Tuesday, October 08, 2013
Borrowing from the Future — Except that We Aren't
This morning’s New York Times featured an utterly clueless op-ed by Stephen D. King (not the horror writer, at least not intentionally). It would take too long to go through all the errors and misrepresentations he managed to pull together, but one in particular deserves mention, since it is a common meme: fiscal deficits mean that “we are borrowing from future generations”.
Let’s look at this calmly. First, suppose we have a closed economy; there is no trade and no international flows of lending and debt service. In this state of happy isolation, the government may choose to run a budget deficit. If it does, it issues bonds. People who want this kind of asset buy the bonds, and it is their purchase that funds government spending not covered by tax revenue. These bonds have maturities, so what happens when their time is up?
One of three things. First, the bonds could be redeemed with no new bonds issued. This would reduce the amount of bonds in private portfolios, but it would give the ex-bondholders an equivalent amount of cash to spend on something else. The cash comes from a budget surplus, which means that taxpayers have paid in extra. Those who don’t own bonds are now net payers to those who do. From an accounting standpoint, however, they also gain in the sense that they are no longer liable to pay a stream of interest on the bonds into the future.
Historically, this doesn’t happen very much. The best example is the huge deficits that the US and Britain used to finance WWII. Neither country ran equivalent surpluses later on to “pay off” the debt. Their economies grew, inflation eroded debt claims, and over time the debt-to-GDP levels slid back down to more reasonable levels. Specifically, when the war bonds came due these governments simply issued more bonds to finance their redemption; they rolled over the debt. That’s what happens in 99% of the cases, and you can see this by looking at how small and infrequent fiscal surpluses actually are. This refinancing through issuance of new debt is option number two.
The third possibility is default. Banana republics and governments under the influence of suicide cults sometimes do this. ‘Nuf said.
So where is “borrowing from the future”? Well, all government is borrowing from some people to pay other people, and paying back these debts, should it ever happen, simply reverses that flow. Either way, money is making its way from one group to another at the same point in time. Note that interest on the debt has nothing to do with present vs future either: the current generation, which incurs the debt, begins paying interest immediately in exactly the same way their distant descendants will.
None of this means, of course, that deficits are innocent in every respect. To run them, the government has to be able to sell its bonds or, if the central bank is going to monetize them, the economic environment has to permit this. (It can’t be too inflationary.) That can break down. Past experience can guide us in assessing how close we are to the upper limit of our fiscal space. (The struggling countries in the Eurozone are a special case, because they don’t borrow in their own currencies.)
Ah, but you say, we are not in a closed economy. Some of our borrowing is from foreigners, and debt service transfers money from us to them. Some responses:
1. This is not about present versus future, but our people and their people. After all, international interest payments, like intranational ones, don’t wait to be paid; we begin paying them right away.
2. The world as a whole is a closed economy. If “we” are everyone in the world (and in some senses we are), there is no outside, at least economically.
3. The amount of foreign borrowing to finance fiscal deficits is not directly a function of the size of the deficit but of whatever determines our international payments position—our current and capital accounts. To make the case that government borrowing increases the current account deficit, you have to, well, make the case. For instance, is there a historical relationship between the size of US fiscal deficits as a proportion of GDP and corresponding current account deficits? Show this if you can. (In general there isn't, although the current account and the sum of net domestic borrowing, both public and private, is an accounting identity. If two things are an identity, one does not "cause" the other because they are both the same thing.) On a theoretical level, the idea is that issuing more public debt raises domestic interest rates, which in turn raises exchange rates, which in turn increases trade deficits. OK, try to show that. (The US record doesn’t provide much support.)
So there you have it. At an individual level, borrowing is truly borrowing from the future. At a population level, borrowing is the creation of assets and liabilities across different people. People like King are committing a fallacy of composition.
Incidentally, we are borrowing from the future. We are shirking the investments we need to make so that our children and grandchildren can live in a habitable world with a well-educated population that enjoys a productive infrastructure. No fallacy of composition there.
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Sometimes a post is so good I can find no reason to comment other than to say...Great post. But that feels like lame cheerleading.ReplyDelete
What the hell. I'll be a lame cheerleader... Great post. :-)
Let’s say we have two groups. In the first are the “We, Us, and Ours”, and in the second are the “Them, They, and Theirs”. Also, let’s say the first group is comprised of the lower 99% of wealth and the second group the top 1%. This “They” group owns over a third of the wealth so “They” are in a fine position to lend to the government when it needs the funds.Delete
The “We” got along with the “Them” swimmingly several decades ago, with both benefiting from a growing economy and both seeing the future as prosperous. But, then “They” decided that “They” weren’t getting “Their” do, so “They” pushed the government for changes to “Their” liking. Now “They” have great influence over the government which “We” do not. So, “Their” taxes were cut and “Our” programs were cut. All of a sudden “We” didn’t feel so prosperous. “We” saw “Our” standard of living drop. “We” saw a less rosy future for “Us” and “Our” children.
Instead of letting “Our” standard of living drop, “We” started borrowing from “Them” to finance a continued prosperous like lifestyle. This of course, meant that “We” owed “Them” the balance of the loan and interest, so this game could not go on for long. “We” were borrowing from “Our” future generations.
The government similarly cut back and shifted spending to placate “Us”. To do this the government had to borrow and the only ones able to lend were “Them”. So, the government now owes “Them”. Instead of investing in the future for “Our” children, the government instead continued spending on “Us” for current benefits, but cut investment spending for “Our” children in things like: roads, bridges, schools, education, research, etc. So, “We” really are borrowing from “Our” future generations by not investing in “Our” children’s future.
“They” on the other hand saw “Their” fortunes increase as interest payments flowed in. And “They” saw the future of “Their” children improve as “They” will also get interest payments well into the future.
“We” are done for, but “They” are living high on the hog.
