly plan their lifetime earnings and consumption so that, at the moment of their death, the expected value of their bond holdings is zero. Over a large enough population, collectively, it will be zero.
In this world the government throws a big party, financed by a bond issue. The current generation finds itself liable for higher taxes for debt service, but at the same time the possessor of these same bonds. That’s a wash. But they do get the party, so they come out ahead.
What happens next is that some of these oldsters die, and some new babes are born. Collectively the oldsters leave nothing for the newcomers except the tax liability. As more and more of the initial generation get older and see the shadow of the Reaper in the mirror, they sell their bonds to the young. The young acquire the bonds, but they also part with their money; that’s a wash. But they still have the tax liability, so they are worse off than they would be had there been no party and no debt. Moral of the story, the Greatest Borrowing Generation was able to enjoy extra benefits at the expense of Generation Next. And you could demonstrate that the Nexters would be able to borrow from the following generation in the same manner, kicking the distributional can down the river of time, to really mix a metaphor. Thus we would witness “time travel” in the sense proposed by Nick Rowe.
Convinced yet?
But there’s another world. In this one people are exactly the same as before, differentiated only by age. Bonds are still fairly priced; buying or selling them has no effect on expected wealth. But we drop the rule that says that only young people can buy bonds from old people, and we especially drop the rule that say that, on balance, people plan their lives so that no bonds are bequeathed to the next generation.
The party remains the same and so does the initial bond issue. But when it comes time for Generation Next to take the stage there are important differences. First, the Nexters are receiving many of their bonds for free. This is a wealth transfer from the older generation to the young. Depending on the size of the bequest relative to the number of bonds still in the hands of the aging party veterans it can be partially, fully or overfully offsetting.
But that’s not all. The Greatest Borrowers, even as they approach decrepitude, may purchase additional bonds from the Nexters. That’s a wash directly, but it can eventually result in even larger bequests.
Note that in both worlds it remains the case that at each moment in time assets are identical to liabilities, so no distributional effects across time periods is possible, but generations overlap in time, and it’s possible for resources to be shifted from young to old or old to young. The question is whether this generational transfer is actually taking place and in which direction.
So which world is it? The Rowe-Farmer world is clearly a special case, with no bequests and a strict age structure for bond purchases and sales. (The latter constraint is more important for Rowe than Farmer, but I’ll leave that aside.) It is absolutely true that it is possible to model a special case in which they are right and Krugman is wrong.
But in the general case the direction of the transfer is unknown: it could go from younger to older or older to younger or be too small to notice. And, in case you’ve been reading your Piketty, we do in fact live in a world of bequests. Meanwhile, according to the Fed’s regular survey of household finances, accumulation of financial wealth continues monolithically right up until retirement, so there must be a lot of oldsters buying bonds from youngsters (or disproportionate purchases of new issues). In general, then, Krugman is right.
A lot of economic wisdom boils down to knowing whether you’re dealing with a special case or a general one.
Peter: I basically agree. If bequests increase by the same amount as the debt (as they would under Barro-Ricardian Equivalence), there is no burden on future generations. But if they don't increase, then there is a burden (unless it's offset by increased government investments etc., or we live in a Samuelson 58 world where r < g so the government can run a sustainable Ponzi scheme and never raise taxes to service the debt).
ReplyDeleteThough whether Paul Krugman would say that Barro-Ricardian Equivalence is basically right.....is another question!
ReplyDeleteIt's tough to have it both ways, where debt is no burden, and Barro-Ricardian equivalence is totally wrong.
"A lot of economic wisdom boils down to knowing whether you’re dealing with a special case or a general one."
ReplyDeletecan be shortened to:
"A lot of economic wisdom boils down to fudge."
Shall we start with Adam Smith? "The annual labour of every nation is the fund which originally supplies it with all the necessaries and conveniencies of life which it annually consumes, . . . " Not the labor theory of value, which some find in this analytic convenience, but the simple truth that we have only the present moment in which to produce or consume. The future is not ours to see. Or burden.
ReplyDelete.
We cannot eat today apples, which are yet to be produced. Nor can the printing presses at the Treasury Department manufacture future apples.
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What the Treasury can print are debt obligations -- pieces of paper and, in nominal terms, these always demonstrate a perfect Ricardian equivalence: the bonds start out with a nominal worth exactly matching the future tax obligation, which funds them.
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We could take into account the future effects on future productivity of whatever investment is funded by borrowing in the present, but the burdens of that investment, if any, are on the present, as consumption is foregone. More relevant to the calculation of putative future burdens would be the utility of a circulating financial capital: the usefulness of a marketable debt of certain nominal value as a reference and anchor for a financial system. The usefulness, we might suppose, would depend on a stable relation of the nominal value thru the sequence of time to claims on production and resources as they become available in the future sequence of present moments. That stable relation, if it is to obtain, would be the product of a continuing management of currency and marketable debt -- monetary policy by a central bank, in other words -- balanced against the fiscal policy and capacity of a government managing the division of production and consumption in the current present moment.
