I thought we all had this debt burden stuff sorted out 30 years ago. Obviously we didn't.
We should have had a bigger argument about it 30 years ago, which would have sorted it all out. But we didn't. Maybe because we spent all our time arguing about other stuff 30 years ago, and didn't have time to argue about this stuff as well. Or maybe because most of us were too embarrassed to mention we had totally changed our minds on this, and that the views we used to say were uneducated views were in fact right after all. So we silently changed our beliefs, and tried to forget we had ever believed anything different. But not all of us noticed this change in beliefs, and still thought everybody else believed what we all used to. So now we are re-fighting the old ground we should have fought properly 30 years ago.
There are 4 possible positions to take on the debt. One of them doesn't make sense; the other 3 do. Which of those 3 is right is an empirical question.
Here are the 4 positions. I gave each one a name. I made up the quotes.
1. Abba Lerner. 'The national debt is not a first-order burden on future generations. We owe it to ourselves. The sum of the IOU's must equal the sum of the UOMe's. You can't make real goods and services travel back in time, out of the mouths of our grandkids and into our mouths. The possible second-order exceptions are: if we owe it to foreigners; the disincentive effects of distortionary future taxes; the lower marginal product of future labour if the future capital stock is smaller.'
2. James Buchanan/uneducated person on the street. 'The national debt is a burden on future generations of taxpayers. Foreigners are basically irrelevant. Any second order effects of distortionary taxes and lower capital stock are over and above that first order effects of the taxes themselves.'
3. Robert Barro/Ricardian Equivalence. 'The national debt is not a burden on future taxpayers (except for the deadweight costs of distortionary taxation) but only because ordinary people take steps to fully offset the burden on future generations by increasing private saving to offset government dissaving and increasing bequests to their heirs to offset the debt burden.'
4. Samuelson 1958. 'If the rate of interest on government bonds is forever less than the growth rate of the economy, the government can run a sustainable Ponzi finance of deficits, where it rolls over the debt plus interest forever and never needs to increase taxes, so there is no burden on future generations.'
I personally was taught 1 as an undergraduate. And I believed in 1 until about 1980, when I spent some time reading Buchanan and Barro arguing with each other. And I worked 4 into my own beliefs soon after.
And now, I believe 1 is false. The truth is some sort of mixture of 2,3, and 4. What precise mixture of 2,3,4 is true is an empirical question. My prior is one third-one third-one third.
Until last week, I thought that almost every macroeconomist had now realised that 1 was false. And I wrote a post arguing 1 is false. My post was triggered by Paul Krugman's recent post, which I interpret as saying that 1 is true. Paul wrote two later posts too, which I interpret as also saying that 1 is true.
Many other bloggers have now waded into this debate. Good! Finally (I was scared we were going to keep on ignoring this question)! Bill Woolsey. Greg Mankiw. Don Boudreaux. Karl Smith. Daniel Kuehn. Jim Hamilton. Noah Smith. (I must have missed some. Sorry.)
And look, just because deficits have costs doesn't mean we shouldn't do them. Like a lot of things, deficits have benefits too, and sometimes the benefits are bigger than the costs. But we shouldn't ignore those costs, just because we think the benefits are bigger than the costs.
And what we need to do more work on is this: we know Samuelson is right, if we know for sure that the interest rate on bonds is less than the growth rate of GDP forever. That is a sufficient condition for Samuelson being right, but I rather doubt it's a necessary condition. What if the interest rate will probably be less than the growth rate part of the time for a rather long time? Could Samuelson still be right, or at least partly right?
I really wish I could get my head around that question, but I can't. My hunch is that NGDP bonds would play a role in the solution, because a bond indexed to nominal GDP would resolve the uncertainty of whether the interest rate would be above or below the growth rate of GDP. And if we got the duration of those NGDP bonds right, we ought to be able to get around the problem of r being sometimes greater and sometimes less than g. Somehow, it just must be possible to eat the Samuelsonian free lunch, even if it's only a temporary and uncertain free lunch. And NGDP bonds just must be the way to eat it, somehow.
And if I could only get my head around that question, I might come up with something that would make both Scott Sumner and the MMT guys very happy indeed. Which would be neat. Plus, as a side-benefit to making both those guys happy, it might be very good for the poor ignorant uneducated slob on the street too.
But my brain just can't figure it out, yet. Maybe some of you younger, keener, brighter, people could work on this?
Worthwhile Canadian Initiative 
No not so much. I’m saying that in your model there is no growth therefore all any one is talking about is how their output is distributed. Of course it’s possible to distribute the apples unfairly. In your model there would exist an optimum distribution of apples that maximizes overall apple consumption over their life time and that is how they would be distributed most likely since everyone is the same. It makes no sense to contemplate a world where one generation thinks they can fleece another in a world where nothing changes. Rolling over principal and interest until they have everything without anybody figuring out what’s going on requires irrational agents. The opposite of what’s assumed in economics. You created a simple world everyone eats only apples, makes only apples and it’s the same number of apples every period but they’re too stupid to figure out the simple world they live in. The concept of compound interest doesn’t exist in the world you’ve created. The only thing that does make sense in your model is communism.
@Bob Murphy: Noooo! Don’t forsake Mises, he was right.
Thanks to Nick, JKH et al for all this.
I need to read JKH’s whole accounting post, but based on a skim, I think I entirely agree with JKH and thus Nick here- if the tax occurs, then it is a burden. Of course.
But isn’t the more interesting issue when taxes are needed to pay back the debt? This is the problem I had with Nick’s original post. At first, it seemed like Nick was saying always and eventually. But then there was the full employment clarification.
But is full employment a sufficiently defined condition? If the economy reaches full employment and the govt continues to spend, the debt can still be funded without a tax (****and doesn’t that trigger JKH’s ‘no tax, no burden’ condition??****), but the result is inflation. And you can only call inflation like a tax at the individual level depending on your assumptions of how the net financial assets from the deficit spending are distributed throughout the economy (and assuming it’s not so inflationary we’re in hyperinflation land and the economy ceases to exist). From an accounting perspective of the macroeconomy, the impact of a deficit here remains wholly different from a tax, since the former remains a net add of NFA and the latter a subtraction.
JKH, I’d be really interested to hear your opinion here. The whole reason I posted all that finance stuff from Fullwiler in the other thread was to show that the debt can always be funded, without a tax, and not at market determined prices but where the Fed sets interest rates. And that’s because the Fed makes credit infinitely available at the price (interest rate) it has full power in determining. I think Nick thinks interest rates on govt debt are ultimately market determined, and that if inflation goes up or is expected to go up, the interest rate on govt debt necessarily has to go up. I think the latter will only occur if the Fed raises interest rates. But in any case, a tax isn’t theoretically necessarily, and inflation remains the only issue. And so when is that a burden?
To reassert, there are a lot of assumptions that have to be made here, so one should be careful about which side they pick here regarding whether or not govt debt is a burden- it depends.
wh10
I’ll reflect a bit on your comment, but this may be of some help for starters:
http://worthwhile.typepad.com/worthwhile_canadian_initi/2012/01/matt-yglesias-and-spilt-milk.html?cid=6a00d83451688169e20162ff0558cc970d#comment-6a00d83451688169e20162ff0558cc970d
Thanks JKH. If I could add, it seemed your initial response to my concerns in Nick’s original post invoked the MMT view that the govt could always pay off the debt with an overdraft from the Fed (assuming IOR at target) in order to quell others’ concerns of debt repayment/solvency. But I think we can still show ‘monetization’ is never necessary (even if MMTers say it’s a false dichotomy from debt issuance) and that the market will always take on the debt at Fed determined prices. I think there are two components to this: the availability of credit at Fed determined prices and the finance stuff I posted from Fullwiler. It also seems to be an extension of the same conversation we we’re having regarding Fullwiler’s strong to weak forms = bond issuance is also possible at whatever interest rate the Fed wants.
The issue here is not the normative one of whether or not a fiat currency issuing government should ever run or need every run a surplus.
The issue is the positive one of whether or not an actual event in which taxes are used to pay down debt (i.e. a budget surplus) constitutes a burden for the generation that pays the taxes.
Nick’s model (and my accounting for it) shows it does, unless the generation that pays the taxes inherited the bonds from the previous one.
wh10,
“it seemed your initial response to my concerns in Nick’s original post invoked the MMT view that the govt could always pay off the debt with an overdraft from the Fed (assuming IOR at target) in order to quell others’ concerns of debt repayment/solvency.”
sure, but that’s not the issue here, see previous
“I think we can still show ‘monetization’ is never necessary”
to a point, perhaps to a very high probability point, but never say never – the ultimate insurance is the threat of being able to print and it’s there if its ever actually needed in dire circumstances – agreed though that to the degree its a credible threat, it almost certainly won’t have to be used
If my responses seem contradictory in total, can you link to my comment that you reference – I really do think it’s a separate issue though
To reiterate and for people to mull over since we’ve presumably moved passed the ‘if tax, then burden’ proof and are now on to ‘if debt can always be issued and at what price’:
“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.