For some other thoughts on this see:Delete
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" We are shirking the investments we need to make so that our children and grandchildren can live in a habitable world with a well-educated population that enjoys a productive infrastructure. No fallacy of composition there."ReplyDelete
That's awesome . I'm sure they will have an illustrious future in the service sector or in private prison - either as a prisoner or working there.
i agree that the debt binge is sustainable and that unlike other countries the USA has no risk of default; however this won't necessarily mean more prosperity for most of the country. It just means the political & technological elite can fund their technocratic utopias with impunity.
Income taxes for 99% of the nation have not risen a single penny since 1993 despite record debt and the USA is paying less interest on its debt than in the 90's. Although each American may technically 'owe' $xxx per person, unlike a personal loan there is no expectation this will have to be paid.
The vast majority did not see their income taxes rise in 1993 either.Delete
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The post is incorrect . The flow of money in a debt spending transaction is not between borrower and lender. The actual transfer of money in the debt spending equation is between the tax payer and the recipient of the government spending. At the end of the process , - the recipients of government spending and its legacy have more money, and so also for their descendants as they in turn inherit or receive the legacy of the spending, the bond holders , interest aside, they are returned to their original position, and the future tax payer has less money and so the borrowing is in fact from the future.ReplyDelete
this post is wrong on so many levels I wouldn't know where to even start....Delete
Borrowing is in lieu of taxes. Without borrowing money flows from taxpayer to recipient, with borrowing it flows from lender to govt to recipient.ReplyDelete
Peter: here's the opposing view: http://worthwhile.typepad.com/worthwhile_canadian_initi/2011/12/debt-is-too-a-burden-on-our-children-unless-you-believe-in-ricardian-equivalence.htmlReplyDelete
As you can imagine, I didn't find your model convincing when I read it back then. To short circuit all the other stuff, my bottom line is that we borrow (disinvest) from the future when we leave it a combined per capita capital stock (produced, natural, human, social) less than we have inherited ourselves, and we invest in the future if we leave it a larger combined per capita capital stock.Delete
" we borrow (disinvest) from the future when we leave it a combined per capita capital stock (produced, natural, human, social) less than we have inherited ourselves"Delete
Isn't leaving the next generation "more Debt" the same as leaving them "less Capitol"?
Isn't our continual operating at a huge deficit raising the cost of borrowing world wide and forcing developing countries to delay/decrease their development? Aren't we prolonging suffering in those economies who must compete with us in the "closed economy" of the World? Can 3rd world farmers really afford to pay interest at all?
Did you read the post at all?
Have you looked at interest rates lately? Or at savings rates in rapidly developing countries - and the fact that they actually export capital? Do you understand what the zero lower bound is?
Your whole post suggests you live in a bubble and take no information in at all.
This comment has been removed by the author.Delete
Wow reason, you're really educating us!Delete
"at a population level, borrowing is the creation of assets and liabilities across different people."ReplyDelete
This is true however, not many kids are holding government bonds, so liabilities "across different people" ends up being "across generations". If too much debt is accumulated at some point the government will have to do some debt reduction. Whoever will be holding no government bonds at that point will get less from the government than others.
Now there are many other variables. If the money was spent on long term infrastructure or education that benefits the young then there might not be an issue of equitability across generations. Or for a private sector example, if the multiplier is high and debt funded tax cuts raise privates investment disproportionately and grows GDP and creates a better future job market, the young may also benefit more than they lose from this debt. There is no guarantee that the debt money will be spend in such ways though.
You don't pay the dead.Delete
In your "burden on our children" argument, you claim that private debt is not like public debt because you pay off your own debts while government taxes children.
But of course, in the real world children inherit the debts of estates, which are reduced by those debts. If my house is not paid off, and my children inherit it, they reap the increase in value though they are still liable for the debt. As a society, our public debts are inherited ALONG WITH THE PUBLIC ESTATE.
You also say "The only case where it does not create a burden on future generations is where Ricardian Equivalence holds." Sorry, but that ignores the opportunity cost of missed profitable intergenerational investments. Education, infrastructure and defense for example.
So many of these arguments seem to depend on abstraction which conceals that the real world violates unspoken assumptions and ignores primary purposes of the actions.
Mike: I fully agree that public investments that are bequeathed to our kids are an asset to them. Just as public debts that are bequeathed to our kids can be a liability to them.Delete
JMK (1936)"If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course, by tendering for leases of the note-bearing territory), there need be no more unemployment and, with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is. It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing."Delete
But children also inherit the assets of the estates - and these may include government bonds, as well as the improved infrastructure, education etc. They can then sell the bonds to pay the taxes that the government levies to repay the bonds.Delete
Here's another way of thinking about the whole matter; In the real economy, there are various things that can be done or not; build bridges, go to college, expand a business. Government influences what gets done now, by taxing & spending; changing incentives, buying stuff directly. Money (including bonds) is a store of value; how much you have determines how much claim you have to current & future resources. If money disappeared, (or, say, bonds were repudiated) the real economy would not be affected (directly & immediately) but who owned what would change; former bondholders would be worse off, everyone else would be better off, but (in a closed economy) it'd be a zero-sum game.
The money garnered from the original sale of bonds goes to the recipients of government spending in the present and then is inherited by their heirs or circulates in the economy.ReplyDelete
The members of the future generation that inherit bonds are only getting back the money that they would have inherited anyway and so the bond repayment cannot be treated as a gain to offset the burden on future tax payers. The future tax payers have less money after the taxation to pay the debt and so the national debt is a burden on the future generation.
hmm, i don't see how the argument about current generation starting to pay interest immediately is at all relevant. What about the principal? Also, borrowing is not just about debt - what about pensions? if current generations get on a per capita basis higher benefits than they ever paid in, and future generations end up getting less because of the burden of prior generation's commitments, how is that not inter-generational transfer? finally, your scheme only works if every generation can continue to borrow from the future (actually increase the level of borrowing), but what happens when due to contractionary demographic trends (which has not happened in recent recorded history but we know is coming) future generations cannot borrow forward?ReplyDelete
Incidentally, we are borrowing from the future. We are shirking the investments we need to make so that our children and grandchildren can live in a habitable world with a well-educated population that enjoys a productive infrastructure. No fallacy of composition there.ReplyDelete
Usually Nick Rowe shows up around this time to pull out various arguments that purport to show at least the theoretical possibility of a temporal sequence of public debt decisions that leads to a net transfer of wealth from a last future generation to the generation that initiated the sequence. But as far as I have been able to determine, those possibilities all depend on the assumption that the initial generation borrows to increase consumption rather than investment.
