Nick Rowe on the burden of the debt
I’m pretty sure that some people are misunderstanding Nick Rowe’s post on the burden of the public debt. Or maybe I am. In any case I’ll try to state his case as simply as I can, and you guys tell me if I’m off base.
Suppose the public debt has no impact on current investment or current consumption, or the entire future path of consumption from now until the end of time. Would Nick be wrong? It seems that way, but not if you look closely.
If the government gives a lot of money to people who are old right now, and as a result they consume more right now, then by assumption the currently young must consume less right now. Since we are assuming no change in the paths of aggregate consumption and investment from now until the end of time, all generations excluding the currently old must consume less, in aggregate. Suppose the current old generation consumes $100 billion more. Also assume that each future generation, including the current younger generation consumes $1 billion less over their lifetime. Then assume that after 100 generations Earth is destroyed by an asteroid. QED.
Nick’s critics are defining “generations” weirdly, like “people of the 1980s,” or “people of the 2020s,” or “people of the 2070s.” Nick uses the more natural definition of a generation; all people born in a particular decade, not all people alive in a particular decade. Or did a miss something here? This seems too easy.
PS. Here is Nick’s newest post on the topic.
PPS. Is this a big problem? No. But the deficit is a big problem for other reasons.
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13. October 2012 at 06:49
You didn’t miss anything important.
I think the word “cohort” might be clearer than “generation”.
Do we aggregate across people alive in a particular year? (like GDP does).
Or do we aggregate across years of the lifetime of a particular cohort?
JP Koning has a good old blog post on this. http://jpkoning.blogspot.ca/2012/01/debt-generations-savings-and-economic.html
13. October 2012 at 07:57
This argument reminds me of Nick’s many posts about Say’s Law, where it turns out that no two people have the same version of Say’s Law in mind. (It was a relief to check the two most advanced textbooks I own and find that neither of them has an entry for Say’s Law in the index.) I’ve never quite figured out what the point at issue really is.
At least Scott’s post is clear. If there’s a finite horizon and each generation, when young, gives to the older generation then the generation which is young when the asteroid hits is the loser. So the old (t=0) generation wins and the young (t=T) generation loses. Every generation in between breaks even.
But I don’t think Brad DeLong, Dean Baker and Paul Krugman will feel they have to adjust their thinking in the light of that.
13. October 2012 at 08:11
It’s really very simple. When the government borrows money to buy stuff, there are three gross transfers between the government and the general public. The government takes money from the public twice: once to fund the spending and once to fund the repayments (assume lump-sum repayment). The government gives money to the public once: to make the repayments. (If the debt is rolled over then replace the last transfer with another three.) All three sums have the same (discounted) value. So there is a net loss to the public from this, and if the public benefit from government spending is not large enough then a net loss to the public overall. (If the spending is a tax rebate then the net effect is zero.) If the borrowing crowds out investment then also subtract the net productivity of investment.
The whole confusion is just an inability of people’s minds to cope with transitivity. (Misapplying it, in this case.) A government bond is essentially an entitlement to everyone else’s future income. So obviously if enough people get them it cancels out, leaving the government with all the money. It’s like a public goods situation – in reverse. (I like that idea – we pay for public goods, naturally, with anti-publicgoods.)
13. October 2012 at 08:18
Or to put it more succinctly, the state is that fiction whereby everyone endeavors…
13. October 2012 at 08:19
Suppose real (and nominal) interest rates are negative. A tax cut seems like a no brainer. The total amount of taxes that must be collected is lower.
But the future generation that pays off the debt is still has to pay higher taxes. They pay for all their public services and then higher taxes because of the tax cut that allowed the earlier generation to consume extra.
Of course, you can always save the tax cut… oops, the real (and nominal) interest rate is negative.
Fixing the monetary problem is always going to be the first best solution.
Running government budget deficits to raise the natural interest rate just doesn’t seem efficient to me. Sure, it is good for some people, but not everyone.
13. October 2012 at 08:22
Isn’t the ultimate damage done by public sector debt the increased current and future allocation of resources based on politics instead of entrepreneurial calculation, profit and loss? I tend to start with a basic classical model (aka Law of Markets) of growth: real savings which finance effective investment that leads to increased productivity in the output of goods people actually want at cost-covering prices. How good is government at this task? Basically, it’s horrendous.
