Steve Landsburg has what I think is the best response so far to my "Debt is too a burden on our children unless you believe in Ricardian Equivalence" post.
[Update: I strongly recommend Steve's latest post, which puts everything together.]
Steve says "I want to explain what [Nick] means, and why it’s wrong." But he doesn't really say I'm wrong. (I think that's just a rhetorical flourish!)
He does something more interesting. He takes a public choice perspective. He is asking who my audience is, and who I'm trying to convince. He goes "meta" on me.
Here is my version of Steve's argument. (The following are my words, not Steve's).
'What's wrong with you macroeconomists is that you think in terms of aggregates, not individuals.
Some individuals are Ricardian. They care about their grandkids, foresee the future tax burden on their grandkids created by the debt, and increase their bequests to their grandkids to fully offset that burden. So those individuals won't care whether current government spending is financed by taxing or borrowing. They don't care if the taxes fall on themselves or on their grandkids.
Other individuals don't care about their grandkids. They want to shift the burden of current government spending off themselves and onto their grandkids. So those individuals want current government spending to be financed by borrowing rather than taxing. They want the taxes to fall on their grandkids and not themselves.
So no individual will see any problem with borrowing to finance current spending. They either don't care, or else prefer it. Nick doesn't have an audience for his post.'
Again, those were words I have put into Steve's mouth. Read the original to decide if my version is fair and accurate.
I think it's a really neat argument. I didn't see it coming.
It's not just a "neat" or "clever" argument. It raises a rather fundamental question about any economic writing that is supposed to be policy-relevant. "Who's your audience?"
Here's my response.
Suppose I have a friend who cares about his grandkids, and who reads the New York Times, and believes everything he reads in the New York Times. And suppose the New York Times tells him that the debt is not a burden on his grandkids. What should I do? I should write an open letter to the New York Times saying that the debt is too a burden on our grandkids, unless we as individuals take offsetting action and increase our bequests to our grandkids in response. And hope that the people who write for the New York Times will be convinced by my argument and change their minds. Which is what I did.
(Again, just to repeat what I have said elsewhere, the fact that deficits may have costs on future generations does not mean we should not run deficits. Because deficits may have benefits too, both on us and on future generations. Nearly everything we do has costs as well as benefits, and we should consider both.)
In other news, Bob Murphy has done a 180 handbrake turn on the question of the debt burden. Well done Bob! To paraphrase (OK, totally distort) Keynes: 'When I hear a convincing counter-argument I change my mind; what do you do sir?'
I really wish all of us, myself included, could be always as open and honest (and funny) about changing our minds as Bob has been.
But what interests me most about this is how Bob describes how wrenching a paradigm shift it was. That's exactly how I felt when I made the same 180 turn in the 1980's. It ain't easy, when you have been so used to seeing the world one way, and convinced that is the right way to see it, to suddenly switch to seeing it the other way. It's jarring.
And, Bob is no Keynesian. Bob came to his original perspective from reading Ludwig von Mises, not Abba Lerner. This question of the burden of the debt cuts across the dimension of big government vs small government. Not everything is ideology.
Worthwhile Canadian Initiative 
Nick: First thing is, that I am in the same position as Bob is now. I believed in “we owe it to ourselveses” in a way that was not correct. Your simpe overlapping-generations-apple-economy model cured me of it and there is no comming back now. This is just another example of influence of WCI on me and my thinking. And it is kind of a response for Krugmans’s recent blog (which I really like) where he asks:
“First, there is no such thing in modern America as a pundit respected by both sides. Second, there are people writing about economic issues who are a lot less confrontational than I am; how often do you hear about them? This is not a game, and it is also not a dinner party; you have to be clear and forceful to get heard at all.”
My answer would be, “read WCI”. I have written this recently on and I must repeat it, that it is stunning to see that there are people like Nick that are not only willing to discuss their ideas with broad audience, but they are actually gettind something from it and returning later to sharpen their arguments or present a fresh way of seeing things. I am recently (since I discovered WCI) also having this “Kung-fu master” feeling that Bob has. It is very much like my experience with genius professor of Math in my University, who was able to solve complex mathematical problems in his mind and who was always willing to engage students in a discussion proving them wrong or right in matter of seconds and in the process being able to refine his own thought on issues he was working on independently.
