I don't normally do blog posts with just a link to someone else's blog post. We aren't that sort of blog. But I'm going to make an exception in this case. Bob Murphy's latest post on the burden of the debt is very clear, very comprehensive on both sides of the debate, and very funny. It's a fitting capstone to this debate.
That's probably it for me on this subject. But you never know for sure……..
OK, just one last slogan: macroeconomics is about PEOPLE, not GDP!
Worthwhile Canadian Initiative 
To generalize from my previous comment:
Govt debt can cause loss of utility in the future only if the transfers it effects deviate from those that would have been needed to maximize utility.
In Bob’s model no transfers are needed to increase utility so any that do take place cause a loss of utility.
In an alternative model where transfers between individuals or between generation would improve total utility then government borrowing will only be harmful if it causes deviations from this optimal set of transfers that would have been required.
In a model where savings and investment is allowed then government actions can screw things up both by leading to lower than optimal output as well as lower than optimal distribution of goods. But in the unlikely event that the govt can do the right thing at the right time the outcome will be optimal.
Rob,
I’m not sure what you are talking about, regarding my model. For example you wrote:
The only way that the model shows that debt “causes” a future loss of utility is in the sense that a debt transfer creates an obligation for a future transfer. However it is clear that the govt could avoid this further loss of utility by simply defaulting or taxing the bond holders an amount equal to the bond payment.
No, debt “causes” a loss of utility because, once set in motion, it necessitates that either (a) the government will default, thus reducing the utility (relative to no debt scenario) of whatever sucker rolled over the debt or (b) it taxes future people to service the debt. The only way debt would not “cause” a loss of utility in the future is if everybody could keep rolling it over and nobody were ever taxed, not even to cover interest payments.
The stuff you are saying about the sensitivity of the result to my assumptions is wrong. Just think about it: People are worse off if they get taxed for something that they aren’t reaping any benefits from. It’s a pretty simple result. Krugman et al. got lost in thinking that in the future, people taxed to service the debt will be helping the bondholders who are getting paid, but that’s not a wash, since the bondholders earlier in their lives reduced consumption in order to get into the position of holding that debt. (Or, they might have, unless Ricardian Equivalence is perfectly true.)
Nick Rowe: Maybe you’re right, but the thing with the govt/private debt distinction is that it sounded like Dean Baker was leaving open the possibility that private debt could hurt future generations. Remember, his point was that debt couldn’t hurt our grandkids. But he said “at least government debt.”
So the thing you’re focusing on, is actually correct, right? Private debt can’t hurt future generations, because they can refuse to accept it unless there are offsetting assets to accompany it?
Bob Murphy,
“I don’t think that word means what you think it means.”
Interesting point.
Perhaps its conceivable as a hypothetical, but inconceivable as an actual.
Bob Murphy,
Your hypothetical Krugman reply does sound a LOT like him.
Will be interesting to see something.
On the first point : Do you agree that any transfer of any kind in your model will reduce average utils per person compared to what it would be with no transfers ? So a bond issued in period 1 will reduce average utility on everyone. Move to period 2. If the govt wants to maximize future average utility from period 2 on it has to default on the debt, or pay the debt and tax the receiver an equal amount. failure to do so will leave the bond-holder (old Bob) better off but reduce the average utils for everyone else in the model who lives in period 2 or later. The same thing will happen in every period – the more transfers the govt does the worse the average utils become because no transfers is always the best option. I’m not explaining this very well but I don’t think it matters because I think this is just a symptom of the much more general issue I raised in my second post (and I welcome your comments on that)
On your second point : I agree in the real world tax is bad. But in your model it is not bad(if I understand the utility function) if it equalizes an individuals consumption over 2 periods. For example if the distribution over everyone’s lifetime was – period 1: 150 period 2 : 50, if the govt taxed them in period 1 and gave them a transfer in period 2 t the combined tax and transfer would increased their lifetime utils.
I apologize in advance in the (statistically probable) case that I am wrong here and wasting your time.
@JKH
It’s from the Princess Bride
[Vizzini has just cut the rope The Dread Pirate Roberts is climbing up]
Vizzini: HE DIDN’T FALL? INCONCEIVABLE.
Inigo Montoya: You keep using that word. I do not think it means what you think it means.
Share this quote
Min: “Could you spell out what you mean by such a negative bequest?”
Suppose I die with zero assets, but an unpaid debt. Can my creditor come after my kids to make them repay the debt?
I’m not at all sure of my legal history, but I think that in the olden days in England they could. My kids were liable for my unpaid debts after my death.
Nowadays they can’t. If I die with unpaid debts (and no assets), too bad for my creditors. My kids can walk away from my old debts So people will not lend me money if they don’t expect me to repay before I die (or leave sufficient assets when I die to cover those debts).
So, as a private person, I can’t just borrow what I want, spend it all, and say my kids will cover it. But I can vote for a government that does that for me.
Bob: “So the thing you’re focusing on, is actually correct, right? Private debt can’t hurt future generations, because they can refuse to accept it unless there are offsetting assets to accompany it?”
Yes.