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To support the thesis of a future "burden" of debt incurred in the management of present consumption and production, it is necessary to conceive of some constraint placed on that future management of future production and consumption. The usual conservative trope is to insist that the debt will have to be "repaid" in the future, with the implication that future consumption will be reduced. But, this trope introduces an impossibility: nature does not permit us to eat future apples today, despite Nick's feverish fantasies to the contrary. If at some point, the debt is "repaid", it will be repaid, as it was issued -- in nominal terms by a fiscal authority. Ricardian equivalence always holds in nominal terms: bondholders have "saved" in anticipation of the tax obligation by taking possession of the bonds, and the repayment of the debt will be accomplished by returning the bonds from whence they came.
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Of course, we may suppose that those taxed will not be identical with those holding the bonds in that future period of repayment, and there will be distributional implications, as claims on present consumption are transferred to obtain the bonds. What that balance will be is a matter of future, not present decision, so it cannot be said to be entailed with the force of determinative logical necessity by the decision, in the present moment, to manage consumption and production by issuing public (or private!) debt. The future will manage itself, and the claim of "burden" requires identifying a constraint placed on future decision-makers by the printing of convenient fictions (aka bonds) in the present.
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I will not say that there are not such constraints implied by the commitments inherent in those fictions, though I will assert that the utility of marketable debt means that the issuing of debt now can also add to the capacity of the future to manage itself. It is not a foregone conclusion that debt will prove itself a "burden" reducing future consumption or production. But, we will not find those constraints, burdens or capacities, or understand them, with intergenerational transfer models.
Yes, Bruce, but ABSTRACTING from reality and uncertainty about the future...
ReplyDeleteNick Rowe seems (from his blog) a nice person, and is certainly not unintelligent. Yet he cannot escape a compulsion to see the world in terms of very simple models. The patent inadequacy of this procedure never registers, not even as the flickers of unease evident in some of Brad DeLong's musings.
ReplyDeletePlus both sides are simply omitting huge factors.
ReplyDeleteOn the Rowe side the continuing economic utility of past investments. After all Hoover Dam is still generating electricity.
On the Krugman side the factor that we are not just talking about presence or absence of intergenerational transfer but also he transfers between economic classes. Today's bond issuances (debt) are certainly tomorrows wealth (assets) but thtat doesn't mean that tommorrow's asset holdes are symmetric with tomorrow's debtors. The incidence of the pleasure of the big party we throw today may well not match the incidence of drudgery in cleaning up. In the future bond holders collect and income tax payers pay. And only if the shares of collection and payment are equal is their any symmetry at all.
And agruablt there is not that symmetry now, and there certainly wouldn't be if we institutes anything like the Ryan Path to Prosperity that proposes to remove ALL tax on returns from capital, including interest and redemptions of bonds. Under the Ryan model the wealthy of today would grab much of the benefit of the party thrown by debt finance (especially holders of defense stocks) but to the extent that their wealth came from returns on capital be exempt from the repayment even as they were themselves collecting those same payments.
To see how this worked historically you could examine the Sinking Funds the British used to finance the French and Napoleanic wars. The rich got ever richer by lending money at high rates to the government (the Funds) even as the repayment was mostly shifted to consumption taxes. (Hmm do the Stamp Acts and the Boston Tea Party come to mind here?)
So pardon my language but screw these intergenerational calculations that don't take into account the varying incidence of the cash flows to and from the borrowing. Itself largely driven by the progressivity or not and capital share or labor share of the resulting taxes.
"(Hmm do the Stamp Acts and the Boston Tea Party come to mind here?)"
ReplyDeleteI'm afraid the slogan "no taxation without representation" has been abbreviated to "no taxation" notwithstanding that the short form has come to mean "no taxation for those who can buy the most representation."
Debt is an accounting wash if assets=liabilities.
ReplyDeleteThis is the case if there are 2 distinct parties, and the debt is actually paid back - the liability part.
With over $18 trillion of public debt, and no principal or even interest paid back in years, someone please tell me " Where does the liabulity part come into play if it is not paid back?
Don Levit
It is possible to abstract the issue from inter-class transfers.
ReplyDeleteThe first key point is that most production is consumed in more or less the same time period as it was produced. This is true of almost all services, and services are a pretty huge part of a modern economy. It's also true of anything with a short shelf-life, like most food. For such goods and services, the people of a future year will produce and consume them, and we from the past can't affect their choices. If the people of the future year don't like the distribution of income we have left them, they can change that distribution through taxes and redistribution. We eat what we grow and they will eat what they grow.
Now, some goods last for years. These goods can generate future consumption issues. If we, this year, fail to build enough cars, there may be a shortage of ten-year-old cars ten years down the road. You could say that by consuming services and vegetables instead of cars, we have stolen used cars from our children. I doubt that potential shortages of semi-durables, however, are that much of a problem.
Where you do run into trouble is if the present generation does not build enough structures, roads and bridges, sewage systems---and does not invest enough in capital assets. Such failures will reduce our children's productivity and indeed make them poorer. But here's the rub. Those who howl about stealing from our children typically recommend that we abstain from this dirty deed---by slashing investment! The government in particular must not run a budget deficit, to build infrastructure or for any other purpose. And, of course, the deficiency in aggregate demand that results from the austerity demanded by those who would "protect our children" is doing more damage to future productivity and future wealth than anything else imaginable. It is those who cry about stealing from our children, therefore, who are ther true thieves.