D'oh, didn't see Nick has already replied.Delete
See my reply to Nick, below!Delete
Dan, you're correct. It is choosing consumption over investment today, not government deficit spending, that imposes the burden on the future generations.
Nope! It depends whether that investment (or the benefits from that investment) are donated or sold to future generations, and on whether that investment raises or lowers the marginal product of future generations' labour.Delete
One example: we borrow to build schools to educate future generations, and give them a free education. Sure they benefit from the investment and bear the burden of the taxes, so one offsets the other.
Second example: we invest in robots, that are labour-competing and lower the MPL of future generations, and then we sell those robots to future generations. No offset. Future generations lose twice, because they pay higher taxes to service the debt, and suffer lower wages.
And if we borrow for the school and soon after opening it is hit by a disaster (natural or man-made) the future benefit is....?Delete
What is far more likely is that the huge investment in the school provides students with an education of little value and they do not contribute to Society, but are a drain on it. Then...
Just for fun, here's the result of me thinking intensely about this question for about twenty minutes:ReplyDelete
- the observation that government debt is a burden on future generations refers to future generations of tax payers, and it is correct. Couching the argument in terms of consumption by the whole future population misses the point. It is the same as saying that taxation itself is not a burden simply because that government taxes from the economy and then spends back into the economy , which is an absurd reduction of the facts of the matter.ReplyDelete
It's not absurd. If the government taxes $100 each from 1000 people in some neighborhood, and then uses the money to plant public apple orchards in that neighborhood that, over time, deliver $1000 worth of apples per capita to those very same residents, then the taxation was not a burden - or rather you can say it was a short-term burden offset by a longer term gain.Delete
Similarly, if the government issues debt in the present which is successively rolled over until some future generation pays off the debt with taxes, but the initial cohort (and intermediary cohorts) do not use the revenue from borrowing to advance consumption from the future into the present, but instead to invest, then the generation that pays the debts may receive a net benefit. They might have fewer dollars than they might otherwise have, but more schools, parks, bridges, etc. left to them by prior generations.
Also, it's not even clear that they experience a net loss of nominal dollar income compared to the counterfactual circumstance of no debt. Not only might they have more dollar income than they would otherwise have due to inflation - already mentioned in the post - but even in the absence of inflation they might have more real dollar income if the investments made by prior generations were of the right kind.
Your description of government investment is correct , however the same argument can be said about all government taxation and investment even in the absence of debt, and so your description does not apply to the particular analysis of the transaction and implications of government debt spending.Delete
You're right, and there should be no fundamental distinction between the two cases. The basic issue is the same in both cases, whether we use debt to finance an increase in current spending or use taxation. It's always a question of the distribution of the costs and distribution of the benefits, and the latter question in part depends on what kinds of expenditures are undertaken. In the case of taxation, the population that bears the costs and at least part of the the population that enjoys the benefits happen to be alive at the same time. In the case of debt transmitted across generations, the two populations happen to be more spread out in time. But how the costs and benefits are distributed among them depends on the type of expenditures.Delete
The point pertinent here to this posts' comment thread is that the original post concludes there is no burden due to "... assets and liabilities" which is incorrect as tax burden cannot be netted of with a return to bond holders, as bond holders are only getting there money back. Paul Krugman made the same mistake in the blog "we owe it to ourselves". That blog was in Dec 2011.
> Dan K 11.10amDelete
Except there is a difference. When debt is used instead of current taxation - then we don't know how affordable that burden will be.
Well, we know that any debts that are paid at any date in the future will be paid from people who are alive on that date to other people who are alive on that date. So it all depends on what those people decide to do politically.Delete
You are not correct there, - the affordability is arrived at by the funds of the taxpayers at the time, the recipients are only getting their money back there is no gain to them,Delete
Can you discuss what happens when current borrowing is used for consumption? For example, I'm a disabled veteran who receives a payment each month from the VA. Presumably a percentage of that money is borrowed since the government is running a deficit.
That payment, a transfer from government to me, fuels my consumption since I don't have a bunch of wealth and use that money to live on. However my consumption doesn't simply disappear into thin air - it pays various businesses for goods and services. Some of it returns to the government in taxes and some spins through the economy.
So is my VA benefit entirely at the expense of some future generation - presuming a continuity in government that could be many many generations into the future before the last one.
It seems that if deficits stay in a range where they're outpaced by growth, inflation, and productivity that even if they're spent on consumption they're fairly harmless. And it's not only the tangible goods we build that the next generation inherits. If some of this leads to a fairer, more humane, and more participatory society then haven't we passed along something of value to future generations.
> Dan KDelete
To illustrate the affordability problem - using some figures for example - if the aggregate of all tax payers income is $1000 000 it may plausible to incur a 10 year debt of $400 000 . But if 5 years on , when the capital repayment falls due , GDP has fallen and the aggregate of tax payers funds are $400 000 then the debt repayment of $400 000 is now in fact unaffordable. That is an example of the affordability problem.
The loss of the productive effect of money in the economy that goes to pay taxes to cover the debt service is entirely ignored by this marxist author. He assumes no negative impact of the taxation of this money (which would have far more efficiently benefitted society than govt spending) and assumes a multiplicitive benefit from govt spending. All the while ignoring the corrosive effect on individual incentive by entitlement spending. A worse example of backfilling economic theory to justify failed keynesian economics I have not seen. Trust markets, not govt.Delete
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A wiggle on this that has been discussed both publicly in the political arena and in the academic lit, although it tends to get forgotten and ignored most of the time involves the public sector aspect of this consumption vs investment decisionmaking. What the budget deificits are being run up for matters: whether the government spending is for consumption or investment, and an unfortunate aspect of our most recent deficits has been that while many called for increases infrastructure spending, aka public investment, not much of that has happened.ReplyDelete
The situation gets further muddied by the nature of our public accounting. At state and local levels there is a clear distinction between consumption (current) spending and investment spending, with for nearly all state and local governments in the US there being a rule that currrent/consumption accounts be balanced. Borrowing is tied to specific investment projects with these often being approved by bond referenda. What is going on is transparent.
Howver, the federal government makes no such distinction, and can borrow at will, more or less. I note that when people start talking about the making such accounts for the federal government, debates erupt about what is reallhy investment and what is not. Is fighting a war to prevent the nation from being conquered from abroad (or to conquer and dominate others) an investment or not? Most say no, but some say yes..
Absolutely, Barkley. There is so much confusion on this issue it would make sense to have a clear, if not perfectly precise, estimate of consumption vs investment. But my point is that debt vs tax financing per se has no intergenerational implications, only the distribution of assets and liabilities across society -- which of course sometimes has further implications for the fragility of the credit structure.Delete
For the mountains of debt incurred by Western governments over the last 15-years, what do we have to show in terms of improved capital stock (transport, infrastructure etc) or education? Very little. So, if one of our governments went bust, what would they have to show for all of this debt? Very little (don't forget in addition to debt mountains they've sold off most of their capital stock industries). Profligate spending in the West, on baubles and consumables, has led to wealth transfers not seen since WWII. The transfers have been to China, Germany and producer countries. Have a look at the changes to their infrastructure, eduction levels etc. If they were to go bust tomorrow what would they have to show? Whole new socio-economic systems.ReplyDelete
The author of this article is wrong. Huge accumulations of government debt without a corresponding increase in capital stock or education will leave future generations significantly poorer.
Which would your children prefer, a house mortgaged to its valuation limit or a house with no mortgage?
Or ownership of a mortgage-backed security that paid them a regular flow of income from someone else's mortgage? Again, it's not about kids versus adults at any point in time but one person's kids versus another's.Delete
From an omniscient point of view, the socially ideal deficit (or surplus) is the one that minimizes tax rates, now and forever. Constant tax rates are more efficient than up and down.ReplyDelete
In the real world, it's a matter of taste because more debt (less surplus) is riskier, and risk is a matter of taste.
That's just about the worst argument I've ever read. Lets try a little thought experiment: suppose the government spends the entire deficit on throwing a party for taxpayers. Would you deny that we are "borrowing from the future" in that case? The only people that wouldn't be borrowing from the future would be the ones that bought the bonds.
Here's another one: Lets say the government spends the deficit building roads. Consider two situations: (a) The bondholders voluntarily throw their bonds in the trash can. (b) The bondholders keep their bonds and expect to get paid. In both cases we get to keep the roads. Would you say we're no less indebted to the future in case (b) then in case (a)?.
Selling bonds puts you in debt, BECAUSE YOU HAVE TO PAY THEM OFF IN THE FUTURE.
Whether you spend the deficit on something wise or something stupid, you are still borrowing from the future.
However, simply pointing out that deficits represent a debt that must be paid off in the future does not provide enough information to decide whether or not deficits are a good idea. Deficits are a good idea, and are fair to future generations, if what we can buy with them now (and pass on to them) will be worth more to them then what they will have to pay the bondholders.
Sorry to have made such a horrible argument, Larry/Anna. Incidentally, when you say "Selling bonds puts you in debt, BECAUSE YOU HAVE TO PAY THEM OFF IN THE FUTURE", who are you paying them off to?Delete
Larry & Anna, I don't think you can borrow from the future because it is a violation of special relativity.Delete
um. the us government borrows with long duration bonds, many of which are purchased by foreigners. we are indeed borrowing from future generations. we get the benefit of the borrowing now, but the bulk of the debt service comes later. i just don't understand your argument.ReplyDelete
I'm in complete agreement with your conclusion.Delete
answer this concise question: if the treasury issues a standard 30 year bond right now, who bears more of the burden: americans in the next 5 years or americans >20 years from now?Delete
If by "Americans" you mean "the population residing within the US in aggregate", the answer is neither. There is no net burden. (I'm abstracting from the role of international capital flows, which I skimmed over in the post.) From your wording it sounds like you think your question is some sort of zinger, but it strikes me as completely zingless.Delete
What if that bond is used to purchase a satellite which is sent away from the Earth, wears out and provides no economic benefit to anyone on the planet? There has to be a loss somewhere to offset those $Billions (or at least the repayment of the value of the raw materials in now useless device).Delete
The role of international capital flows are important here, given the size of US external debt. US private and public external debt is >80% of GDP. The inflow from borrowing this amount will eventually flow out, as debt is serviced and principal comes due.Delete
by the way, i think you need to read a primer on bond duration and face value.ReplyDelete
I think you miss the real issue: government borrowing allows for government to divert economic resources in the present towards government expenditures. With tighter constraints, government would instead be forced to focus its expenditures on more cost-effective measures.ReplyDelete
The real cost is the opportunity cost of investing this money in the real economy.
Better not drive your car on a "government" highway; it's dangerous when your not on real roads.Delete
There it is. Intellectual dishonesty at it's best. Govt spending is all roads, bridges, schools and "shovel ready jobs." You're a leftist hack disguised as an economist. Krugman would be proudDelete
government borrowing allows for government to divert economic resources in the present towards government expenditures.Delete
This is the correct way to think about it: not as borrowing from the future, but as competing for resources in the present. However, to the extent that the economic resource is labor or can be produced through the application of more labor, that's not zero-sum at the moment.
With tighter constraints, government would instead be forced to focus its expenditures on more cost-effective measures.
What happens in reality is that government focuses on the most politically untouchable measures. While most of the federal budget is for things like Medicare that are not investments in the future, the marginal federal dollar is quite investment heavy. Whenever the smaller government crowd has gotten their way, it has meant cuts in research and investments, while no one really has any good ideas for what to do about the rising costs of Medicare.
Govt spending is all roads, bridges, schools and "shovel ready jobs."