Third, if the public doesn’t want to hold bonds, there are these things called banks that offer these things called time deposits, and the public can hold these and earn interest at virtually any maturity. And then the bank can hold a Tsy and earn a spread, or it can hold interest earning reserve balances and earn a spread.
These don’t work nearly as well for countries for which there is any significant risk of default (Greece), but that’s another story and perfectly consistent with MMT..”
In fact, now that I recall our conversation that spanned heteconomist, winterspeak etc, it seems we’re in a similar situation here. In the Eurozone, where mkts perceive default risk given the restrictions on the ECB, we agreed it all comes down to the issue of the interest rate on the debt, and that it could be resolved by the ECB if those restrictions were removed. Even though I am proposing different circumstances here (deficit spending at full employment leading to inflation, but no restrictions on the CB), isn’t it effectively the same? The mkts might not perceive default risk, but the interest rate is still a lever of the Fed’s, despite inflation and Nick’s claims that interest rates on the debt would have to rise… no? And would purchasing in the secondary mkt even be theoretically necessary?
‘The issue is the positive one of whether or not an actual event in which taxes are used to pay down debt (i.e. a budget surplus) constitutes a burden for the generation that pays the taxes.
Nick’s model (and my accounting for it) shows it does, unless the generation that pays the taxes inherited the bonds from the previous one.”
Agreed. I am asking about a different issue, the normative issue.
“If my responses seem contradictory in total, can you link to my comment that you reference – I really do think it’s a separate issue though”
Sorry- we might not be connecting. Agreed – it is a different issue (see above :)). I am not asserting contradiction, just wanting to explore the other normative issue. Specifically the issue of deficit spending at full employment, with inflation, and if debt can continue to be sold and in accordance with FFRs, which the Fed sets where it wants.
Agreed on ‘never say never.’ My thinking is more theoretical (semi-strong, strong), but we can allow the possibility of the CB stepping in, as in our discussions at heteconomist, winterspeak, etc.
wh10,
that’s all interesting stuff, but once again it’s not the issue relating to Nick’s model
I agree that a fiat currency issuing government can force any deficit it wants into the monetary system – one way or another – including central bank shenanigans to buy bonds through what are essentially understood forward contracts with dealers and many other permutations
The issue being discussed here (once again) is IF the government taxes to pay down debt (or the cumulative deficit), is there a net generational burden? Nick’s model shows there is.
OK. We agree it’s a separate issue. Good.
The issue you’re interested in is quite massive in its potential operational complexity. I need to take a break for a bit.
Right (once again) I just wanted to move beyond the positive issue (which I am in agreement with- always thought it was obvious) to the normative.
And it’s relevant here, because if we are going to evaluate the truthiness of Nick’s 1-4 above, then we have to understand the normative. Nick also continues to write generalized statements that imply normative issues like “If the government runs a deficit now, there is a cost to future taxpayers” (http://worthwhile.typepad.com/worthwhile_canadian_initi/2012/01/matt-yglesias-and-spilt-milk.html?cid=6a00d83451688169e20162ff0558cc970d#comment-6a00d83451688169e20162ff0558cc970d).
Sorry – looks like we were posting before we saw each other’s most recent comments.
“And it’s relevant here, because if we are going to evaluate the truthiness of Nick’s 1-4 above, then we have to understand the normative. Nick also continues to write generalized statements that imply normative issues like “If the government runs a deficit now, there is a cost to future taxpayers”
Now that I haven’t been tracking, but its a fair check.
I’ve only taken Nick’s model at face value and demonstrated by accounting I think that its totally correct at face value – i.e. as a positive type proposition. And I asked a few questions of Nick at the outset to confirm what I think was his concern that not everybody agreed with it as a positive type proposition. And BTW I’m having the same type of discussion with Ramanan on the international side.
That said, I think Nick is pretty comfortable with the BASIC model in which i less than g means sustainable deficit financing.
Now I’m breaking.
