By this point, those of you who have been reading Free Advice should understand exactly what Don Boudreaux and Nick Rowe were saying, when Dean Baker and then Paul Krugman last year first started up the Great Debt Debate. What is still extremely interesting to me personally, is how many economics bloggers have concluded that Krugman was essentially right all along. No, he wasn’t, and that’s what I’m going to demonstrate in this post.
Before embarking on this thankless task, a disclaimer: This isn’t merely because I’m out to get Krugman, though I must admit that’s probably part of the impetus. Rather, since so many people to this day can’t see how clearly and obviously Krugman’s writing on this–from the get-go and including his latest post–is based on a fundamental mistake, it makes me suspect that these people never really understood the controversy. Therefore it’s worthwhile, I hope, to walk through this stuff at least once more from first principles, to get you guys to see the specific argument Baker and Krugman were making–their essential “insight” into why the federal debt can’t burden future Americans–so that you will then more fully appreciate why Nick Rowe picked the specific counterexample that he did. (Inconceivably, we still have critics complaining that our counterexamples are “totally rigged to show a burden.” Yes my friend, that’s how counterexamples work! You deliberately calibrate them to show your opponent has made a false general statement. My goodness this debate has been exhausting.)
First off, Krugman and Baker both admit that there is a sense in which private debt can burden a household in the future. They are simply denying that this “micro” insight can be aggregated to the macroeconomy as a whole. In other words, they claim there is a fallacy of composition going on. Just to make sure you believe me, here is Krugman on December 28, 2011:
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 just to make sure you believe me when I say Krugman’s position has not budged one iota in this entire debate, here is Krugman on October 12, 2012 (after he explicitly acknowledged Nick Rowe’s role in this):
[L]et me suggest that the phrasing in terms of “future generations” can easily become a trap. It’s quite possible that debt can raise the consumption of one generation and reduce the consumption of the next generation during the period when members of both generations are still alive….
But that’s not what people mean when they speak about the burden of the debt on future generations; what they mean is that America as a whole will be poorer, just as a family that runs up debt is poorer thereafter. Does this make any sense?
OK, does every see this? Krugman admits that for an individual household, yes of course debt can impose a burden in the future–the household has to make interest payments that “go out the door.” But this micro logic breaks down, Krugman believes, when you aggregate it to the country as a whole. This is because one American household’s interest payment on the federal debt, goes into the pocket of some other American household that is holding the Treasury bond. So the wealth stays within the household, when “the household” is the USA.
Now that you see this is the essential “insight” that Krugman and Baker were making, you can understand why they laid so much stress upon whether Americans versus foreigners would be holding the debt in (say) the year 2100. Look guys: Krugman made the title of his inaugural blog post “Debt Is (Mostly) Money We Owe to Ourselves.”
Why did Krugman and Baker lay so much emphasis on Americans vs. foreigners owning the government debt–why did they in fact base their entire case on it? They did so because their argument for the non-burden of debt totally breaks down if our grandkids have to make interest payments to foreigners in 2100. But so long as the American taxpayers in 2100 are making interest payments to American Treasury holders in 2100, they think it’s a wash, and that we can’t possibly be burdening them. As Baker himself said on December 27, 2011, in the post that set the blogosphere on fire:
As a country we cannot impose huge debt burdens on our children. It is impossible, at least if we are referring to government debt. The reason is simple: at one point we will all be dead. That means that the ownership of our debt will be passed on to our children. If we have some huge thousand trillion dollar debt that is owed to our children, then how have we imposed a burden on them? There is a distributional issue — Bill Gates’ children may own all the debt — but that is within generations, not between generations…
One can make the point that much of the debt is owned by foreigners, but this is a result of our trade deficit, which is in turn caused by the over-valued dollar.[Emphasis in original.]
So now you see the power of Nick Rowe’s original counterexample (and my elaboration with purdy pictures). We are showing that this “insight”–that private debt can be a burden, since you are making payments that leave the household, while public debt can’t possibly be a burden, since Americans are just paying other Americans–is wrong. In our little models, there are no foreigners; the debt is always “owed to ourselves” in that little economy, and yet clearly the future taxes needed to pay down the debt impose a net burden per capita on everybody alive at that time. It’s not a wash, a mere hurting off one grandkid with a simultaneous and equal helping of another grandkid, at least not in the way Krugman and Baker have been leading their readers to believe.
One last major point here: Notice how my interpretation of Krugman and Baker’s position, can explain all of their writings throughout this debate. I can explain why they concede private debt is burdensome, while public debt is not, so long as Americans in the future end up holding the Treasury bonds. In contrast:
==> Steve Landsburg says Krugman is right in one respect, but wrong because (Landsburg claims) Krugman forgot to make the point that it’s irrelevant whether Chinese or Americans hold the bonds. No, Steve, as Krugman’s very post title indicates, Krugman thinks it does matter. He didn’t forget to make what you consider to be the essential point; Krugman doesn’t see the essential point.
==> Gene Callahan is wrong for thinking Krugman has merely been talking about the net transfer payments being the burden. If that were the case, Gene, then Krugman would think even private debt isn’t burdensome. After all, whatever the guy in the street thinks about “my credit card debt imposes a burden on me next month,” I can reproduce exactly the same thing by having someone mug the guy next month. Nope, if Krugman were exonerating public debt for the reason Gene claims, then Krugman wouldn’t have said public debt is fundamentally different from private debt.
==> Daniel Kuehn is wrong for thinking Krugman was only talking about real GDP, and not about future Americans. Private debt doesn’t lower my marginal productivity and paychecks in the future, either. So again, Krugman’s distinction between public and private debt would make no sense, if Kuehn is right.
==> Scott Sumner is wrong for thinking Krugman finally gets it with his discussion of Rowe. Nope: Krugman italicizes in the passage Scott quotes, the alleged importance of two generations being alive at the same time. That is clearly not needed in Rowe-type models, as my canonical example illustrates. Every single person alive in 2012, can enrich himself at the expense of every single person alive in 2112, using deficit finance and taxes levied for bond retirement in 2112. Krugman clearly doesn’t get it. If Sumner were right, Krugman wouldn’t have put in (and italicized!) the clause about the two generations needing to be alive at the same time for Nick’s “magic trick” to work.
In conclusion, my interpretation of Baker and Krugman perfectly explains their every move in this entire debate. In contrast, for Landsburg, Callahan, Kuehn, and Sumner: