09 Jan 2012

The Economist Zone

Economics, Financial Economics, Humor, Krugman 123 Comments

Don’t worry everyone, all that stuff about government debt and future generations is out of my system. After several colleagues have told me repeatedly that I am being obtuse on this, I realize that I’m not cut out for economics and commentary on public policy. Instead, I’ll turn to writing for TV. I have an idea for a new series called “The Economist Zone.” Here’s the pilot. Tell me what you guys think, if you have a few minutes to read it. Thanks.

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THE ECONOMIST ZONE

The scene opens with a million people–all named “Old Al,” oddly enough–looking very sick, and a million other people–all named “Young Bob”–looking very concerned. In addition, there is a politician, and a pundit named David Brooks. Oh, and there are economists–lots of them.

POLITICIAN: The Old Als are weak and dying!

CROWD: Boo!

POLITICIAN: We need to do something to help them!

CROWD: Woo hoo! Yeah!

POLITICIAN: They each deserve 3 more apples before they die!

CROWD: Woo hoo! Yeah!

POLITICIAN: So I’m gonna tax each Bob 3 apples to pay for it!

CROWD: Boo!

POLITICIAN: (pauses) Uh, I know! I’m gonna borrow 3 apples from each Bob, at a 0% interest rate, to pay for it!

CROWD: Boo!

POLITICIAN: OK, make it 100% interest! I’ll give each Bob 6 apples back in period 2 if you lend me 3 apples today!

CROWD: Woo hoo! Yeah!

VOICE FROM BACK OF CROWD: But wait, how are you gonna get the 6 apples to pay us back next period?

POLITICIAN: (pauses) Uh, I’ll tax the young Christys 6 apples each!

CROWD: Woo hoo! Yeah!

VOICE FROM BACK OF CROWD: But wait, we didn’t even want to cough up 3 apples to help our elderly. Why will the million Christys next year agree to a tax hike of 6 apples?

POLITICIAN: (pauses) Uh, because I’ll tell them that if investors ever doubt the willingness of the government to redeem its bonds, then trees will stop producing apples and we’ll all starve!

CROWD: (murmurs)

POLITICIAN: (pauses) Uh, I know! I’m gonna borrow the 6 apples from the young Christys, at 100% interest! They’ll love rolling the bonds over! If you guys want to do it this period, so will they, next period!

CROWD: Woo hoo! Yeah!

DAVID BROOKS: You should all be ashamed of yourselves! If you want to give our elderly Als 3 apples each, fine, but let’s have the decency to tax ourselves and pay for it. We can’t pass on a huge debt burden to our kids and grandkids.

DEAN BAKER: Don’t listen to him, everyone. Brooks is a fool who does little but eat more than his fair share of apples every year. As a society it is impossible for us to impose government debt burdens on our children. The reason is simple, by period 3 we will all be dead. That means that the ownership of the government debt will be passed on to our children. If we have some huge thousand trillion apple debt that is owed to our children, then how have we imposed a burden on them? There is a distributional issue — Christys’ children may own all the debt while Daves’ children don’t hold any bonds — but that is within generations, not between generations. As a group, our children’s well-being will be determined by the productivity of the trees, which we all know in the real world is forever fixed at 200 apples per period.

Now don’t get me wrong, if our kids ended up owing apples to some hypothetical guys that lived in a different Excel spreadsheet across the ocean, then our kids would be burdened if we borrowed apples today. But Brooks never said a word about this hypothetical possibility, so clearly this subtlety isn’t even on his radar screen.

DAVID BROOKS: Hey I object–!

PAUL KRUGMAN: Well spoken, Dean. But let’s make this empirical for a second: Looking at the data, we see that we live in a closed Excel spreadsheet. There are no apples flowing into or out of our hands or our children’s hands. That’s why David Brooks doesn’t understand debt.

He thinks of debt’s role in the economy as if it were the same as what debt means for an individual: there’s a lot of apples you have to pay to someone else. But that’s all wrong; the debt our government creates is basically apples we owe to ourselves, and the burden it imposes does not involve a real transfer of resources.

That’s not to say that high debt can’t cause problems — it certainly can, if our politician were to do something silly like impose a tax that weren’t lump sum (can you imagine?!?). But these are problems of distribution and incentives, not the burden of debt as is commonly understood. And as Dean says, talking about leaving a burden to our children is especially nonsensical; what we are leaving behind is promises that some of our children will pay apples to other children, which is a very different kettle of fish.

DAVID BROOKS: You are such a Keynesian scumb–

PAUL KRUGMAN: Please, let me continue. I can see you’re still not getting this. Instead of dealing with a hypothetical example, consider our own history: Remember what happened on the previous tab in this Excel workbook? When our Excel table had that big war with the 9-period orange growers who lived in a different Excel table? Our government emerged from that war with debt exceeding 200 apples; because there was almost no way to move fruit between tables at the time, essentially all that apple debt was owned by people who lived in our table, people like Christy and Dave and Eddy.

Now, here’s the question: did that debt directly make the whole table poorer? More specifically, did it force the table as a whole to have less apple consumption than it would have if the debt hadn’t existed?

The answer, clearly, is no. Yes, some taxpayers in the table had to pay the interest on that debt. But who received that interest? Other taxpayers. Not exactly the same people, of course — maybe Frank had to pay George. But the table was not like a home buyer who has to scrimp to find enough apples to make his mortgage payments; the table was both the borrower and the lender, and was essentially paying apples to itself.

DAVID BROOKS: Huh, I never thought of it like that. And I watch the History channel a lot, where they have documentary after documentary about those evil orange pickers and the big war we had with them. I guess I see what you mean about the Excel table just owing apples to itself collectively…But still, I can’t help worry about us burdening our descendants by passing down a gigantic debt burden that they will have to service.

PAUL KRUGMAN: Look, don’t beat yourself up; we can’t all be trained economists. Try thinking of it like this: Suppose that for some reason the Excel table temporarily ends up being ruled by a guy who is driven mad by power, and decrees that everyone will have to wear their underwear on the outside (sorry, Woody Allen reference) everyone will receive a large allotment of newly printed government bonds, adding up to 500 percent of GDP–that’s 1000 apples, a fantastic sum.

The government is now deeply in debt — but the Excel table has not directly gotten any poorer: the public, in its role as taxpayers, now owes 500 percent of GDP, but the public, in its role as investors, now owns new assets equal to 500 percent of GDP. It’s a wash.

So where’s the problem? Well, to pay interest on that debt, the government will have to raise a lot more apple revenue. Again, this is a wash — the extra apple revenue is matched by the extra apple income people receive as bondholders. Now it’s true, if we imagined some crazy hypothetical world where the politicians implemented taxes that varied based on behavior, then high debt might make the whole Excel table poorer. But fortunately in the real world, we just have lump sum taxes, so this isn’t an issue. Our real GDP–how many apples we produce collectively per period–won’t be affected by this alleged “debt burden” that’s got you so worried will hurt our kids.

DAVID BROOKS: Gosh, I admit you make a lot of sense, but I feel like I’m being hoodwinked. Surely this plan is going to foist a huge debt burden on our descendants. I mean, it has to!

MATT YGLESIAS: Dr. Krugman, sometimes you’re too tied to your academic models. Let me try a different approach on this guy; I know how pundits who have no formal training in economics think. OK Mr. Brooks, Dr. Krugman is correct to argue that so long as government debt is held within our Excel table, then it doesn’t create a “burden” on the table in the sense of draining it of apples. I think the point can maybe be more clearly made in reverse. If a few generations down the road–let’s say in period 7–George and Hank are furious at us for passing on this alleged “burden,” then they can enrich themselves at that time by telling the politician to default on the debt. Will that work?

DAVID BROOKS: Well, no! It won’t, because whoever was supposed to get paid–either George, Hank, or both–will lose out as bondholders! Ha, nice try, Yglesias.

MATT YGLESIAS: (sighs) I can see you’re not a philosopher. You’re correct to point out that it won’t enrich them if the government defaults. But that just shows why your worries are unfounded. A government borrowing apples from its own citizens doesn’t gain access to any orchards that wouldn’t have been available by just raising taxes, and by the same token an Excel table doesn’t enrich itself by its government refusing to make promised apple payments to its own citizens. It’s only when borrowing from or repaying foreigners from other tables that our table as a whole is gaining or losing access to fruit. None of which is to say that debt dynamics are a matter of indifference. Obviously people care quite a lot about which specific people possess the apples. But it’s bad weather or locusts that can immiserate the next generation, not the prospect of the next generation’s taxpayers transferring apples to the next generation’s bondholders.

DAVID BROOKS: I admit, I can’t really put my finger on what’s wrong with your guys’ argument, but to be honest I never really trusted you Keynesians who think we just need to bake some more apple pies for prosperity. I’m going to turn to this guy over here, a trusted Austrian who isn’t afraid to write books on politically incorrect stuff.

BOB MURPHY: You know it’s ironic, Mr. Brooks, normally I can’t stand what these three knuckleheads say about government policy. But in this instance, I think they are technically correct. Although I’m against this deficit spending plan because I don’t think it’s fair that anybody down the road gets hit with an involuntary tax on his apple crop, even so I have to admit that the scheme won’t make our descendants on net poorer. Some grandkids might be poorer because of the tax bill, but–like these guys have been saying–those apples will just go right into the mouths of other grandkids. I mean really, it’s not like we have a time machine, for crying out loud! We can’t literally take apples away from our descendants and eat them today. Every period, no matter what we do, there are 200 apples produced and consumed. All the government down the road will ever be able to do to our descendants is rob one to enrich the other; it can’t make them all collectively poorer than they otherwise would have been. It’s not like we’re dumping chemicals in the soil that will reduce apple output in period 3 or something. It is physically impossible for us to affect what happens to the people collectively in period 9, because we know that no matter what, the two of them will eat 200 apples total. If one person eats fewer because of taxes to service the debt, then necessarily the other person will eat more apples.

Don’t misunderstand me: In a hypothetical world where we could cut back on our apple consumption today, in order to plant more apple trees and raise total apple output in (say) period 5, then this immoral scheme would also objectively make our descendants poorer. But in the real world, where we have no such growth in real output, this isn’t an issue.

DAVID BROOKS: You spend time thinking about hypothetical worlds where apple output increases over the time periods?

BOB MURPHY: Once you start thinking about apple crop growth, it’s hard to think about anything else.

DAVID BROOKS: Well, I guess that’s that. If the Keynesians and Austrians agr–

DON BOUDREAUX & NICK ROWE: Stop!! This is all totally wrong!! Buchanan showed us why!! There was nothing wrong with your initial reaction, Mr. Brooks! Think of the great-great-grandchildren!!

BOB MURPHY: (puzzled, grimaces, shouts for joy) Yeah! Holy smokes! They’re right! Sorry Mr. Brooks, I was totally wrong. It is possible for our generation to impoverish future ones. Wow this is really neat! Let me walk you through a diagrammatic explanation

DAVID BROOKS: OK now it’s back to being the free-market guys against the Keynesians. I need a tie breaker. What about you, Professor Landsburg? You’ve always struck me as a pro-market guy who’s still a straightshooter.

STEVE LANDSBURG: Krugman has been saying a lot of good stuff on this. I’m sorry Mr. Brooks, but if you ask me what I think of your fears about a debt “burden” I have to tell you that I think they are idiotic. My only quibble with Krugman is that he’s wrong to focus on whether the government bonds are held by Eddy, Frank, etc. Even if the government in period 9 had to ship apples over to a different Excel table, our descendants wouldn’t be burdened by the IOUs floating around at that time. They would essentially be apples they owed to themselves.

