So, I was out there shovelling snow, thinking about writing a post on the burden of the debt on future generations. And about how macroeconomists' beliefs on this question had silently shifted about 30 years ago, and about how we as a profession have engaged in a sort of "memory falsification" (like Timur Kuran's concept of "preference falsification"), because we didn't want to admit that we now believe something we used to believe only unsophisticated economically illiterate rubes believed.
And I then I thought "Nah, what's the point of rehashing old ground?. Nobody nowadays believes that old "we owe it to ourselves" stuff that we used to believe."
And then I came inside and read Paul Krugman's blog post. Now I absolutely have to write the post I had decided not to write.
"That’s not to say that high debt can’t cause problems — it certainly can. But these are problems of distribution and incentives, not the burden of debt as is commonly understood. And as Dean says, talking about leaving a burden to our children is especially nonsensical; what we are leaving behind is promises that some of our children will pay money to other children, which is a very different kettle of fish."
Sorry, but that's just plain wrong. The economically illiterate rube who thinks that the national debt is a burden on our children or grandchildren is basically right. It's the exact opposite of "especially nonsensical". Unless you believe in Ricardian Equivalence.
[Update: Paul Krugman has a second post.
"And you don’t have to be a right-winger to acknowledge that yes, very high marginal tax rates act as a disincentive to productive activity. So real GDP may well fall significantly.
This is what I mean when I say that the burden of debt is about incentives, not about having to deliver resources to other people.
……
The general point is that the analogy with a family that owes too much is all wrong. Unfortunately, this dumb analogy dominates our national discourse."
And I'm saying that it's not (just) about incentives, and it is about having to deliver resources to other people, and that the analogy with the family is not dumb and not all wrong (even though, like all analogies, it doesn't work perfectly).]
In the olden days we all used to believe NB. At least, all educated sophisticated people believed NB. Only uneducated unsophisticated people believed B. But we all smugly knew that "the man in the street" was wrong. In fact, a quick test for whether someone was educated and sophisticated was whether he believed B or NB. Maybe a few of us educated sophisticated people might have believed B, or didn't really understand why NB was so obviously correct, but we kept our beliefs secret, because we didn't want other people to think we were uneducated or unsophisticated rubes.
I can still remember an economics seminar at Carleton, sometime in the 1980's. The visiting speaker was an older guy, an old-school Keynesian from one of the top US universities (I have forgotten his name). Halfway through the seminar, he said "I assume that the audience here is economically literate, and that nobody here believes B?" He paused and glared around the room. The blood went to my face (a grad student told me afterwards my face was red). I raised by hand, and said that I believed B.
James Buchanan was not a sophisticated macroeconomic theorist. He didn't do macro. He did political economy/public choice. He had zero authority in macro theory. James Buchanan argued for B. But he was just a farmboy, like me. (Yes, I do have a slight chip on my shoulder; why do you ask?)
Then, all of a sudden, it seemed like all the educated sophisticated people switched to believing B. It was a very quiet revolution. There were no visible signs of argument at all. One day we all (I mean all we educated sophisticated people) believed NB; and the next day we all believed B. And we all stopped our smug condescension about the poor ignorant "person on the street" who believed B. In fact, we never mentioned the fact that we all used to believe NB. We wiped our old beliefs from our memories, like Soviet photographs. It was just too embarrassing to talk about.
There's a danger to this sort of memory wiping, and silent shifts in belief. Some people never got the memo, and still believe the old NB like we all (all educated sophisticated people) did once. Plus, it says something about our beliefs in general if we all just believe what it is fashionable to believe. (And we do, very often, which is why many of our beliefs, especially educated sophisticated beliefs, really suck).
Paul Krugman is a much better economist than me. But he never got this memo. It's time to re-open this old box of suppressed memories.
Let me make some simplifying assumptions so we can get to the heart of the distinction between B and NB. (Yes of course these assumptions are false and unrealistic, but by excluding areas where we agree we can focus on the area where we disagree.)
Assume: closed economy; no investment or real capital of any kind; lump-sum non-distorting taxes with zero collection costs; positive real interest rate and zero real growth; exogenous full-employment level of output; apples are the only output good; apples cannot be stored; identical agents; overlapping generations; no funny stuff.
Suppose the government makes a transfer of 100 apples to the current cohort, financed by borrowing. Does that create a burden on future generations? Yes or no? B or NB?
I say Yes. I say B. It does create a burden on future generations. The only case where it does not create a burden on future generations is where Ricardian Equivalence holds. According to Ricardian Equivalence, the person in the street realises it will create a burden on future generations, and so saves the whole of the transfer payment, including interest, passes it on as a bequest to his children, who pass it on to their children, precisely because he wants to offset that burden on future generations.
The person on the street, in his unsophisticated uneducated ignorance, is basically right. The debt is a burden on his kids, or grandkids. Only if he anticipates that burden, and decides to offset it by increasing his bequests, a la Barro-Ricardo, does he eliminate that burden
No. My argument does not involve time travel. It doesn't require we can take apples grown 100 years from now, put them in a time-machine, send them back in time, and eat them today. But it is as if we could.
