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How is that the counter examples of debt can be a burden has become there will be a burden (unless something mitigates it)?

Roger: these are my counterexamples to my counterexample. Maybe you have some more?

But look, it's really really simple. If you tax someone, they are worse off. Unless there's some indirect benefit.

Is the need for Ricardian Equivalence in 0 contingent on the point about inheritance?

Because if you just sell the bond when you're old and then spend the proceeds before you die we can dispense with inter-generational altruism and any reliance on strict Ricardian equivalence.

Or am I missing something?

Well I'm thinking more in the line of the original Krugman argument and the milk critique(or Rowe critique). We can affect unborn people through a systematic redistribution scheme, but not with a one time sting right? Thus in the Krugman sense of unborn generations any temporary rise of debt will be a wash (someone will have payed but not the unborn ones), right? I just read all the posts relating to the topic so I can easily be completely confused.

PS: Just in case I still have your attention before the tsunami of comments arrives: I=S it is an accounting identity because undesired savings are an investment as well, but if the stock is perishable (intra or even inter period) the firm just loses all ( or part) of the unwanted investment and thus S>I. How tired I am?

"There is no burden on future generations because the extra taxes to service the debt will be paid to those same future generations that inherit (sic) the bonds"

What is your assumption *today* about those future taxes? I can somehow understand why you want to call debt as burden today given the structure of today's tax system, i.e. mostly labour and consumption. But if you assume that the tax system can change in the future (and it really can and even most likely will in whatever ways) how can you insist to call it burden? Example: what if in the future there will be a 100% tax on any capital gains on government bonds. Equivalently, the whole yield curve falls pretty much to zero. Equivalently central banks does QEUnlimited.

Nick:

How about this argument: "Yes, monetary policy is not limited at the zero bound, but due to political and institutional reasons it is. Therefore, running a budget deficit at the zero bound is useful because it creates additional safe assets that can help reduce the excess demand for such assets."

Or this not so good one:

"Yes, monetary policy is not limited at the zero bound, but due to political and institutional reasons it is. Therefore, running a budget deficit at the zero bound is useful because it can create the expectation of a permanent increase in the future monetary base to pay off the debt."


Daniel: I'm not sure if I'm misunderstanding you, or you are misunderstanding me.

If Ricardian Equivalence is true, then there is no net burden of the debt, because we will bequeath (as a freebie) the bonds to our kids, and they to their kids, to exactly offset the burden. Future generations will then inherit (in the true sense, as opposed to "buy") the bonds, as well as the tax burden.

Roger: "We can affect unborn people through a systematic redistribution scheme, but not with a one time sting right?"

Not right. Suppose we borrow to make transfers to people alive today, then rollover the debt plus interest for 100 years, then tax everybody alive 100 years from now to pay off the accumulated debt.

Actual I = actual S is an accounting identity. Desired I = desired S is an equilibrium condition. If some stuff perishes before it is sold and consumed, we either have to include or exclude that in both I and S. Best to exclude it.

Sergei: if I don't know who will pay the extra taxes, then I don't know who will bear the burden. It might be workers 20 years from now, or landowners 100 years from now, or people owning bonds 42 years from now...but it's a burden to someone, if taxes have to be increased.

David: I see those as slightly improved variants of my 1.

Got it, I guess I was just using (6) and paying it in time.

I am unsure of what you mean by "on average" and "forever" but I have no doubt 4 is true presently and for the foreseeable future.

Lord: I don't know what I mean by "on average" and "forever" either, because my math isn't good enough. But r being less than g for the "foeseeable future" isn't good enough. Because if we follow that policy, the debt will still be there in the *unseeable future*, and it's that unseeable future that worries me.

Nick Rowe: "Actual I = actual S is an accounting identity."

Then why does the term, (S-I), appear in equations?

Min: because:

1. It's talking about desired I and desired S.

2. Its' talking about private S and I, as opposed to national S and I, which includes government S and I.

3. It's an open economy, and S and I ignore foreign S and I.

Nick Rowe: "There is no burden on future generations because the extra taxes to service the debt will be paid to those same future generations that inherit (sic) the bonds." That is a really bad argument."