DAVID BROOKS: Well that last line makes absolutely no sense to me, but I know you academics like to be deliberately provocative. But OK, you side with Krugman. So you’re saying that these other guys are wrong?

STEVE LANDSBURG: Look, you’re putting me in an awkward position. I’m friends with those guys. But yeah, I mean Boudreaux likes to go read verbal stuff, instead of thinking it through with precise models, and Nick Rowe is a Canadian, so there ya go.

DAVID BROOKS: And this Murphy character?

STEVE LANDSBURG: He’s a nice guy.

DAVID BROOKS: But when it comes to his dispute with Krugman on whether the government debt can be a burden on future generations, do you think Murphy is making intelligent points?

STEVE LANDSBURG: (pause) Bob makes really funny videos.

DAVID BROOKS: Well, I guess that does it. Go ahead, Mr. Politician, let ‘er rip! A round of 3 apples, for all the old timers! And 100% interest income, for all the young people!

CROWD: Woo hoo! Yeah!

After the decision to give the Old Als 3 apples as a transfer payment, paid for by running a government deficit, events unfold in the following manner:

DAVID BROOKS: (stunned) What the–what the heck just happened?!

BOB MURPHY: Perhaps I can be of assistance. First of all, remember that all of us have the same utility function of U=sqrt(A1)+sqrt(A2). If we had all just consumed our endowments, we would all have 20 utils during our lifetimes (square root of 100 plus square root of 100), with the exception of Old Al and Young John who would only have utility of 10 because they live only one period. Now if you check the math, you can see that Al, Bob, Christy, Dave, and Eddy all have more than 20 utils with their actual consumption patterns, while Frank, George, Hank, Iris, and John all have fewer than 20 utils with their actual consumption patterns. Just like Boudreaux, Rowe, and I were saying, government deficits allow the earlier generations to benefit at the expense of subsequent generations.

DAVID BROOKS: (turns to Landsburg, furious) You lied to me!!

LANDSBURG: What the heck are you talking about? Dude, you need to calm down. Try having some more sex, we’ll all thank you for it.

DAVID BROOKS: You told me our debt wouldn’t impose a burden on our descendants. You told me to trust Krugman!

LANDSBURG: Right, the debt didn’t impose a burden. In fact, it helped our descendants.

DAVID BROOKS: What the heck are you talking about?!!?!

LANDSBURG: You’re even thicker than I thought. Check the numbers. Look, take period 7, where Young Hank lends 10 apples to the government. You’re getting hung up on the fact that with his consumption stream of (90, 105), Hank now only gets 19.7 utils over his life, as opposed to the endowment 20. So you’re blaming his loss of welfare on the debt. But no, his reduction in utility is stemming from the tax the government levies on him in period 8. Suppose Hank didn’t engage in a bond deal with the government, and instead just consumed his after-tax endowment each period. He would then consume (100, 85), yielding utility of 19.2. So contrary to your silly assertion, government debt makes Hank better off. It’s the tax that hurt him. Duh.

DAVID BROOKS: But the reason Hank is being taxed in period 8 is to service the government debt!! The government in our Excel table doesn’t tax for any other reason except to service/retire the debt that our generation initially created by giving a transfer to Old Al. So the debt causes the taxes levied on future generations!

LANDSBURG: Whoa, whoa, whoa. I can tolerate a lot of things, but I won’t stand idly by while someone impugns debt finance. You better take that back, mister. Debt didn’t force the government to levy taxes on those people. Rather, it was the fact that the first five people wanted to all increase their utils. Since we started out in a Pareto optimal allocation of apple consumption paths, obviously when Old Al and Young Bob both improved their lifetime utilities, you had to know people down the road were going to take the hit. Haven’t you ever heard the expression, “There ain’t no such thing as free applesauce”?

DAVID BROOKS: (lip quivering) But…but…Krugman and all those guys led me to believe that it wouldn’t hurt our descendants!

LANDSBURG: You didn’t think levying taxes on people in the future would hurt them? And you call yourself a pundit?

DAVID BROOKS: Well I knew it would hurt some of our great-grandkids, but I thought the government would just take apples from one great-grandkid and give them to another.

LANDSBURG: Right, it did. Don’t you understand how our world works?

DAVID BROOKS: But I mean, I thought it would be a wash, as far as our great-grandkids collectively were concerned. I mean, Yglesias’ thing about the government defaulting, and it just being a wash…

LANDSBURG: Right, it would be a wash if the government had defaulted, say, in period 6. That act would hurt some people but help others, but wouldn’t make society richer or poorer on net.

DAVID BROOKS: Agghh! I’m going crazy here! So how did we end up making Frank through John worse off?! If we had defaulted, and you’re saying it’s a wash…?

LANDSBURG: Oh, I see what’s tripping you up. If the government had defaulted in period 6, it would have been a wash relative to the new scenario where Frank through John already had less utility. Once Al through Eddy had lived and died, and had each achieved more utility than 20, it was obvious that somebody from Frank through John would take a hit. But government tax and bond payment policies could redistribute the hit. For example, if the government had defaulted in period 6 and then levied no taxes, then Frank alone would have taken the full hit. Al through Eddy would have benefited, Frank would have gotten crushed, and George through John would have been unaffected (each consuming 100 apples per period). So Yglesias was right, defaulting on the government’s debt in a particular period can’t make society richer–if it did, then we’d all make side deals with each other and default! Duh. Seriously, you call yourself a pundit?

DAVID BROOKS: (tears welling up in his eyes) But…but…all the stuff about “apple output in any future period is always 200″… If the government takes an apple from one person, it can only give it to someone else…

LANDSBURG: Right, that’s all true. Why is this so hard for you? Look: You guys wanted to give Old Al 3 apples. Somebody had to get taxed to pay for it. You could have taxed the Young Bobs, but chose not to. Instead, you taxed Frank through John, and then the bond market brought that revenue forward (after discounting of course) by getting loans from young people. It’s not the debt per se that made your descendants poorer, it was the government’s decision to tax them instead of taxing the Young Bobs.

DAVID BROOKS: But all of that stuff they were saying about not shipping apples to other Excel tables…

LANDSBURG: Hey! I told you upfront that that was silly. But other than that non sequitur, everything else those Keynesians told you was perfectly true.

DAVID BROOKS: Well, right, now that you mention it, I do remember you saying that their focus on keeping the apples within the Excel table–in the hands of our descendants–was irrelevant. But it’s not like it was a casual aside of their case; they based their whole argument on that “insight” which you said was wrong. And by making me focus on physical apples, they convinced me that it was literally impossible for us to enrich ourselves at the expense of people in, say, period 9, because we only had 200 apples today, and no matter what, Iris and John were going to split up 200 apples then.

LANDSBURG: Hang on a second. Do you honestly mean to tell me you weren’t aware of how debt financing and overlapping generations work? You haven’t read Samuelson’s paper on Social Security?! And now you’re mad at Krugman and me, for not pointing this out to you before? Gee whiz, do you want us to lay your clothes out too in the mornings? You’re dumber than I thought. Maybe you shouldn’t be having more sex.

DAVID BROOKS: (hanging head in shame, cannot withstand Landsburg’s withering criticism any longer and turns to another, inebriated economist) What do you think?

GENE CALLAHAN: Yeah, Steve is right, and Murphy has just been saying one goofy thing after another. Look, we could have achieved the same outcome in terms of everybody’s utils, without using deficit finance at all. Instead, the government could have taxed Young Bobs 3 apples in period 1, then it could have taxed the Young Christys 6 apples in period 2, and so on. So none of this debate was really about whether we could impoverish our great-grandkids; of course we can! The issue has always been, is the debt the thing to blame. What conversation have you been in?

DAVID BROOKS: HUH?!? You’re telling me I missed the whole point of this debate?! The very thing I was worried would happen–that if we didn’t tax the Young Bobs in period 1, but instead paid for the transfer with a deficit, we would foist that burden onto our descendants–is exactly what happened! And I let Dean Baker and all those guys convince me I was stupid!

STEVE LANDSBURG: (aside) You are.

DAVID BROOKS: (turns to a grad student) OK, maybe a younger guy can help me out here. My head is spinning at this point.

DANIEL KUEHN: Well, I’m not really sure why you were surprised by the outcome. Didn’t Krugman let you know that this could happen? I mean, when he said “talking about leaving a burden to our children is especially nonsensical; what we are leaving behind is promises that some of our children will pay apples to other children,” how could that not have tipped you off that the above scenario was possible?

This is the cost and the benefit that Murphy was talking about – costs and benefits on individual children, if you add up their whole lifetime income. But within each period you don’t have a transfer of resources.

Isn’t this the Krugman position? Winners and losers but no additional burden on any particular future time period? If you look at future income levels, that remains unchanged. If you look at individuals in the future, obviously some of them win and some of them lose – but that’s what Krugman said, from the very beginning, was “a different kettle of fish”.

DAVID BROOKS: (entire body is now shaking) How in the world are you describing what just happened?! Looking at the individuals from period 6 onward, it’s not true that “obviously some of them win and some of them lose.” THEY ALL LOST. Every single person who lived from period 6 onward was worse off, because of what we set in motion in period 1. No matter what those poor saps did, we and the next few generations had ensured that they collectively were going to be poorer than if we had just paid for Old Bob’s apples with a tax. And the way the government decided to handle this collective burden, in practice it wasn’t just that some of our descendants (like George and Iris) were worse off, but that others (like Hank and John) counterbalanced it by being better off. No, they were ALL hurt in this scenario. And yet Krugman et al. had convinced me that such an outcome was physically impossible.

DANIEL KUEHN: Ah, the problem here is that you’re mixing up terminology. Krugman has established, quite correctly, that the government in our world could make specific individuals in the future poorer, but not that it could make the country as a whole poorer in the future.

DAVID BROOKS: (pauses for several moments, as saliva begins to hang from his lower lip) Daniel, the country as a whole was poorer from periods 6 through 9.

DANIEL KUEHN: (sighs) No it wasn’t. What was national income in period 6?

DAVID BROOKS: Huh?

DANIEL KUEHN: In terms of apples, what was the sum of everybody’s income in period 6?

DAVID BROOKS: 200.

DANIEL KUEHN: Right. And if you guys in period 1 hadn’t started your deficit scheme, what would national income have been in period 6?

DAVID BROOKS: (reluctantly) 200.

DANIEL KUEHN: Uh-huh. See what I mean? Krugman et al. were totally right–you guys in Period 1 didn’t make the nation poorer in period 6 or 7 or whatever. That’s physically impossible; national income in every period is always 200 apples.

DAVID BROOKS: But…but…even so, every single person from period 6 onward was made poorer by this whole thing.

DANIEL KUEHN: Yep, just like Krugman told you could happen.

DAVID BROOKS: (beginning to sob) No he didn’t Daniel… I, I, I don’t even understand what is happening at this point. I need to sit down. (sits in chair)

DANIEL KUEHN: There, there. The problem is, you keep switching in mid-argument between “the nation” and “people in the nation.” Sure, specific descendants at any future date could have been hurt by you guys in period 1, but not your descendants considered as a collective.

DAVID BROOKS: So, just to be clear: You agree with me that Krugman and the other Keynesians were telling me that the nation as a whole couldn’t be made poorer in periods 6 through 9. You agree with me, that they said that was impossible?

DANIEL KUEHN: Yep.

DAVID BROOKS: (breathes a sigh of relief) OK, good, because Landsburg really had me doubting my sanity there for a moment. So–and I realize I have to do this in baby steps because this stuff is so hard for me to get–you agree with me, that Krugman misled me by claiming that the nation as a whole couldn’t be made poorer in periods 6 through 9.

DANIEL KUEHN: No! What the heck is wrong with you? Krugman is right! The nation can’t be made poorer in periods 6 through 9!! National income is 200 apples, with or without debt. C’mon man, I’ve got a wife to entertain. I can’t be here all day.

DAVID BROOKS: (resumes sobbing) But Daniel, how can it be that Frank, George, Hank, Iris, and John were all made poorer? I just can’t understand how all this is possible. (blows nose)

DANIEL KUEHN: I told you before: You’re confusing the nation with the individuals making up the nation.

DAVID BROOKS: So when Krugman convinced me that it was physically impossible to make the “nation as a whole” poorer from periods 6 through 9, I was wrong to infer that it was physically impossible to make every single member of the nation poorer from periods 6 through 9?

DANIEL KUEHN: (shocked) Yeah, what the heck would make you infer that? When Krugman told you that the “nation as a whole” would have the same income from periods 6 through 9, you didn’t realize that this outcome was consistent with “every single person alive” in periods 6 through 9 being poorer? You honestly thought “the nation as a whole in period 6″ was the same thing as “every person alive in period 6″? Boy Landsburg called it–you’re not too quick on the uptake, are you?

David Brooks throws a noose around a ceiling rafter. Then he stands on the chair.

DANIEL KUEHN: Hey! Get down from there. This is subtle stuff. Don’t be so hard on yourself.

DAVID BROOKS: (relents and steps down from chair) Yeah, I guess you’re right. I mean, if smart guys like Nick Rowe and Murphy could disagree with Krugman on this stuff, I shouldn’t be disappointed that I kept getting confused.

DANIEL KUEHN: Huh? What disagreement? Krugman, Rowe, and Murphy have all been saying the same thing all along.

DAVID BROOKS: (screaming) Aggggghhhhhhhh!!!!

Scene ends with Brooks in a straitjacket, being loaded into an ambulance while muttering about economists and apples. Ambulance driver turns and says to Brooks, “Sounds like a confusing story. Hey, wanna see something reeeaaaally confusing…?”

Screen shifts to a sharp man with a cigarette. He begins to speak. “Picture a world, where people only eat apples. A man consults alleged experts on government deficits, and is taken on a journey that ultimately shatters his mind–a journey that ends, in the Economist Zone.”

Spooky theme music begins playing as screen fades out.

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BONUS FEATURES
Interview With the Director

When I first wrote the above, it was mostly intended to be humorous. However, even the act of writing it has shed new insights for me on this fiendishly subtle controversy.

Let me just say that what has happened here isn’t that “these guys were right” or “these guys were wrong.” The amazing thing is that–if we forgive people for slips of the tongue and missteps that don’t hurt their overall position–every viewpoint I’ve incorporated above, had a germ of validity. And yet, as I tried to show with the exasperated “David Brooks,” it seemed that these economists were contradicting each other.

If I were still a college professor, I would honestly invent a course just to have an excuse to play with that OLG model for hours on end, introducing more features like investment in future trees, altruism between generations, private bond markets, etc. I am still in slight shock from the possibilities that this debate has brought to my attention.

Let me close with one observation, just to make sure all of you understand why I think this is such a big deal: Krugman et al. can correctly argue that today’s deficit financing can’t reduce the sum of individual incomes earned in the years 2013, 2014, 2015…until the end of time, subject to all the caveats about incentive effects and so forth. And yet, James Buchanan et al. can correctly argue that today’s deficit financing can reduce the (after-tax) incomes earned by every individual who is alive in the years 2013, 2014, 2015…until the end of time. At first glance it seems that one of these camps must be wrong, but actually they are both right. But because those statements appear to be contradictory, people on both sides have been quite sure that the other guys were idiots or liars.

UPDATE: I just double checked my intuition on something, and yep it works. So let me report it, since it really helps in tying all of this together and getting a handle on what the #%)(#)($* happened in the numerical example above. Recall that I have Steve Landsburg in the script saying that the government in period 1 is giving Old Al 3 apples, and that it could have either taxed Young Bob at the time, or taxed future people. Now the thing is, the interest rate on government bonds in this world is 100%. So if the government wants to tax somebody 86 apples in period 6, for example, then in period 1 that future tax revenue only has a present-discounted value of about 2.69 apples. (That’s 86*(1/2)^5.) If you go through and calculate the PDV of the future tax levies from the perspective of period 1–discounting by 100% per time period–you will see that the future levies add up exactly to 3 apples. So the words I put in Landsburg’s mouth are totally correct, and that’s a very useful way to think about it, in my opinion. The overlapping generations and bond markets allow the present generation to fund transfer payments out of taxes that won’t be imposed for hundreds of years!

123 Responses to “The Economist Zone”

  1. Brian Shelley says:

    This post was a little Major_Freedom-ish in length.

    However, I agree with you now. Some generation henceforth will get screwed by piling up debt. Krugman, et al. are only right under the condition that the interest rate does not exceed the growth rate. Their view is effectively a ponzi scheme.

    • Major_Freedom says:

      “This post was a little Major_Freedom-ish in length.”

      I was wondering why I liked it so much.

      LOL, I like you Brian, you’re cool.

      Seems I have a signature. Want to here a long story about what I think about that? Yeah, me neither.

  2. Daniel Kuehn says:

    This is really awesome.

    I’m not sure everyone gets what I’ve been saying, but it’s quite obvious from this that you do. That’ll do, I suppose.

    Your last paragraph is exactly right, I think – and Nick made a very important contribution very early on to distinguish all those contributions and say that all of them had something to say. I do wish he gave Abba Lerner more credit in that initial post. After all – the “we owe it to ourselves” dynamic is exactly how we push those costs on individuals into the future (a la Buchanan). The only way we can do that with debt is be creating benefits for others.

    That is not a trivial point. The man on the street sees the national debt as only a liability. It’s not only a liability. And the Buchanan point simply can’t be made without the generation of these assets – the point that Lerner, Krugman, and Baker are trying to draw attention too.

    So your last paragraph here and Nick’s post are very important – there’s a lot to take in and a lot of important contributions to this discussion.

    • Greg Ransom says:

      “The man on the street sees the national debt as only a liability.”

      Bologna. They know the debt is funding the fat retirement of government workers, retiring, e.g. in California, at age 50.

      And they know the money would otherwise be spent by them on their own families.

      • Daniel Kuehn says:

        Right… that’s part of what the funds raised are spent on (they’re also spent on a lot of other things voters want).

        But I think you’re missing the wider point of what I mean by “debt is an asset”, Greg

        • Greg Ransom says:

          I don’t miss the point.

          And part of the Keynes/Krugman fallacy is the fallacy that we can total up expenditures on investment goods in a pile of “K” and we don’t have to look at what is produced.

          When the government “invests” in “green” production facilities which produce goods which are not-economically viable, and production must be halted, production goods must be disposed of, and the factory and machinary which has been built must be decommisssioned or dumped, what you are talking about is economic destruction, not economic production.

          Billions spent on a bullet trains from on tiny town to another tiny town in central California is counted as an increase in the size of “K” according to Keynesian/Krugman accounting rules.

          According to the economic way of thinking, the production of goods is not the production of value.

          But Keynes and Krugman have regressed to a Ricardian / substance theory of value, where increases in the stock “K” based on what has been shifted t into “K” from a stock of goods given a “given” value the past is accounted as an increase in value.

          • Daniel Kuehn says:

            Sorry Greg – I’d respond if I knew what the hell you’re talking about. Now you’re just inventing things about people.

            • Matt Tanous says:

              Aggregation misses very important details, whether it is the “capital stock black box” of the Knightian and Chicago viewpoint or the Keynesian GDP aggregates.

  3. Christopher says:

    Great post indeed. I think there is not much more to be said.

    There is only one thing I don’t understand and if you have the time I would appreciete if some of you guys could explain it. Why doesn’t it matter whether the debt is held internally or externally. One oberservation was “The nation can’t be made poorer in periods 6 through 9!! National income is 200 apples, with or without debt.”
    To me it seems that this is only true if the bonds are held internally. Am I wrong? I read Landsburg’s post but I just don’t get it. Help me out here!

    • Brian Shelley says:

      Who said it didn’t matter whether it was internal or external? I thought it was generally agreed that external debt did matter.

    • Bob Murphy says:

      Christopher I’m not totally sure myself. But for example, it is still true that even if the government in period 7 owed outsiders 50 apples as a bond payment, the national income in period 7 would still be 200 apples. Your income doesn’t change because you owe money to somebody, but your consumption could.

      However, I don’t know if that’s the whole resolution of it or not. You would certainly think that if the government in period 1 paid Old Al 3 apples that it borrowed from abroad, so that Young Bob didn’t need to reduce period 1 consumption, then the first generation would gain even more, meaning the later ones would have to lose even more.

      So yeah, I’m not sure exactly how Landsburg’s “we owe it to ourselves no matter what” point works. I think he is holding everything else fixed, whereas you and I are automatically allowing at least one thing to change because people have more to work with upfront if they borrow from abroad.

      • JKH says:

        Regarding debt held by foreigners, there’s an easy explanation in terms of Nick’s model (which should translate to yours). The burden outcome is no different than the base case where the bonds are held domestically:

        Tax Case:

        At maturity of the bond, foreigners receive apples in exchange for debt.

        Domestic taxpayers pay the apple tax that pays down the bond.

        So the domestic taxpayer and generation is down apples.

        The domestic taxpayer bears the burden by virtue of being part of the generation alive at the time of the bond pay down, notwithstanding zero involvement with bonds.

        And the domestic taxpayer is entirely representative of the relevant (domestic) generational burden, notwithstanding zero involvement with bonds.

        No Tax Case:

        Then the domestic taxpayer and generation is neutral. He never bought the bonds in the first place, and he doesn’t need any more apples from any source to keep his position square.

        So there is no burden.

        And the foreigner either sells the bonds to his next generation, or rolls them as in your model. Either way, because he bought the bonds earlier, or rolled them earlier, the foreign sector generation experiences a net neutral apple outcome. Any in any event, the foreign sector internal experience is not defined as part of the relevant (domestic) generational problem.

      • JKH says:

        I’ll refer to Nick’s model again, because I’m not entirely familiar with your numbers yet (although the model looks fine, excellent, and brilliant, to this observer).

        So the basic logic of Nick’s model is that there’s a required asymmetry of generational apple flows at the front and back ends. The key to understanding the difference between the domestic and foreign held bond scenarios is that although the net asymmetry is the same, the gross construction of the net is different.

        First, the domestic case:

        At the very front end of Nick’s model, the asymmetry results from the fact that the first cohort exchanges bonds for apples with the second cohort. The actual up front bond issue itself has no net apple effect, because apples paid for bonds are also distributed back as a transfer.

        At the very back end of Nick’s model, the asymmetry results from the fact that the final cohort (the one that is taxed) exchanged apples for bonds with the penultimate cohort. The actual bond maturity cum tax itself has no net apple effect, because apples paid for taxes are used to pay down the bond.

        Intermediate cohorts who buy or roll bonds at the beginning of their periods must buy or roll them prior to death, in order to “hedge” their lifetime apple positions back to square, in respect of government debt effects.