My argument is obvious. At least, it's obvious to anyone who has thought about overlapping generations models. And it's equally obvious to the unsophisticated uneducated rube who has never thought about overlapping generations models.
The government borrows 100 apples from each of cohort A, then gives each person in cohort A a transfer payment of 100 apples. It is exactly as if the government had simply given each person in cohort A an IOU for 100 apples. That IOU is a bond.
So far there is no change in cohort A's consumption of apples.
Cohort A then sells the bonds to the younger members of cohort B. So each person in cohort A gets an extra 110 apples (assume 10% interest per generation), which he eats. Cohort A then dies.
Cohort A is better off. Each member of cohort A eats an extra 110 apples. In present value terms, those extra 110 apples are worth 100 apples at the time the transfer payment is made.
Cohort B eats 110 fewer apples when young, but 121 extra apples when old, and they sell their bonds to cohort C. Although cohort B eats 11 more apples in their lifetimes, the present value of their total consumption of apples is the same. The rate of interest must be high enough to persuade them to eat fewer apples when young and more apples when old, otherwise they wouldn't have bought the bonds from cohort A. So cohort B is not worse off.
But (given my assumption) the debt is rising faster than GDP. The government knows this is unsustainable. It cannot rollover the debt forever, because eventually the next cohort will be unable to buy the bonds from the older cohort. So the government decides to pay off the debt by imposing a tax of 121 apples on each young person in cohort C, which it uses to buy back the bonds from cohort C.
Each member of cohort C eats 121 fewer apples.
Cohort A eats more apples, and cohort C eats fewer apples. It is exactly as if apples travelled back in time, out of the mouths of cohort C into the mouths of cohort A. (With interest subtracted as they travel back in time through the time machine.)
Yes, the national debt is a burden on future generations.
Can that burden on future generations be offset in some cases? Yes.
Ricardian Equivalence means that inviduals decide to offset the burden by each cohort giving rather than selling their bonds to their kids in the next cohort. So if you believe in Ricardian equivalence, you can consistently argue that the national debt is not a burden. But it's only not a burden because individuals see it is a burden and take offsetting action. That ignorant uneducated person in the street is still right.
And if the debt is used to finance investment in the kids' education then the burden is offset.
And if the interest rate is permanently less than the growth rate then the "No Ponzi" condition does not hold, and the debt can be rolled over with interest forever without taxing future generations, so cohort A eats more apples and no subsequent cohort eats fewer apples (there is never a cohort like cohort C, they are all like B).
I can relax all the other simplifying assumptions, and show that the basic message is still roughly the same. But not today.
Worthwhile Canadian Initiative 
From the original post: “So the government decides to pay off the debt by imposing a tax of 121 apples on each young person in cohort C, which it uses to buy back the bonds from cohort C.” (my emphasis)
when C is young B is alive and old.
Ian,
Ferrari: my point has nothing to do with government morality as the cause of the problem. It’s about risk management, given the problem.
Regression: it’s not above avoiding the incidence of taxation; there’s no way to avoid the incidence of taxation – whether viewed as a risk or as an outcome. The risk management exercise consists of recognizing the risk of taxation and assessing the corresponding risk of not being able to sell bonds for apples as a result of that risk. That’s what makes the last man standing net short on apples.
Paul Krugman is now responding to his commenters, arguing that it’s not a debt to foreigners, but he is still not responding to this post.
http://krugman.blogs.nytimes.com/2011/12/29/the-burden-of-debt-again-again/
The tax is imposed on cohort C.
Cohort B is a dead parrot when the tax is imposed.
Right Nick?
(Otherwise, you’d have no reason not to impose the tax on B as well, and you didn’t.)
“Ferrari: my point has nothing to do with government morality as the cause of the problem. It’s about risk management, given the problem.”
Yes, and as the government increases the risk that it will be required to tax a cohort the expected value of those cohorts bonds decreases. For example, As government takes on more debt, Cohort B’s bonds are riskier and have a lower EV than cohort A, Cohort C less than Cohort B, etc. We may not know exactly when the tax will occur but the ever increasing threat of it will decrease the value of the bonds over time.
In reality, the bonds would be discounted to provide a 0 yield and people would still buy them because what else is there.
Nick,
“Suppose there were exactly one person in each cohort. Then everything you say is (unless I missed something) absolutely correct.”
Good.
“In fact, in this case, it is inconceivable that B would have bought the bonds from A, because B would know that C wouldn’t buy the bonds from B, etc. By refusing to buy the bonds from A, future generations force A to pay for his own transfer.”
