So, I was out there shovelling snow, thinking about writing a post on the burden of the debt on future generations. And about how macroeconomists' beliefs on this question had silently shifted about 30 years ago, and about how we as a profession have engaged in a sort of "memory falsification" (like Timur Kuran's concept of "preference falsification"), because we didn't want to admit that we now believe something we used to believe only unsophisticated economically illiterate rubes believed.
And I then I thought "Nah, what's the point of rehashing old ground?. Nobody nowadays believes that old "we owe it to ourselves" stuff that we used to believe."
And then I came inside and read Paul Krugman's blog post. Now I absolutely have to write the post I had decided not to write.
"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."
Sorry, but that's just plain wrong. The economically illiterate rube who thinks that the national debt is a burden on our children or grandchildren is basically right. It's the exact opposite of "especially nonsensical". Unless you believe in Ricardian Equivalence.
[Update: Paul Krugman has a second post.
"And you don’t have to be a right-winger to acknowledge that yes, very high marginal tax rates act as a disincentive to productive activity. So real GDP may well fall significantly.
This is what I mean when I say that the burden of debt is about incentives, not about having to deliver resources to other people.
The general point is that the analogy with a family that owes too much is all wrong. Unfortunately, this dumb analogy dominates our national discourse."
And I'm saying that it's not (just) about incentives, and it is about having to deliver resources to other people, and that the analogy with the family is not dumb and not all wrong (even though, like all analogies, it doesn't work perfectly).]
In the olden days we all used to believe NB. At least, all educated sophisticated people believed NB. Only uneducated unsophisticated people believed B. But we all smugly knew that "the man in the street" was wrong. In fact, a quick test for whether someone was educated and sophisticated was whether he believed B or NB. Maybe a few of us educated sophisticated people might have believed B, or didn't really understand why NB was so obviously correct, but we kept our beliefs secret, because we didn't want other people to think we were uneducated or unsophisticated rubes.
I can still remember an economics seminar at Carleton, sometime in the 1980's. The visiting speaker was an older guy, an old-school Keynesian from one of the top US universities (I have forgotten his name). Halfway through the seminar, he said "I assume that the audience here is economically literate, and that nobody here believes B?" He paused and glared around the room. The blood went to my face (a grad student told me afterwards my face was red). I raised by hand, and said that I believed B.
James Buchanan was not a sophisticated macroeconomic theorist. He didn't do macro. He did political economy/public choice. He had zero authority in macro theory. James Buchanan argued for B. But he was just a farmboy, like me. (Yes, I do have a slight chip on my shoulder; why do you ask?)
Then, all of a sudden, it seemed like all the educated sophisticated people switched to believing B. It was a very quiet revolution. There were no visible signs of argument at all. One day we all (I mean all we educated sophisticated people) believed NB; and the next day we all believed B. And we all stopped our smug condescension about the poor ignorant "person on the street" who believed B. In fact, we never mentioned the fact that we all used to believe NB. We wiped our old beliefs from our memories, like Soviet photographs. It was just too embarrassing to talk about.
There's a danger to this sort of memory wiping, and silent shifts in belief. Some people never got the memo, and still believe the old NB like we all (all educated sophisticated people) did once. Plus, it says something about our beliefs in general if we all just believe what it is fashionable to believe. (And we do, very often, which is why many of our beliefs, especially educated sophisticated beliefs, really suck).
Paul Krugman is a much better economist than me. But he never got this memo. It's time to re-open this old box of suppressed memories.
Let me make some simplifying assumptions so we can get to the heart of the distinction between B and NB. (Yes of course these assumptions are false and unrealistic, but by excluding areas where we agree we can focus on the area where we disagree.)
Assume: closed economy; no investment or real capital of any kind; lump-sum non-distorting taxes with zero collection costs; positive real interest rate and zero real growth; exogenous full-employment level of output; apples are the only output good; apples cannot be stored; identical agents; overlapping generations; no funny stuff.
Suppose the government makes a transfer of 100 apples to the current cohort, financed by borrowing. Does that create a burden on future generations? Yes or no? B or NB?
I say Yes. I say B. It does create a burden on future generations. The only case where it does not create a burden on future generations is where Ricardian Equivalence holds. According to Ricardian Equivalence, the person in the street realises it will create a burden on future generations, and so saves the whole of the transfer payment, including interest, passes it on as a bequest to his children, who pass it on to their children, precisely because he wants to offset that burden on future generations.
The person on the street, in his unsophisticated uneducated ignorance, is basically right. The debt is a burden on his kids, or grandkids. Only if he anticipates that burden, and decides to offset it by increasing his bequests, a la Barro-Ricardo, does he eliminate that burden
No. My argument does not involve time travel. It doesn't require we can take apples grown 100 years from now, put them in a time-machine, send them back in time, and eat them today. But it is as if we could.
My argument is obvious. At least, it's obvious to anyone who has thought about overlapping generations models. And it's equally obvious to the unsophisticated uneducated rube who has never thought about overlapping generations models.
The government borrows 100 apples from each of cohort A, then gives each person in cohort A a transfer payment of 100 apples. It is exactly as if the government had simply given each person in cohort A an IOU for 100 apples. That IOU is a bond.
So far there is no change in cohort A's consumption of apples.
Cohort A then sells the bonds to the younger members of cohort B. So each person in cohort A gets an extra 110 apples (assume 10% interest per generation), which he eats. Cohort A then dies.
Cohort A is better off. Each member of cohort A eats an extra 110 apples. In present value terms, those extra 110 apples are worth 100 apples at the time the transfer payment is made.
Cohort B eats 110 fewer apples when young, but 121 extra apples when old, and they sell their bonds to cohort C. Although cohort B eats 11 more apples in their lifetimes, the present value of their total consumption of apples is the same. The rate of interest must be high enough to persuade them to eat fewer apples when young and more apples when old, otherwise they wouldn't have bought the bonds from cohort A. So cohort B is not worse off.
But (given my assumption) the debt is rising faster than GDP. The government knows this is unsustainable. It cannot rollover the debt forever, because eventually the next cohort will be unable to buy the bonds from the older cohort. So the government decides to pay off the debt by imposing a tax of 121 apples on each young person in cohort C, which it uses to buy back the bonds from cohort C.
Each member of cohort C eats 121 fewer apples.
Cohort A eats more apples, and cohort C eats fewer apples. It is exactly as if apples travelled back in time, out of the mouths of cohort C into the mouths of cohort A. (With interest subtracted as they travel back in time through the time machine.)
Yes, the national debt is a burden on future generations.
Can that burden on future generations be offset in some cases? Yes.
Ricardian Equivalence means that inviduals decide to offset the burden by each cohort giving rather than selling their bonds to their kids in the next cohort. So if you believe in Ricardian equivalence, you can consistently argue that the national debt is not a burden. But it's only not a burden because individuals see it is a burden and take offsetting action. That ignorant uneducated person in the street is still right.
And if the debt is used to finance investment in the kids' education then the burden is offset.
And if the interest rate is permanently less than the growth rate then the "No Ponzi" condition does not hold, and the debt can be rolled over with interest forever without taxing future generations, so cohort A eats more apples and no subsequent cohort eats fewer apples (there is never a cohort like cohort C, they are all like B).
I can relax all the other simplifying assumptions, and show that the basic message is still roughly the same. But not today.