        (My sense is that Krugman, in believing in the “we owe it to ourselves” meme as a generalization, has missed the point about the sporadic appearance of asymmetry.)

        Now, the foreign case:

        At the very front end of Nick’s model, the asymmetry has nothing to do with bonds. It is entirely due to the distribution of apples as a transfer. Compared to the domestic case, the asymmetry is the result of one half of the upfront government transaction (the transfer but not the bond issue), rather than the selling of bonds at the end (the domestic source of asymmetry). The other half of the government transaction (the bond issue), combined with the selling of the bonds at the end, has a net neutral apple effect on the foreign sector and doesn’t even touch the domestic sector. So the resulting net asymmetry is the same as the domestic case, but comes about in a different way.

        Finally, a similar variation occurs at the back end of Nick’s model in the foreign case. The domestic sector generation is not involved in the bonds at all. But it ends up net down apples because it must pay the tax. It’s the same asymmetry as the domestic case, but a different way of getting there.

        The full case, domestic and foreign, is laid out here:

        http://worthwhile.typepad.com/worthwhile_canadian_initi/2012/01/the-30-years-debt-burden-non-war.html?cid=6a00d83451688169e20162fef52c26970d#comment-6a00d83451688169e20162fef52c26970d

    • Oliver says:

      Debt is always held internally (i.e. in the respective country’s banking system), but possibly by people/institutions who reside abroad and/or who hold foreign passports. The proceeds of the debt (interest payments and eventually, upon maturity, principle) can also only be spent internally. You cannot spend Swiss Francs in China. The only important question is: will they be spent at all? And, if so, what will they be spent on? The debt itself, on the other hand, is innocuous.

  4. vik says:

    It’s weird how this whole storm in a tea-pot totally misses the one truly salient point re. Govt debt- viz
    1) Agency Hazard- if Govt’s aren’t utterly faithful agents of their principal- the taxpayers- Landsburg’s argument falls immediately.
    2) With Rational Expectations, no Uncertainty, zero transaction costs- the Govt is always a single instantaneously fulfilled market transaction away from zero debt because it can sell its future revenue streams. What makes Govt debt, like any other debt, interesting is if it higher or lower than anticipated- i.e. some risk or information was overlooked. In this case, debt does mean the same thing for the nation, the company’s shareholder, and the individual agent- viz. cut back on entitlements and, so to speak, have a call up of partly paid shares. There is no fallacy of composition here and no need for OLG modelling.
    3) Ricardian Equivalence is built on assumptions which allow agents with Rational Expectations- applying if need be a Shutzian ideal-type Rational Choice hermeneutics- such as to evolve the ‘Verstehen’ (or common sense!) to form coalitions which internally agree to neutralize uncertainty arising from Govt transfer/tax policies. Assume universal risk aversion and such a coalition- which essentially boycotts the Govt bond market and undoes any transfers it otherwise effects- will come to dominate by compensating people not to deal with the Govt or applying a sanction of some sort.
    4) Public finance is a very valuable piece of Social Capital. Debauching it might be the very worst thing we can do.
    Landsburg says ‘The greatest damage one generation can inflict on the next is to consume everything in sight, and this is always possible without deficit finance.’
    This is not true. Deficit finance can lead to hyperinflation, the collapse of the market for Govt bonds, collapse of confidence in the regime, the rise of extremist political parties, War, Genocide, Slavery.
    Lansburg thinks the only way we can fuck up our grand-kids is if we eat up all the non renewable resources and let all capital goods depreciate away to nothingness. But, countries which have been invaded and denuded of all productive capacity and natural resources can still bounce back if they inherit Institutions with a reputation for, or even new found dedication to, thrift, transparency, zero agency hazard etc.
    Indeed, under plausible assumptions and assuming factor mobility, they may well stand taller than the rest- as happened to West Germany- within a relatively short time.

  5. vimothy says:

    Epic!

  6. vimothy says:

    Bob,

    If I were still a college professor, I would honestly invent a course just to have an excuse to play with that OLG model for hours on end

    I think that course might already exist…

    • Daniel Kuehn says:

      Seriously – that sounds like my macro course at GW, which I thought was something of a waste until now.

      That’s not entirely fair – the first half was OLG, the second half was endogenous growth, and I do like the endogenous growth stuff.

    • Bob Murphy says:

      vimothy, no you are misunderstanding me. I’m not saying I would be the first to invent a course studying OLG models. I’m saying I would invent a course that would let me play with these models for hours on end, and be “working.” No such course yet exists.

      • Daniel Kuehn says:

        I don’t imagine that’s one the Mises Institute will go for, huh?

        • Major_Freedom says:

          I thought

          “I’m saying I would invent a course that would let me play with these models for hours on end, and be “working.”

          was what it was all about at the LvMI. I mean just look at how much fun they’re having.

          • Daniel Kuehn says:

            True – I’m just not sure they’d go for such a mainstream neoclassical method as OLG.

            However, Bob’s quite good at translating this stuff into Austrian economics. If anyone could pull it off, he could.

            • Major_Freedom says:

              You could be his devil’s advocate TA.

      • vimothy says:

        Bob, Got ya.

        Maybe you can get the govt borrow some money, then use it pay you to teach youself a course on macro.

        After all, in the future, since assets = liabilities, the debt will be a wash and no one is any the worse off. And since you are strictly better off, this is a Pareto improvement.

        In fact, I expect Krugman and Baker will want to write a couple of op-eds demanding that it be made to happen.

  7. Major_Freedom says:

    “Krugman et al. can correctly argue that today’s deficit financing can’t reduce the sum of individual incomes earned in the years 2013, 2014, 2015…until the end of time, subject to all the caveats about incentive effects and so forth. And yet, James Buchanan et al. can correctly argue that today’s deficit financing can reduce the (after-tax) incomes earned by every individual who is alive in the years 2013, 2014, 2015…until the end of time.”

    The fact that “individual incomes” means “individual nominal incomes”, I think is enough to say Krugman et al are making a moot point.

    After all, the purchasing power of nominal incomes isn’t fixed, so who cares if people are making equal collective nominal incomes relative to some counterfactual world that while having the same nominal incomes, it has higher real incomes because people lent to an entity that produces and earns money to pay back its debt (thus increasing purchasing power of money) instead, as opposed to an entity that has to force a game of nominal income redistribution and net asset destruction on others in order to make good on their debt?

    If the government just printed money to pay back all its debt instead of taxing people, Krugman would probably say

    “We can do better than only “a wash” for future generations. We could increase the sum of individual incomes! So not only would there be no net loss to our future generations, there would be a net gain to future generations as well! [Political group I want to refute] can never win, because even if they succeed in decreasing taxes, I can get my desired increased sum of individual incomes another way, by “reluctantly” supporting central bank policy, i.e. inflation.”

    Since apples are being used for both consumption and “payment”, and so the difference between consumer goods production on the one hand, and money production on the other, becomes harder to disentangle.

    • Bob Murphy says:

      MF wrote:

      The fact that “individual incomes” means “individual nominal incomes”, I think is enough to say Krugman et al are making a moot point

      No, Major Freedom, that’s why I’m spending some much time with this simplistic apple world. We are talking about real income; we’re counting how many apples are produced.

      This isn’t a nominal/real thing. It’s a “adding up the real incomes earned in 2012 by everybody alive” versus “adding up the real incomes earned by everybody who is alive in 2012.” At first glance those seem interchangeable, but they’re not. The only thing that is hilarious to me is that Daniel Kuehn was shocked that people are missing that distinction.

      • Major_Freedom says:

        No, Major Freedom, that’s why I’m spending some much time with this simplistic apple world. We are talking about real income; we’re counting how many apples are produced.

        Are you sure Krugman wasn’t talking about nominal incomes when he said “we owe it to ourselves”? Isn’t the “it” the money being taxed and being given to bondholders, and not pizzas and Toyotas?

        You even said way before that the debt “burden” was the taxation, which is money, and not the fact that you have fewer pizzas and Toyotas.

        Maybe since you used apples in your example, and abstracted away from money, we lost an important aspect of Krugman’s argument?

        “This isn’t a nominal/real thing. It’s a “adding up the real incomes earned in 2012 by everybody alive” versus “adding up the real incomes earned by everybody who is alive in 2012.” At first glance those seem interchangeable, but they’re not. The only thing that is hilarious to me is that Daniel Kuehn was shocked that people are missing that distinction.”

        I mean, Krugman said in his original post about “we owe it to ourselves” here:

        http://krugman.blogs.nytimes.com/2011/12/28/debt-is-mostly-money-we-owe-to-ourselves/

        That

        “What you can see here is that there has been a big rise in debt, with a much smaller move into net debtor status for America as a whole; for the most part, the extra debt is money we owe to ourselves.

        and then

        “People think of debt’s role in the economy as if it were the same as what debt means for an individual: there’s a lot of money you have to pay to someone else. But that’s all wrong; the debt we create is basically money we owe to ourselves, and the burden it imposes does not involve a real transfer of resources.”

        and then

        “That’s not to say that high debt can’t cause problems — it certainly can. But these are problems of distribution and incentives, not the burden of debt as is commonly understood. And as Dean says, talking about leaving a burden to our children is especially nonsensical; what we are leaving behind is promises that some of our children will pay money to other children, which is a very different kettle of fish.”

        He is saying that what is “owed to ourselves” is the money, not the real goods, i.e. real income.

        I love your OLG models and everything, but Krugman was in fact talking about total nominal incomes, not real incomes.

        • Major_Freedom says:

          Just to throw this out there, maybe this means we have to take Krugman’s statements and approach them in a whole new way.

          Maybe we should grant that Krugman is right as far as money goes, both cross sectionally and generationally over time, but then say that because more government borrowing and spending in money reduces economic productivity in real terms, on the basis that it sacrifices private lending and investment according to profit and loss, for the “benefit” of more government spending, which means total production must decline (imagine the government borrowing from the entire pool of the market’s savings and then spending it to get a clearer picture), and when total production declines due to government borrowing, we leave less real capital wealth for our children to utilize for their production and consumption needs. Sort of like eating the seed corn.

          Nominally speaking, it can be a wash for future generations, or it can be a loss, or it can be a gain, depending on total nominal spending and incomes.

          In real terms however, our children lose on net no matter what, no matter how much money is printed, taxed, borrowed, spent, or transferred by government (remember that guys? Austrians? Anyone?), because there is less capital invested according to profit and loss calculations than otherwise would have existed.

          So maybe the problem with government debt is that it forever eliminates the alternative world possibility of that loan money going to some more productive use, like lending to a producer who does not tax or print money to backstop its debt obligations.

      • Daniel Kuehn says:

        re: “The only thing that is hilarious to me is that Daniel Kuehn was shocked that people are missing that distinction.”

        No that’s not shocking to me. It’s precisely because it’s so easy to confuse the points that I think things like Krugman’s Op-Ed are so important to put out there.

  8. skylien says:

    Legen … wait for it … dary!

    I already had an idea of how you may solve this but was not sure. I mean I saw in your earlier example that if G had taxed Iris and John in period 9 each 50 apples then both were worse off, you might stretch this over several generations.. Anyway this shows that if the debt needs to be paid off because the debt level is too high all might suffer over several time periods and the reason this is possible is because generations are necessarily overlapping… The problematic issue due to the democratic process that allows for this borrowing in the first place gets even bigger..