Unless there are some sort of externalities so that my borrowing causes a financial crisis and a recession that leaves my kids unemployed. Maybe that’s what Dean baker meant?
Yancey Ward,
I think I understand the point you’re making, but would disagree. I suppose I’m softening up again on the possibility that Krugman just didn’t think through the numbers, but I don’t think this is a persuasive argument for that.
Suppose Krugman in good faith was arguing the case of consolidated discrete subgroups at some future point in time or some future period of time. So as an example of that, suppose you have the final cohort buying bonds from the previous cohort and subsequently being taxed to pay the bonds down. On a discrete basis, the final cohort ends up short cash as a result of those three transactions. But on a consolidated basis, since the previous cohort is a counterparty to one of the transactions, the two cohorts together ended up flat cash over the period that covered these three transactions. That difference is due to the effect of taking the consolidated view, which has been my assumption for the Krugman interpretation.
As you say, Krugman “foreclosed” on the case of bonds held by foreigners.
But in fact the foreign case corresponding to this example results in a net short cash position for the taxpaying generation under either the consolidated or discrete interpretation. (I do assume that the definition of the relevant generation in either case includes only domestic taxpayers – not foreign taxpayers, and that “we” does not include foreigners, whatever the precise context for “we” turns out to be.) The result is that choice between the “we owe it to ourselves” consolidated interpretation and the Rowe/Murphy discrete generation interpretation doesn’t matter to the correct interpretation of the foreign bond case. The foreign bond case becomes a net burden for the domestic taxpayer in either case.
Assume the consolidated interpretation in the foreign held bond case. So the final foreign cohort buys the bonds from a prior foreign cohort, and the government taxes the domestic sector. The result is that the domestic sector is net short cash, since the bond related cash flow nets out entirely within the foreign sector.
Assume the discrete generation interpretation. This changes the interpretation within the foreign sector, at the option of the modeller I suppose, but that has no bearing on the burden faced by the domestic sector, which is still net short cash. So the result is the same as the consolidated interpretation.
Which is to say that the foreign sector scenario is irrelevant to the issue of assessing the likely applicability of consolidated versus discrete in the case of Krugman.
That’s the way I see it, but it’s also quite possible I really haven’t understood your point. What I’m saying is that the nature of the foreign bond case should have no bearing on whether one chooses consolidated rather than discrete as a ruse to get to the “we owe it to ourselves” conclusion.
Nick Rowe: “So, as a private person, I can’t just borrow what I want, spend it all, and say my kids will cover it. But I can vote for a government that does that for me.”
Who are the creditors in your gov’t analogy?
As I said, I don’t see how this gov’t analogy fits your earlier scenario.
Rob,
I was never making an argument about looking at “average utils per person.” I don’t believe in interpersonal utility comparisons. I used the same utility function for everyone to make it simple, but I could just as easily multiplied each successive person’s function by a bigger and bigger number and gotten the same result. I was never comparing a given person’s utils with somebody else’s utils; rather I was looking at how many utils a person got under the deficit scenario, versus the endowment scenario.
Also, you’re right that if the endowment had a person start out with (150, 50), then a tax and transfer system that transformed it into (100, 100) would make the person better off. However, the only reason the government would be necessary, is if people in the private market couldn’t lend to each other for one period. So if someone tried to justify taxing for that reason, we could say, “Of course, we have to assume private bonds don’t exist.”
(Now Samuelson et al. do make an argument about the benefits of a sustainable Ponzi scheme a la Social Security, which is kind of like what you might be saying.)
Min: “Who are the creditors in your gov’t analogy?”
The kids themselves (or someone else’s kids). They buy the bonds off me and the other old guys, but my kids owe it to your kids, and your kids owe it to mine. So they paid for something that they then owe to themselves.
Bob: “Also, you’re right that if the endowment had a person start out with (150, 50), then a tax and transfer system that transformed it into (100, 100) would make the person better off. However, the only reason the government would be necessary, is if people in the private market couldn’t lend to each other for one period. So if someone tried to justify taxing for that reason, we could say, “Of course, we have to assume private bonds don’t exist.””
In a 2 period OLG model (young/old) private bonds cannot solve this problem. The young people want to lend, but who do they lend to? The old can’t repay them next period, because they will be dead. This is where samuelson comes in. It could be government doing a sustainable Ponzi debt (sustainable because the equilibrium interest rate would be negative). Or it could be that individuals pick up shiny stones and sell them when they are old. If shiny stones are the only durable good, they will be very valuable as a savings vehicle.
I shouldn’t have used the phrase “average utility” but I think the same point can be made in a different (and simpler) way.
You would agree that in a free market with no tax or government bonds there would never be any transfers in your model (people would be happy to lend at a big enough interest rate, but noone would borrow at those rates). For this reason if the govt carries out any transfers it will make at least one person worse off and if the transfer is via debt that person will by necessity will be in the future. I take this to be your point (though you make a point in your model of showing that many generations in a row can have sub-optimal utility , but that always depends upon the govt making additional transfers to make that happen.)