Ok, enough of praise. I will muddle the things a little more as I too am finding this cognitive dissonance too hard to deal with and my mind is too egoistic to give up easily. Assume that we are dealing with your model except that there is growth between generations and there are capital gains. My idea is nothing new, it was actually part of the old Mankiw whitepaper. The point is, that if there are irresponsible parrents that want to use government spending to consume more, this should affect the return on capital for those responsible parents that think about future generations and invest. I realize that this is probably just restatment of Samuelson “interest on debt under growth is sustainable”, but I wonder if market cannot correct irresponsibility so that this Samuelson position holds at all times.
“So no individual will see any problem with borrowing to finance current spending. They either don’t care, or else prefer it. Nick doesn’t have an audience for his post.’”
I see it the opposite
Your audience is everybody
With borrowing, everybody has the option of creating either effect for their kids
With taxation, they lose the option of passing it on as soon as the tax/transfer occurs
With borrowing, they retain that option until the last revision to their will
Options are better; options have value; and these are very long dated options
The rational person should care about that value
And even this “microeconomic” perspective assumes that the knowledge problem doesn’t exist — i.e. the most important of all microeconomic problems doesn’t exit (esp. as the knowledge problem involves coordination of alternative production paths across time — where government often leads to systematic knowledge coordination errors across time by microeconomic evaluators/choosers.)
Steve/Nick writes,
“‘What’s wrong with you macroeconomists is that you think in terms of aggregates, not individuals.
Some individuals are Ricardian. They care about their grandkids, foresee the future tax burden on their grandkids created by the debt, and increase their bequests to their grandkids to fully offset that burden. So those individuals won’t care whether current government spending is financed by taxing or borrowing. They don’t care if the taxes fall on themselves or on their grandkids.
Other individuals don’t care about their grandkids. They want to shift the burden of current government spending off themselves and onto their grandkids. So those individuals want current government spending to be financed by borrowing rather than taxing. They want the taxes to fall on their grandkids and not themselves.
So no individual will see any problem with borrowing to finance current spending. They either don’t care, or else prefer it. Nick doesn’t have an audience for his post.'”
J.V.: First, Thanks!
Normally, the more future-oriented people are (including how much they care for their kids), the lower the rate of interest will be. But the other thing that affects the rate of interest is how early in their lifespans people earn (or get) their income. In models like Samuelson’s, people live for 2 periods, and if they get most of their endowment in the first period they want to save for their old age but can’t. So the rate of interest is very low (it can easily be negative). And a PAYGO government pension plan and/or national debt sustainable Ponzi can solve a problem that the private sector can’t.
JKH: Oooh! Neat too. And I didn’t see that one coming either!
Landsburg:
“Unless! If we — the current generation — foresee all this, and care about our grandchildren, we’ll choose to (in effect) undo what the government has done by saving our tax cuts and giving them as gifts to our grandchildren (presumably as part of their inheritance). This restores every generation’s consumption to the original status quo.”
That’s incorrect.
The tax cuts are saved automatically as a matter of both macro and micro financial accounting.
The macro is a forced result of the current deficit (a la MMT net financial assets).
The micro saving is a forced result of the macro saving. It’s merely a matter of the distribution of that saving. Neither macro saving or its distribution (somewhere) can disappear so long as the debt hasn’t been paid down with taxes.
So, the bonds are a permanent record of saving (until they are paid off), no matter who owns them.
The only question is whether the bonds themselves are gifted rather than sold to the next generation.
Somebody in the current generation has to end up with the bonds.
Those are the ones with the decision.
It’s got nothing to do with a saving decision beyond the point at which the deficit was actually incurred.
The next generation has to inherit them, not buy them, in order not to be down financially, if taxed to repay them.
That’s got nothing to do with a “saving decision” by the current generation.
It only matters who ends up with the bonds that are either sold or bequeathed. The current generation has already done its saving, before that decision occurs.
P.S.
Or, the current generation could sell the bonds to the next generation, and then bequeath them that money. But that’s just a wash, equivalent to beqeathing the bonds in kind. Again, that’s got nothing to do with “saving a tax cut”. The money came from selling the bonds, not “saving a tax cut”. That saving occured as soon as the bonds were issued, macro and micro.