    The only question that remains is how an economist then can fault the man on the street for saying: “Debt will burden future generations” ? It’s like faulting someone for saying “Holding a finger within candle’s fire will burn it” with “No that’s wrong. It doesn’t harm your toe.”…

    • Bob Murphy says:

      skylien thanks. Right, I go back to my original analogy where the layman says, “That guy killed people with a gun!” and Landsburg says, “You idiot, he did it with bullets. People need to stop thinking guns can be deadly weapons, they obviously can’t. Guns are neither necessary nor sufficient for hurting people.”

      • Chris says:

        Maybe that’s the reason that most Libertarians are opposed to Anti-Gun Laws ;)

  9. Ivan Ivanov says:

    I just wanted to join in the singing high praises for you Dr. Murphy.
    This post shows you at your best as an economist, comedian and playwright.

  10. Beefcake the Mighty says:

    Gene Callahan is [not the smartest guy in my opinion.--Edited by RPM]

    • Joseph Fetz says:

      Real slick, Bob. LOL

  11. Anonymouse says:

    If I may attempt to summarize what we have learned:

    Time periods do not overlap, but generations do. Therefore, while it is NOT possible to transfer wealth between time periods, it IS possible to transfer wealth between generations. For that reason, earlier generations CAN impoverish later ones.

    The End

    • Daniel Kuehn says:

      True.

      But we experience life in time periods, in relation to other people in that same time period.

      That seems significant too, don’t you think?

      That doesn’t mean “don’t worry about who gets hurt by debt”. Nobody has said “don’t worry about who gets hurt by debt”. So we should stop pretending anyone has said that.

      • Major_Freedom says:

        I would say not as significant as you probably think.

        After all, wealth production, exchange, and income are all temporal concepts. They necessarily take place over time, sometimes, perhaps oftentimes, decades or more for the total production cycle to take place.

        Because of that fact alone, we cannot possibly abstract away from the “earlier generations CAN impoverish later ones” context, in order to focus on the “but we experience life in time periods, in relation to other people in that same time period” context.

        It would be like claiming you can abstract away from time in order to explain how the economy works. Oops, isn’t that what Keynesians do? [Ducks and runs away quickly before being pelted with eggs].

        • Daniel Kuehn says:

          re: “Because of that fact alone, we cannot possibly abstract away from the “earlier generations CAN impoverish later ones” context, in order to focus on the “but we experience life in time periods, in relation to other people in that same time period” context.”

          Right.

          Nobody is asking you to abstract away from that.

          • Major_Freedom says:

            What is the significance then of “But we experience life in time periods, in relation to other people in that same time period” that ““earlier generations CAN impoverish later ones” cannot explain, or does not explain well, or masks/hides?

            • Daniel Kuehn says:

              Earlier generations can impoverish later ones through debt obviously doesn’t carry with it the implication that earlier periods can’t impoverish later periods through debt (although the OLG model here can show BOTH points).

              My point, Major Freedom, is that one does not have to abandon the first point to make the second.

              Why would one want to abandon the first point to make the second point?

              You act as if we have to choose between the conclusions.

              We don’t. Both are right.

              • Major_Freedom says:

                This time, THIS TIME, I am actually very laid back, so my questions aren’t rhetorical / agenda driven / jabs, you know how like they usually are.

                “Earlier generations can impoverish later ones through debt obviously doesn’t carry with it the implication that earlier periods can’t impoverish later periods through debt (although the OLG model here can show BOTH points).”

                I hope you can understand why I asked what I asked, if I were to next respond and say that I don’t see how “periods” can be impoverished that is apart from people, and hence “generations” by implication, being impoverished. I mean, the two stage generation model Murphy laid out was, I think, to separate young non-tax-paying people, and old tax-paying people, or young tax-paying people, and old non-tax-paying people.

                I’m seriously really trying to disentangle the differences between periods and generations, because I’m one of those morons who is having trouble differentiating between the two.

                I mean in my mind I can’t even conceive how cross sectional time periods, APART from generations would work. Yes, I know the given argument, which is that generational differences are between young and old, and time period differences are cross sectional slices over time, but I just can’t think how the latter can make sense by anything other than through the generational understanding.

                I mean, even for an individual, when you think of them, you must think of them over time, and when you do that, you’re immediately taking into account an older version of them, and the current, newer version of them.

                The OLG model is simplified, so it can’t elucidate the fact that when we say “new generations are burdened by previous generations”, all we are really saying, in my mind at least, is:

                “The future is going to be worse than it otherwise could have been had certain variable(s) in question been different.”

                This future can include the person making this statement, or it can exclude them, but all else equal, saying the above statement NOW, the future for everyone is going to be worse than it otherwise could have been had we did things differently.”

                Maybe economics can allow us to say that a person “voluntarily” lending money to the government is a priori worse off, FOR THEM and for EVERYONE ELSE, because they have just encouraged/obligated a violent agency to unleash indiscriminate confiscation of wealth which can include the person who originally lent to it, and if not the person who lent to it, then certainly others.

                Suppose I just take $100 from you. Is it really possible for me to say that I gained and you lost, and that there is no “collective” loss or gain? I would say there IS a collective loss. I would say that I lost and that you lost. You lost because I took your money. I lost because I lost what I could have traded with you had you been able to utilize that $100 for yourself, improving yourself in some way thus making you stand in a better trading position vis a vis myself. I mean, imagine if you were starving, and that $100 was your only meal ticket. If I took that money from you, I potentially sacrifice a lifetime of internet squabbles.

                So back to your point then, I don’t see how in one “time period”, which is supposed to be a zero time cross sectional abstraction from reality that always moves forward, it is possible that wealth redistribution can ever lead to a net zero “collective” loss. I think the mere presence of the violent redistribution generates losses for everyone, including those who gain what others have lost.

                What people miss, I think, is that even though some gained what others have lost cross sectionally, those who gained actually incurred a loss of what they otherwise could have gotten from others had they not been sacrificed but approached peacefully.

                I think that’s why humans decided to engage in peaceful productive activity in the first place. If no gains could be made in this way, compared to straight up redistribution like the lower animals, we would have never started to do it.

                So maybe we’re missing a huge elephant in the middle of the room by saying there is no net loss to everyone in a world where some people are robbed to pay others. Maybe everyone loses, we just can’t see it because it’s a counterfactual, so we instead get sucked into focusing only on the OBSERVABLE “gain” and “loss”, and believe it can only be a wash collectively.

                The more I think about this, the more I doubt the entire premises Krugman you and you are depending on when you make your arguments. I just seems like you’re ignoring the benefits of free trade for all people, and how reducing free trade incurs an unobservable cost on everyone, that can ONLY be understood.

              • Anonymouse says:

                “…earlier periods can’t impoverish later periods through debt…”

                It is true that, in a simple consumption-based model, earlier periods can not impoverish later ones.

                However, in the real world – where debt can alter the absolute amount, proportion, and direction of investment – earlier periods CAN impoverish later ones.

      • Anonymouse says:

        “True. But we experience life in time periods, in relation to other people in that same time period. That seems significant too, don’t you think?”

        Yes, but I think the main point anti-debt people are trying to make is that it’s unethical for one generation to benefit at the expense of another. Talk of time periods has been used to obfuscate rather than shed light on this fundamental issue.

    • Yancey Ward says:

      Time periods do overlap just as surely as generations do. If you fall for the sleight of hand in trying to ignore this, you will overlook certain aspects of this problem. Instances in time are what don’t overlap.

      • Anonymouse says:

        I have to disagree. Period A (2000 – 2010) and period B (2005 – 2015) do not exist simultaneously for five years. They SHARE the same five-year period. Real time is singular and does not overlap with itself.

        • Yancey Ward says:

          Not sure what we disagree about. A time period is a mental construct. It can be for the past, for the future, or it can contain the instant in time in which it was formed. However, time periods can overlap in a construct, or may not, but if they do not, then they share nothing.

  12. John G. says:

    Neat, creative approach, the screenplay, Doc. And it was helpful and enlightening. Thanks for your efforts!

  13. Nick Rowe says:

    Excellent Bob!

  14. Sealander says:

    Bob: This made all the hours of lost productivity from reading these collective debt blog posts worth it. Thank you.

  15. Nick Rowe says:

    Bob: we need a slogan

    Economics is about:

    “PEOPLE, not GDP!”

    maybe.

    “PEOPLE, not time periods!”

    Dunno.

    • Major_Freedom says:

      Mises already beat you guys to it.

      “HUMAN action is purposeful behavior.” – pg 1, chapter 1, paragraph 1, sentence 1, “Human Action, A Treatise on Economics.”

    • Silas Barta says:

      “PEOPLE, not GDP!*”

      *NGDP is okay though.

      • Major_Freedom says:

        Even when unemployment rises and impoverishment rises, NGDP is all that matters, ergo NGDP is the most efficient target. QED.

  16. Greg Ransom says:

    Take a look at this image of how retirement pay is progressively swallowing almost all of the state of Illinois education budget, as the state begins to fund an ever increasing part of its budget with borrowing / debt:

    http://wp.patheos.com.s3.amazonaws.com/blogs/theanchoress/files/2012/01/ILEducationSpendingHigherEduc.jpg

    Not to worry! We just owe it to ourselves!

    • Yancey Ward says:

      Well, of course! Why should we be drawing distinctions between those drawing benefits and those paying them. They are all Americans, and they are all human beings.

    • Edwin Herdman says:

      Illinois needs to balance its budget, but then again Illinois is not fiscally sovereign.

  17. Scott says:

    Ha, ha! That was great!

    I finally understood why there won’t be 0% interest in this particular world, even with no economic growth — because people’s productivity/consumption doesn’t fall when they get old, or for any reason at all. Sorry, I was having a hard time subjectively relating to them. This world is too weird for me to relate to, I suppose. But if, say, old Al was too sick to pick apples, you might have told the other guys that they might want to hold such a bond so that they could redeem it if they ever got sick like he did, and could keep their utils up.

    And if every character’s output fell by 1/4 or so in their ‘old’ phase (as with real people), then the bond scheme would have some utility for them and wouldn’t blow up over time due to interest. But you’d still have to tax somebody someday to pay for it….

    Anyway, really great! I was just being brain-dead. I think I agree with you now.

    • Bob Murphy says:

      Scott: For the people who are never taxed in either period, there has to be positive interest rate in this particular example, because to do something like (99, 101) would make the person worse off. Since there’s diminishing marginal utility in each period (that’s why I used sqrt), if you are going to give up some of your consumption in period1, you need to be offered more than 0% interest to compensate.

      • vik says:

        Why is there no subsistence lower bound in this economy? Since apples can’t be stored anyone producing more than subsistence is stupid. Your table crashes immediately. Al can lend apples to the Govt to get back them same apples. Otherwise nothing happens in this model.
        The insight for you to carry away is that if the Govt tries to achieve a policy objective by using a policy instrument predicated on agents being less rational or having a smaller information set, then even a small perturbation in agents information or intertemporal pref. will lead to a totally unintended consequence such that the policy instrument has to be abandoned.

        • c8to says:

          more apples, like more sex, might be more fun, no?

          you are scrooge mcduck then sitting on your millions saved but never consuming extra?

  18. Yancey Ward says:

    I am sorry, but Krugman making the distinction about external vs internal debt demonstrates that he didn’t really understand what he was writing in the initial blog post, so even if I credit Kuehn for actually understanding this (I don’t- his arguments in defense of Krugman have changed constantly over the last week, too, as Murphy has methodically cornered him).

