20
Apr
2012
Yet Another Attempt at the Government Debt and Future Generations Issue
Whoa, I almost spared all of you by forgetting to link to my latest article in the Freeman. I did my best to summarize what is wrong with the we-owe-it-to-ourselves “insight” on government debt. I’m pretty sure the example I spell out in the article is new. Anyway, here is the conclusion:
If an imperialist government paid for popular spending programs by levying a tax not on its own citizens but on a conquered land, the scheme would of course be a gigantic theft working across space and through the currency markets. Deficit finance is similar, working across time and through the bond markets. It allows today’s citizens to pay for government goodies by levying a tax on unborn generations who have no say in the political decision.
Keep flying the flag, Bob! Have you caught any of the recent chatter about how long exponential economic growth can go on for? Obviously this is relevant to the possibility we discussed last time round that the debt might not burden anyone if you can keep rolling it over.
Great article !
I’m glad to see that this time you don’t use the the OverLapping Generations model that I think confused the issue last time this was discussed on your blog. In this article you show that bond-funded government spending pushes the debt onto future generations by analysis of the future utility of bond-holders v future utility of tax payers.
With this approach you can say ‘Thus the group “people alive in 2112” is collectively made poorer by the scheme.’ without needing the dubious assumptions of the OLG model.
Rob wrote, “…without needing the dubious assumptions of the OLG model.”
Actually, a model that assumes either (a) people live forever or (b) the generations all perfectly come into life and die at the exact same times, would be dubious. OLG is the real world.
I don’t disagree that generations overlap in the real world. I just think that the OLG model used when this was being discussed before was very simplistic and assumed its own conclusions (If I remember correctly it just started off with a distribution that was optimal and then “proved” that any change to this distribution caused things to become suboptimal)..
I liked the way it was described in this article much better and I’m still trying to think through you and Richard’s assertions that OLG is still implicit in it (see my comment below).
Rob,
You still need OLG to get the result. Notice the future people *paid* the discounted value of the bond to acquire it from the older people. If there were no OLG, the bond would be automatically bequeathed to the future generation when the previous one died, and there would be no burden. The creation of the burden, as it were, is due to the exchange. You might find this post of mine helpful for explaining why it’s the overlap that makes all the difference.
http://shewingthefly.com/2012/01/24/maybehopefully-the-last-thing-i-have-to-write-about-the-burden-of-public-debt/
Richard
Perhaps I am oversimplifying (or indeed just missing something) but I am sort of seeing it this way.
In 2012: The party goers obviously benefit. The bond buyers are making a rational decision and either benefit (if they would have accepted a lower interest rate) or break even if they are marginal buyers
in 2112: The tax-payers obviously lose out. The bond holders are in 3 groups.
1) Original holders (now very old) who break even since they just get their money back plus interest.
2) People who bought the bonds during the past 100 years – seems like there situation would be the same as the first group.
3) People who got the bonds as gifts. I’m not sure the fact that the bonds were gifts changes anything. In 2112 they just get paid out on an asset they happen to own that they could have sold had they wanted to. The don’t really gain from the maturity of the bond.
So
in 2012 some win , no one loses
in 2112 some lose, no one wins
I don’t see why OLG is needed to derive this result.
I don’t see why OLG is needed to derive this result.
Oh because in order to make your earlier analysis possible, there has to be a way to allow the earlier generations to consume more at the expense of the later ones. If we are not invoking capital consumption, then we need an OLG framework.
To help me understand:
Suppose there were no OLG and (say) everyone dies in 2062 to be replaced by a new generation who inherited the bonds.
The original buyers in 2012 wanted to benefit their their kids so they are happy to buy the bonds. Still no one loses in 2012
Are you assuming that in this scenario the benefit to kids who inherit the bonds would (or at least could) exactly cancel out the tax payers loss so its potentially a wash ?
If one assume a model where consumption is the same in 2012 as 2112
then the statement “bond-funded government spending will leave future generations worse off” appears to mean :
“Govt spending financed by borrowing will alter the distribution of consumption in the future. Unless this leaves no one worse off then one must conclude that the effects were negative”.
Even in the non-OLG version future tax payers will clearly be worse off. This is why I don’t see why OLG is needed to demonstrate the point.
“One major problem with this viewpoint is that it ignores a government deficit’s tendency to divert resources out of private investment and into consumption chosen by the political process. Deficits therefore cause future generations to inherit fewer tractors, tools, and other equipment, reducing their ability to produce and making them poorer.”