No. It’s not inconceivable. It’s risk management. Nobody knows the future. B has to make a judgement about the risk of taxation during the life of B. If that risk is less than 100 per cent probability, B may buy the bonds. If the probability of taxation during the life of B is less than 100 per cent, then the probability of being able to sell the bonds to cohort C will be non-zero. The bonds will be risk adjusted in price to reflect these probabilities. And when the price is adjusted for the risk, the yield will adjust a well – higher – compensating any cohort that choose to buy the bonds for the risk that it takes on in doing so.
JKH, it’s a net transfer from young C to old B to redeem the bonds. The government could be collecting taxes from both young and old and providing services to both young and old. Paying off the bonds still means, in total, taking extra net taxes from young C and giving the apples to old B to retire the debt.
Or, it could just be that income taxes are only levied on the young. This would make some sense actually since presumably people produce more apples when they’re young than when they’re old. They’d want to buy the bonds to smooth out their consumption over the two periods of their life. So it could just be that only the high income young pay any tax.
“Yes, and as the government increases the risk that it will be required to tax a cohort the expected value of those cohorts bonds decreases. For example, As government takes on more debt, Cohort B’s bonds are riskier and have a lower EV than cohort A, Cohort C less than Cohort B, etc. We may not know exactly when the tax will occur but the ever increasing threat of it will decrease the value of the bonds over time.”
Agreed. In this case, the bond risk is complicated because they are real apple bonds. The bonds are still worth 100 apples on 100 apples for purposes of redeeming them for taxes. But they’re not worth 100 apples in the market for bonds, essentially because the threat of the same tax means they’ll no longer be available for sale in exchange for apples.
(For those MMT’ers who may be tuned in to this episode of WWCI, this aspect bears an eerie resemblance to Mosler’s plan for Greek “Mosler bonds”, which would redeemable at par as currency for tax payments.)
JKH: Nick’s right. In a two agent model, C can negotiate the old man (B) down to next to nothing for his bond (since C can afford to wait), but where there are many agents an efficient yield (lets assume a policy rate somewhere around expected NGDP growth) will be paid for the bonds. Otherwise rates will rise and the CB will buy the bonds. And C will get stuffed. How, in your model, does the market price of bonds get impacted by the probability of the payment of a tax? The bonds are worth what they are worth by virtue of an arbitrage relationship vs the policy rate.
Nick,
“Suppose there were one hundred people in each cohort. Then what you say is incorrect. (That is what I was talking about when I made the distinction between what is individually rational and what is collectively rational. When there’s only 1 person per cohort, collective and individual rationality of a cohort are the same thing.)”
I recognize the connection to your earlier point. I’ll have to work this one through in more detail, but I know right now that I disagree.
BTW, regarding the “Mosler bond” reference, I argued with him at very great length on his blog that what he was proposing was essentially a Ponzi scheme (argued politely, that is). The same dynamic appears here in terms of the reliance on an inter-generational dependence of each generation to sell its bonds to the next in order to end up net flat in apple consumption, given that the first starts out net long, but that somebody must end up holding the bag in the event of taxation.
“In reality, the bonds would be discounted to provide a 0 yield and people would still buy them because what else is there.”
“And when the price is adjusted for the risk, the yield will adjust a well – higher – compensating any cohort that choose to buy the bonds for the risk that it takes on in doing so.”
But as people percieve that the risk will most definately occur before they cash out their bonds they will simply not purchase the bonds no matter how much you promise them in interest because they know you are just going to take it all back.
Like I said earlier, you can do this a couple times by taking a hit on the financial reputation of the government but eventually you end up in banana republic territory where the government has a difficult time taking on any future debt. This removes the benefits of fiscal policy to future generations that previous generations benefitted from.
K,
I don’t believe in binding liquidity traps now as a result of the ZLB, let alone with no physical currency, so I certainly don’t assume a ZLB problem at the end of expansionary civilisation!
An inflationary burden that is necessary to lower interest rates on government debts (without raising taxation) is still a burden. The “interest rates below the growth rate” seemed interesting precisely because no extra inflation would be necessary.
K,
I think the most reasonable interpretation is that all bonds are one period maturity and when Nick says an old cohort “sells” the bonds to the young cohort then he really means that the government rolls the debt.
Otherwise, as you say the young C can negotiate old B down since B doesn’t value future consumption at all (they’ll be dead) so any price above zero that they can get is worth it.
The problem with long term bonds is that B should anticipate that they’ll be in a lousy bargaining position and so not pay much for the bonds and thus A never gets a transfer.
I think the interpretation here should be that A gets issued one period bonds, when A “sells” them to B this is intermediated by the government. The government sells 110 apples worth of new one period bonds to young B and uses the proceeds to pay its debt of 110 apples to old A who’s bonds are maturing.
If B refuses to buy the newly issued bonds then they get taxed 110 apples so the government can pay its debt to A (assuming no default).
I think that’s the most sensible interpretation and makes Nick’s point the in the starkest way. Once the bonds are created, if the government won’t default then some future generation has been burdened.
I don’t understand why we have to talk about this fictitious apple world that operates nothing like a banking system with a sovereign govt denominated currency. Why can’t we talk about a simplified worlds with bonds, bank loans, primary dealers, and investors? Is that too finance-y? Too complex?
Perhaps the model that Dean Baker and Krugman envision is like this:
The government borrows real goods in period 1 from a few rich dynasties (Gates, Buffet, Walton, etc.) and gives them bonds in exchange (as an aside, it is assumed that the government either trasnfers those real goods or burns them such that total long run output does not increase). These dynasties are not credit constrained and they bequeath the bonds from generation to generation. The rest of the economy is comprised of credit constrained dynasties/overlapping generations. Ricardian equivalence does not hold because a tax cut will lead to higher transitory spending by the credit constrained households.
Eventually at some point, government debt is cleared either through additional taxes (a redistribution from tax payers to the rich dynasties) or through default (a redistribution from the rich dynasties to everyone else). This looks like a dynastic model whithout Ricardian equivalence where the burden of debt is primarily redistributive.
@K – I think we don’t need to actually track individual government bond sales to check if they are typically intergenerational. If we assume that government bonds are a fairly fixed proportion of wealth across agents, then all we need to see is how much wealth today has been created by the current generation as opposed to inherited from the previous generation.
As Gates and Buffet are first generation billionaires, I think, empirically, an OLG model as described by Nick is a better fit than the dynastic model above but I am sure this could be tested better.
wh10,
Making things any more complex than they need to be in this exercise is to be avoided. There’s a time and a place for detailed institutional descriptions; abstract modelling about the fundamental causal effects of intergenerational debt is neither the time nor the place. Hence the simplifying assumptions.
Adam: I basically fully agree with you (and Nick). There wasn’t much more to say after you said:
“Seems to me that once the bonds are created, provided the government doesn’t default then A is gonna receive a transfer. The only question is which cohort pays.”
Basically if we assume that each cohort overlaps with the next for half of their consumption/production then one cohort can decide to increase their share of total consumption by 50% and every cohort after that can give up 50% to the previous cohort and take 50% from the next. It’s impossible to take more production than that since you can’t pull it back from the future. But as long as a generation has sufficient political power it can pull off the trick. But only one generation can get the benefit, and eventually as W Peden says, given the finite size (or at least very low growth rate) of the universe, the gig will come to end and someone’s going to pay.
Unless rates, as Andy points out, continue to run below NGDP growth in the long run. In which case we are getting a free lunch thanks to the risk averse preferences of our descendants who choose to share a tiny fraction of their immense wealth with us by collecting infinitesimally less interest than the rate of growth produced by their immense futuristic economies.
W. Peden, but my problem is that I have no reason to trust this model accurately reflects the fundamental causal effects of intergenerational debt as they exist in the real world. And the real world contains a credit system with a central bank, which doesn’t exist in this model.
Nick made a comment to me a while back that he’ll only trust the MMTers once they demonstrate to him comprehension of some economic concepts he views to be very important (and correct). I have the same problem here. I struggle to trust Nick’s thinking until he demonstrates an understanding of the economics behind various the credit system and real-world financial constructs.
You act as if I am talking about icing on the cake that doesn’t matter for the main takeaway. I am not. I’m talking about the cake.
primed: Maybe, just maybe. Except, there’s a long history of economists saying that it is impossible to impose a burden of the debt on future generations, except via lower investment, debt to foreigners, distorting taxes (all of which i have ruled out by assumption). I’m not sure where this “no burden” theory came from. Abba Lerner, possibly? But it was orthodoxy until somewhere around 1980. And Paul Krugman is, most plausibly, just reflecting that old orthodoxy.
wh10: when some economists say something is theoretically impossible, and you want to show that it is possible, you set up the simplest possible model in which that something can happen. Even my model is not simple enough, because we are still arguing about it.
The absolutely last thing we want to do is bring “primary dealers” and stuff like that into the model. They add nothing, and merely obfuscate the picture.
What Nick said.
Put another way: the weather is part of any complete explanation of shifts in economic growth. For instance, some winters are very harsh and cause considerable temporary fluctations in national output. Each country has its own weather policy; even within a country, some areas will deal with the weather better than others. One could make a career out of talking about the institutions, the weather and their relation to changes in output.
Would such a description be relevant to working out the causal relations between fiscal policy and real growth? No. Adding detail SOLELY for the sake of representational is not the point of modelling here. What is interesting is causally relevant details, in particular the logic of an intergenerational sale of government bonds.
Nick,
But why should anyone believe your model is at all representative of how govt debt works in the real world? You never engage, for example, Fullwiler’s response that I posted above (and thus, why I never know if you really understand this stuff). Instead, you retreat to your simplified models when faced with what you view to be ‘obfuscations’ and then proclaim you have it right because it works in your model. Then someone else responds that your model does not properly correspond to the real world, and we’re back to square 1.