    If you are going to make the argument that the debt is a wash because some apples/money are owed to other people in a future time period, then why draw any distinction at all between national borders? If the debt is a wash, then it must be a wash regardless of where beneficiaries/burden-bearers live, right? It shouldn’t matter that Americans on net might be worse off in the future since the world on net still has the same income (all else being equal), or if it does matter, as Krugman suggested right at the beginning (otherwise, why would he offer it as a caveat?), then making the argument that “we owe it to ourselves” was always a non sequitur that he never expected to get called out on. Seriously, an individual is to a national entity, as the national entity is to the entire world.

    What is really good about this last example of Murphy’s is that it clearly shows that it is possible for nearly every single person alive at some point in the future to be made worse off as the burden of the transfers gets recognized and finally liquidated, meaning that beyond that point, future people again become indifferent to what happened in the past.

    • Daniel Kuehn says:

      I’ve only changed one position, and that’s that I’m prepared to give Dean Baker more credit than I did initially (I haven’t come out with this outright because I’m still chewing on it).

      Otherwise nothing has changed. As different issues come up I’ve focused on those different issues. And once things got real specific about what costs they were referring to it was clear to see what the disconnect was.

      But if you’re going to claim that my defenses have “changed constantly” I’d appreciate it if you produce some evidence. The focus of the argument has changed somewhat with the introduction of the OLG models… that’s about it.

      Until I gave up on it yesterday, you kept trying to get me to defend something I’ve never defended. So I’m not quite sure you’ve got the firmest grasp on what my defenses or arguments have been.

      • Yancey Ward says:

        Daniel,

        You have moved from the position that the the problem in the future is one of distribution of resources to one where the outcome cannot be rectified by redistribution. It was good that Murphy got you to acknowledge that single, important fact. This goes to the heart of what Krugman was trying to imply in that original blog post- that in the case of internally held debt, the “owing it to ourselves” means that the burden is one for the future selves to correct, or not, as they see fit, because it only was a matter of distribution (that is what he meant by “different kettle of fish”).

        You wrote the following last week on your own website:

        There is no burden on future generations in Bob’s example.

        You eventually tried to back out of this position by trying to focus on “Iris” in that example as an individual rather than as a placeholder for a generational cohort in his OLG model. Is or isn’t Iris a future generation in this model, and do you acknowledge, now, that she bears a burden in the future in this same model? Do you acknowledge that Iris cannot ever be made whole in period 9 in the future without making some contemporary, or future person worse off in this same model?

        I realize you are trying desperately to group the collective at any point in time as net neutral (this is certainly what Krugman was doing right from the start), but that is an assumption built into Murphy’s and Rowe’s model, and it is illegitimate for you to try to use this assumption as proof that you and Krugman understood and agreed with Murphy all along. You clearly didn’t since you did write that quote I cited above.

        Let me try this another way since it has been difficult to get a straight answer out of you- if it really is just net neutral over the entire collective at a point in time, then shouldn’t it be possible to make Iris’s consumption over her lifetime 200 apples without harming any other person? And if you agree that it is not possible (something you did agree to yesterday) then of what matter of importance is the claim that “we just owe it to ourselves”? Everyone before her was happy to overconsume, but are now dead, and everyone after her is going to be indifferent if she and her generation is left holding the bill.

        Krugman’s initial statement was a massive non sequitur and is the cause of the blog war the last week. If he really did hold the position that you now claim he did, why did he muck it up so royally? I assert he mucked it up because he didn’t understand what he wrote and why it was wrong.

        • Daniel Kuehn says:

          re: “You wrote the following last week on your own website:

          There is no burden on future generations in Bob’s example.

          You eventually tried to back out of this position by trying to focus on “Iris” in that example as an individual rather than as a placeholder for a generational cohort in his OLG model.”

          I didn’t change my position here – this was when we were sorting out exactly what people meant when they were using the word “future generation”. I no more changed my position than Bob did – we just all agreed to use Bob’s terminology more or less.

          I made my point back then conditional on how we were defining things.

          re: “I realize you are trying desperately to group the collective at any point in time as net neutral (this is certainly what Krugman was doing right from the start), but that is an assumption built into Murphy’s and Rowe’s model, and it is illegitimate for you to try to use this assumption as proof that you and Krugman understood and agreed with Murphy all along.”

          First, there’s nothing “desperate” about what I’ve been doing and I’d appreciate it if you don’t talk about me like that. Second – what I’ve been saying is that the models don’t provide the counterargument to Krugman that they think they do. If they want to actually move away from the assumption of an endowment economy that’s great. I encouraged that too in fact (although I’m not doing all that work personally). But they can’t pretend they’ve contradicted point when they haven’t.

          re: “Let me try this another way since it has been difficult to get a straight answer out of you”

          I’ve provided nothing but straight answers Yancy. I’m really getting sick of these insinuations from you.

          • Yancey Ward says:

            Daniel,

            You still didn’t answer the questions. This is why I make the insinuations I have made. Does Iris represent a future generation/s? Can she be made whole without transferring the burden to her contemporaries, or her future generations? If you agree that she cannot be made whole, do you now agree that the debts incurred today, all else being equal, do represent the present and past overconsuming at the expense of future generations?

            These aren’t hard questions, Daniel, and yet, when pushed to answer them you consistently fall back to trying to pretend there is great honest debate about what is meant by “future generation”. There really isn’t any debate about that you, yourself, is trying to create by, I now think, by deliberately trying to aggregate future people’s inappropriately.

            What you are trying to do would be exactly would be equivalent to someone trying to claim that income disparity in March 2012 is going to be meaningless since, on aggregate, the country’s income is the same whether it is skewed or if everyone had identical incomes. You would surely not agree with that, would you? Yet Krugman was trying to imply something equivalent about debts in the future, internally held.

  19. JP Koning says:

    Bob, thanks for all the commentary on this. It’s been interesting.

    I’ve learnt that the method by which one aggregates individuals into groups, and the labels that one attaches to such groups, can have an important influence on a debate’s ability to reach resolution. If people are aggregating differently, and using non-standard words for their categories, then the debate will degenerate into shouting matches.

    I’ve also learnt that future cohorts can indeed by made poorer by present cohorts who borrow to finance consumption.

  20. Bob Murphy says:

    Thanks for the kudos everyone. I don’t want to admit how much time I spent over the weekend getting this ready. (Also, for those who are curious, I had that Excel table already constructed when I made my wager to Daniel Kuehn in an earlier post. But the young whippersnapper didn’t step into it.)

    Also, just to be clear, I don’t think Krugman, Baker, and Yglesias realized future generations of people (not time periods) could be made poorer in this fashion. In fact, if they did know that and still wrote their columns/posts the way they did, I would think they were bad guys. But no, since I didn’t think it was possible until reading Nick Rowe’s stuff on this, I am giving them the benefit of the doubt.

    • Daniel Kuehn says:

      I’ve got to confess I’m somewhat confused about the concern with the ordering of the burdened future generations (ie – cohesive sets of individuals who live across multiple periods with other similarly coherent sets of individuals who live across slightly different periods).

      I didn’t think about this until your example either – whether after a certain period every generation carries a lifetime burden or not.

      My question is – why does this matter? Who cares if the burden comes after a couple generations that benefit or before? Or perhaps the burden and benefit are alternating. What is the significance of this observation? What’s the value added on top of the fact that we know somebody in the future is going to be burdened?

      Also – I like the exposition of the Landsburg position here. I hadn’t been paying attention to that front quite as closely (in fact its impressive that you’ve been juggling three or four fronts). That was a good summary. I’m not sure Landsburg’s point is as crazy as “guns don’t kill people – bullets do”. It’s an important point, particularly once you take Samuelson into account and you realize you don’t necessarily have to have any taxes at all (ANOTHER THING that laymen could be reminded of by a gifted NY Times blogger who deserves our support in his public education efforts).

      • skylien says:

        ” Who cares if the burden comes after a couple generations that benefit or before?”

        Just read the exchange between the crowd and the politician again. It is because those future generations cannot “Boo!” today.

        • Major_Freedom says:

          “It is because those future generations cannot “Boo!” today.”

          Maybe they can, and that’s what was keeping Keynes up at night.

  21. Bob Murphy says:

    Hey everybody, I updated the main post with this interesting twist. I had it in the original version implicitly, but I want to make sure you see how cool this is:

    UPDATE: I just double checked my intuition on something, and yep it works. So let me report it, since it really helps in tying all of this together and getting a handle on what the #%)(#)($* happened in the numerical example above. Recall that I have Steve Landsburg in the script saying that the government in period 1 is giving Old Al 3 apples, and that it could have either taxed Young Bob at the time, or taxed future people. Now the thing is, the interest rate on government bonds in this world is 100%. So if the government wants to tax somebody 86 apples in period 6, for example, then in period 1 that future tax revenue only has a present-discounted value of about 2.69 apples. (That’s 86*(1/2)^5.) If you go through and calculate the PDV of the future tax levies from the perspective of period 1–discounting by 100% per time period–you will see that the future levies add up exactly to 3 apples. So the words I put in Landsburg’s mouth are totally correct, and that’s a very useful way to think about it, in my opinion. The overlapping generations and bond markets allow the present generation to fund transfer payments out of taxes that won’t be imposed for hundreds of years!

    • Major_Freedom says:

      Maybe I am being pedantic here (don’t laugh!), but if an agency ONLY financed its operations through voluntary borrowing, say for 100 years, then is it really accurate to even call this agency a government in the first place? Why wouldn’t it just a Bernie Madoff Ponzi scheme, the only difference is that Bernie Madoff also imposes his own laws on the rest of society?

      I think an agency that does not tax cannot possibly considered a “government” agency.

      All the example comes down to, if there is only voluntary lending to finance the agency, is this question:

      “Does Bernie Madoff burden future generations because of his Ponzi financing activities themselves, or does it depend on the future outcomes of how exactly the cash flows will be “distributed”?”

      Now, Landsburg can shoot back and say “I’m assuming perfect foresight and everyone knows what’s going on”, but there is no way that’s a realistic assumption, and we’re trying to explain the real world after all.

      I would hope that most people would say of course Madoff is burdening the future just by virtue of him borrowing from new borrowers and doing nothing with the money except paying back old borrowers. The burdened future is going to be on everyone, but not because of potential future financing activities and money flows, but rather because the future will have been deprived of the real output from legitimately productive activity that could have been made since the start. I think this important point was totally glossed over in the whole debate.

      I mean, it would be silly to say that lenders in the Madoff scenario are gaining utility solely by virtue of lending to him, and that Madoff can only reduce total output by how he finances his operations in the future. The total utility includes lenders being paid back plus interest. Not everyone can be paid back plus interest, so nominally, it’s a net loss. In real terms, we can say that even if everyone did get paid back, because Madoff either printed what he needed, or he taxed those OUTSIDE the scheme, it would STILL be a net loss to everyone, because no matter how much new money and no matter how the new cash flows differ in the future, the future has ALREADY been deprived of the real wealth that could have been had, if the lenders lent their money to a legitimately productive agency, and not a Ponzi scheme.

      If this is an “unrealistic” assumption, then just ask yourself how many people today, in the real world, voluntarily lend to an agency they know to be doing nothing except borrowing from new lenders and paying back old lenders. Only a total moron would voluntarily give money to this agency. That is why it is, I think inaccurate, to abstract away from taxation until only a distant future time period. The loss is had the moment the scheme started. People lend to the government because they know the government WILL get the money from someone, or some thing, if they have to. That initial agreement to lend, then, is crystalizing a future of taxation and nominal loss, as well as a future guaranteed real loss that is had by virtue of NOT lending money to a productive entity that doesn’t back it’s debt by taxation.