How would the generation inheriting the tax burden not receive the bonds? In a discreet two-generation set up, that isn’t even possible, is it? As long as the bonds are outstanding, someone must have them. Assuming that they are not burned (i.e. repudiated), they will be inherited by the next generation, unless the previous generation decides to pay them off, in which case the tax burden goes away, too.
All of this is really just a fence-post error — an assumption that the older generation does not pay taxes, and that only the younger generation pays taxes. This isn’t a good assumption to make given continuous overlapping generations. In a binary model, you need the population of old = population of young, so old would be about 37 until death, and young would be 0-37 (37 is the median age). Do you really want to go and argue that everyone stops paying taxes after the age of 37? If anything, you would model this as the young paying no taxes, and the old paying both taxes and receiving benefits, hence the “fence-post” error.
If you make the assumption that everyone pays taxes until they die, then you get Krugman’s conclusion that it all boils down to distribution.
Whoever is receiving more in income that arises both directly and indirectly from the government spending than they are paying in taxes is benefitting and has the opportunity to consume more, and whomever receives less is not and has their consumption curtailed. In aggregate, the indirect benefits of stabilization are a net positive, so there is a net positive aggregate gain from most forms of government deficit spending. That aggregate gain may not result in a specific gain to each individual. The wealthy certainly gain in that they are receiving concentrated levels of interest income, far more than they pay in taxes. The young and the poor gain in that they receive benefits and are either receiving an education and not working or their wages are lower. The middle class — it depends on whether the result of stabilization policy support enough gains in output versus the tax burden. But it all boils down to distribution and multipliers, not a binary “old” versus “young”.
As a model, those who pay the final tax to fund the bond maturity can’t be the same ones as those who received the original expenditure benefit. A long time period is required to achieve full separation between those two populations – decades obviously.
Relative to that full separation scenario, the population of those who in fact both received the original benefit and paid the final tax starts to increase (from a starting point of zero) and increases as a subset of the total population who paid the final tax, as the time period between the original benefit and the final tax is made shorter and approaches zero.
It’s a starting point model.
“As a model, those who pay the final tax to fund the bond maturity can’t be the same ones as those who received the original expenditure benefit. ”
Agreed. Which is why you should not use “generational accounting” to discuss government tax burdens.
The numbers don’t work out that way.
So you move to something else — rich versus poor, disabled versus abled, etc.
And you make the clear case whether the transfer is justified on economic and welfare grounds or whether it is not.
You do not talk about “passing debts to your children” or else you will mislead, because if you try to separate by age, you find that the extremely old and the extremely young receive far more in benefits than they pay in taxes, and everyone else receives a bit less — depending on your starting assumptions about the impact of government deficit spending on total income. So you can’t model this as the young paying for the old, since that’s not what we see. If you must boil it down to only two generations, then it must be that only the older generation pays taxes and the younger generation only receives benefits (e.g. education, infrastructure).
But here, I am making a quantitive argument, that Nick’s qualitative argument is so far from reality as to not be a good starting point for discussion of government debt burdens. It is anti-pedagogical in that it gives you the wrong intuition, and the math is also unhelpful, as uni-directional inter-temporal transfers are not a good way to get a handle on what is going on.
“It is anti-pedagogical in that it gives you the wrong intuition”
I understand your point(s).
Try this as an alternative way of looking at it, in addition to what you’ve outlined:
Suppose you take a more abstract view of what a “generation” is. Consider that the situation in the model requires a budget surplus – i.e. debt can only be paid down with the taxes that constitute a marginal budget surplus. Then consider that governments tend to run surpluses only periodically, and that surplus periods are sometimes separated by quite extended deficit periods (really generalizing here).
Then, for a given surplus period, define the “generation” that corresponds to it as the population of taxpayers that fund that budget surplus.
Then it’s the case that you can identity such populations of taxpayers over time who do incur taxes at the margin and incur a burden relative to those the population that benefited from the deficits that preceded that surplus period.
Those populations may be overlapping, but their difference is still defined on the basis of time separation.
My argument is not that having too little or too high of a debt burden causes no changes in consumption, but that the changes hit all generations that happen to be alive at that time roughly equally.
The Ricardian approach assumes aggregate income is constant, and moreover that the debt and repayment obligations are real, rather than nominal. I.e. when the parents tighten their belts, the kids go on a shopping spree. But that is not what we see, even to first order. When the parents tighten their belts, so do the kids, and when the parents receive more disposable income, then so do the kids.