Why can’t we just say the following:
PuS (public savings) = T (tax revenue) – G (government expenditure)
PrS (private savings) = Y (national income) – T – C (consumption)
Y = C + I (investment) + G + NX (net exports)
S (national savings) = PuS + PrS = T – G + Y – T – C = Y – C – G = I + NX
In period one, a bigger budget deficit lowers PuS, which (unless this induces offsetting rises in PrS) lowers S, which lowers either I, NX, or both, which raises C, G, or both. In period two, a bigger budget surplus raises PuS, which (unless this induces offsetting declines in PrS) raises S, which raises either I, NX, or both, which lowers C, G, or both. Thus, if our generation incurs government debt, while the next generation pays it off, then we enjoy higher C/G, and they suffer lower C/G.
In short, more government debt today burdens future generations, so long as Ricardian equivalence does not obtain. Am I missing something, or is this just a less elegant way of telling your story?
Ram: because in my first post in this series, I=S=NX=G=0 by assumption in all periods. Y was constant. And I still got a burden on future generations.
Y=C+I+G+NX (or, I-S+G-T+NX=0) is a useful identity for some purposes. But it isn’t very useful for intergenerational accounting. Because it provides a cross-generational snapshot at a point in time, and not a picture that allows us to compare across generations over time. Andy Harless is better at explaining this.
JKH: I think you are correct. I think I could restate what Steve said to make it correct (in terms of desired saving, or in terms of some individuals saving, etc.).
Ah, OK, guess I missed the importance of I=S=NX=G=0 the first time through.
Nick,
Once more, I think Landsburg has missed the most important point of your post. That is the question of whether or not future generations inherit or buy the bonds that were originally bought by the current generation.
If the next generation buys the bonds, they swap them for money, which the current generation can use to consume products that might otherwise have been consumed by the next generation. That means the current generation has consumed twice – once using the transfer, and once using the proceeds from the bond sale. That double consumption effect is what is necessary to transfer a burden to some future generation, provided that some future generation is taxed to pay down the bonds. Your model lays that out pretty neatly.
This has nothing to do either macro or micro with human behaviour in terms of people deliberately “saving the tax cut”. The tax cut was saved automatically at the macro and micro level as soon as the bonds were issued. From there, it’s actually a question of the velocity of money and multiplier effects and various financial transactions as to how the saving that’s connected with the tax cut gets transferred around the system and ultimately distributed at the micro level. But whatever the distribution, the entire amount is only saved once as an aggregate quantum at the macro level, and that occurs as soon as the bonds are issued.
Here is my example to illustrate this point:
Every last taxpayer that gets the tax cut can go to Vegas and blow the whole thing, and that has nothing to do whatsoever with the final resolution of whether or not there is a burden for the future generations. That money that gets blown on the Vegas trip ends up redistributing the initial net saving and related money associated with the tax cut to airlines, their employees, Vegas hotels, and blackjack dealers. All of those agents may end up saving the money and buying the bonds with it. And they may choose to either sell or bequeath the bonds to their descendents.
That choice of those blackjack dealers et al has absolutely nothing to do with “saving the tax cut”. The tax cut is saved automatically at the macro level as soon as the bonds are issued. From there, it’s a matter of whether those blackjack dealers et al in their retirement choose to bequeath the bonds to their children, or sell them to their children for proceeds which the retired dealers then blow on a trip to Hawaii. It’s that final Hawaii trip in effect that transfers the contingent burden to their children – contingent on a future government decision to tax them in order to pay down the bonds.
So “saving the tax cut” is absolutely irrelevant to this problem.
BTW, I attempted to follow that whole discussion on Ricardian equivalence (prodded by Krugman on Cochrane) that sort of paralleled your generational theme with Krugman, and it’s not clear to me that any of your profession really understands “what is meant” by Ricardian equivalence. What I mean by that is that it seems to me that some of most esteemed names amongst your colleagues have been involved in a debate wherein everybody has a different interpretation of what is meant by Ricardian equivalence. And if the best names in the business all disagree with each other, what possible absolute truth can it represent in terms of a reliable and consistent meaning?