      Imagine if everyone lent money to ONLY taxing entities. What would happen to the future economy? I hope people can see that even if people “voluntarily” lent to them, the future is still a guaranteed loss compared to what could have been produced had people only lent to productive agencies. Well, what’s true for many taxing entities is also true in principle for one taxing entity as well. It’s a net real loss AS SOON AS the lending takes place.

      • vik says:

        Absolutely! This model doesn’t have Rational Expectations built in. Okay, if you give the Govt an informational edge, they can take advantage of ‘fiscal illusion’ , BUT they can themselves be gamed so this policy tool never hits its policy objective. If the Govt is rational it abandons it. If it is irrational- then okay- but a story about stupid people and irrational Govts isn’t the sort of story that yields anything for Econ. It’s just Vaudeville.

        • Major_Freedom says:

          Actually vik, I am saying that it is wrong to even think that one could have rational expectations built in, because rational expectations is itself untenable. It requires everyone to have the same information set and the same model of the economy.

          I think that’s impossible in the real world.

          • vik says:

            Quite agree. But it is also the case in the real world that when the Govt tries to take advantage of information asymmetry or adaptive expectations then it misses its policy targets and has to abandon the policy instrument..
            Landsburg was saying something silly- viz debt don’t matter if its Govt debt- vide http://socioproctology.blogspot.com/2012/01/landsburg-getting-it-wrong-about-public.html- but Bob isn’t helping matters with his Excel table.
            The real issue here is that us guys are the White hats- we KNOW that populist ‘eat the rich’ redistribution will seriously fuck up not just our kids but everybody’s kids- but some real intelligent guys are being real sloppy in presenting the case. It’s like they think our shared Reality is supervenient on silly toy Universe models which were exploded before I was born by Muth and so on.

            • Major_Freedom says:

              Well if Murphy started and stayed with Austrian concepts, it would more than likely go over the heads of those he’s debating with.

              It’s kind of like the Team USA basketball team taking it easy on Team Japan, because if they played according to their vision for how the game is supposed to be played, there wouldn’t even be a game and everyone would go home, and we’d be out of an otherwise entertaining game.

              But yeah, once you start insisting on realistic assumptions, we’d kind of become compelled to consider reality itself, which is what confused people in the first place such that there is a debate about it now.

              If you ask me, the more I think about this, the more I am coming to think that what I said here:

              http://consultingbyrpm.com/blog/2012/01/the-economist-zone.html#comment-31117

              and here:

              http://consultingbyrpm.com/blog/2012/01/the-economist-zone.html#comment-31135

              is the one half of the universe where the true answers reside.

              I think Murphy’s conclusions follow from his model, but a model is only as good as its assumptions, and I just don’t see the government waiting any more time than immediately after it is established before it starts to tax people, and because money is fungible, it is impossible to delineate tax money and borrowed money such that we can say “taxes were raised to pay back debt.”

              I think the OLG example is not even an example of government in the first place. It’s just a Ponzi scheme.

              I don’t anyone who exposes a Ponzi scheme is wrong to say “this is wasting resources and making the future worse off than it otherwise would have been” until some indefinite point in the future where the scheme is financed by taxation, after which people say “OK, before I wasn’t sure, but because this scheme was financed voluntarily. But because the latest round of dividends was financed by taxes, it generated losses to everyone/some that otherwise would have been gains to everyone/some.

              Yes, the models given STIPULATE that everyone knows what’s going on, and agrees to it, but like you said, it’s just not a realistic assumption to make.

            • Edwin Herdman says:

              What is this “the Govt” that “tries to take advantage of information asymmetry” you speak of?

              Oh, individual politicians we should vote out?

              Carry on, then!

      • Major_Freedom says:

        It’s like the law of opportunity costs applied to Ponzi / government debt. The more the Ponzi / government borrows and spends, the more alternative choices that have to be given up, choices that include lending to a legitimately productive entity that could have cured cancer, or lending to a consumer who could have bought a new house, after which they had enough real wealth that freed them up to choose previously submarginal wants, like saving a larger portion of their income that goes to curing cancer, or whatever.

        Other than some folks here, almost everyone are either ignoring opportunity costs, or assuming them away, and are trying to find gains and losses and net gains and net losses in a one-dimensional history.

        Murphy is the only one who even provided a hint at a systematic treatment of opportunity costs with his “No government activity” alternative chart. Almost everyone else are stuck in comparing observable consumption over time, instead of what could have otherwise been produced and consumed over time.

    • Rob says:

      “The overlapping generations and bond markets allow the present generation to fund transfer payments out of taxes that won’t be imposed for hundreds of years!”

      Won’t issuing govt bonds alone potentially allow you to do this even if you don’t have OLG in the model?

    • vik says:

      You clearly think your model abstracts from some feature of the real world. What is that feature?
      Apples are perishable and no asset other than bonds exists. Okay. There’s a subsistence lower bound beyond which there are diminishing returns- okay. The Govt can enforce debts better than agents can- okay. There’s a precautionary demand for bonds because people have ‘fiscal illusion’- okay.
      Clearly, if apple production is at a level past aggregate satiation- their price is zero and redistribution meaningless.
      Given your assumptions you can show something which looks like ‘bond market allows the present generation to fund transfer payments out of taxes that won’t be imposed for hundreds of years!’
      But that it isn’t what you’ve shown. The Govt has introduced a new Economic good- viz insurance against starvation or, more mildly, the possibility of saving- and so, naturally, the ppf has shifted and what was Pareto optimal aint so any more.
      On the assumption that the Govt is more creditworthy (believable) it earns a rent- a sort of siegneurage- and so there’s a surplus to be distributed.
      But that surplus aint apples- its apples and the oranges of having hedged a future risk.
      So all you are really proving is that even a false sense of security gained by sacrificing apples now for the promise of apples later – even that is an economic good.
      Big surprise?
      I think not.
      Why do you think what you are up to is meaningful? And, BTW why not do the thing Game Theoretically and get ESS results which can be tested or grant insights otherwise out of our ken?

    • Ralph Musgrave says:

      Bob, Why do you make assumptions that are totally unconnected with the real world? Take the 100% interest rate assumption: the ACTUAL yield in government bonds in the US and UK (i.e. after taking inflation into account) is very near zero – actually negative in the case of the UK. So why not just assume a 0% interest rate? It cuts out a VAST amount of hot air.

      As to the idea that oldies sell bonds to youngsters (one of Nick’s initial assumptions) neither you nor any of the other contributors to this debate seem to be the slightest bit interested in whether this ACTUALLY HAPPENS in the real world. Well it DOES happen to some extent, in that pensions sell bonds to fund their retirement, while younger people buy them to build up their pension pots.

      And having accepted that the above mentioned phenomenon actually occurs in the real world, how about asking to what extent that REAL WORLD phenomenon is influenced by a rise in government debt? That’s what I do here under the heading “pensions”:

      http://ralphanomics.blogspot.com/2012/01/is-national-debt-is-not-normally-burden.html

      If you don’t make realistic assumptions, you just make academia look like a waste of time and money, which to a significant extent is what it is.

    • Oliver says:

      The overlapping generations and bond markets allow the present generation to fund transfer payments out of taxes that won’t be imposed for hundreds of years!

      Why not write:

      the OLG and bond markets allow any generation to fund transfer payments out of taxes that won’t ever be imposed, because in the real world there is no beginning and no end. The real world isn’t a model. Any beginning scenario is hypothetical and in any realistic end scenario presumably has lots of bombs, people in uniforms and scary political propaganda to distract from petty apple problems. Debt never gets paid down in aggregate.

      • Bob Murphy says:

        Oliver, you don’t think you and I are currently being taxed to service the government’s debt?

        • Oliver says:

          Probably, but all the while new debt is being created, either privately or by government. Either that or GDP, and thus output of apples, as in the original Nick Rowe model, is shrinking – which violates his assumptions. On the whole I’d say, the higher the IOU to gdp ratio (and that includes all kinds of IOUs like government debt, government money, bank credit, shadow bank credit, and all bets on the prior), the more fragile the system becomes. The more ficititious claims for every real asset , the more disruptive changes in behaviour will become. What I don’t see is the specific transmission that purpotedly makes government debt the boogey man among all these. If anything, government can be trusted to be the last man standing because it’s highest up the ranks of the liability pyramid. That, and the fact that government debt/gdp is peanuts in comparison to derivatives/gdp, for example.

        • Oliver says:

          Having said that, I’m no longer sure a large amount of outstanding liabilities is necessarily a bad thing. It would seem to represent societal inter-connectedness more than anthing else. But then again, too much inter-connectedness might be what’s cause the current generation to forget to make real things for fear of losing out on claims on real things they hope will be made by future generations. There’s too much hedging and not enough innovation and real risk taking going on. And then there are those who think that when government takes on more risk in an attempt to fill the gap, things must neccessarily go wrong. Theyse people are not being helpful in any way.

          Hope that makes at least some sense, but it’s becoming peripheral to the post, so I’ll leave it at that.

        • Oliver says:

          And, having said all that, and having slept over it for a night, it’s dawned upon me (pardon the pun) what you and Nick have been trying to get at with our model all along. At least I think I now understand.

          In your example, the logic of debt results in unequal and uncontrolable distribution of consumption within and between your stylised generations.

          To get this result, you have had to make (completely over the top, unrealistic) assumptions concerning:
          - interest rates (level, variabilty & control over)
          - the ability to freely trade debt during time periods
          - to bequeathe debt to ones offspring
          - offsetting effects of taxation
          - offsetting effects of government investment
          - growth
          - and probably many others

          Would the shown effect still be measurable if you relaxed any one of these assumptions?

          And what alternative would you suggest, assuming that some form of intergenerational social transfers must be upheld?

          • Bob Murphy says:

            Oliver, Krugman et al. made all those assumptions. They were trying to show that in such a hypothetical world, debt would impose no burden whatsoever on our descendants in any way. Little pieces of paper we handed down to future governments wouldn’t be able to make our grandkids poorer on net, it could just enrich some while burdening others.

            They were wrong in a very subtle way, so that’s why I used this model.

            Sure, if you start adding in some other stuff, that might mask the effect. But the effect is still there, and Krugman was still totally wrong to say (quoting Baker) “the idea of burdening our children with debt is especially nonsensical” (paraphrasing).

            I’m not saying he was stupid; I myself would have been a strong advocate of the view that in this simple world, the people living in period 8 could not possibly be affected by anything the people living in period 1 did. And yet we see that in a very important sense, they can be.

            • MamMoTh says:

              Krugman is not wrong, as Gene and others have clearly shown.

              You should really give up playing with toy unrealistic models of nothing, and do something useful with you life.

              Future generations need cold fusion, not blogs.

  22. Rob says:

    So here’s my stupid question of the day.

    At first I thought that all this model proved was that tax was always bad, A very simple model where the govt taxes the youngers of every generation 3 apples to give to the old makes everyone worse off over their lifetime.

    But only if olders have an endowment of 100 apples. If they have an endowment of 0 when old, then any tax from yuoungers to them will increase everyone’s lifetime utility. Intergenerational socialism seems to be a good thing in OLG models. Have I gone wrong somewhere ?