Now, if you start talking about smaller cohorts — not two cohorts, but, say, 20, cohorts, then you can easily see aggregate transfers occurring from one cohort to another without an overall reduction in aggregate income. But with just two cohorts, if 50% of the population reduces their consumption, then this will cause a general recession and everyone’s income will decline. However, as soon as you add many cohorts, then unless you are talking about very targeted tax burdens only borne by a specific group, you are not going to see a correlation between generation #19 transferring real resources to everyone else and a change in the overall government tax burden when generation #19 is alive.
So this approach is fundamentally the wrong approach. The government debt burden should always be viewed as a purely nominal quantity, that while it may affect many things when it is at the “wrong” level, is going to hit both the young and the old in the same direction via changes in aggregate output, not relative changes in a generation’s share. In that sense, you are right, if we have too little debt now, we can be dooming future generations to less consumption if they are mired in a prolonged slump, and if we have too much debt now, then there may be a period of future austerity that dooms everyone to too little consumption as well. But the mechanisms behind that are not going to be ones of generational accounting as outlined here.
The crux of the issue is the definition of “generation”. Rowe defines it as a cohort of individuals born at a certain time (of the same age), while Krugman defines it as a cohort of individuals alive at a certain time (of different ages). It is obvious that debt can redistribute real resources from the cohort of individuals born in 1990 to those born in 1950, but it is impossible for debt owed between the individuals alive in 1950 to (in and of itself) affect the total real resources available to those alive later in 1990.
“It is obvious that debt can redistribute real resources from the cohort of individuals born in 1990 to those born in 1950, but it is impossible for debt owed between the individuals alive in 1950 to (in and of itself) affect the total real resources available to those alive later in 1990.”
The model is true in a generalized way and more.
If the government levies a broadly based surtax 40 years from now to pay down a deficit that was incurred today, the average date of birth of those who pay the tax will be later in time than the average date of birth of those who receive the benefit of today’s transfer.
Both monetary and incremental real resources are transferred to those who receive the benefit of the deficit today (e.g. transfer). And both monetary and decremental real resources are transferred away from those who pay the tax 40 years from now. That assumes that the transfer today causes an equal increase in aggregate demand and GDP, and the tax 40 years from now causes a equal decrease in aggregate demand and GDP, compared to the counterfactuals of no transfer and no tax respectively – i.e. it assumes transfer and tax multipliers of one. Different multiplier assumptions can adjust from there.
If you substitute “population with an average date of birth” for generation, the model is true in a more general sense than Nick’s discrete generational specification. It is a future cohort that incurs the burden that is the cost of the benefit to today’s cohort, even though the cohorts thus defined may be intersecting.
Furthermore, if the difference between the two average dates of birth is a sufficiently long period of time such that the two cohorts are non-intersecting, the model is true outright as per Nick’s specs.
The relationship between today’s deficit and the future surplus is perfectly unambiguous if budgets are balanced in all other years. Otherwise, there is potential ambiguity in exactly “which” year’s deficit and debt is being paid down by that future surplus – unless specified by assumption of association, which Nick’s version does in effect.
Can somebody with Herculean computer skills turn off these damn italics?
Perhaps with a comment directed to that purpose?
trying to turn off italics.
“That assumes that the transfer today causes an equal increase in aggregate demand and GDP, and the tax 40 years from now causes a equal decrease in aggregate demand and GDP”
OK, that is a heterodox position. if you read Barro’s paper, the argument is that changes in debt can neither increase nor decrease total output. “Aggregate demand” has no meaning in a model in which production = income and all transactions occur as barter (e.g. Barro’s model).
Going further with this heterodox argument — which is not a standard intergenerational transfer argument — leads to the conclusion that increases in aggregate demand and output today due to expansionary fiscal policy may result in future decreases in aggregate demand due to contractionary fiscal policy or other side effects of carrying a large debt burden (e.g. inflation, since we are rejecting the standard view, we might as well think about a fiscal theory of the price level).
I think it’s a reasonable argument to make, but not all the argument that was made in this post. And the key difference is that the expansion today affects all people living today — e.g. all generations still alive. And the contraction in 50 years affects all generations alive in 50 years.
So this is not really an argument about inter-generational transfers, even though some generations alive today will not be alive in 50 years. This is a different, heterodox argument, about the effects of nominal income flows on real output, and has nothing to do with IOUs for apples.
“and has nothing to do with IOUs for apples”
Not sure about that, but I think I understand all the rest.