While this is a small part of the total federal budget, it was a very large part of the stimulus bill, and it would likely be something we'd get more of if we weren't so focused on the deficit. The political reality is that there is no pro-government-investment-but-against-other-government-spending movement with any political clout, and even the tea party is mostly full of people who favor spending on defense, medicare, and social security, so our political choice is between lots of entitlement spending and no investment, and lots of entitlement spending and some investment.
The argument that my-liability-is-your-asset, as thoughtfully stated here, still falls short of addressing the intergenerational deadweight loss meme.ReplyDelete
People who think like Larry and Donald McCarthy above are focused on the intertemporal transfer of utility. They assume that the beneficiaries of deficit spending have increased utility in the present; those whose incomes must allocate toward repayment of the debt that financed the spending have their utility reduced in the future. Your assertion that future generations also receive interest payments on debt, implying zero NPV, is overshadowed by the lack (until the comment section) of clear distinction between deficits and the debt typically used to finance them.
You squeezed the topic of debt dynamics into a post WWII analogy without nailing the point that deficit spending resulting in nominal GDP growth exceeding nominal interest rates is sustainable and arguably desirable. Kudos for not flame-baiting the austerians, but they can read this and still go away thinking that future taxpayers literally have to pay for today's deficits -- all without giving an ounce of thought to what might be happening to taxpayers incomes in the interval (as is often the case with those fixated on the supposed immorality of debt). --Rob G.
You are quite right about the importance of the national income effects of government spending, another point I could have made and didn't. But think again for a moment about WWII. Suppose the war effort had been financed not by war bonds but by much higher taxes (for instance wealth taxes) or by selling off other government assets. Would this have made future generations better off in some sense because we hadn't borrowed from them?Delete
Meanwhile, I had already jumped for some of the bait before I got to your kudos for not doing it. Damn.
"The third possibility is default. Banana republics and governments under the influence of suicide cults sometimes do this. ‘Nuf said."ReplyDelete
Summing it up:
The Republicans: Give me $1,000 or I'll burn our own house down; why won't you negotiate?! Why won't you offer $500?!
The traditional media: Both sides are equally at fault (always, the facts are irrelevant); the Democrats should "negotiate".
WWI and WWII represented two of the greatest wealth transfers in human history, as in the first instance the Allies transferred huge amounts of wealth to the US and in the second instance the UK & Commonwealth transferred to the US. In both instances, although the US issued its own war bonds, it was a huge net beneficiary of these inflows, which were used to build industrial infrastructure to support the war effort. Over the last 20-years, a similar event has happened with China as the US and Western countries have raised debt to support spending on items which have been provided for by China's new industrial infrastructure.ReplyDelete
Had this debt been used to develop new industrial infrastructure in the West, we would be in a much better position than we are now. Instead, its been largely wasted on baubles and consumer expenditure.
Current government expenditure largely supports consumerism not investment. And that, leaves future generations much less well off. Your "virtual roads" is a case in point: they are now in uniformly poor condition.
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If every tax payer lends the government $100 and receives a $100 bond the next generation of tax payers inherits the bonds and the government re-pays the bonds by taxing the new generation of tax payers - they receive the tax back in the bond payment and their net position on that transaction is zero , but overall their net financial position is less the $100 that they would have inherited if the government had not taken it from their parents.ReplyDelete
I think that neatly illustrates how the national debt is a burden on the future generation of tax payers.
It neatly illustrates how you're not thinking it through. What happened to the money that the government took in by issuing the bonds in the initial period? Did it disappear under a desk somewhere in the Treasury Building?Delete
It's interesting, by the way, that you say the government "takes" money from people it sells bonds to. We usually think of taxes as a form of taking and selling stuff, like bonds, in a market as a form of exchange.
You are asking what happened to the money that the treasury took in by issuing bonds in the initial periodDelete
Well the answer is that the money went to the recipients of government spending
Arguing that at some point in the future the government debt will be "paid off" so that there is no longer any government debt, is like arguing that at some point in the future all private debt will be "paid off" so that there is no longer any private debt. It's complete nonsense.Delete
Savings deposits are bank debts. Does this mean that at some point in the future all these debts will have to be "paid off" so that there are no longer any bank debts or savings deposits? No, of course not, that would be ridiculous.
Of course the analysis of the burden on future tax payers caused by the national debt transaction must consider the portion debt in question being paid off or else there is no debt transaction to analyse. If you prefer however to consider what happens if it is not paid off then you must consider that the lenders have permanently gifted the money or have been deprived off it by default. Either way the burden is still there.Delete
As for your second point about bank deposits, which is not really relevant to the national debt analysis , - in principle it is possible that all deposits and loans could net out at some point when depositors buy things from borrowers.
In your example you assume people have some money they got from somewhere which they then lend to the government. Where did those dollars come from? Answer: the government first issues the dollars which the population can then use to buy government bonds. Either the govt has to lend the dollars to the population or spend them into circulation, before the population has dollars with which to buy govt bonds.Delete
"the lenders have permanently gifted the money or have been deprived off it by default."Delete
Wrong. If you buy a government bond your financial wealth does not go down, it stays the same and then increases over time as interest is paid. If you own a govt bond your ability to spend is not reduced. You can sell your bond at any time if ever you feel like spending instead of saving. Owning a govt bond is practically the same thing as owning money which pays interest.
In that case of outstanding bonds, the tax payers are paying for the interest payments.Delete
The point is -
the Blog post incorrectly states that we are not borrowing from the future because repaying the debt is a reversal of the original loan transaction .
That is wrong because repaying the debt involves taking money from the tax payer to re-pay the lenders, and the recipients of government spending keeping the money that was temporarrily borrowed from the lenders.
There is no reversal. It is from tax payer to recipient of government spending.
Do interest rates matter? It would seem to my non-economic mind that profligate borrowing resulting in 10% finance rates in the future paid to Deutsche Bank vs 1% today would certainly be costing the future generation 9% that could hsve been spent on something else. But I'm not an economist so what do I know.ReplyDelete
The real shuck here, it seems to me, is the one that becomes clear when you look at the real sector.ReplyDelete
When the government issues bonds it buys goods or labor that are produced now. Our children and grandchildren are not shipping fighter planesback to us in their time machines. Our pensions from the government don't reach through the ozone to snatch food off the check-out line of our grandchildren's supermarket.