    • Nick Rowe says:

      Rob: No, you haven’t gone wrong anywhere. Yours is an extreme example of the Samuelson 1958 case. The real interest rate is strongly negative in your model (everyone wants to lend, even if they have to pay someone to borrow from them). So the equilibrium real interest rate will be less than the growth rate of the economy. So a Ponzi scheme is sustainable. The government could borrow at negative interest, and never have to increase taxes (as long as the economy lasts forever).

      • Rob says:

        So for Austrians this model has got to be suspect, right ?

        They would deny that it is possible to measure the utility lost by the younger generation through tax against the utility gained by the older generation from the transfer (even if they will eventually be the older generation themselves).

        • Nick Rowe says:

          Rob: all generations could gain. It could be voluntary. It’s debatable whether or not you would need government. All you need is some purely fiduciary asset. Bits of paper, or shells, or metal, will do. Samuelson called it “money”, but that is debatable.

          • Rob says:

            So you would have apple-coupons and the young would sell apples to the old for coupons that they would then save for their own old age ?

            How would the coupons get into the system in the first place without govt action?

            • Nick Rowe says:

              They were just lying around on the beach. Or people were wearing them as jewelry. The physical form doesn’t matter, as long as they are durable, and not easily reproduced. Land works fine. So do shiny stones.

              • Rob says:

                Ok suppose they were shells.

                Why would the young have a reason to start accepting them from the old in the first place, ? Why would the first transaction take place , when at that point the young person would have no reason to value the shell as something he could eventually trade back into apples ?

            • vimothy says:

              Hey Rob, Didn’t Carl Menger have something to say about that? ;-)

              • Nick Rowe says:

                Rob: maybe just a very slight preference got the ball rolling. The stones were pretty.

                Yep. Menger and Von Mises kick in here. Strategic complementarity, and regression theory of money.

              • Rob says:

                The simplified version of Menger’s story is that commodity’s like gold that has high marketability eventually became used money, so things moved organically from barter to money.

                My question was why in an apple-endowment economy would money emerge ? But I guess that a fairly pedantic issue given that its just a model.

      • Major_Freedom says:

        “So a Ponzi scheme is sustainable.”

        That statement will be Rowe’s inadvertent nemesis, haha

    • Major_Freedom says:

      Why will an endowment of 100 for the old lead to a gain for them on the basis that the young are taxed, but an endowment of 0 for the old will not lead to a gain for them on the same basis?

      Are you saying going from 100 to 160 apples doesn’t increase their utility, but going from 0 to 60 apples does?

      Are you making a declining marginal utility of income type argument?

  23. vik says:

    ‘Now the thing is, the interest rate on government bonds in this world is 100%’ – doesn’t matter the yield on them will still depend on the real interest rate determined by intertemporal preferences.
    Essentially, all you’re saying is Govt can think its going to redistribute in a certain way but cant guarantee that outcome coz bonds are tradeable.
    But, if this borrow/tax mix doesn’t hit redistribution targets- why would the Govf want to stick with it? You haven’t proved what you think. All you’ve said is the Govt can, administer an exogenous shock based on it’s not being constrained to Rationality.

  24. vimothy says:

    But only if olders have an endowment of 100 apples. If they have an endowment of 0 when old, then any tax from yuoungers to them will increase everyone’s lifetime utility. Intergenerational socialism seems to be a good thing in OLG models. Have I gone wrong somewhere ?

    Nope, you are correct.

    It’s easy to see that you could set up a model with the same intertemporal preferences as Bob’s above, where every generation earns its entire lifetime income when young (say); then having the govt transfer from the young generation to the old could be a pareto improvement.

    • Ivan Ivanov says:

      Isn’t that only true if you assume people are too dumb to save on their own?

      • vimothy says:

        Could be–or you could assume that no saving asset exists, and so on.

        • Nick Rowe says:

          Yep. But almost anything could serve as a savings vehicle in this case, as long as it is reasonably durable and not easily reproducible. Shiny stones would work fine.

          • vimothy says:

            What I think you’re saying is (intrinsically worthless) “money” could be that asset. So say that there is no money and consumption goods last for one period. Then…

            • vimothy says:

              BTW, Nick: are you pleased with your “30 days blog-war over the debt”? Seems to be still going pretty strong here!

              • Nick Rowe says:

                Yep. This post is the capstone of the whole debate.

                I’m a little disappointed PK hasn’t responded. Oh well.

              • Bob Murphy says:

                Nick, the funny thing is that Krugman is one of the few people who would understand my Excel table in about 8 seconds and realize why I designed it just that way. Then he could say either, “Yeah OK, that’s a subtlety we missed, but it’s still true in the real world that deficit spending right now is needed,” or he could say, “You’re overlooking that in period 6 blah blah blah…” But I don’t think he would raise all of the objections that a lot of people here are raising on his behalf. (I don’t mean Daniel Kuehn by the way.)

  25. Robert says:

    Finally understand this. Terrific example of thinking things through and questioning your own beliefs.

  26. Per says:

    Great post Mr Murphy!

  27. MamMoTh says:

    This sucks. People want coconuts, not apples. You should give up writing for TV too, and get back to working on cold fusion. That’s where we need you.

  28. Matt G says:

    Aside: doesn’t Bob’s model demonstrate the usefulness of cardinal utility? (even if we believe that it doesn’t exist in real life)

    • Greg Ransom says:

      Murphy is taking sides with Wieser and Hayek against Rothbard and Lachmann …

  29. JKH says:

    Regarding your update, I couldn’t quite follow the explanation at the time, but it equates to the following, which is certainly true:

    The sequence of the transfer payment, followed by all the tax payments, represents the present value of a bond, followed by its nominal cash flow:

    Principal: transfer payment of 50 to old Al
    Interest payments: all tax payments of 50 starting with Bob and ending with Iris
    Principal repayment: tax payment of 50 from young John

    Transfer payment = A bond of tax payments

    OK?

    • JKH says:

      those numbers apply to the post that follows this one, but same idea

  30. Edwin Herdman says:

    Huzzah! Thanks for taking the time to put this all together. This whole debate has been very useful.

  31. Mike says:

    Great post, but I have one question. It seems that this assumes a finite time period and thus a finite number of total apples, so at some point someone has to have an utility less than 20. However, in real life you could argue that the time period would be infinite (or close enough to it) and thus an infinite number of total apples so that everyone can continue to borrow against the infinite supply of apples and never have their utility go under 20.

  32. James Oswald says:

    Bob, this post is fantastic. I now think you understand this issue better than anyone, and kinda feel sorry for Brooks.

  33. Adam (ak) says:

    Let me wade into this debate despite being late – don’t know whether anyone will read this. I think that there is nothing wrong with the example but it does not debunk Abba Lerner at all (I am not interested in defending the position of some de-sexed Neo-Keynesians , they deserve their fate, they need to be bashed to make room for something else).

    Abba Lerner wrote: ”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.’

    1. The original issue was not an evil and corrupt government hijacked by interest groups buying support of some social groups by redistribution of income (sneaking apples from Bob to give them to Al). It was about financing the war effort after 1941 (1939 in the UK) in an non-inflationary way and later financing the cold war. It was about not letting Adolf Hitler or later Joseph Stalin to rule the world. There can be a genuine cause for national income redistribution and increased government spending. The reason why bonds were issues was precisely to award these people who contributed to increased savings and reduced consumption during the war at a cost of these who didn’t.

    2. The example does not describe monetary economy and assumes constant production of apples (100% utilisation of productive capacities). 100% capacities utilisation was a norm during the war. This may not be the case during the peace (or “cold peace”) periods. Now it is estimated to be “78.1 percent, a rate 2.3 percentage points below its long-run (1972–2010) average” (see Federal Reserve statistics – Industrial Production and Capacity Utilization – G.17)

    3. I would like to see an example where government deficit spending offset by bond emission is used to prop up GDP during a recession when some apples will inevitably go bad if not purchased and consumed by someone. Obviously we may deny such a possibility and assume that in the long run Say’s law holds water, the economy will get back to an equilibrium and no opportunities are lost but this needs to be proven. It would be interesting to model investment spending, capital stock and the development of productive capacities (in your country and in China) with and without government intervention.

    4. The term “next generations” has been redefined. Lerner used it in the sense “people living here in the future time periods”. In this example redistribution of income between different groups of agents is considered. This is OK but I would not need to write a 5000-words article to prove that some people are better-off and some are worse-off if the government redistributes the income by taxing some of the people and awards some with interests.

    5. (regarding another blog article) To pre-empt one of possible counter-arguments against issuing securities: There is NO crowding out – this is a fake concept, an artefact of separating lending and spending operations on the same (or linked) markets). You stated that “When the government runs a budget deficit, the total demand for loanable funds shifts to the right. This pushes up the market interest rate, which causes some people to save more (moving along the supply curve of loanable funds) but also means that other borrowers end up with less. In effect, the government competes with other potential borrowers for the scarce funds available. Economists say the government borrowing crowds out private investment.”
    5a. We cannot see anything like that in the real life – see Japan and its public debt – 200% of the GDP and very low bond yields.
    5b This is because the government re-injects precisely the same amount of money to the economy during the same period. I am assuming less than 100% productive capacity utilisation as otherwise inflationary processes may develop.

    Here is what Michal Kalecki wrote in 1943 (Political Aspects of Full Employment):

    ‘It may be asked where the public will get the money to lend to the government if they do not curtail their investment and consumption. To understand this process it is best, I think, to imagine for a moment that the government pays its suppliers in government securities. The suppliers will, in general, not retain these securities but put them into circulation while buying other goods and services, and so on, until finally these securities will reach persons or firms which retain them as interest-yielding assets. In any period of time the total increase in government securities in the possession (transitory or final) of persons and firms will be equal to the goods and services sold to the government. Thus what the economy lends to the government are goods and services whose production is ‘financed’ by government securities. In reality the government pays for the services, not in securities, but in cash, but it simultaneously issues securities and so drains the cash off; and this is equivalent to the imaginary process described above.
    What happens, however, if the public is unwilling to absorb all the increase in government securities? It will offer them finally to banks to get cash (notes or deposits) in exchange. If the banks accept these offers, the rate of interest will be maintained. If not, the prices of securities will fall, which means a rise in the rate of interest, and this will encourage the public to hold more securities in relation to deposits. It follows that the rate of interest depends on banking policy, in particular on that of the central bank. If this policy aims at maintaining the rate of interest at a certain level, that may be easily achieved, however large the amount of government borrowing. Such was and is the position in the present war. In spite of astronomical budget deficits, the rate of interest has shown no rise since the beginning of 1940.”

  34. Saturos says:

    This is an excellent teaching post (also hilarious).

    As I explained on Sumner’s blog, the fundamental fallacy is to offset the same debt twice. You can say that all lenders get repaid, so that’s a wash. Or you can say that all taxes are paid to the same people they are collected from, so that’s a wash. You can’t say both at once, though.

    Now if Bob had somehow turned his 3 apples into an orange tree, instead of giving them to Al, then he might have had 6 oranges next period, and traded them for 6 apples from Christy. And conceivably, the government could have done a similar thing, only it would call the tree a “public good” and force the beneficiaries (and others) to pay, and so without revealed preference we would never know whether Bob’s savings were used optimally…

    In that scenario, it would be correct to offset future orange payments against future apple receipts, and future orange receipts against current apple curtailment. (If alternatively we offset current apple curtailment against future apple receipts, and orange payments against orange receipts, then the latter would b truly arbitrary.)

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