Pls note I qualified “generational” by modifying it to include any population separated by time and actuarial change – with the pure case being sufficient time separation to admit the conventionally defined distinction between generations.
E.g. the qualified definition would in theory define the “next generation” mathematically as the current population minus one death or plus one birth, etc. As time passes, the overlap between current and next generations diminishes.
“As time passes, the overlap between current and next generations diminishes.”
closer to intended meaning:
“As the time that separates two different, specified “generations” (modified definition) expands, the overlap between the two diminishes”
I went back and read the first post.
My big question is where the 10 extra apples cohort A ate came from?
The government didn’t give it to Cohort A it only gave IOUs plus the original 100 apples back.
Which means it has to come from Cohort B.
I’d argue that if Cohort B knows there is never growth in the economy, they would discount the price of the IOU to 100. They would NOT pay 110 apples. They don’t give a damn about the loss of present value of one part of Cohort A to another part of Cohort A. That is Cohort A’s problem and there is no debt burden on Cohort B or any other future cohort. There are always 1000 apples for each generation and a 100-Apple piece of paper that circulates like fiat money.
Your example only works if the interest rate is fixed and arbitrary or if there is no knowledge of prevailing growth rates to price interest rates.
rsj: “How would the generation inheriting the tax burden not receive the bonds? In a discreet two-generation set up, that isn’t even possible, is it? As long as the bonds are outstanding, someone must have them. Assuming that they are not burned (i.e. repudiated), they will be inherited by the next generation, unless the previous generation decides to pay them off, in which case the tax burden goes away, too.”
When you say “receive” and “inherit” the bonds, that can mean either of two things: they inherit them as a free gift from the previous generation (#3 Ricardian Equivalence); or they buy the bonds from the previous generation (#2Buchanan). It makes a very big difference.
Pretty sure, Nick Rowe’s example is wrong.
The assumptions that:
1) growth = 0
and
2) interest rates are > 0
Are mutually exclusive.
(words ‘real’, ‘average’ & ‘long term’ omitted for clarity).
Michael: “The assumptions that: 1) growth = 0 and 2) interest rates are > 0 Are mutually exclusive.”
I’m pretty assure that Nick is assuming that growth is whatever it is and that rates are something higher. But whatever, makes no difference. I am, however, very interested in how you would derive your claim, or the more general claim that asymptotically rates must be less than or equal to nominal growth.
K,
My claim is only about the example given. But in that example, the issue is that if there is no prospect of REAL growth why would any claim to be able to pay REAL interest in the long run even be credible? If its not credible (and it isn’t) the market would set the real interest rate to a level that is credible.
The only artifact then is present value, but…
Although I live in a world where I can risk my present value (“lend”):
A) as a favor,
B) to exploit through obligation, or
C) to gain additional return.
In Nick’s Example, when Cohort A lends money to the government possibilities B and C do not exist. B is treason and as far as C, in the aggregate there is never a possibility of change in the rate of return. Since you can’t reasonably profit from lending the government money, how could lending to the gov’t have any meaning besides doing it a favor? You could never be compensated for your loss of present value (except through a sense of citizenship).
Michael: the rate of interest in a simple OLG model like mine will depend on two things: individuals’ rate of time preference; what proportion of their endowment individuals receive when young and when old.
If they have very high rates of time preference, and if most of their endowment comes when they are old, the equilibrium interest rate will be very high, because everyone will want to borrow to consume more when young. I can make the equilibrium rate of interest as high as I want by playing with those two assumptions.
Nick,
OK I can see that, but it seems that only assumes that the debt sale only factors in what sellers want to get paid and not what prospect they actually have of getting paid.
Again I think the example breaks down in a conversation like this:
Cohort A: I have this IOU I’ll sell you for 110 apples
Cohort B: Ok, I’ll give you 100 apples for it.
How and why would any rational member of Cohort B move up from that price? At that point regardless of Cohort A’s time preference is the interest rate is now zero.
Michael: We should instead ask this question: what rate of interest will the government need to promise to pay on its bonds in order to persuade A to buy them? The easiest way to think about is in terms of one period (or rather, one generation) bonds, that the government has to rollover every generation. So the government first figures out the rate of interest it needs to promise cohort A to buy the bonds. Then it figures out the rate of interest it needs to promise cohort B to buy bonds so it can redeem the bonds it sold to A. And so on.