@JV Dupois, who wrote:
[Krugman wrote:] “First, there is no such thing in modern America as a pundit respected by both sides. Second, there are people writing about economic issues who are a lot less confrontational than I am; how often do you hear about them? This is not a game, and it is also not a dinner party; you have to be clear and forceful to get heard at all.”
My answer would be, “read WCI”.
I think that Krugman, with typical United Statesian provincialism, used America to mean The United States. It is the opposite of synechdoche, the device of indicating something by referring to one of its parts (sails for ships, etc.) In this case, a part is indicated by referring to a large collective or aggregate to which it belongs.
So, I refute your answer!
(By “large” in the 2nd paragraph of my comment above, I of course meant “larger”)
Isn’t it more that it’s a bit harder to say what RET means for G than what RET means?
IIRC, Nick has a post on that round here somewhere…
If one assumes a static population of potential taxpayers and a form of savings that grows at the same rate as the interest on the bonds the government sold then would not an individual who cared about his grandkids be better off paying the tax if he he was expecting to have more than one grandchild (and he wasn’t relying on the other 3 grandparents to make a similar legacy)?
In fact the only person who actually be better off not paying the tax would be someone with no descendants.
JKH: “Nick, Once more, I think Landsburg has missed the most important point of your post. That is the question of whether or not future generations inherit or buy the bonds that were originally bought by the current generation.”
I don’t think he missed that bit.
Take the simple example of a closed economy with no investment. Then when the government makes a transfer payment, the accounting determines that they must save it all (actual private saving is identically equal to actual government dissaving).
But if they are non-Ricardian they will try to dissave it, and the result will be a higher interest rate and/or higher output (depending on if the model is classical or keynesian) until they stop trying to dissave it.
And if they are Ricardian they will desire to save it all at the current rate of interest and level of output, so the transfer will have zero effect on interest rates or output.
JKH and vimothy: Suppose there’s an increase in G financed by borrowing, what happens? I like to split this into 2 questions:
1. an increase in G financed by an increase in T;
2. plus, a cut in T financed by borrowing.
Ricardian equivalence tells us the second has zero effect. So we now concentrate on the first question. And the answer to that depends on what that G is spent on. For example, if G is a perfect substitute for C, it has zero effect. The government taxes me $1 and spends it on apples and gives me the apples. I just buy $1 less apples myself.
A lot of the confusion comes from people having different implicit assumptions about whether G is a substitute for C. John Cochrane implicitly assumes perfect substitutibility. Paul Krugman implicitly assumes zero substitutibility. They each think the other is an idiot.
I stayed out of it this time around. I couldn’t be bothered. Last time I intervened was when the Chicago guy from the World Bank explicitly said that it all depended on how productive an investment G was. And he was right. And PK and a lot of people missed his point. Because if G is highly productive, an increase in G financed by borrowing would reduce future tax liabilities. So you get a reverse Ricardian effect, and a very big multiplier.
Rob: I think you are onto something there.
Steve says “I want to explain what [Nick] means, and why it’s wrong.” But he doesn’t really say I’m wrong. (I think that’s just a rhetorical flourish!)
Agreed.
Again, those were words I have put into Steve’s mouth. Read the original to decide if my version is fair and accurate.
Your version is fair and accurate.
But as far as your audience goes: You’re assuming an audience that doesn’t think clearly about how big a burden govt policies impose on their grandchildren. This is an audience that has been bombarded with warnings from bloggers, journalists and politicians about how big that burden is. If the audience is misestimating the size of the burden, I do not see any reason to assume they’ve underestimated as opposed to overestimated. So when you address this audience and say “Increase your estimate!”, you are, as far as I can tell, equally likely to be pushing them in the right or the wrong direction.
JKH: That money that gets blown on the Vegas trip ends up redistributing the initial net saving and related money associated with the tax cut to airlines, their employees, Vegas hotels, and blackjack dealers.
You seem to be assuming that hotel and airline services are provided at zero cost (and therefore at an enormous mark-up). In a world where everything is costless, there is surely no such thing as a debt burden.
Nick 8:09
Thanks. That’s helpful on Ricardian.
It seems to me then that much of the discussion is conflating multiplier dynamics with Ricardian dynamics.