You presuppose that money lent by investors to cover deficits in an account sense would have been used on capital goods investments: if there is recession or depression or even significant idle capacity (when deficits occur), by definition there is a lack of sufficient capital goods investments. The process of government stimulus on public works will make the community richer, not poorer, in the long run in these circumstances.
Also, money can get recycled on secondary financial asset markets over and over. Where is are the secondary financial asset markets in your simplistic analysis?
You presuppose that money lent by investors to cover deficits in an account sense would have been used on capital goods investments
That presupposition is certainly a valid one, considering how nobody forced any of the multiple generations of investors to save and invest and increase capital, as they just did it on their own.
What is presupposed that isn’t so valid is the presupposition that deficits are just redirecting money that would have been spent on Big Macs and beer, but because they’re going to a deficit instead, they go to nice schools and roads and medicare.
if there is recession or depression or even significant idle capacity (when deficits occur), by definition there is a lack of sufficient capital goods investments.
No, that is a false inference. It’s not there is a lack of sufficient capital goods investment, it’s that there is a lack of sustainable capital investment in line with real consumer preference.
Not only that, but it is a myth to believe that inflation financed deficits, or debt financed deficits, ONLY affect “idle resources” before it affects everything else. The primary effect of deficits is affecting what is available to be bought at the time, which means operational going concern outputs, such as military equipment, food for seniors receiving social security checks, and so on. Deficits primarily affect in use resources and already hired labor. They don’t get attracted to idle resources and unemployed workers first like a magnet, with only “secondary” affect on in use resources and already hired labor.
Furthermore, all idle resources require complimentary resources to function, and so any spending that would bring into use an idle resource, will necessarily carry with it an additional demand for complimentary factors as well, such as energy, rent, equipment, and so on. These non-idle resources will be affected by the deficits, thus bringing about crowding out of those resources away from those who don’t receive deficit money.
The process of government stimulus on public works will make the community richer, not poorer, in the long run in these circumstances.
It depends on how you define richer and poorer. Public works make people poorer to the extent that they value other things more urgently first, before they are willing to have more public works. There are only so many friggin roads that are needed. Public works make people richer to the extent that they value public works more urgently first, before they are willing to have more other goods.
The key resolution to settling such matters is, and this burns you statist Keynesians so much that it blinds you with rage, the only way to settle this is by observing individuals making their own individual choices concerning their own individual property, and watching where profits are made and where losses are made. You can only do this through the market process, not the political process.
So you can’t arbitrarily state that all public works makes people richer. It carries a cost, as do all other projects. The only way to know if the gains exceed the costs is within the very market process that is overruled by politics and the resulting “public works.”
Also, money can get recycled on secondary financial asset markets over and over. Where is are the secondary financial asset markets in your simplistic analysis?
Money doesn’t just stay in the secondary financial asset markets “over and over.” It is not a source of finds that can be redirected to government deficits at “low” cost to “the economy.”
Money that is earned selling financial assets, doesn’t just stay in financial assets. The financial assets are claims to company cash flows. The money finds its way into companies that produce real goods.
The reason why you see financial markets grow in nominal terms over time is because of inflation. It typically affects financial securities before wages. This nominal growth gives the illusion that the money just stays there, going back and forth from speculator to speculator, never going into real production. But the money does go into real production, it’s just that by the time it does go into real production, there is already another round of inflation from the Fed, boosting the prices once more, and thus maintaining the illusion that the money is just circulating there.
http://3.bp.blogspot.com/__la3i20FSkw/Sw159aqiK0I/AAAAAAAAAUQ/FhzEIkty4zw/S332/StopSpendingMyMoney.jpg
Yeah I know it’s a cheap gag, and no particularly intellectual argument, but I laughed pretty hard. Anyhow, why shouldn’t small government advocates get their “save the babies” propaganda? Everyone else does it.
Totally and completely off topic, but I just had to share this paper:
http://philrsss.anu.edu.au/people-defaults/alanh/papers/fifteen.pdf
This argument is less persuasive than your earlier ones, and you seem to undercut your own conclusion by saying the investors of 2012 don’t lose out. If the investors of 2012 are OK because they can buy and sell the paper, then the same thing is surely true of the investors of 2013 because subtracting 1 measly year from the term of a 100 year bond won’t really change anything meaningful with regard to prices. The same goes for the investors of 2014, and on through the years. Eventually you get to the point where inter-generational effects disappear, and the bondholders are the same generation as the taxpayers.
Your other argument was better, because it showed that *any* taxpayer-subsidized lending creates a class of winners (the bondholders) and losers (the taxpayer-victims)