Who makes that argument? I have not heard it, except as a straw man. What I have observed is debt/deficit hawks claim that the national debt will be a burden on future generations. They say that in order to scare people. People get scared because they make the analogy with owing a debt to a bank or loan shark. In this analogy, the future generations are the ones who owe the debt. Who they owe the debt to is some Other. To counter that propaganda, it is correct to point out that, for the most part, the people to whom the debt is owed will be fellow citizens, just like today. Therefore the supposed burden that debt/deficit hawks are using to scare people is not the spectre that they conjure.

That is not to say that people cannot pass burdens on to future generations.

Nick Rowe: "I don't know what I mean by "on average" and "forever" either, because my math isn't good enough. But r being less than g for the "foeseeable future" isn't good enough. Because if we follow that policy, the debt will still be there in the *unseeable future*, and it's that unseeable future that worries me."

There are any number of possibilities for the unseeable future. A caste society with debt peonage is one. A revolution is another. Inflation is another. If r > g becomes a problem, inflation can restore the balance between debtors and creditors. No? Boundary conditions matter.

Min: "Who makes that argument? I have not heard it, except as a straw man."

Dean Baker: http://www.cepr.net/index.php/blogs/beat-the-press/children-and-grandchilden-do-not-pay-for-budget-deficits-they-get-interest-on-the-bonds.

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

"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."

I want to try what amounts to a variation on argument number 4, although it sounds quite different.

-- The marginal product of capital is the rate at which we can substitute future consumption for current consumption.

-- Therefore it's appropriate to discount future flows at the marginal product of capital to get a present value.

-- If you discount the flows from a government bond at (any reasonable estimate of) the marginal product of capital, you get a value that is far less than the market value.

-- Therefore the government gets a windfall when it sells a bond: it is, in effect, borrowing a little bit of money (at an interest rate equal to the marginal product of capital) and having a bunch of extra money dropped in its lap (and potentially that of taxpayers, whose current taxes can be reduced, and any reduction in distortions is gravy) which it doesn't have to pay back.

-- Essentially, then, the government, merely by virtue of being a trusted sovereign, has access to a technology for producing something (liquidity? insurance?) that people want, but it can only produce this product when it borrows money.

-- Therefore, any downside to deficit spending has to be set off against the fact that it enables this marvelous technology that produces something from nothing. Presumably there is some optimum, but it is almost certainly a positive deficit, even during good times, except perhaps if the debt is already very high (which presumably makes the government increasingly less trustworthy and thereby reduces the value of its product by more than the amount it makes from selling the product).

Even more than that, we can't be sure which direction the burden is passing, to the future or to the present, so foreseeable is our best measure for our actions.

Andy: "The marginal product of capital is the rate at which we can substitute future consumption for current consumption."

Hush! All the Cambridge UK types will come down on you like a ton of bricks!

What you meant to say is "The marginal product of capital times the marginal rate of transformation of current consumption goods into current capital goods is the rate at which we can substitute future consumption for current consumption."

OK, now where were we?

Dunno. 4 works even in a pure consumption economy. Once we introduce liquidity premia, my mind drifts off to Friedman's Optimum Quantity of Money. How much risk is the government taking on? Dunno. I can't get my brain around this properly yet.

BTW, did you see my NK OLG model? Dedicated to you. Was that the argument you had in mind?

Nick,

1. I've posted this elsewhere, but what if we implement a bond sales tax based on the spread between the rate of interest depending on debt service as a share of GDP? How could "future generations" ever be burdened then?

2. Why should bond buyers/bond holders ever expect "burdensome" returns? How is this normal? If you want/expect high returns you should be investing in the private market.

3. Why do you think it's right to say bond holders can be burdened since they're taking on risk voluntarily? Nothing is forcing anyone to buy a bond.