In the future, when the descendants of the people who buy the bonds cash them in, they may buy old airplanes, or food that we planted now. Time machines only work one way, future-wards. Most of what they spend their money will go on goods and services produced in their time.
This "robbing the future" thing is silly: it assumes backwards pointing time machines which don't exist.
What's mising from this discussion? There's nothing in the article about how the bonds are bought by those who can afford them -- and could have afforded taxes; they are paid off by everybody. A largely regressive tax system, e.g. sales taxes and Social Security taxes, pays the interest.
Why don't the complainers ever get into these interesting aspects of things?
David: "This "robbing the future" thing is silly: it assumes backwards pointing time machines which don't exist."Delete
Here's how to build a time machine that makes milk travel backwards in time:
There is no backwards time machine , but there is a forward time machine. The recipients of government spending, their descendants and the economy itself takes the money from the lenders forward in time . When the lenders are reimbursed , from newly taxed money, the equation simplifies to the conventional transaction of government spending where the transfer is to recipients of government spending and from tax payers.Delete
in your post you assume that at some point in the future the government debt will be "paid off" so there is no longer any government debt. Why do you make that assumption? Would you make the same assumption for private debt? Will all private debt be "paid off" at some point in the future so there is no longer any private debt?
Nick, in the post you cite and the earlier one about how overlapping generations models show that we actually do borrow from the future, you simply assume that borrowers are old and lenders are young. Isn't that begging the question? We are borrowing from our children because (in this constructed example) we are borrowing from our children.Delete
Philippe: I made that assumption because it was simple, and I wanted a simple counterexample to disprove the claim that it is impossible to make milk travel backwards in time out of the mouths of the yet-unborn into the mouths of the current generation. One counterexample is all we need to disprove a general claim about impossibility.Delete
What happens if the debt is never paid off? That depends. It depends on whether the rate of interest r is greater than or less than the growth rate of the economy g. Let's consider both cases:
1. If r will always be greater than g, then if the government just rolls over the debt + interest, the debt will grow at rate r, and GDP will grow at rate G, so the debt/GDP ratio will be growing at rate r-g. Eventually it will reach a level that the young generation simply won't be able to afford to buy the debt from the old generation. This is clearly unsustainable. So at some future time the government will need to increase taxes to pay some of the interest on the debt, to prevent the debt/GDP ratio growing further. And it is those extra taxes that will constitute the burden of the debt on the generation(s) that pay them. (Just as it is the taxes to pay off the debt that are the burden in my simple example.)
2. If r is always less than g, then if the government simply rolls over the debt + interest, and never increases taxes, the debt/GDP ratio will slowly decline over time. So it is perfectly sustainable forever. In this case there is no burden on future generations. (And actually, as Samuelson 1958 showed, future generations are actually slightly better off with the debt, because it gives them a nice savings vehicle that increases their lifetime utility.)
(3. If my math were better I would also work out the realistic case where r is greater than g in some years and less than g in other years. But it isn't, so I can't.)
Bottom line: debt may or may not be a burden. It depends. But it certainly can be a burden, despite what some economists say about fallacies of composition and time travel.
Peter: well, someone has to buy the government bonds, and then sell them again later. So they must be older when they sell them than when they buy them. And since we all die eventually, we can only sell them to our children.Delete
Now, if we *gave* the bonds to our children, instead of *selling* the bonds to our children, things would be very different. We are then in the world of Barro-Ricardian Equivalence, where there is no burden. (Or, where there is a burden, but it is exactly offset by the bequests we make to our kids.)
Willem Buiter did a neat paper once, where he showed that Ricardian Equivalence still held if you assumed people lived forever. It is births, not deaths, that violates Ricardian Equivalence and makes the debt a burden.
Nick, if you sell the bonds to the children, what do you do with the money? Either spend it (which equals income for the children) or pass it on to the children as their inheritance, no?Delete
If you spend it, it's income for the children, but they give you their milk in exchange. So it's not free money to the kids.Delete
(Yes, I did assume full employment there, but I have also worked out what happens if you don't assume full employment. I don't remember the answer right now, but it wasn't a simple "no burden' result.)
"Eventually it will reach a level that the young generation simply won't be able to afford to buy the debt from the old generation."
I can't see why they wouldn't be able to afford it, if they create the money in which the debts are denominated. What might happen in your scenario is that the interest payments get so large that they result in a large increase in income and spending which leads to inflation. But this would also increase growth and probably lead to a shrinking deficit.
Philippe: OK. But if people buy a bond, expecting the bond+interest to double in value, and inflation causes it to fall in value, there's your burden on the future generation. It's just like taxation.Delete
Peter: totally off-topic: sort of a belated response to your previous post: http://worthwhile.typepad.com/worthwhile_canadian_initi/2013/10/degrees-of-freedom-forward-guidance-and-rules.htmlReplyDelete
Yeah, off-topic but whatever. I did read it, and I agree with your summary of the literature that argues for the superiority of policy rules over policy discretion. I think the emergence of that literature and its dominance over macro discourse is what's interesting. It has something to do with the specific policy issue from which it emerged, reducing inflationary expectations, which is different in important ways from other policy issues (even increasing inflationary expectations incidentally). But above all it is a change in the underlying conception of what models are supposed to do. Suppose you are right and the CB should have a policy rule which tucks away a degree of freedom. It is still a leap to say that the model of how the economy *does* work should coincide with how, at least in respect to this policy actor, it *should* work. Formally, this is a way to close models that are otherwise difficult or even impossible to close, but it also changes the relationship between the model and the user of the model (the policy maker). If you think that policy is or could be a product of a democratic process, there is an important political angle too. From a social science/policy perspective it's a big shift, and I'm calling attention to it.Delete
On another level though, all the debt and associated consumption does lead to stealing from future generations. Not money, but resources, both nonrenewable and renewable resources that are consumed more rapidly than they can be replenished.ReplyDelete
if that argument were true then it would apply to all consumption, not just consumption financed by government deficit spending.Delete
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For anyone who is considering the idea that debt spending is not a burden on future tax payers consider this fact -ReplyDelete
Debt spending is certainly not a burden on tax payers now, and so if you are also considering that it won’t be a burden on future tax payers either , then you have eliminated both possibilities of where the burden of government spending , funded by debt , could lie, and therefore countenancing something that evidently , must be impossible.