If we have an unequal distribution of endowment then transfers are possible that make some people better off and none worse off as you have acknowledged. These transfers can be via bond or via tax. There are also possible transfers in this model that will make at least one person worse off (for example: if the govt sells the youngers a bond for transfer to the then old, only to then tax them to pay off the bond in the next generation). The point being that each model has an optimum set of transfers that will improve both parties utility. If the govt carries out these transfers (via bonds or taxes) noone loses. If it carries out different transfers then at least one persons utility will drop. In your model the set of transfers that will improve at least one persons utility and decreases no-ones is empty.
“the only reason the government would be necessary, is if people in the private market couldn’t lend to each other”. This is sort of my point. People will always try and maximize the present value of their current and future income steams. In a free market they will work out the optimal transfers so that everyone (at least ex ante) wins. The reason that govt borrowing is bad is that the govt will screw the transfers up and end up making at least one person in the future worse off (except in your model where all transfers do that). If by a miracle the govt could simulate the same set of transfers via borrowing and tax that the private sector would achieve via borrowing and trade then govt borrowing would not be a burden on the future.
To restate:
If transfers can improve Pareto efficiency then in principal there is no reason why the govt should not be able to facilitate those transfers via bond-financed debt – but in reality one may doubt the likelihood of the govt achieving this better than a free-market.
Rob I’m not trying to be difficult but at this point I don’t know what you are getting at. If we have a model where one guy grows apples and another guy grows oranges, and we say for some reason they can’t trade voluntarily, then a government tax scheme could make them both happier.
Moi: “Who are the creditors in your gov’t analogy?”
Nick Rowe: “The kids themselves (or someone else’s kids). They buy the bonds off me and the other old guys, but my kids owe it to your kids, and your kids owe it to mine. So they paid for something that they then owe to themselves.”
So the creditors are heirs and the debtors are heirs. Which is different from the private debt, where the creditors are not heirs and the heirs are possibly debtors.
BTW, around 20 years ago I heard on public radio about people inheriting debt in India, which had led to debt peonage because of ancestral debts. I don’t know if the law has changed since then.
Bob: I think (not 100% sure) you are not getting my &Rob’s point.
Let me try it this way, because it doesn’t necessarily involve government.
Suppose there are exactly 1,000 people in each cohort. Suppose one of them comes up with an idea: he makes exactly 1,000 special engraved disks, that cannot be copied. He calls a meeting, gives everyone in his cohort one disk and says: “when you are old, sell your disk to one person in the next cohort for 50 apples, and tell him to do the same when he is old”. The disk is like a chain letter, except you only pass on one copy, not several, and everyone only gets one copy.
As long as nobody breaks the chain, everyone in all cohorts is better off. The first cohort is much better off, because it eats (150,100) instead of (150,50). But all subsequent cohorts are better off too, because they eat (100,100) instead of (150,50).
Min: interesting about India. That’s probably illegal now (unless the government does it).
Bob,
I am saying that in that scenario the trade and the govt transfer would achieve the same result and you would have to bring other factors in to show why the trade is better.
It would be easy to construct a model where govt actions exactly simulates the transfers involved in a debt transaction that would benefit both parries.
Instead of:
A lends to B, B consumes more (he has a family to feed), and in the next period he pays B who needs to pay for his retirement (obviously have dropped the 2 period OLG constraint here).
we have:
Govt issues a bond and sells it to A, and the govt makes a transfer to B. In a later period the govt taxes B and uses the money to repay A who can now retire.
Now I can think of many reasons why the free-market version is better than the govt version (mainly around revealed preference). But within the constraints of the discussion we have been having doesn’t the second option show that govt debt sometimes does not cause loss of utility?
“There is no way I can read Paul Krugman or Dean Baker as saying anything other than ‘the kids are alright; don’t worry’.
I can read Krugman and Baker as saying, “The kids are alright; don’t worry, because the increase in production as a result of deficit spending has enabled us to increase their bequests by as much as we have increased the debt, and what matters is not the debt itself but how much is produced and consumed.” (This isn’t Ricardian Equivalence; it’s a matter of people leaving larger bequests because they have more income, not because they expect their descendants to have less.)
One could imagine asking them the question, “Did the Reagan deficits (i.e., when we weren’t in a liquidity trap) make our children poorer (ignoring the part borrowed from abroad)?” and the answer could be, “No, the deficits didn’t make our children poorer, but the additional consumption that resulted made our children poorer.”
It would be nice to hear what they actually have to say.
I have to say I really appreciated Bob Murphy’s post because it highlights a point that I’ve struggled to stress with non-economists, namely that we do not disagree on the methodology, models, or outcomes of well defined models. Where we do disagree is on two key points 1) the assumptions, and 2) the focal point of the outcome. (And the focal point of the outcome is usually tied to subjective preferences or underlying assumptions.)
The assumptions are necessary for the solving of the model, but they often get burried and lost deep in the bowels of the model construction and occassionaly forgotten.
So, what I take from this discussion is that public debt that is being serviced is not a burden on future generations.
(Of course, in policy land, what really matters is whether a given level of debt that can be serviced: but that is not the issue being discussed here.)
Lorenzo: Not really. It is the future servicing of the debt, in paying taxes to cover interest and/or pay down the debt, that will be a burden on future generations.