4. A bondholder is a creditor, but the debtor is not "future cohorts," but the economy as a whole. The economy as a whole include bondholders. Therefore bondholders cannot be burdened if they're taxed to pay for their own bonds.

That should have been: "the spread between the rate of interest and the rate of growth," but it would be like a reverse-inheritance tax.

a) Don’t use bad arguments to defend deficits, but equally don’t use bad arguments to avoid them. The worst argument to avoid them is that they have to be paid off – the Ricardian assumption. That’s the wrong starting point for the argument. Be proactive rather than passive in resisting the Ricardian meme. There is something to be said for the value of a process that produces debt at the risk free rate (and its term structure in the case of bonds). The government has a monopoly on risk free rate liabilities and there is demand for them (I think DeLong emphasizes this). This doesn’t mean deficits should be reckless and unlimited and it doesn’t mean surpluses won’t be justified on occasion. But the assumption of repayment is wrong as the starting point. That’s why the assumption of taxes as a conditional outcome is so central to your exposition of debt burden.

b) For today’s environment, your number 3 is good. Market pricing is basically telling you to run deficits, and to lock in long term money in doing so - which unfortunately is QE and twist incompatible.

" Therefore, any downside to deficit spending has to be set off against the fact that it enables this marvelous technology that produces something from nothing. Presumably there is some optimum, but it is almost certainly a positive deficit, even during good times, except perhaps if the debt is already very high (which presumably makes the government increasingly less trustworthy and thereby reduces the value of its product by more than the amount it makes from selling the product)."

Is that an argument for a minimum level of gross government debt regardless of the net debt of a sovereign? Providing risk-free returns as a sort of infrastructure...

So, something like Norway having a government debt and keeping assets in a sovereign wealth fund, even though its net debt is negative.

anon:

1. Hmmmm. I'm not sure I fully understand this. Wouldn't there be a risk the government would be suddenly unable to borrow if it hit that ceiling, because it would have to raise rates to compensate for the tax? Or is it like my trill perpetuities plan?

2 and 3. It's not the bondholders who pay the burden. It's the people who pay the taxes to pay the bondholders.

4. See my counterexamples.

JKH: we don't know the future, and don't know whether, at the margin, the present value of extra taxes will equal the extra deficit.

I understand that economic models with inheritance typically satisfy Ricardian Equivalence, but that does not mean that all models with inheritance satisfy Ricardian Equivalence. Govt. bonds could be inherited with Ricardian Equivalence being violated for other reasons (for instance, the poor, who do not own govt. bonds are liquidity constrained). A realistic model (well, to the extent macro models can be realistic) could be easily constructed with dynasties of wealthy bond owners and overlapping generations of non-Ricardian poor.

While I understand your reasoning, every time you conflate the concept of inheritance and Ricardian Equivalence, I feel you are making a false equivalence. This bothers me even more in posts where you are being very careful and specific about various conditions.

1. Maybe rates would rise. But we're talking about burdening the future, if a bond auction fails and the government can't borrow, it can't burden. But you're not answering why bond holders should be expecting to extract burdens on the economy in the first place? (I'll have to read the trill post again later, I read it before and some of it went over my head.)

2., 3., and 4. I'm saying we tax the bondholders to pay the bondholders. And that this is a risk of buying bonds. (I don't know what you want me to see in your counterexamples, I understand the basic argument, and agree that the burden can be imposed, but am saying it's a policy choice/risk of buying bonds, not a function of the debt.)

You can't transfer the burden to the future by selling your bond because the person buying the bond is assuming that risk by buying the bond of their own free will. If for some generation government policy favors bond creditors that's a policy choice. Saying that bond holders deserve to impose burdens is creditor bias.

primed: I see your point, but I'm not sure how easy it would be to construct a model where RE is false but there is no burden.

"A realistic model (well, to the extent macro models can be realistic) could be easily constructed with dynasties of wealthy bond owners and overlapping generations of non-Ricardian poor."