In conclusion. - Government spending transfers money from tax payers to the recipients of government spending. Moving the tax burden to tax payers in the future is the whole purpose of debt spending, and that is what it does.
see Nick Rowe's comment above. "Bottom line: debt may or may not be a burden. It depends".Delete
You clearly haven't thought this one through very much. Instead you just assert that your assumption (debt is a burden) is true, and then conclude that therefore your assumption that debt is a burden must be true. That's called circular reasoning, by the way.
The debt spending transaction is quite simple.Delete
When the government taxes to spend it is called a tax burden on the tax payer.
When the government chooses instead to defer this with debt, the burden is put on the tax payer at a later date. That is how spending using borrowing works .It is an accounting identity .
perhaps you should read Nick's comment.Delete
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In Nicks comment tax payers pay for interest payments on an ongoing basis in his examples and so yes there is always a tax burden on the tax payers caused by the debt.Delete
Actually they don't. Read again.Delete
Your right. And, Bernie Madoff couldn't agree with your more.ReplyDelete
when interest rates turn around and go to 5 percent then some ppl will definitely pay big time...ReplyDelete
The problem it seems is not that the government is paying back the interest immediately, but the money borrowed by the government is being used in a poor manner. The borrowing is not used for investment that will increase the amount of goods and services the country could produce in the future.ReplyDelete
For example, if a business borrows money to expand the business and the business grows in profitability, then that borrowing was an investment in the future. But, if that same business borrows money and then uses it in a manner that does not add value or investment to the business, then there is no growth in the business and the debt is a burden to the business as results is less opportunity for that business. Likewise, if US government borrows money and it does not bring an increase in some future value to our economy, then the borrowing is a burden.
Our government is not spending the money borrowed on infrastructure improvements, research and development or other such projects. Those spending are being hugely cut. Also, that money is being taken from businesses that could have used that money to grow their business and higher more people, thus growing our amount of goods and services. In fact, the amount the government borrows can be looked at as a loss of revenue for future private sector businesses that would have grown the economy more. As the government spends and borrows more, the less the private sector grows. Each generation, this loss would grow more and more. So, our future generations have fewer opportunities for jobs and would have to pay at a higher inflation rate. So, yes it is borrowing or more likely stealing from future generations in the form of loss opportunity and jobs.
100% correct. Decreasing the velocity of money in the economy and assuming the compounding of benefit from "wise" govt spending is why liberals should never control the purse.Delete
absolutely. Its seems that the progressive economist who espouse the above opinion, don't consider the opportunity lost as a tax. But, since we won't see it because we keep going deeper and deeper down this rabbit hole, they don't bring it up. Government spending is wasteful spending and missed opportunity for private sector to generate goods and services to capitalize on the markets.Delete
Wrong Fucking Wrong.ReplyDelete
The US and Britain were NOT closed economies before, during, or after WW2.
Generational theft isn't an argument about government deficits. It's about what one generation receives in transfer payments versus what they put into the system. Regardless of what government debt is or who finances it, as the system stands today, the generation being born today is receiving MUCH different amounts net of what they will have to contribute.ReplyDelete
Your post is misleading and irrelevant.
Let dumb this down with an analogy. Because I disagree with the Author.ReplyDelete
The US Government issues debt of 35k dollars a year for 10 years consecutively to pay for grandfathers medicare, medicaid, and social security expenses.
Grandpa net receives benefits of 35k per year for the next 10 years. But you say that because he is paying interest of 3.5% or (1.2k) per year you believe he isn't passing his debt to his grandchildren? Because his grandchildren can take out another loan upon expiration to pay back the principal? What happens when the grandchildren retire and want the same benefits as Grandpa? They would have to double the debt, which is not sustainable long term.
Debt makes sense when it is an investment. AKA it provides a return greater than interest being paid. An example would be building a bridge that spurs economic growth and in turn brings in more tax revenue to the government. Paying for teachers that make for a smarter future work force. The problem with the US is our debts have shifted away from investments to expenses. And unfortunately as our debts grow, it is harder to give up expenses versus investments. Look at Greece.
How do we reverse this trend? Not by believing articles like this. Our deficits are growing. Lets look at what our expenses are
This article is not worth bandwidth it consumes to display it.ReplyDelete
Nick, why are you choosing to forget about the incredibly thorough, logically watertight, and clever post I wrote showing why the "debt burden" is no big deal? ;-)ReplyDelete
Noah; because I read it twice and still could never figure out what exactly it was you were saying in that post. That may be my fault, of course, because my math and stuff is cr*p.Delete
This is what I *think* you were *maybe* saying: "If we borrow to give money to cohort A, doing that does not put a burden on cohorts B, C, D, etc., provided we increase taxes again on cohort A and pay off all the debt before cohort A are all dead."
Which would be true, but somehow less than convincing as a general argument that we shouldn't worry about the debt.
As you can guess, this "burden of the debt" question really bugs me. Not, as some might think, because I am especially debtaphobic. But because I am embarrassed as an economist that so many of our best and brightest spent so long laughing at the poor economically illiterate rubes who don't understand that we owe it to ourselves, when in fact those economically illiterate rubes are a lot closer to the truth than those who laugh at them. And that it took a farmboy like Jim Buchanan to point out the rubes were basically right and all the clever city kids were wrong. And that I really did think that all the clever economists had figured out Jim Buchanan was basically right 30 years ago, and that they had been horribly wrong, and had just kept very quiet about it because they were so embarrassed. And I was just stunned to see Paul Krugman hadn't got the confidential memo to stop laughing at the rubes, because the rubes were right.