Then you could use the same rate(s) of interest to figure out what the government would need to promise on 3 (or more) generation bonds.
“The easiest way to think about is in terms of one period (or rather, one generation) bonds”
Yeah, that helps.
Nick, this is why you can’t think in terms of real goods of production like apples and loanable funds and instead need to recognize the power of credit in a fiat economy with a central bank creating reserves out of thin air. If the Fed and by extension banks create credit out of thin air at some price the Fed determines (and you admitted this in your post about growing debt, and I thought we saw eye to eye on this at the time), it is that that price which will determine the interest rate to be paid on govt debt given competition.
Seriously, why am I wrong about that??? Again, please don’t ignore this:
“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.”
BTW, this is me coming back after the New Year, when I was away from the computer, to explain why this is important and you can’t just go “back to apples” to understand interest rates on govt debt and when taxes are necessary. Like I acknowledged above, I agree that if there is a tax, that is a burden. But I am addressing a different issue here since you’ve ventured into the interest rate argument.
Ok,
I took a minute to scan the comments to see if anyone raised the issue of inheritance here or in the other post but didn’t see any.
You know, Gov’t taxes C to pay B, B dies apples go back to C.
I am feeling like if this all depends on generational overlap AND limited inheritance AND unproductive debt then #1 is just short hand for #4 (Samuelson). But I am not an economist so what do I know…
wh10:
Do you remember my very old post:
http://worthwhile.typepad.com/worthwhile_canadian_initi/2011/04/reverse-engineering-the-mmt-model.html
Suppose that third diagram in that post (where desired saving and investment are independent of the rate of interest so the IS curve is vertical) were true. Then there is no natural real rate of interest. The central bank can set whatever real rate of interest it likes, even in the long run.
I think that’s where you are coming from.
(Almost) everyone else in this debate has in mind a model where desired saving and/or investment depends on the rate of interest, and the IS curve slopes down (like in the first and second diagrams) and there is a well-defined real natural rate of interest, and the central bank cannot permanently set an interest rate either above or below that natural rate without destroying the economy by creating hyper-deflation or hyperinflation.
That’s where the rest of us are coming from.
I don’t want to get into that debate here (because I’ve got too much on my plate as it is), but that might help clarify the issue for you.
Michael: when I talked about “Ricardian Equivalence” that is talking about inheritance. Ricardian Equivalence says that we will increase our bequests to our kids to offset any increased debt burden on our kids. My simple model explicitly assumed Ricardian Equivalence was false.
Nick, I think you are right that’s where the debate is, and we don’t have to do that now, but by retreating to ISLM you are continuing to ignore the above quotes / how the Fed and credit market actually work. When you talk about desired saving and/or investment, you are envisioning having to convince someone to give up their apples. In the real world with credit markets, no one has to give anything up. Instead, the credit market creates an opportunity for a costless profit – essentially arbitrage that anyone would take advantage of.
Or alternatively, you’re thinking about it as if the borrower has to borrow out of the money of another person, but again, we settled that misconception on your ‘growing debt over time’ post.
wh10: “When you talk about desired saving and/or investment, you are envisioning having to convince someone to give up their apples. In the real world with credit markets, no one has to give anything up.”
When aggregate demand is at the right level (when we are scared that any additional increase in AD would trigger accelerating inflation) you do have to convince someone to give up eating their apples, if you want to eat them instead. The government/central bank cannot allow the total demand for apples to increase any further.
Nick, for the purposes of understanding what is operationally possible, you need to, for the moment, separate the ability to sell govt debt from what happens to the prices of goods and services. After, we will integrate and make sure things jive.
The Fed, directly or indirectly, supplies all the credit that is needed at a certain price to get the debt to sell, at a price which is necessarily tied to the price of credit the Fed controls, assuming the ability for actors to fix costs in forward mkts. For this reason, the Fed does not have to vary the interest rate to get the debt to sell, at any level. At this stage, the Govt does not have to convince any one to give up their apples or savings to get the debt to sell at a certain interest rate. Instead, the interest rate on the debt arbitrages with the price of credit that the Fed controls. (Repetitive, but I want to be clear.)
If too much deficit spending occurs, and there is too much demand, then prices on apples will rise. But if the govt engages in bad policy from a price stability standpoint and wants to continue selling more debt, in order to deficit spend again, it is back to square 1. No one needs to be convinced to buy the next batch of debt- the price is still ultimately determined by the Fed.
