Suppose you wanted to take milk away from people on the east coast, and give it to people on the west coast. But you don't have any way of transporting the milk quickly enough to stop it spoiling before it gets from one coast to the other.
Here's how you do it:
You take milk away from people on the east coast. You move it a few kilometres west, then swap it for fresh milk from the people living a few kilometres inland from the east coast. Then move that second batch of milk a few kilometres west, and repeat. And keep on repeating until you get to the west coast.
Suppose you wanted to take milk away from people who won't be born until 100 years in the future, and give it to people alive today. But you don't have a time-machine.
Here's how you do it:
You borrow milk from people who are young and give it to the people you want to give it to. You wait a few years, then borrow some more milk from people who are young, and use it to repay the milk you borrowed from the people who were young but are now old. And keep on repeating until you get to the people who were born 100 years after you started. You don't borrow milk from them; you just take it.
Now read what Paul Krugman said:
"First, however, let me suggest that the phrasing in terms of “future
generations” can easily become a trap. It’s quite possible that debt can
raise the consumption of one generation and reduce the consumption of
the next generation during the period when members of both generations are still alive." (italics in original).
Worthwhile Canadian Initiative 
Nick, you are just describing an asset bubble.
Generation 1 borrows to buy land hoping to re-sell to generation 2 for a profit. Generation 2 does the same. At some point, the bubble pops, and that generation is screwed, as they have the debt but do not have an asset that they can re-sell.
Or if you don’t like borrowing, Generation 1 buys an asset that delivers 1 consumption good/year for $10. Then rates fall and Generation 2 has to pay $20 for the same stream. Then rates fall again and generation 3 has to pay $30 for the same steam.
Each generation gets $10 of consumption transferred to it from the previous generation as a result of interest rate policy.
Up until the CB raises rates, and generation 3 is screwed.
I would say these transfers are the big story, and the CB has a large role to play in this story.
The fiscal deficit transfer story describes unicorns. The set of assumptions necessary to observe such a beast in the wild almost never happen. The monetary policy transfer story happens all the time.
Point me to an integenerational transfer, and I will show you a secular movement in interest rates behind it.
Moreover, I think it’s curious that when someone brings up private borrowing, its “we owe it to ourselves”, but with government borrowing, we start to disaggregate between borrowers and lenders.
rsj: with private borrowing the borrower doesn’t get to use tax collectors to compel other people to pay his debt.
rsj, here is what I am seeing.
savings of the rich = dissavings of the gov’t (preferably with debt denominated in medium of exchange) plus dissavings of the lower and middle class (preferably with debt denominated in medium of exchange)
Alex, he doesn’t need to. If the central bank sets the rate of discount, then your wealth can go up or down with the same ferocity of a tax collector.
But at least we vote on tax policy.
Nick,
I’m trying to get clear on the aspect of the interest versus the principal amount of the debt, and the interpretation of that on the incidence of the burden, as previously discussed.
I think you’ve been saying in effect that if some future generation is taxed to pay interest on the debt, the debt ends up being a burden at that point. That’s a minimum condition, so to speak, and that assumption is inherent in your idea of a counterexample, I think.
I think the reason it becomes a burden in your view is (at least implicitly) that the interest is no longer being paid by the issuance of new debt (at the macro level) – i.e. the debt has become too big to keep growing it in order to cover the interest. Any interpretation other than that becomes a contradiction – because if interest weren’t being paid up until that point by increasing the outstanding debt that would imply that some interest could only have been paid by imposing taxes previously, which is a contradiction to the assumption of first tax incidence and resulting burden identification.
So, the point at which taxes are imposed to pay interest on the debt is the point at which the debt stops increasing to match the accrual of interest on it.
And therefore the point at which taxes are imposed to pay interest on the debt is the point at which that generation in aggregate no longer has bonds representing the full value of its original principal plus any earned interest – to sell to the next generation. At the margin, it doesn’t have the value in bonds in total that it should have accumulated, based on the original contracted interest rate with the government, and based on the assumption that no taxes would be imposed even just to pay interest on the debt. So the debt becomes a burden, because that generation can’t realize it’s originally contracted full amount of expected debt that it would be able to convert to purchasing power by selling it to the next generation.
Does that sound right in your view?
Clearly, Nick is describing an equilibrium which cannot exist (unless one assumes agents are stupid, or some sort of mixed strategy equilibrium of which this is a realized path, in which case debt is not a net burden in “expectation”). This explains why nobody gets his “counterexample.”