I agree - I was shocked when I read Paul Krugman's NYT Blog Dec 2011.Delete
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I really liked this post, and without much specific competence (I studied economics but I am not a professional economist) I would like to point out two elements that seem to get somewhat blurred in the debate:ReplyDelete
- when used in public speaking, and especially in political public speaking (not just in the US, I am writing from Italy) the assertion that increasing public debt means borrowing from future generations usually implies the idea that debt for a nation is more or less the same thing as debt for a family, therefore our children will have to pay the debts of our government the same way I would have to pay the debts left by my father: this is plainly and completely wrong
- the other idea that frequently hides behind the public debt = borrowing from our children equation is that any money diverted to public spending is wasted for all long term purposes. Seen from Italy, land of one of the most inefficient governments in the western world, this idea has indeed some appeal: but it is more a political than an economic statement, it is easily disproved by facts if taken literally and if not it needs qualifications (a lot of). So wouldn't it be better to openly contend on the efficiency of government spending, rather than pulling our poor children into the equation with a dubious rethoric trick?
enrico's comment shows just how badly we economists have mis-taught our students.Delete
"...therefore our children will have to pay the debts of our government the same way I would have to pay the debts left by my father: this is plainly and completely wrong"
In an overlapping-generations macroeconomic model, it is plainly and completely right. If enrico had never been taught any economics, he would almost certainly understand this better. That is why I am so embarrassed as a teacher of economics.
Nick, are you saying that anyone who thinks the assumptions that underpin OLG models are misleading (for at least some purposes) isn't an economist? Or just a poorly trained economist?Delete
Nick you don't need to be embarassed as a teacher, but maybe a little as a polemicist. What I did mean is that in practice, in history and for most logical purposes the assertion that states (or nations, or generations) repay debts and carry their burden the same way as (sometimes) families do is not sustainable. But of course there are models, not specifically meant to answer this kind of question, where you can make states behave like families; then I will simply reply that those models are not very significant in this debate. More generally, I was trying to make the point that the debate was becoming very technical when the misunderstanding (and in my view the mistake) is very basic. You reject my comment with a technicalityDelete
Models this, models that. If you had been taught engineering you'd understand the limitations of models. Since economists argue about realities based on their modeling assumptions, you'll never actually help our society, just keep hurting it.Delete
What part of, if the baby boomers rack up 80 trillion in unfunded liabilities and then they die, their children will have to be taxed through inflation or actual taxes to pay it back? Doesn't matter who borrowed and used it. We're still getting taxed and we did not receive the proceeds from the initial borrowing. It's actually likely a little afghan boy received them in a form of a scud missile. That was the product of our stimulus spending.
Peter: sorry for the delay in replying. Canadian Thanksgiving.Delete
I wouldn't say "not an economist", nor "poorly trained economists". I would say that what many economists, and many well-trained economists, have been wrong on this question. It's not a question of agreeing or disagreeing with the assumptions underlying particular OLG models. The fact that we can use simple OLG models to set up a *counterexample* to some general claims is what is important. If I can find just one counterexample to the general claim that debt cannot burden future generations, (unless it's a debt to foreigners, or reduces investment, or causes distorting taxation) then I have disproved that general claim.
To all of you who still think there cannot be a burden, just ask yourselves this one question:ReplyDelete
Suppose that, instead of *selling* the bonds to the next generation, we *gave* those same bonds to the next generation. Would *giving* them the bonds make them better off than if we *sold* them the bonds?
Obviously, it would.
Nick, who is "we" and what is our relationship to the "them" who receive the bonds as gifts? Are both part of the same group or are they different groups? And who is proposing to sell bonds to the "next" generation? I realize this is the convention in OLG models, but empirically, what is the average age of bondholders relative to the population as a whole?Delete
Ignores the basic fact of life and economy. Yes, as the author says, the state and the individual is not the same, but it should be applied to the text, too. Try to raise credit in the bank in the name of your unborn child!ReplyDelete
Secondly is it the same when you take out a loan and when Bush borrows in your name and name of your children and grandchildren to kill Iraqis!?
When a government's total expenditures exceed the revenue that it generates excluding money from borrowings then it is having what is known as Fiscal deficit. Deficit differs from debt, which is an accumulation of yearly deficits.ReplyDelete
This argument is flawed. It can be argued that our current administration hasn't been able to do all they wanted to do because of the fiscal issues caused by our accumulated debt. Doesn't that mean the current generation is burdened by what past generations left them? Same going forward as long as some principle isn't paid off to reduce the debt and not just interest payments. Just paying interest and leaving principle to be paid in the future is robbing prosperity from the future. It doesn't matter who it's owed too as much as that it is owed.ReplyDelete
It could be argued that the Clinton administration was similarly constrained, but the Bush administration clearly wasn't. Why? Where is the threshold at which the accumulated debt becomes unacceptable and constraining? If Bush had run up less debt, would the GOP be okay with the deficit levels we are seeing under Obama?Delete
Needless to say, I find your claim that we are currently constrained by our accumulated debt implausible. In this country, deficit mania is what happens when Congress (or part of it) and the President are at odds with each other, and is never actually about the deficit, as evidenced by Republicans' refusal to consider a deal that includes new revenues, and the inclusion of tax cuts for the wealthy in both Paul Ryan's and the Simpson-Bowles "deficit reduction" plans.
Greece is actually constrained by its accumulated debt, so it is possible, but we are nowhere near their debt levels. Then again, Japan isn't constrained by their debt levels and we are nowhere near Japan's debt levels; the threshold for countries with their own currencies may be much higher than for countries like Greece.
Peter Dorman, believe me, I used to think exactly like you on this issue, and then Nick Rowe got me to change my mind. He's not saying you have to endorse every little thing in his OLG model, but his point is, once you "see" why your argument doesn't work in his model, you can generalize it.ReplyDelete
I tried to translate Nick's insight into an easier-to-read format in this post.
Again, I'm just asking you to make sure you understand why your argument in this current blog post doesn't work in a simple OLG framework. The kind of arguments you're using--"interest payments can't burden our grandchildren on net, because they are just transfer payments from one subset of grandkids to another"--misses out on something really important.
do dollars grow on trees?Delete