So, to the extent that government gains control of a larger share of real resources now or in the future, we’re lowering our potential growth path and thus making the future poorer than it could be.
The same is surely true of government transfer payments which move capital from investment spending to current consumption spending. That many of these transfer schemes, like Medicare and Medicaid, are also administered through massive regulatory regimes featuring central planning and price controls, that makes the use of resources even more destructive. So the medical services sector has been ruined by Medicare and the regulatory regime that’s emerged since the 1960s. That so much money is pulled out of private hands through FICA and funneled into this system makes the impact that much worse than simply moving resources from investment to consumption.
Put another way, government transfer payments are, at best, akin to consumer debt plus added dead-weight-loss of making the economy less efficient and thus less capable of paying back the debt. So our national debt is basically the equivalent of a 21 year old loading up his apartment with credit-financed gadgets and goodies which he can only barely afford today at lower interest rates, none of which will add to his ability to earn a higher income.
If it were real “investment”, which is rarely the case, the debt could prove to be a net positive, just like private business debt. Imagine a world where today’s social security beneficiaries had invested their past withholdings in actual real investments. To the extent that the aggregate investments proved profitable, the current benefits being paid would literally have been created out of the increased real output from those past investments. That’s not a transfer. That’s the world getting richer and savers reaping some of the benefits. Instead, those folks were forced to pay for government consumption which likely contributed to the “Great Stagnation”, forcing current workers to pay for retirees with no new resources to draw from to do it.
In the aggregate, we’re all poorer today than we would have been had today’s retirees been able to invest privately instead of in Social Security. We don’t have the fruits of those investments which could have been helping to pay for today’s needs. Instead we have bridges to nowhere, pointless wars everywhere and a ratcheting regulatory regime that’s smothering the future.
Now, all of that already happened and to the extent that the government borrows today, it is further robbing the future of what would have been created had those resources been invested for real.
13. October 2012 at 08:48
Thanks Nick,
Kevin, I can’t have been that clear, as you seem to have misunderstood my post. I’m claiming every single future generation will be worse off.
13. October 2012 at 08:58
Scott, fair enough. I’ll have to add you to the long list of people whose take on this I don’t understand. I thought that with “no change in the paths of aggregate consumption and investment” only those at the two ends of the path, so to speak, would be affected.
13. October 2012 at 09:44
Read DeLong’s post on this. He’s spot on in his reasoning but wrong in his assumptions on three important questions:
1. Can the government get a better rate of return on its investments than the private sector,
2. Are we better off increasing consumption now (mostly through entitlements) than we would be with higher GDP in the future, and
3. Most importantly, are temporary increases in government spending during an AD shortfall likely to be become permanent resulting in lower future GDP because private investment is being crowded out.
13. October 2012 at 09:51
This is definitely a good point; however, I do feel like one of the reasons that public debt has increased is because private debt has fallen. There is no doubt that the deficits we’re running are unsustainable, but cutting government spending will be painful and deflationary. The deflationary effect of cutting government spending could be offset by the Fed printing money. However, wouldn’t another reasonable solution be to have the Fed come in and literally print money to pay off the public debt(in effect using a printing press to finance large deficits). This has been done with QE, but I think it needs to be done on a larger scale. Couldn’t the Fed literally print money and give it to the Treasury? The money could be used to either give massive tax cuts, for spending on public works, infrastructure, assistance to state and local governments, etc.
13. October 2012 at 09:52
Kevin, Imagine everyone originally planned to consume $200 each 30 years, and they all live 60 years. The old generation today consumes $300, an extra $100. The young generation today consumes $100, but $299 when they are old, for a total of $399, or $1 less than originally planned. The next generation consumes $101 when young and $298 when old. And the next generation consumes $102 when young and $297, when old. And so on.
The first generation consumes an extra $100, and each subsequent generation consumes a total of $399 over their life, $1 less than with no intergenerational transfer.