Shouldn’t a “standardized” explanation of RE incorporate multiplier scenarios as well where G is inevitably involved, to make it generally clearer? I.e. as you have I guess? i.e. shouldn’t any RE discussion be fully consistent with clearly stated multiplier assumptions where G is even mentioned?
Conversely, unless potential or assumed multiplier scenarios are covered in the discussion, it shouldn’t even reference G expenditure in the context of RE?
Steven L.,
“You seem to be assuming that hotel and airline services are provided at zero cost (and therefore at an enormous mark-up). In a world where everything is costless, there is surely no such thing as a debt burden.”
I think I was implicitly assuming, to make things very simple, that all that Vegas related expenditure added to GDP, generating additional equivalent income (ultimately) to the providers of inputs – income that ended up being saved. So I think that assumes a multiplier of 1 on the tax cut (not sure), and shifts the location of the associated saving from the transfer recipient to the ultimate income earners behind the provision of the Vegas related services. That includes the costs of the related hotel and airline services, including salaries, other upstream inputs and the income behind those, cost of capital, etc.
meant transfer, not tax cut above
Nick,
“But if they are non-Ricardian they will try to dissave it, and the result will be a higher interest rate and/or higher output (depending on if the model is classical or keynesian) until they stop trying to dissave it.”
I think that corresponds to my Vegas example, where the transfer recipient hits the town. But somebody ends up saving as per my reply to Steven L. above; its forced by the original transfer. Saving as an already realized flow and now stock becomes the hot potato. And there is still the issue of whether the current generation sells or bequeaths the bonds to the next, as per the blackjack dealer’s retirement decision.
Steve, the key thing is people have no firm or consistent idea of what significance this all may have for their own affairs, or when this significance might come into play in a way that makes a difference for their own plans.
And the inability to plan is one of the burdens all of this debt accumulation has on prospect for the successful coordination of production and consumption plans across time of particular persons and entities.
Steve writes,
“But as far as your audience goes: You’re assuming an audience that doesn’t think clearly about how big a burden govt policies impose on their grandchildren. This is an audience that has been bombarded with warnings from bloggers, journalists and politicians about how big that burden is. If the audience is misestimating the size of the burden, I do not see any reason to assume they’ve underestimated as opposed to overestimated. So when you address this audience and say “Increase your estimate!”, you are, as far as I can tell, equally likely to be pushing them in the right or the wrong direction.”
Nick’s entire thesis is based on the assumption that oldies get youngsters to buy bonds off them. Nick and supporters seem to have no interest in the real world – in the empirical evidence. That is, do oldies actually sell bonds to youngsters?
Well they do in that the above process is a normal part of the pension system. That is, oldies sell bonds (and other assets) to fund their retirement. But the $64k question is: “do oldies BOOST their consumption in retirement by the above means given an INCREASE in government debt?”. And my answer to that is “I doubt it”. Reason is that even if there were no government debt at all, those planning their pensions could choose any standard of living they want in retirement (within the constraints posed by their income when young) by using other assets, or using pay as you go or “unfunded” pension schemes.
Ergo I don’t see a strong reason for thinking that the creation of government debt, or an expansion therein, places a burden on future generations (given Nick’s other quite reasonable initial assumptions – closed economy, constant full employment, etc)
Ralph,
“But the $64k question is: “do oldies BOOST their consumption in retirement by the above means given an INCREASE in government debt?”.”
Consider again the dynamic of Nick’s model.
The first cohort gets to consume twice – once when they get the original transfer funded by the bonds; once when they sell the bonds to the next generation. They’ve double dipped. It’s their double-dipping into consumption, with the help of the sale of outstanding bonds, that causes a chain reaction whereby that creates a burden for the ultimate holders of the bonds who are taxed to pay them down.
So it’s their choice to sell the bonds rather than bequeath them to the next generation that results in the double-dipping of consumption. And that double-dipping of consumption is inherent to the potential for a future burden in the event of a future tax to pay down the bonds. But it’s the fact that they got the original transfer that put them in the position to make a choice with that particular consequence.
If the bonds weren’t issued, and the same cohort faced a similar decision to consume or not out of other savings, it obviously doesn’t have the same implication for Nick’s model because Nick’s model isn’t even operative, given there was no original bond issue. No bond issue; no tax problem; no burden question.