Now policy could be so bad that we eventually find the economy hyperinflating, but there is a middle ground between inflation and destruction of the currency.
The point is, the level of inflation is always the issue, but it doesn’t impact the interest rate which is needed to sell the debt. And even if you would think the Fed would be wise to change interest rates, that is not going to impact whether or not the debt gets sold at whatever price the Fed wants. The same amount of net financial assets will still be injected into the economy through that deficit spending and transmit to prices. Changing interest rates might change the amount of NFA being added to the economy through interest payments on debt or change appetites to borrow credit etc, but it doesn’t matter for the purposes of selling the debt.
We may or may not be partially agreeing. It’s like you keep moving the goal posts, refusing to think about the process by which govt debt is sold, and skipping to what will happen to the price of goods and apples. And once you see that the price of apples starts to rise, you declare game over. But I am not saying the price of apples won’t rise – that’s not the game I am playing. I am talking about govt debt and the interest rate at which it can be sold. Instead of thinking about apples, think about what is involved when the govt sells debt, and you necessarily need to understand the system to properly do this; you can’t think about it like me having to borrow from you.
wh10: some background:
http://worthwhile.typepad.com/worthwhile_canadian_initi/2010/08/taylor-wicksell-fisher.html
Whether or not I believe it, nothing there suggests, to me, that the interest rate on debt is not operationally at the control of the Fed, and the point still stands that the debt can always be sold at whatever interest rate up until the currency is destroyed. I say that happens if the govt deficit spends way too much. If you subscribe to the idea that changing the interest rate to the right level will solve part of the inflation problem, then the Fed still has full ability to do that. But none of this means debt can’t be sold at the Fed’s price in fiat free floating system. It just means inflation is a problem.
One day I am going to study econ more formally (grad degree?), understand this stuff better, and be more convincing to myself and others on how this stuff works.
wh10: “It just means inflation is a problem.”
Imagine that you believed that if inflation were a problem, and you didn’t raise interest rates to control it, inflation would become an ever-worsening problem, like a slippery slope that would get worse and worse and eventually destroy the monetary system.
That’s what I and most economists believe.
It’s a bit like saying “It just means our falling off a cliff is a problem”.
When you get to grad school you will know more (I mean really know more than the others). Because you will have tried to think through this stuff, not just copied out the math models. The two are (or should be, if the world was as it should be) complementary. And you will rack your brains trying to fit it all together. Good luck!
wh10,
The issue is that even if it controls a nominal short term rate, the Fed doesn’t control the real rate of interest that consumers are will to lend at. That’s determined by things like their intertemporal preferences, etc.
BTW, a couple of years ago, I read too many econ blogs and weird hetero papers (;-D), had the same idea as you, swapped from English Lit, and enrolled in “grad school” (as you guys call it) to study econ. Now my life is basically one long neverending bloody optimization problem. (Is the function defined on a compact set? What about its Hessian matrix of second order partials? Is the value function also continuous? Nnnnnnn). So my advice is to be careful what you wish for!
You are brave, vimothy, going from EngLit into that deep end. Unfortunately, vimothy’s experience may be all too representative. Oh God, why can’t we find some sort of happy medium? I used to know what a Hessian matrix is, but I’ve forgotten now.
Nick, I am not saying it isn’t a problem. I agree that would be a logical conclusion if I believed in the natural rate. I could also not believe in the natural rate and instead believe self-fulfilling inflation or hyperinflation could occur if the govt is adding too much NFA to the economy and causing prices to rise due to AD, independent of interest rates. But in either case, it still doesn’t show why bonds will not be sold as per the Fed’s policy… until the economy ceases to exist. The govt may throw the economy into hyperinflation, but they do it at their own interest rate on the debt! In any case, MMT/Lerner wouldn’t advocate stimulus past full employment and would adjust taxes or the interest rate to address the situation, although they might view the interest rate as more important via the interest income NFA channel. Seems in this regard we’re not far apart..
“The issue is that even if it controls a nominal short term rate, the Fed doesn’t control the real rate of interest that consumers are will to lend at. That’s determined by things like their intertemporal preferences, etc.”
Vimothy, consumers don’t have to lend their apples or savings as in the loanable funds model. Again, credit is made out of thin air and defended at a certain price by the Fed. This I think is our disconnect.
Per your decision- are you still enjoying it? Is all that math stuff useful in understanding or exploring these kinds of problems? Nick, your thoughts?