Fine, throw out ‘primary dealers.’ How about introducing a central bank and a credit system reflective of how they work in the real world? These are INEXTRICABLY attached to govt debt.
Peden, you and Nick don’t get it. You’re merely asserting things like a credit system is not important. That’s all you’re doing. It’s absurd.
K,
To be pedantic (it is almost my name!) I wasn’t saying that the universe is finite in SIZE, but rather finite in resources (by which I mean usable resources). The universe (or the billions of light-years of it that we can observe) is mostly made up of dark matter and dark energy which have no real use beyond creating employment for physicists who can’t do anything else. Paraphrasing Lord Salisbury’s comment on the western Sahara, “It’s what you might call very marginal cosmos.”
Of course, the primary modern constraint on avoiding passing on debt burdens is not the universe as a whole, but the level of modern growth that is commensurate with not destroying civilisation with global warming or radioactivity, which are also burdens on the next generation (i.e. my generation).
W Peden: “An inflationary burden that is necessary to lower interest rates on government debts (without raising taxation) is still a burden.”
I don’t get this. We are not talking about surprise inflation. We are just talking about higher equilibrium inflation in order to accommodate lower real rates at the ZLB. It’s not lowering anybody’s debt which, in real terms, will continue to compound at the real rate at equilibrium.
I didn’t say you believed in liquidity traps (my comment about liquidity traps was an aside). But presumably you believe that people wont hold negative nominal rate debt. And the reason for this is the existence of physical currency with zero nominal yield. So if we abolish hand-to-hand currency then we can set negative rates (and then liquidity traps, for those who believe in them, go away).
Krugman still has a good point, though. Lets say generation A, in its old age, decides to throw itself a monster bash and retire in Barbados at the expense of generation B, and they decide to arrange for the government to pay for this through our democratic process. It’s not very fair to B, but that’s our system and those are the breaks. But have they burdened future generations who are not party to this deal? That really depends on how well B negotiates with C. If C doesn’t agree, then B will pay for it, since “C doesn’t agree” means “C has the political power to decide who is going to pay”. Maybe C will say “sorry, you blew it, Pops. You no longer get social security/medicare. And there’s a special new ‘pensioner’s tax'” So in the end, I agree with Krugman (and in spirit, though perhaps not in technical detail, with JKH). A and B will make whatever arrangements their relative negotiating positions permit and since they were both alive to be party to the transfer, then it’s ostensibly a fair deal. From there on, each generation can negotiate (via the tax and transfer system) with the next.
Let me be clear. It’s not that I am proclaiming your model is not representative enough in that it doesn’t have all the details. I am saying it’s not representative enough in that it doesn’t properly capture the bare minimum “causally relevant details” that allows us to understand fiscal policy.
And then all Peden does is assert I am wrong. And then I say Peden is wrong. Back and forth.
It would make me happiest student if you would engage the other side on its own terms, instead of retreating to your models that the other side views as a non-starter.
wh10,
“You’re merely asserting things like a credit system is not important. That’s all you’re doing. It’s absurd.”
Of course a credit system is important, for SOME issues. Is it relevant to modelling intergenerational debt burdens? The assumption is surely “no”, since additional assumptions (i.e. an economy at below full-employment) have to be added to make it relevant.
“why should anyone believe your model is at all representative of how govt debt works in the real world?”
There are many different reasons to model. One is to pursue empirical adequacy e.g. you make a long-run growth rate model and test it against the data. Another is to isolate causal connections. In both cases, representational accuracy is important ONLY insofar as it aids the actual goal of the model. That’s why you get population models in biology that assume an infinite number of rabbits.
wh10: in this particular case, where all I need to do is show how something is possible, because I am trying to disprove someone who says it is always impossible, all I need to do is find one case where it is possible.
More generally though, here’s how model-building works:
1. The first person lays out a simple model to demonstrate something.
2. If a second disagrees with that model, he can’t just say “assumption X is unrealistic”. The onus is on the second person to explain why assumption X matters, and why you would get different results if you changed assumption X to assumption Y. Because any model, no matter how detailed, is always false in millions of ways. The only true model of the world is the world itself.
But this is wandering off-topic.
Even though i am not keeping up with comments, I just wanted to say I am really pleased to see a number of good commenters here basically on board. Now, how can I attract the attention of the rest of the world, and PK in particular?
One thing I now think I was wrong about: I thought that basically (almost) all macroeconomists understood that the debt is a burden (subject to the exceptions we have already discussed). I didn’t think this would be (as) controversial.
“2. If a second disagrees with that model, he can’t just say “assumption X is unrealistic”. The onus is on the second person to explain why assumption X matters, and why you would get different results if you changed assumption X to assumption Y. Because any model, no matter how detailed, is always false in millions of ways. The only true model of the world is the world itself.”
I did. I had a huge post above. And it’s just ignored. If you can always borrow at x% and earn y%, then you will always do that if y% is anything above x%. And you need a credit system for that. And that’s what happens in govt debt. So you need a credit system to understand intergenerational debt.
