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 
A sidenote: condition #4 (Samuelson 1958) is called “Domar condition” in Japan, based on Domar, Evsey D., (1944) “The Burden of the Debt and the National Income,” American Economic Review, 34(4), pp.798-827. However, one Japanese economist pointed out that Domar actually didn’t state such a condition in the paper. Nevertheless, the name has already acquired popularity in Japan. Another example of particular keyword gaining momentum of its own.
P.S. So-called “Bohn condition” is also popular in Japan, which states that the debt is sustainable even if “Domar condition” is not met, as long as the following rule is observed: improve primary balance even slightly whenever debt increased. In fact, I was referring to that rule here.
Please discuss whether what the government does with the money it is either printing, or borrowing and taxing. If it is not relevant at all then we can increase civil servant pensions, hire extra hookers for politician parties – it makes no difference. If the quality of government spending matters at all then we have to consider principle agent problems among civil servants and politicians. the golden rule of economics is surely to look for differences in behaviour when spending your own money or someone elses. The reason to limit ruthlessly the capability of governments to tax, print and/or borrow is that the best route from my wallet to that of others is when they sell me something I want, and if I don’t spend today I (or my heirs) can spend even more tomorrow with no stress or need to make a return. The poor sod who borrows from me has to pay it back to me, and if he/she is the government then he has to take it away from someone else.
From a macro economic perspective: by ignoring the many inefficiencies, conflicts of interest and worse of government spending, we can conclude that printing and borrowing money may be OK or even desirable at different times and places. In countries run by people, its best to pre agree some limits and rules of thumb so that if they decide to increase their own pensions, at least they have to cut back on the hookers (just like the rest of us).
Technical progress, competition, capital mobility and the profit motive should lead to growth provided the place is reasonably governed. letting the central banks print like crazy except as a short term measure, to followed by currency bonfires to soak it up when things pick up, is risking too much.
Nick (also wh10),
After all isn’t fiat money just debt with a zero interest rate? It seems like as long as the government has previously replaced barter with money they can drive the nominal interest rate to zero whenever they choose.
But… by introducing money did we go from a one good model to a two good model, stealthily?
Look at this net worth statement for each cohort (pardon my rounding):
A 1000 apples + 110 apple debt asset (incl. 10% interest)
B 1000 apples + 119 apple asset (incl. 8% interest) + 2.0 apple dollars
C 1000 apples + 126 apple asset (incl. 6% interest) + 4.5 apple dollars (note apple dollars, unlike apples can be inherited!!!)
D 1000 apples + 131 apple asset (incl. 4% interest) + 7.0 apple dollars
E 1000 apples + 133.5 apple asset (incl. 2% interest) + 8 apple dollars
F 1000 apples + 133.5 apple asset (incl. 0% interest) + 8 apple dollars
Which by is effectively the same as…
F 1000 apples + 141.5 apple dollars !
The original interest, which was a promise by the government to rob THE next generation by 10 percent more apples has been harmlessly (?) converted to a promise to rob SOME future generation by exactly 141.5 apples – and that can be put off perpetually.
My hunch is, 1 and 4 are perfectly compatible, or rather 4 is a subset of 1, if one assumes the nominal interest rate (the one paid on the national debt) is a policy variable, which I think is the MMT position. But 1 is more flexible in tweaking the flow of real output, whereas 4 is ‘playing it safe’ at the expense of potential output at times when the interest paid on outstanding debt exceeds growth. That, and the different implied multipliers in the quotes should make at least those two add up. Not sure about the others.
Using your apples as money, here’s how I would frame the exercise (assuming for a moment that interest rates are fully market determined, but constant – a silly assumption?):
Assume apples are money and oranges are goods an services.
There are 100 apples circulating in period 1.
Government sees new potential for creating oranges where none are being produced under current circumstances. It does the following:
It asks the people currently holding the apples under which conditions they would voluntarily give up the option of spending 20% of them on oranges for a while by having them locked up for 1 period. Several buyers agree to do so at 1 extra slices per year (10% interest).
So now, at the beginning of period 2 there are again 100 apples circulating (80 old and 20 new), plus 20 old ones locked up, yielding 2 extra whole apples at the end of the period, making the total 122 (= total deficit of 22 = 22%)
Period 3 sees the same thing happening. While the first locked up apples mature at the beginning of the period, that leaves 122 free apples (97.6 old, 24.4 new) + 24.4 locked up ones + 2.44 in slices = 148.84 (= total deficit of 26.84 = 22%)
Questions:
Is my account an accurate description of reality in your opinion?
At what rate does the amount of oranges grow? Can one tell by my example (or any of the above quotes, for that matter)?