13. October 2012 at 09:52
Here is the graph of total debt vs public debt vs private debt.
http://research.stlouisfed.org/fred2/graph/?graph_id=91144&category_id=0
13. October 2012 at 10:04
Scott –
Would it make a difference if a large portion of the debt is held by foreigners? I understand that’s not the case in our country, but it seems to me that if those bonds are being inherited by the same taxpayers who will be paying off those bonds it’s much less of an issue than if the bonds are foreign held.
13. October 2012 at 10:10
Wow, I just saw this from George Will:
http://www.washingtonpost.com/opinions/george-will-too-big-to-maintain/2012/10/12/9f8f8e94-1497-11e2-be82-c3411b7680a9_story.html
He advocates Richard Fisher, the worst Fed President, to be the next Treasury Secretary!
13. October 2012 at 10:15
Scott,
Where are you getting the $1. I can’t understand what you are saying.
13. October 2012 at 11:59
dtoh, By assumption.
13. October 2012 at 13:17
I’m with Kevin — nothing in your original post let on to me why consumption would permanently fall. Your response to dtoh further illustrates the problem: where do you get the $1? There’s no “$1” in your original post, or any description in your comment of where “$1” came from.
“If the government gives a lot of money to people who are old right now, and as a result they consume more right now, then by assumption the currently young must consume less right now.” Yes, of course, that is the distributional transfer inherent in debt. The currently young consume less because they are paying taxes (front-loading the consumption decline) or interest (amortizing it).
“Since we are assuming no change in the paths of aggregate consumption and investment from now until the end of time, all generations excluding the currently old must consume less, in aggregate.” I thought I agreed with that, reading “the sum of all generations excluding the currently old must consume less” — that’s the distributional transfer.
“Also assume that each future generation, including the current younger generation consumes $1 billion less over their lifetime.” I missed that the first time around. No, I don’t assume that; you’re assuming the purported conclusion.
Total consumption and investment are unchanged (by assumption). You need to explain how that is compatible to a “$1” perpetual loss to all subsequent generations.
dtoh: About the 3 points DeLong is wrong about, okay, but that’s not the Rowe/Sumner argument. They’re trying to argue not that there are marginal inefficiencies due to the debt — DeLong agreed with that in his most recent post — but that owing debt to future generations results in a loss. But they need to explain where that loss is supposed to come from (and why), and so far neither has done so.
13. October 2012 at 15:31
“Suppose a hydrogen bomb exploded over New York City has no impact on the number of living or dead … ”
“Suppose the public debt has no impact on current investment or current consumption.”
13. October 2012 at 15:40
Note well — Krugman & DeLong favor taking money from one group and giving it to another, most especially away from groups they don’t like.
E.g. the Boomer Generation consuming everything / making all of the choices for us, and crapping on the rest of us.
So Krugman & DeLong are just making another duplicitous argument to get what they want, as they do over and over again.
13. October 2012 at 19:34
As a young man, I basically followed George Will on his speaking tours (at the same time I was following the Dead and then Phish).
He doesn’t miss much.
If Romney wins, besides Scott having to dedicate his book to me, as his whole theory becomes a moon around my planet, or planet around my sun…
we will ALSO get to see how the hegemony takes down Scott’s notion that the the allocation of capital is an incredibly hard or important thing – you just remove govt. and then keep bankers from being too big – and the hegemony gets what it wants, the god like celebration of entrepreneurs on their rise.
If Romney loses it wil sadden me for many reasons, a smaller reason is that I truly think it will dramatically improve the field of Economics when you all have to accept the primary desires f the hegemony in all of your equations.
We’re SO CLOSE to deeply rattling everything you hold dear, you should want it- it would be a ver exciting time.
13. October 2012 at 21:30
All forced wealth transfers (government debt), even those that result in nominal offsetting transfers of gains and losses, incur costs without corresponding gains.
Case closed.
13. October 2012 at 22:25
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13. October 2012 at 23:07
Wait – Morgan, if the allocation if capital isn’t incredibly difficult, then why do the people who do it get to be hegemons?