And that’s guaranteed earnings mind you.
More specifically: “First, there are these things called primary dealers, who can borrow at the repo rate and fix their costs for any maturity in forwards and buy any Tsy issue that goes above the borrowing costs. And the repo rate–created out of thin air with just a previously issued security as collateral–always arbitrages with the overnight target rate. Second, there are these things called hedge funds–like 100s of Warren Moslers–who can (and in the case of Mosler, have and will continue to) borrow at LIBOR and fix this rate at any maturity in swaps or forwards. And LIBOR arbitrages at the overnight target rate, while eurodollars are created out of thin air like any bank loan.”
Any takers? Or is it back to apples?
“The assumption is surely “no”, since additional assumptions (i.e. an economy at below full-employment) have to be added to make it relevant.”
That’s just entirely false. We’re not talking about credit created for private sector activities. I went over this with Nick several weeks ago. See above.
One has to assume the reason government implemented this represents a common need that does not go away simply because they botched the design and no one was smart enough to figure it out. Anyone trying to buy future apples in the present would face the same problem but not buying is not a solution. Yes, people will buy things even if they expect to lose money if that is the best they can do. Apples perish.
I know of no program that started by paying out benefits first and collecting premiums later so this seems remarkably irrelevant. The bigger question is if this benefited A, what did A do with it? In Apple world there isn’t much that can be done, perhaps some starving has been avoided, perhaps some heirs are left better off, and perhaps that assurance is enough. The program is modified to accord to reality as best we can anticipate. Facing reality may represent a burden, but not facing it a calamity. You can pretend facing it is some betrayal as it is a burden, but it is only a burden because of your unrealistic expectations.
wh10,
I’ll leave the economics (not my field) to Nick Rowe, since my methodological point has been made. I hope it’s clear WHY this causal modelling is taking place and WHY saying “that’s not a representational model” is missing the point.
Nick Rowe,
“One thing I now think I was wrong about: I thought that basically (almost) all macroeconomists understood that the debt is a burden (subject to the exceptions we have already discussed). I didn’t think this would be (as) controversial.”
I think that this thread is probably extremely unrepresentative of macroeconomists as a whole. A post like this is naturally going to be more interesting to precisely those people who disagree with that proposition. It’s just like a post saying (amongst other things) ABC isn’t believed by most economists will attract the Austrians. It doesn’t mean that most economists are Austrians or even take ABC seriously.
wh10: and why will all that show it is impossible for the debt to imposes a burden on future generations? Otherwise, yes, it’s back to apples.
Lord: “I know of no program that started by paying out benefits first and collecting premiums later so this seems remarkably irrelevant.”
??? Whenever the government runs a deficit it is doing just that. Unless all the deficit is used to finance investment for the future generations, which offsets the burden of the debt.
W Peden: you could be right. Sample selection bias is omnipresent in who comments.
Nick and Wh10,
Let me take a stab at attempting to assess wh10’s MMT related concerns in the context of Nick’s model.
Nick, I interpret your government finance model as non-fiat, because it is an apple finance model. The government borrows apples in the first instance. So I assume reasonably I think that you have no apple issuing central bank in this model. If you did, it would be an apple fiat model, and the government could deficit spend in apples, while issuing bonds to drain apple reserves etc., as per MMT. But I assume your model doesn’t extend to the fantasy of an apple creating central bank. Instead, the government is forced to borrow apples when it wants to spend them. Its apple bond financing is constrained by the requirement that the apples already exist to borrow. The government doesn’t have the option of creating them through fiat. So, because this is a non-fiat model, MMT has no direct relevance to the model.
In the apple system, A buys apple bonds and the government makes a transfer payment of apples back to A. A then sells its bonds for apples prior to death. A ends up being a net consumer of apples. And the cohort that is finally taxed, C, ends up being a net producer of apples. The fact that A net consumes while C net producers is interpreted as a burden on C, the future generation.
In the fiat system, A buys dollar bonds and the government makes a transfer payment of dollars back to A. A then sells its bonds for dollars prior to death. A ends up being a net consumer, using the dollars to consume, apples for example. And the cohort that is finally taxed, C, ends up being a net producer of whatever it sells (apples for example) to the preceding cohort in exchange for the dollars they were paid when they sold their bonds to C. The fact that A net receives dollars and net consumes apples, while C net disburses dollars and net produces apples, is interpreted as a burden on C, the future generation.
Those two paragraphs look pretty similar. But I think the MMT response to the second scenario would be something like the following:
MMT maintains that there is no financial constraint on the ability of government to deficit spend in dollars, whether it issues bonds or just leaves the money spent as is. The government always has the operational option of crediting reserves for bond maturities, for example. The only legitimate constraint is real, not financial. Real capacity pressures may lead to inflation pressures, which the government may want to respond to with tighter fiscal policy, for example.