All of this headache can be avoided by restating the proposition. “There is no continuation equilibrium where debt is a…”
The “you” who decides to “simply take” the milk from the people of 2112 is not the same “you” that borrowed milk from some people of 2012. Prof. Rowe has not shown how any action taken in 2012 could restrain the decision-makers of 2112 from rolling the debt over, just as their predecessors did for the preceding century. Of course, if one could arrange to live 150 years, and win thirty- or forty-odd elections consecutively…
You are now clearly within a social-economic model. Any prohibition on violation of budget constraints is a matter of custom and law, and assuming it in an economic model is a counter-factual simplification.
Any such simplification shapes the domain of validity of the model. Any results of a model used outside its domain of validity have to be treated with extreme suspicion.
Since debt default and credit risk are a necessary part of any description of how debt works in modern economies, models which assume budget constraints are binding appear to have little or nothing useful to say about problematic debt or about the effects of instruments like credit default swaps or securitized debt obligations.
The key problem with piling on debt is risk of constraint violation. This risk has to be market priced, which creates a positive feedback expectation term and introduces the problem of systemic risk and correct option pricing and VAR analysis in the face of it.
So in the case of exponential apple debt, at some point the non-creditors will rebel against their shrinking share of total apples, and debt will either be repudiated or inflated away.
You can look at it a different way. Suppose debt reaches ten years’ apple production, and the creditors have reached retirement age with the expectation of having claims on ten years’ production, that they propose to exercise over the next ten years. Now what?
When such an outcome begins to appear likely, investors will flee the most vulnerable appearing forms of debt instruments and seek safety in the least vulnerable, creating distortions in interest rates as safety trumps yield. These distortions in turn create opportunities for interest rate arbitrage, a risky carriage trade and speculation in default risk, which aggravates the problem (like with Italian debt).
So while I agree with the analysis here of multi-generational debt, I think that with a more realistic model, issues of budget constraint violations both intratemporal and intertemporal will appear, and the effects of default risk on debt pricing will be dominant.
BTW, I’m mostly just channeling Leijonhufvud and Buiter. There’s nothing here that’s exactly hot news.
Dan: that’s like saying; jumping out the window is not what hurts; it’s hitting the ground. (Of course, if r < g, you never do need hit the ground.)
No it’s not, Nick. Unlike the case of jumping out a window and hitting the ground, the things that impose costs on the future generation in your counterexample are not natural or probable consequences of debt issuance. They are completely separate contingencies that you have built into the case, and that have no inherent connection to the debt issuance itself. You have built in that the debt is issued and reissued in each generation to finance more consumption of things of ephemeral value rather than investment in things of enduring value. So instead of a jumping out the window analogy, I would say it’s more like your are saying that going for a run can be harmful because you might run into a brick wall. Well yeah … so try not to do that.
Dan, it’s not the debt, but the interest on the debt.
I don’t see how the interest generates the problem, anon. Suppose we forget about the generations and just consider a single generation of people who happen live for a few hundred years. Suppose the public borrows x units of good Y from private individuals at 1000% interest, to be repaid in exactly 100 years. And suppose whatever kind of thing Y is, the public always repays its debts by taxing its members for the full amount to be repaid. So a hundred years after the borrowing, the public repays those private individuals 11x units of Y. Has the society as a whole harmed itself by doing this?
There is no single correct answer. It all depends on what Y is, what the public did with the original x units of Y when it borrowed it, how many private individuals we are talking about and who they are, etc.
At a first pass, the society redistributed x units of Y initially, and then 100 years later redistributed 11x units of Y. On its face, and absent further detail, that’s a wash. But we can consider detailed scenarios, some of which are good and some of which are bad.
1. The public borrows all of the gunpowder in the kingdom (100 tons) from its producers in year one, and uses it for the most awesome fireworks display ever. Subsequently, lacking gunpowder, they are defeated in a war by their neighbor to the south and spend the next 100 years paying that neighbor tribute. 100 years later the kingdom redistributes 1100 tons of gunpowder from everyone in the kingdom to the original producers. They have all suffered from their course of action.
2. The public borrows all of the gunpowder in the kingdom (100 tons) from its producers in year one, and uses it to defeat their neighbor to the south. That neighbor then spends the next 100 years paying that kingdom tribute. 100 years later the kingdom redistribute 1100 tons of gunpowder from everyone in the kingdom to the original producers. They have all benefited from their course of action.