“Reason is that even if there were no government debt at all, those planning their pensions could choose any standard of living they want in retirement (within the constraints posed by their income when young) by using other assets, or using pay as you go or “unfunded” pension schemes.”
That’s all true except for the fact that there’s no contingent tax liability in respect of paying down the bonds – so the specific tax threat that is described in the problem doesn’t exist, and it’s that tax that creates the final net burden. The fact that the problem is moot when the pre-existing conditions that are essential to the problem haven’t been created doesn’t mean there’s no difference in the final outcome.
Aside from that, people should decide whether they’re interested in playing the game of assessing the logic of Nick’s model or trashing it because its specifications aren’t a perfect match for the complexity of the world and don’t provide globally comprehensive 401K balance sheet transitions, etc. But it’s really not cricket to do both, unless the difference between those two things is specified.
As the relative layperson in the group, this all seems a bit silly.
1. In all periods, the aggregate amount of apples produced and consumed is unaffected by the debt. This is what Krugman is pointing out and he is correct. (I just read some of Murphy’s posts and it surprises me that he ignores this simple fact in his own examples and scenarios.)
2. The debt can change the distribution of apples consumed.
3. Depending on expectations, some people might end up consuming fewer apples over time then they had expected. One good example is if they own government debt that they think can be honored on a real basis without increasing taxes. This is where Rowe/Murphy are correct.
What am I missing?
To be clear, I do understand that the debts created by one generation could affect the distribution in future generations. Whether that makes Krugman “wrong”, though, I think becomes a matter of interpretation of his intended point. (To me, Krugman has a consistently cavalier attitude towards government redistribution of wealth.)
“In all periods, the aggregate amount of apples produced and consumed is unaffected by the debt… What am I missing?”
It’s affected in the first period if the transfer payment is used to consume apples and in addition proceeds from selling the bonds are used to consume apples. That’s double dipping on consumption.
And its affected in the final period when the tax causes a decline in apple consumption in that period. That’s the zero consumption that is the offset to the front end double dipping.
It’s not the outstanding debt that’s the issue – its the use of the transfer payment funded by debt creation to consume apples, and the non-use of the tax payment by the taxpayer to consume apples.
Steve: Thanks!
“But as far as your audience goes: You’re assuming an audience that doesn’t think clearly about how big a burden govt policies impose on their grandchildren. This is an audience that has been bombarded with warnings from bloggers, journalists and politicians about how big that burden is. If the audience is misestimating the size of the burden, I do not see any reason to assume they’ve underestimated as opposed to overestimated. So when you address this audience and say “Increase your estimate!”, you are, as far as I can tell, equally likely to be pushing them in the right or the wrong direction.”
Maybe. But it’s also an audience that has been told (if my interpretation is correct, and the audience may have adopted the same interpretation), that the burden of the debt is zero (except for tax disincentives, debt to foreigners, etc.).
Thanks JKH.
I think I’m correct that in all time periods the aggregate consumption of apples is unchanged regardless of debt policy. I haven’t seen an example given by Nick or Bob Murphy that shows a change in aggregate apple consumption in a given period. In fact, it is impossible based on the assumptions of their simple models.
I think I was missing, though, Nick’s point that due to overlapping generations, the older generation could take consumption from overlapping younger generations in exchange for bonds that cannot be repaid on a real basis without increased taxation (assuming no GDP growth). In other words, the distribution effects could cross generations due to overlapping generations. Again, though, the aggregate consumption in a given time period is unaffected. If someone thinks that last point is wrong, I’d love to be corrected.
At least that’s my latest understanding.
Ken,
Hmm – maybe – I don’t know to be honest.
But let the time period of the overlap approach zero.
And consider the dividing line between generation B and C, where C gets taxed.