The point is that the financing sequence that led to a government decision to impose an apple tax in Nick’s model is not relevant in the fiat model. The government following MMT policy would never impose a tax merely because of a particular financing sequence. For example, if apples were the only commodity, the government wouldn’t impose a tax at all unless apple producing capacity was binding to point of introducing apple inflation.
In Nick’s apple model, the issue is solvency in apples. In the fiat model, the issue is never solvency in dollars; it’s inflation. (That was the point of the MMT debate with Krugman.)
All that said, Nick assumes a state of full employment. So I guess that means that what becomes an apple solvency issue in Nick’s model becomes a dollar inflation issue in the fiat model, with identical timing. Given that timing, the same decision to tax should result. So the two approaches seem reconcilable.
That’s my initial impression, anyway.
JKH: I think that’s fairly accurate.
You can, if you like, assume there’s a central bank that always adjusts monetary policy, however defined, to keep the economy at full employment. If that requires setting an interest rate above the growth rate of GDP, which is what I have explicitly assumed, then eventually the government will have to increase taxes, or else create a surprise inflation which “taxes” away some of the value of the bonds held by the grandkids (cohort C). In either case the grandkids pay the burden.
JKH,
One wee quibble: at several points you switch between “fiat model” and “a government following MMT policy”. I assume that we’re supposed to regard these as equivalent, because that’s how I’ve generally found neo-chartalists to use the terms, but I could be wrong. I was actually under the impression that an MMT government wouldn’t finance its operations through bonds in the first place.
I don’t think that anyone denies that the government can finance its debts through “printing money”. For the purposes of intergenerational burdens, I think that one can regard such inflationary policy as the equivalent of a sales tax on all purchases (though in practice it will be like a series of sales taxes, with the rates depending on the amount of spare capacity in particular markets). Different theories of price determination will differ from that assessment, though, and we’d really be straying off-topic if we got into them…
As it is, I agree that neo-chartalists have anything controversial to say here: debts, under certain assumptions, create certain burdens on future generations that may met through taxation or inflation. I think that, given there are finite resources in reality, those assumptions are always met i.e. the interest rate on debts always ends up exceeding the real rate of growth such that a generation has a burden.
No, only deficits larger than the long run growth rate or larger than that over the cycle and only that without investment value. Certainly wars are a huge generational transfer. Sure hope they appreciated it.
A key assumption in this model is that the interest rate on money is above GDP growth.
Clearly that does not have to be the case. Risk-free assets have a lower interest rate than risky assets. There’s nothing strange about an economy where investment returns are above GDP growth, but the return on money is below GDP growth.
K: “Krugman still has a good point, though. Lets say generation A, in its old age, decides to throw itself a monster bash and retire in Barbados at the expense of generation B, and they decide to arrange for the government to pay for this through our democratic process. It’s not very fair to B, but that’s our system and those are the breaks. But have they burdened future generations who are not party to this deal? That really depends on how well B negotiates with C. If C doesn’t agree, then B will pay for it, since “C doesn’t agree” means “C has the political power to decide who is going to pay”. Maybe C will say “sorry, you blew it, Pops. You no longer get social security/medicare. And there’s a special new ‘pensioner’s tax'” So in the end, I agree with Krugman (and in spirit, though perhaps not in technical detail, with JKH). A and B will make whatever arrangements their relative negotiating positions permit and since they were both alive to be party to the transfer, then it’s ostensibly a fair deal. From there on, each generation can negotiate (via the tax and transfer system) with the next.”
Doesn’t that concede the point that Nick is making? Sure, the exact identity of the generation who bears the burden may be a function of bargaining between the generations, but that concedes that it will be borne by someone other than A (unless ricardian equivalence holds).
As for whether such an outcome is fair, surely the fact that the original decision was made through the democratic process doesn’t inherently make the decision fair (after all, by that logic, tax cuts for millionaires are fair, since they were made through the democratic process – surely that’s a hard proposition to swallow. Democracy may be a better system than all the others, but it isn’t neccesarily fair).
More to the point, because we’re having a discussion of government borrowing, both the A’s and the B’s are agreeing that the cost will be borne by a future generation, otherwise the B’s could just “give” (through their taxes) some of their apples to the As. Implicitly, in this model, the A’s are saying “give us apples” and the B’s are saying “sure, but only if we can try to punt the cost of those apples to the next generation”. The B’s might fail in so doing (though,in practice, given the electoral advantages of the old in most democracies – they’re richer, better connected, they vote, and they get to brainwash the generation after them into believing that social programs that benefit them are a core institution of their society – I’d bet on the “old” generations to kick the can to the young until the government goes under,i.e., the Europe scenario), but there’s something decidely unsavoury about that kind of “deal”.
The real problem is that, in the absence of some sort of ethical rationale for the proposed redistribution to the As (equality, perhaps, if the A’s are expected to be poorer than the Cs – which is surely why people accept the provision of CPP/social security to the first generation of seniors, who paid far less than they took out, as being fair), it’s hard to see the fairness in a decision make by one cohort (call them the ABs) to benefit that cohort (or a subset thereof) at the expense of future cohorts (the CDs, DEs) who had no say in the original decision.