14. October 2012 at 05:22
Defining healthcare as accessible only at the apex (a lifetime of learning) did a great job of smashing Say’s Law. To blame government for today’s debtload in this regard is mostly silly in that much of government redistribution of the near future exists primarily to maintain that contract with healthcare providers and yet serve as many citizens as possible. Why would the very industry that benefits most from wealth in the present seek to undermine itself?
14. October 2012 at 06:03
Saturos,
You wound me.
Scott’s wrong about who and what the hegemony is. I am correct.
The hegemony is NOT the top 1%. It is not the management of Fortune 1000 living in Blue States. It is not Wall Street bankers.
The 1% are merely the “B power”
The “A power” are the top 33%+ of America that will spend part of their earning lives in the top 20% of earners in any given year.
I argue the A Power are the Hegemony. Basically your SMB Republicans / Tea Party / Libertarians.
The C Power are everybody else. A big part of which are non-voters. The poor.
The sides aren’t perfect, more public employees should be back down in the C Power… something Mitt will fix.
The A Power has half the likely voters. They own all the houses. The own all the SMBs that matter. They are better educated. They run the churches and the PTAs. They own 200M guns. AND they are much richer than the 1%, the B power.
I argue the the hegemony benefits when the Fed and the Government are two distinct entities that both exist to SERVE the hegemony.
The Fed is an insurance policy that is meant to work for the Hegemony to make sure the Government suffers if it stops serving the A Power.
——
My point is the the hegemony… they do not care for or want a bunch of bankers being the richest guys…. they see the B Power running the Fed and it annoys them.
Note: the A Power WANTS to hear that Romney will replace Ben. The C Power is to stupid to even mention it. Obama who serves for the C Power doesn’t even think Monetary matters.
To Obama yelling about the top 1% the B Power is sham, he needs their money, even though he hates them.
But Romney yelling about Ben is honest. Romney knows the Wall Street bankers have to be put down a few notches, broken up, size limited, and he knows even some Wall Street Bankers want the kind of changes. Not all, but some. And Romney LIKES the Wall Street bankers.
Because Romney also knows the economists are not that big a deal. The really big deal is making sure the A Power have out their animal spirits. As long as that one thing happens, every thing is fine.
ND IF the A Power thinks the B Power is getting hooked up by the Fed, animal spirits will NEVER come out.
The A Power have to be convinced that they are getting what they want, that they are the boss. Amongst the A Power there is a clear fear that something has gone horribly wrong, that’s why little towns in swing states are jam packed with Romney turnout.
America is at a crossroads. My bet with Scott is that the A Power will AGAIN (like 2010) flex it muscles, put Romney into office…
And Romney will take steps during his first term to truly codify the A > B > C. rule. He’ll kick many public employees out of the A Power. And he’ll weaken the big banks.
I could be wrong. America could already be over line. Unfixable. At which point, I’ll accept Scott’s approach as the best way to slow down the march to become France.
But I don’t think so.
14. October 2012 at 06:30
Morgan, you should definitely get a blog.
14. October 2012 at 11:31
No one ever needs to argue this topic again. Bob Murphy’s post is sublime: http://consultingbyrpm.com/blog/2012/01/the-economist-zone.html
14. October 2012 at 13:14
polymath, I am not arguing that there are any inefficiencies. There are, but that’s not the argument I am making here. Here I claim there is redistribution between generations.
14. October 2012 at 18:45
I don’t understand what is so complicated and confusing about the whole issue.
Assume no (that is, ignore real) deadweight cost of taxes, fiscal crowding out, rate risk causing loss of value of bonds (see USA late 1970s-81), wealth distribution results, etc — say real effects of debt on the economy don’t exist. Thus assume the real economy produces the exact same product with as without the debt.
OK, so the debt is incurred to transfer to persons born before from Time 1real product of the economy of value of $X *from* persons born after Time 1.
The answer is right there in what you say you just did — transferred from a fixed unchanging total an amount *to* one group *from* the other group.
The reduction of real economic product available to the second group is the “burden” upon it. (Forget the dang bonds, they are irrelevant in real term, mere “bond illusion”.)
What could be simpler?
Without the debt used to transfer $X, all persons born before Time 1 receive the benefit of economic product in the amount of $P1, and all those born after it receive the benefit of economic product in the amount of $P2.