You can multiply these examples at will. For every bad one there is a good one. Nick is relying on a kind of conservative stereotype about government and public spending – that it consists mainly in wasteful consumption-fueling transfers – to get his bad case scenario off the ground. But the fact is that much government spending is carried out to provide a variety of valuable goods and services to the society, many of which directly benefit the younger members of the society and future generations.
Now I personally think that if we are talking about the redistribution of real goods and services – and not money – then taxation is usually a better course of action than borrowing, since the borrowing almost always ends up on net redistributing value from the less affluent to the affluent, while taxation generally redistributes from the more affluent to the less affluent.
Min: Really? I would have thought that the older generation was overall the creditors of the younger generation, who have debts like mortgages and student loans. No?
And what was wrong with my statement then that it is pretty much the same distribution for public debt as for private debt?
Min: Really? I would have thought that the older generation was overall the creditors of the younger generation, who have debts like mortgages and student loans. No?
Sergei: And what was wrong with my statement then that it is pretty much the same distribution for public debt as for private debt?
Nick Rowe’s whole argument assumes that it is the younger generation who are the creditors for public debt. If it is the older generation, what are we talking about?
Min: I’ve assumed each person lives for 2 periods: young and old. In a more realistic and complicated model with continuous time, the people owning most debt would be people at the point of retiring. 65 year olds are “old” in common parlance, but “just at the end of being young” in my model.
Nick Rowe: “I’ve assumed each person lives for 2 periods: young and old. In a more realistic and complicated model with continuous time, the people owning most debt would be people at the point of retiring. 65 year olds are “old” in common parlance, but “just at the end of being young” in my model.”
Thanks, Nick. 🙂
That raises a number of complex issues, doesn’t it?
Dan, your examples are a little crazy.
The first loan went bad. The second loan paid off. (Basically, kingdom two paid no interest.)
(Since there is no money, labor is more like money.)
The real analogy starts on the west coast.
A on the west coast asks B, who lives somewhat inland, for some milk. He says, “I have an IOU from Z on the east coast for 100 litres of milk.” B says, “Oh, really?”
Take it from there! 😉
Well, maybe B takes the IOU in exchange for 65 litres of milk. And later B trades the IOU for 70 litres of milk from C. Etc., etc. Then X trades the IOU to Y for 98 litres of milk, and then Y trades it to Z for 100 litres.
OC, in the time travel story there is no IOU from Z.
“Now read what Paul Krugman said:
“First, however, let me suggest that the phrasing in terms of “future generations” can easily become a trap. It’s quite possible that debt can raise the consumption of one generation and reduce the consumption of the next generation during the period when members of both generations are still alive.” (italics in original).”
OK. I followed the link. Here is Krugman’s next paragraph.
“But that’s not what people mean when they speak about the burden of the debt on future generations; what they mean is that America as a whole will be poorer, just as a family that runs up debt is poorer thereafter. Does this make any sense?”
Note that what the people that Krugman is talking about are making a different claim than you, Nick, and an erroneous one. There are apparently a lot of such people in Washington. Warren Mosler speaks of Al Gore talking that way when he was vice-president.
This argument started, not in 2011, but in the spring of 2010. At that time there was an onslaught of propaganda from the debt/deficit hawks, claiming that the debt and deficit were bad, and that they would be a burden to future generations. Not that they might be a burden, but that they would be. That frightened people, which was the purpose of the propaganda. Few economists responded to debunk the propaganda. Those that did included James Galbraith and the MMT people.
In part as a result of that propaganda, the Tea Party swept into Congress in the US. During the debt ceiling debate of 2011 the same erroneous claims were made. It was those claims that Krugman and Baker debunked. Since you live in a more civilized country, Nick, I think that you read more into what Krugman and Baker wrote than they intended. They were countering the craziness in Congress, not making extreme claims themselves.
Dan, your examples are a little crazy.
The first loan went bad. The second loan paid off. (Basically, kingdom two paid no interest.)
No, I’m assuming that both loans are paid in full. The first kingdom loses a ton of money due to its tribute payments, but it doesn’t go insolvent. Future gunpowder production continues, It’s debts are all paid.
Min’s post said: “Nick Rowe: “I’ve assumed each person lives for 2 periods: young and old. In a more realistic and complicated model with continuous time, the people owning most debt would be people at the point of retiring. 65 year olds are “old” in common parlance, but “just at the end of being young” in my model.”
Thanks, Nick. 🙂
That raises a number of complex issues, doesn’t it?”
Add wealth/income inequality. Can that bring up the issue of retirement age “inequality”? What happens if some entities continuously run surpluses but won’t retire (stop running surpluses)? I’m thinking Warren Buffett and Apple Corp.?