Two choices:
– B sells bonds to C, and B consumes with the money received from C for the bonds, while C forgoes consumption; C uses the bonds to pay the taxes, i.e. the bond maturity proceeds pay the taxes
– B wills bonds to C, and C consumes with the money he didn’t pay B for the bonds; C uses the bonds to pay the taxes same as the first case
In the first case, B consumes within epsilon preceding B’s death
In the second case, C consumes within epsilon following B’s death
Technically – feasible depending on the non-zero period for consumption choice, overlapping two different periods
Realistically crazy, I know, but I think that was my intuition for the model
Either way, I’m not sure the interpretation of that aspect is critical for the model
JKH if you have time, you’re needed on aisle 3 http://worthwhile.typepad.com/worthwhile_canadian_initi/2012/01/the-30-years-debt-burden-non-war.html?cid=6a00d83451688169e20168e5132e84970c#comment-6a00d83451688169e20168e5132e84970c
Sorry to keep repeating myself, but do you honestly think anyone see a deficit, concludes there will be higher future taxes, and increases the bequest to their kids?
I don’t see anyone (or at least no significant group of people) reaching that conclusion and I see even fewer taking that action.
Do economists really live in world where this type of action actually happens?
Nick, since I’m still having trouble deciding what I believe here, I’d like to see this problem thought through in MMT world, where the government never borrows. It just prints dollars when it wants to buy something. Let’s assume either no taxes, or taxes exactly sufficient to keep inflation steady. Might be clarifying?
Steve: If the deficit is money-financed, and the money pays no interest (it’s like currency) then it’s different. The big difference concerns the “No Ponzi Condition”. (Read the #4 option in my previous post). This is one of the important reasons why people like me want to use monetary policy, rather than fiscal policy, to increase Aggregate Demand in a recession.
But suppose, just for the sake of argument, that we start at full employment. Then the government decides to cut taxes, or give everyone an annual transfer payment, and it finances the resulting deficit by printing zero interest money. That is the “helicopter money” thought-experiment (except the helicopter keeps on flying every year. If the helicopter doubles the money supply every year, then the price level would double every year, and the value of money people held would be halving every year, exactly offset by the new money they got given by the government. So the transfer is paid for by an inflation tax.
Adam: “Do economists really live in world where this type of action actually happens?”
let me give you a small-scale example. We had our street paved a couple of years back. The local government gave us a choice:
1. Each of us could pay the cost in one lump sum. (Balanced budget, with an increase in taxes to pay for the increased government spending).
2. Each of us could have the cost amortised on our taxes over 10 years at 5% interest (IIRC). (Deficit-financed increase in government spending, because the local government would have to borrow the money to pay for paving the road).
That choice made almost no difference to me. I almost flipped a coin before deciding what to do. I was behaving exactly like Ricardian equivalence says I would.
If I had less savings, and couldn’t borrow (except at much higher than 5% interest), and if I were living hand-to-mouth, then it would have made a big difference to me. I would have strongly preferred option 2, because option 1 would have meant I would have to cut back my current consumption to pay the lump sum tax bill.
Does that example scale up? Well, that’s the big question. Econometricians have tried to test it. Not very conclusively. One neat paper I saw ages ago, by Mankiw, estimated that about 50% of the population seemed to act like 1, and the other 50% like 2. That’s my guess. Though I’m sure it depends on a lot of things.
JKH and vimothy: Suppose there’s an increase in G financed by borrowing, what happens? I like to split this into 2 questions…
Nick, thanks for that.
Like the Kocherlakota thing, seems like much fuss over nothing and mostly people talking past each other.
Nick, Is that really Ricardian Equivalence or is that just choosing the option which works out the cheapest based on your expectations of a number of future variables ? If they had chosen a third option of paying for it by selling 100-year bonds would you really have bought the bonds or taken out other forms of savings to cover your descendants tax liabilities ?
Rob: If I had been totally indifferent between paying for the road in 1, 10, 100, whatever years, then it would be exactly Ricardian Equivalence. And it made very little difference to me.
“If they had chosen a third option of paying for it by selling 100-year bonds would you really have bought the bonds or taken out other forms of savings to cover your descendants tax liabilities ?”
Basically, roughly, yes. I’m thinking past my lifetime.
BTW, nobody believes Ricardian Equivalence holds exactly.
Having now read the Wikipedia article on “Ricardian Equivalence” twice I consider myself something of an expert on the subject. It seems that Ricardo didn’t really believe in it himself, and it is mainly used as a tool for anti-Keynesians to claim that deficit spending by the government is doomed to fail since people will just save the amount of the additional spending.