With the debt used to transfer $X, all persons born before receive $P1 + $X, all those born after receive $P2 – $X.
The “burden” born by the post-Time 1 generation is the loss of $X in real resources available to it.
Let’s see Dean Baker refute the laws of arithmetic.
BTW, this is exactly how the Social Security Trustees describe the financing of Social Security benefits.
1) Social Security as a “paygo” program has all its benefits paid entirely from SS tax, with all SS tax used exclusively to pay benefits. Thus over the life of the program benefits paid exactly equal taxes collected.
2) SS participants retired through today have received $20 trillion more in benefits than they paid in through tax.
Thus,
3) All future participants must receive $20 trillion *less* in benefits than they will pay in through tax. QED.
That’s why the Trustees project negative returns on contributions to today’s workers and the young.
There is no way around it. It is the Iron Law of Arithmetic.
And that arithmetic is a $40 trillion swing downward, generation to generation, from being made $20T richer by SS to $20T poorer by it. Anyone who thinks that is going to have no effect the future political popularity and viability of SS is in denial.
And one form of this denial is people like Dean Baker repeatedly claiming that transfers *from* one generation *to* a prior generation somehow come at *no cost* to the generation paying the “from” amount when they are financed by debt, (because the “from” people get some kind of paper in exchange).
14. October 2012 at 23:47
Total consumption and investment are unchanged (by assumption). You need to explain how that is compatible to a “$1″³ perpetual loss to all subsequent generations.
It is not only compatible but is forced.
If total consumption is unchanged, and consumption to the generation born before Time 1 is increased by $X, then consumption by the generations born after Time 1 *must* be reduced by $X. That is the burden that falls on the generation post-Time 1.
If consumption to the generations born after Time 1 isn’t reduced by the same amount it is increased for the earlier generation, then somehow total consumption increases miraculously just due to the transfer. Free lunch! We should be transferring money to the older generation as fast as we can shovel it with the biggest shovels we can get. But we have specified that total consumption remains unchanged. Arithmetic dictates the rest.
Whatever bonds are left to the post-Time 1 generation are in no way compensation to it, because the asset value to them of the bonds is exactly offset by the corresponding debt service cost they must pay on them, which nets the value of the bonds to them as a generation down to exactly zero. (Assuming all the bonds are owned domestically, of course, or else their value to them is less than zero.) And with the bonds having a net zero value to them, they are left with the pure loss of the $X they’ve transferred away to their predecessors.
See my comment just above on the Social Security Trustees’ take on why future SS beneficiaries must receive benefits totaling $20 trillion (actually $22 trillion) less than the SS taxes they pay, and a corresponding negative return on their contributions. *How* that negative return will be spread around among different parties, and in what amounts and time periods, is undetermined as yet and will be decided by future politics — but its total amount is already determined.
In reality all the argument about Social Security “reform” needed to get it back on a fiscally balanced basis reduces to deciding just who is going to eat that $22 trillion loss, and how.
Multiply by all other debt-financed entitlements, etc.
15. October 2012 at 00:35
If the government gives a lot of money to people who are old right now, and as a result they consume more right now, then by assumption the currently young must consume less right now. Since we are assuming no change in the paths of aggregate consumption and investment from now until the end of time, all generations excluding the currently old must consume less, in aggregate. Suppose the current old generation consumes $100 billion more. Also assume that each future generation, including the current younger generation, but excepting the 100th one, consumes exactly the same over their lifetime, because they never pay off the debt. Then assume that after 100 generations Earth is destroyed by an asteroid. The last generation then gets to consume less, because they die after 30 years in the asteroid strike.
The debt is not a burden because all of humanity is dead and nobody cares.
QED.
This whole argument turns on the repayment of the debt. This only makes sense if there is a “last” generation which does not require any transfer from the then-working generation. In any other case, the alternative presented in the hypothetical is a false one: Even if there is no debt, there has to be some kind of transfer payments from the young to the old, unless you want to let old people starve. With or without the debt, the young generation never gets to enjoy all that they produce, since they have to provide for the older generation.