Does it matter if there is a discrepancy in the respective growth rates of apples and oranges?
Which growth rate is more important?
My guess, as above, is it’s all about the interest rate and multipliers and in the end, it’s about oranges, not apples.
wh10, where did you get the idea that HFs or BDs are infinite consumers of any asset with an interest rate greater than their borrowing costs? If you knew even one leveraged investor, you’d know why that isn’t true.
Miyagi, in the real world it’s not infinite, I’m not talking about all types of investors, default-free govt debt is different than all other assets, and the additional condition is that you need to be able to fix your debt roll over costs in forward markets.
Re Posted by: Winslow R. | January 06, 2012 at 03:58 PM
“Mosler says something like the long-term tsy rate is based on expectations of current and future fed funds rates and the natural rate is zero.”
Important to note, especially since vimothy has mentioned it, that Wicksell and Forstater do not use the Wicksellian or successor definitions of natural rate:
Click to access natural-rate-is-zero.PDF
“This paper argues that the natural, nominal, risk free rate of interest is zero under relevant contemporary institutional arrangements.” (emph added)
Their point is that the nominal interbank target rate has to eventually fall to zero when a CB uses interest rate targeting in a soft (fiat) currency system (esp where balanced budgets or fiscal surpluses are seen as desirable objectives) because under such conditions, the sovereign govt sector is not supplying net financial assets (NFAs); and in the case of budget surpluses, it is subtracting from NFAs.
This would be analogous to a gold standard-era policy of shutting down mine production and even re-burying gold (b/c monetary gold constituted NFAs then). Things were bad enough when they couldn’t produce enough gold to support fixed nominal parity, i.e., even while adding NFAs, when insufficient, depression still resulted: http://en.wikipedia.org/wiki/Long_Depression.
And these are both similar to the assumption that govt debt, which constitutes a portion of NFAs in a soft currency system, will some day have to be repaid. And that’s the highly questionable assumption that Nick’s argument relies upon.
Granted, if under a gold std, gold were produced well in excess of demand, then it could make sense to rebury some as long as nominal parity was fixed (thank you very little Sir Isaac), ignoring the function of non-monetary gold. Likewise, if NFAs in a soft currency system are well in excess of a non-inflationary (or desired inflationary) level, then the removal of some of them via taxation and/or CB operations (or perhaps lessening their potency via other regulatory channels?) is necessary. But in both cases, it’s not so much about imposing a burden as pursuing an optimal policy course. Right?
The concept of NFAs seems to be the unmentioned elephant in this thread (though wh10 has mentioned them more than once, and Michael Carroll pointed out that both money and bonds are govt debt).
Going back to Wicksell and the concepts vimothy has invoked…
In his pure credit economy treatise, he hypothesized that if the banking sector set the marginal loan rate below the marginal return on productive investment, then a process of ongoing inflation would result, and vice-versa for deflation (some bizarre assumptions required, but he seemed aware of that). From there, it’s implied (though I think he delved into this in other writings) that if the real lending rate is a function of additions to NFAs (monetary gold, in his time), then when those additions were excessive (low in relation to available returns on investment), overinvestment and inflation would occur, and when they were in short supply relative to marginal rtns on capital, deflation (as measured in and reflected by interest rates). People have argued over this stuff since he published it, so feel free to point out where I’m wrong.
From that, it seems rather apparent that:
* When transferred into the realm of real world operations, Wicksell’s model absolutely required the support of the gold sector’s ongoing additions to NFAs, whether one subscribes to a cumulative process or not (most economists do not).
* In a soft currency system, the issuing govt (typically a CB via monetary and/or fiscal operations) assumes that role from gold mines.
* Many tools in the macro toolbox have not been updated to reflect the reality of this post-1973 transition in the U.S. and many other places.
Key among the latter is the intertemporal govt budget constraint model, which assumes that (1) deficits cannot be run indefinitely, when in fact, under a soft currency system, they almost always must be, and (2) M and B are very different, when in fact, they are the same thing, liabilities of the sovereign issuing sector, and together net of all financial liabilities, the stock of NFAs. (h/t to Fullwiler: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1722986)
As just one result of applying this hammer of a model to the screw that is modern monetary systems, we get well-intended but absolutely dead-wrong warnings from folks like Paul O’Neil and Gokhale/Smetters, Larry Kotlikoff, Peterson/Walker, Concord, Tea Partiers, etc, re the USG going broke, intergenerational burdens, and the like. But once you get your head around NFAs in a soft currency system, it becomes apparent how nonsensical these arguments and analyses are.
Though to be fair, as long as politicians believe this nonsense, the Tea Partiers have a point, even though they’re dead wrong themselves on budget deficits…