I’m pretty much a paid-up member of the Anti-Keynsian League , but can see this theory has some serious issues. Clearly there will be a tendency for people to save more in the expectations of future higher taxes as a result of government borrowing. If I know taxes will double next year I will probably save more now. But because of time preference probably not to the full extent of the expected tax increase. If the tax increase was expected to be 1000 years from now time preference would almost certainly eliminate any effect on my current spending no matter how much I care about my descendants.
Ricardian Equivalence claims that 100% of government borrowing will be factored into current spending. Common sense says that time preference, ignorance, and selfishness will all mean that it will be less than 100%. In addition things like chances of default, inflation, Bob Murphy becoming president and abolishing all taxes , all make us less likely to save the full amount. My guess is that for most expected tax increases greater than 10 years away the effect of Ricardian Equivalence would be 0%.
I have not seen one good defense of this theory. Can you point me to one ?
Rob: time preference doesn’t invalidate REP. The higher is the rate of time preference, the higher is the equilibrium interest rate, and the bigger the increase in future taxes. It’s a wash. Ignorance is debatable. Some people might underestimate, others might overestimate. (You might argue that ignorance leads people to underestimate changes.) Not leaving bequests will invalidate REP. So will immigration, etc.
Again, nobody believes it 100%. Nobody believes any theory 100%. But then nobody believes the exact opposite either – that people ignore the future. The truth very probably lies somewhere between those two extremes. The most sensible thing to say is that there is some truth in REP.
The original paper is by Robert Barro “Are bonds net wealth”.
Rob, I’ve got one: the Ricardian Equivalence theorem tells you exactly what conditions need to be satisfied for Ricardian Equivalence to hold.
What vimothy is saying (I think) is that Ricardian Equivalence is like the Modigliani-Miller Theorem of corporate finance (actually they are almost brother and sister). The MMT says that the corporate debt-equity ratio is irrelevant. That is a very surprising result. We “know” that it must be false. But it’s also an incredibly useful theorem. Because by telling us under what conditions the MMT is true, it tells us where to look if we want to explain what determines the debt/equity ratio. RET tells us where to look if we want to explain why tax vs bond finance matters. That makes it a very useful theory.
Yep. Arguing whether RE is true is pointless. Arguing why RE might be false is useful.
Arguing whether RE is true is pointless. Arguing why RE might be false is useful.
Nick, that’s well put.
Ok. I can see that Time Preference is not relevant to the discussion. Thanks for clarifying that.
If all we’re talking about is a tendency for govt borrowing to lead to an increase in savings levels at any given interest rate then that is a useful theory.
However , anyone who claims that RET proves that govt borrowing and govt taxing are equivalent in their effects is making a claim that is not supported by this more limited interpretation of the theory.
Steve L. is not claiming that: He’s just claiming that those who want to save to offset taxes will do so. My original point about this being irrational under certain circumstances (where paying the present tax will be cheaper than paying the future tax for many descendants) still seems valid. Doesn’t that itself further weaken RET ?
“Arguing whether RE is true is pointless. Arguing why RE might be false is useful.”
This is common in the human sciences. Figuring out why Plato and Russell, for example, were wrong about concepts / language / math turned out the be very hard — and ultimately very fruitful. Ditto figuring out why Mill & Carnap & Popper & Nagel & Hempel were wrong about the nature of science and scientific explanation. Etc.
In economics note well:
Those who claimed that we could do without interest, money and private property led to some of the most important advances in all of economics, e.g. to the work of Wieser and other on interest, and the work of Mises and others on the the role of money prices and property rights in social coordination.
Similarly those who insisted that “just prices” could be determined led to the beginnings of modern economic science, e.g. the work of the Spanish Schoolmen.
But note well, in these cases arguing whether xyz is true or possible led directly to singly fruitful understandings of why xzy must be false or impossible.
Similar things have happened in macroeconomics …
Rob: “Doesn’t that itself further weaken RET ?”
At the individual level I think it does. At the aggregate level it might all (roughly) cancel out. Those with more kids will save more, and those with fewer kids will save less.
Greg: nice comment.
Plus they will pressure for the tax option and object to the public debt , not be indifferent as he claims “In this story, nobody who is alive today actually objects to the public debt. So Nick cannot use this story as a reason for you, me or anyone to become a deficit hawk.”