15. October 2012 at 00:49
Also, in the hypothetical, it might have been a good idea for the government to go into even more debt, in order to invest in an asteroid defense system.
But then, the hypothetical people in the hypothetical are clearly stupid anyway. Because what should you do when faced with immediate certain extinction? Why, pay off the national debt of course, you certainly would not want to owe anybody money when the world ends, that would look really bad!
Seriously: In any reasonable scenario I can imagine, where the transfer payments from one generation to the next end, there are always more serious problems than the debt itself.
So while the point is valid, I cannot see that it has much relevance for real life.
15. October 2012 at 03:16
Jesus.
If we establish a one time policy to kill every Baby Boomer and their parents and liquidate their assets and give it to their children…. do their kids and grandkids get to consumer more?
Yes.
15. October 2012 at 13:27
assume that after 100 generations Earth is destroyed by an asteroid. The last generation then gets to consume less … The debt is not a burden because all of humanity is dead and nobody cares.
This is the Samuelson’s old “Social Security is a Ponzi Game that Works” argument. Have every generation just pass the whole bill for the ‘backward transfer’ on to the next — adding more to it for itself! — on and on, so far into the future that nobody cares.
Alas, it doesn’t work. That’s why the Trustees say every generation going forward from now will take a loss on contributions, as the result of those up until now receiveing a $22 trillion gain. But wouldn’t it be nice to avoid all the cost of that $22 trillion until the last generation existent on Earth, and keep adding to it until then? Gee, why don’t they do that? 🙂
This whole argument turns on the repayment of the debt.
No it doesn’t. The idea that repayment can be delayed until the last generation existent on Earth (and then we default!) is bogus. Debt must be *serviced* in real time continually from the date it is incurred. The cost of ongoing debt service discounted to present value equals the full amount of the debt. This must be paid this year, next year, every year, until the end of the Earth.
So again, “the young inherit the bonds so they come out whole” is false because they also inherit the cost of debt service on the bonds, which at least equals the value of the bonds they own (in the real world the cost is much more). So they lose the consumption transferred to their seniors, and in the form of the bonds get … nothing.
And this is why the *your* Social Security benefits will be worth less than the contributions you pay into SS, *you* will feel the burden of the SS’s backward transfer, even though the end of the Earth presumably remains a good long time away.
BTW, it is also why Franklin Roosevelt expressly opposed any kind of “intergenerational transfer” in SS and barred any from being in the SS Act he enacted. And did so vehemently that when he found some aids had slipped such into the Act starting in the 1960s (thirty years in the future!) he pulled the Act from Congress, had a famous tantrum, and ordered a re-write of the law.
This is the fun of politics. FDR vehemently opposed intergenerational transfers and banned them from Social Security. Today the Dean Bakers of the world say we have to run up these intergenerational transfers “to protect FDR’s vision of Social Security”.
Even if there is no debt, there has to be some kind of transfer payments from the young to the old, unless you want to let old people starve.
Why? Wouldn’t it be better to make transfers from rich to poor? That certainly *doesn’t* require transfers from young to old — quite the opposite, if you take a look at the wealth distribution tables. “Old” does *not* equal “poor” in our world. The young are the poorest today.
Is there some particular merit in having the young minimum wage workers at Warren’s Buffett’s Dairy Queen stores be made poorer on a lifetime basis (via that negative return) in order to finance transfers to Warren?
I cannot see that it has much relevance for real life.
Social Security became hugely popular politically as the result of sending $22 trillion net to past-generation seniors — to *all* of them up to Warren Buffett. It is going to make present and future workers poorer over their lifetimes by $22 trillion, starting right now. If you don’t think this has much “relevance for real life” either in substantive merit or politics … just wait a few years.
15. October 2012 at 14:12
What other reasons? Yglesias has been arguing recently that the problem with the deficit is that it’s too small.
I’m not so sure about that, but I am inclined to agree that for the short and medium term the deficit isn’t really a problem (e.g., nothing’s being crowded out).
15. October 2012 at 15:34
[…] time around, when Scott Sumner says he doesn’t see what the big deal is, or Steve Landsburg thinks that Krugman has it almost, […]