Min said: “This argument started, not in 2011, but in the spring of 2010. At that time there was an onslaught of propaganda from the debt/deficit hawks, claiming that the debt and deficit were bad, and that they would be a burden to future generations. Not that they might be a burden, but that they would be.”
It seems to me the most likely scenario is that the debt denominated in medium of exchange will be a “burden” to the many and a “benefit” to the few.
Econ 101 tells us this geographic transfer will inevitable have investment and consumption distributional effects on the East Coast and the West Coast.
Now move one to Econ 201 when we introduce choice between shorter and longer production processes producing superior or inferior output, and converting fewer or greater ‘noneconomic’ goods into economic goods at the margin.
The wealth effects across time of the wealth transfer from East coast to West coast can be enormous.
(I’m well aware that most economists would flunk Econ 201).
Dan, kingdom one: 1200 tons (produced)/1200 tons (consumed). Kingdom two: 100 tons (produced)/1200 (consumed). Who’s wealthier?
Kingdom one had a labor burden. (You’re saying they “suffered.”) Sure, neither one is in debt. But there’s nothing magic about paying off all your debt. Only if you go back in time, before they paid off all that debt, kingdom one was facing a serious burden.
Yes, “they owed it to themselves.” But you’re not mentioning who produced what: the distributional and generational fallout. (Remember we’re talking about generational burdens. This is maybe the “how,” you’re talking about.)
Krugman also decried the growth of debt under Bush when we were not under current circumstances of the zero bound, so it is not that he always sees it as irrelevant, just not applicable to current conditions.
Krugman decried Bush’s recovery job numbers in 2004 and praises Obama’s recovery job numbers in 2008, which are far worse than Bush’s.
Krugman argues whatever he wants to achieve the political outcome he prefers — he falsifies the arguments and theories of others constantly to gain ‘advantage’ for whatever conclusion he holds at the moment.
All of this has been repeatedly flagged and rehearsed for going on the second decade.
Who hasn’t had enough of it?
“Krugman also decried the growth of debt under Bush when we were not under current circumstances of the zero bound, so it is not that he always sees it as irrelevant, just not applicable to current conditions.”
If you think sectors, then private sector debt is being rolled over the same way government debt is. You cannot use Nick’s micro logic here that his kids are not inheriting his debts, because as a generation they start with taking on debt, and of course these liabilities have other side, and those are savings. Older people usually have savings. Unless you want to get rid of monetary economy the way we have It(and Nick is not some Austrian nut case)you have economy where debt is being ‘rolled over’. If you assume that older people transfer those financial assets to younger generation by spending those financial assets and younger generation has to work for them, then wealth transfer happens regardless of It being government or private sector debt. Of course those financial assets never seem to get spent, so there is no real wealth transfer, because Nick’s kids are inheriting those financial assets he has accumulated ( I think 🙂 ). If you think of rental income then MMT proposes 0 interest rates.
In the apple model world that Nick has created the only thing that can be lent is that which has not been consumed. It will be exactly equal to what is borrowed. In every period forever. It doesn’t matter what interest rate Nick has ARBITRARILY CHOSEN. The interest rate will be a function of the rate of saving and the realized return will be determined by the rate of saving in the following period. Repeat.
Taxes are always a burden on those who pay compared to not paying them. Transfers are always a benefit to those who receive them. Time travel is impossible.
In Nick’s model any excess of saving beyond the amount to be transferred will push the rate to zero. Any saving below what is required for transferring to oldies will see the rate go to infinity. Otherwise we’re talking about a different situation than the one described by Nick, one where oldie consumption is variable with the rate of interest.
Or have I missed the point entirely?
I shall now prove that backward time travel remains impossible and that Nick’s accounting trick does not change the laws of physics.
Suppose the two coasts produce 10 million gallons of milk a week, each.
Physical Milk example: By transporting milk from east to west consumers in the west coast can consume 15 million gallons while those in the east consume 5 millions gallons.
No physical laws are violated.
But we can not make milk travel backwards in time, not in physical reality.
It is simply not possible for both coasts to consume 15 million gallons this week (30 million total) and pay it back by consuming 10 million gallons next week.
If they tried they would quickly find that, today, there is only 20 million gallons total and, next week, that if they consume 10 million gallons the other 10 million will simply spoil.
Technology (cheesemaking, pasteruzation, etc.) allows us to preserve milk into the (near) future, but we can not do the reserve, that is, consume future milk today.