“And one of us is totally wrong: either me or PK. It’s not like I’m disagreeing with some no-name blogger.”
This is nowhere near as mysterious as you are insinuating. To continue in the vein of your “P and NP” terminology*, you and Krugman are both making valid arguments, but yours is false. It profits you nothing to obey the rules of logic but apply them to false premises. Compare and contrast:
1. You assume full employment whereas Krugman assumes substantial slack.
Observation: we are a long, long way from full employment.
2. You assume a Ponzi condition whereas Krugman does not.
Observation: anemic though US growth may be, it still exceeds the nominal rate of interest on government borrowing.
3. You assume that younger generations buy bonds issued by older ones, whereas Krugman does not.
Observation: in fact, older generations are creditors and younger ones debtors.
There is nothing wrong with your argument except that it does not connect with reality at any point. Why would you expect Krugman to come along and rebut you? There is nothing to rebut.
* As you may have guessed, I did not care for this: it did nothing to clarify your argument, and could easily be confused with the subtle, beautiful, and useful ideas of that worthwhile Canadian**, Stephen Cook.
** Though like you, Cook is Canadian by choice, not by birth. All the more dear to us then.
Phil:
1. As discussed with Andy upthread, my argument still holds if we assumed unemployment.
2. Paul Krugman assumes that the current deficit implies future tax increases. That’s all I need for my argument. The No Ponzi condition is only needed to make sure there’s an increase in future tax increases. Since PK assumes a future tax increase, I don’t need it in my argument with him.
3. If the younger generation do not buy the bonds from the older generation, then what exactly do the older generation do with them? Either they give them to the young for free, in which case we are into Ricardian equivalence; or else they take them to the grave with them, for company?
4. The use of P and NP for a proposition and its negation goes back a long way. You do not care for my use of them? Too bad.
Nick Rowe: “in this particular case, where all I need to do is show how something is possible, because I am trying to disprove someone who says it is always impossible, all I need to do is find one case where it is possible.”
Sorry, Nick, you are making a stronger claim than that: Not “Debt may be a burden,” but “Debt is too a burden.”
Nick Rowe: “More generally though, here’s how model-building works:
“1. The first person lays out a simple model to demonstrate something.
“2. If a second disagrees with that model, he can’t just say “assumption X is unrealistic”. The onus is on the second person to explain why assumption X matters, and why you would get different results if you changed assumption X to assumption Y. Because any model, no matter how detailed, is always false in millions of ways. The only true model of the world is the world itself.”
You left out an important step, the one where the model builder justifies his assumptions. After all, the model builder has the burden of proof. 🙂
Now, there are cases where the justification comes afterwards. In such cases the justification is empirical. 🙂 The model acts like what is being modeled in significant ways, within certain bounds of error.
In this case you have modeled the debt burden without money and with gov’t policy that guarantees default, and you have also made assumptions about who buys bonds and when, as well as assumptions about parent child relationships, all without justification. Perhaps some empirical justification may be had in gov’t defaults. Who got stiffed? 🙂
Nick”if the generation that benefitted from the deficit is already dead, it’s too late to make the choice to tax them. They have consumed the deficit, and you can’t get them to pay higher taxes from the grave.”
If they are dead, they cant be a burden on the future generation (given domestic financed debt). You are not going to put apples on their graves. If they are dead, the next generation has inherited the bonds and the bonds will stipulate a transfer within that generation.
erik: “If they are dead, they cant be a burden on the future generation (given domestic financed debt).”
Yes they can, as my example showed. They have already eaten 110 of cohort B’s apples. Which is OK by cohort B, as long as B can eat 121 of cohort C’s apples in return…
I’m sure Krugman understands this. But:
1) This would only mean that the younger generation as a whole loses a portion of the amount borrowed, not the whole thing as is popularly assumed — and Krugman wants to point out a big reason why this popular assumption is untrue.
2) If the money borrowed is used so that the young cohort can get a much better education, much better childhood nutrition, much more advancement in science and medicine, a world not decimated by global warming, etc., then the younger generation makes out far better on net.
Nick: “Yes they can, as my example showed. They have already eaten 110 of cohort B’s apples. Which is OK by cohort B, as long as B can eat 121 of cohort C’s apples in return…”
The only way they can take anything from cohort B is if they are alive at the same time.
If they are alive at the same time, and output is Y, they have a choice about how to distribute that output, no matter what some paper is saying (through e.g. taxes, which you can implement since they are alive and not dead).
When cohort A is dead, they can no longer be a burden on B.
When cohort B is dead they can no longer be a burden on C.
If A and B and C is alive at the same time, the distribution of the resourses is primarely a normative issue, and the distribution between generations will mainly be politicaly determined (through e.g. taxes on the working B´s and welfare to the young C´s and old A´s).