A simple 50-50 model (half Ricardian population, and half making no bequests) wouldn't do it. The deficit would need to be twice as big to cure the same recession. So future cohorts of the non-Ricardians' kids would be twice as worse off.

anon: "I'm saying we tax the bondholders to pay the bondholders."

OK. So I borrow money from you. I then say I'm going to tax you to pay you the money I owe you. You are worse off. (BTW, that is exactly what is happening in my model already).

Nick,

I agree that's what is happening in your model, but you're ignoring my argument. (I'm interpreting what we both agree is happening differently.)

"OK. So I borrow money from you. I then say I'm going to tax you to pay you the money I owe you. You are worse off."

Notice that "you" in this case is the government. Not me, anon. When you lend the government money, the economy as a whole becomes your debtor. The economy as a whole includes you. If you're taxed to pay some of your own bond payments, that's simply a risk of buying a bond in the first place.


How about if all taxation is from the wealthy (those who inherit and bequeath the bonds) and deficits arise from government spending on public projects?

Sorry, "I" is the government in your example.

@ Nick Rowe

I guess you are disagreeing with me, but I do not see the evidence. Take part of the Krugman quote:

"not the burden of debt as is commonly understood."

You are not talking about the burden of debt as it is commonly understood. Krugman is. He is not saying what you think he is.

How did you proceed from showing that debt can be a burden on future generations, to concluding that debt is a burden on future generations? The latter is an empirical issue which has not been addressed by the recent debates.

This can't be how macroeconomics work, is it? Where is the empirical evidence?

Dan,

Nick has always said there are conditions under which debt won't be a burden.

Could you elaborate more on point 0 or post some links where one could look deeper into the argument against inheritence?

I'm a #2, #3 guy myself.

Nick,

You would be my personal hero if you can either (a) explain or (b) get Dean Baker to clarify what he meant when he posted this in the comments of his last post on this topic:

It's the fraction of the spending from interest on government bonds that is spent by people without kids (i.e. not saved) and not received from taxes paid by people who also owe bonds. [The true measure is the consumption based on bond wealth, but I'm going to be sloppy and use this as proxy.] Currently, net interest is a bit over 1 percent of GDP. It also only applies when the economy is at full employment (don't hold your breath on that one). My guess is we're talking about a burden that is hovering around 0.1-0.2 percent of GDP...

I am on the cusp of getting what he means--it's on the tip of my tongue, as it were. But I'm not quite certain. My suspicion is that he's wrong (i.e. not setting up the measurement correctly), and that I could do one of those big apple models to show that his measure would show little burden, when in fact the burden is huge.

But, before wasting my time on that, I want to be crystal clear on what Dean Baker means by the above. Any thoughts?

Bob,

He's saying you have to subtract the taxes bondholders had to pay themselves to pay interest from the amount they spent and did not give to their kids. He's "guessing" this is about ten to twenty percent of net interest payments. I'm guessing net interest is interest minus growth.

(I'm guessing the bondholders taxed would, in principal, have to be same as those who spent.)

Nick,

I will try a different tack. Suppose that there are no government bonds traded in a secondary market. However, there are government "deposit accounts", that anyone can open by depositing funds in (the sole) government bank. This is the only bank. The savings accounts pay an overnight interest rate as set by the central bank.

In this model, there is no difference between bonds and deposits. Government spends money by marking up someone's deposit account (whoever it buys goods from) and then immediately paying interest on it. Government taxes by reducing someone's deposit account.

In this model, does expansionary monetary policy (e.g. fiscal policy) cause a burden on future generations?

Bob: All he is really saying is: if Ricardian Equivalence is half true, then the burden of the debt is only half the debt. Because half the bonds weren't bought but were received as gifts from the parents. Trouble is, if Ricardian Equivalence is half true, you need double the deficit to get the same fiscal stimulus. So you end up with exactly the same burden on the kids as you would if Ricardian Equivalence were 100% false.

It's the same old story. He wants to have it both ways. He wants to lean pro-Ricardian when it comes to the burden of the debt, but anti-Ricardian when it comes to the power of deficits in increasing AD.

Dan: It depends. Suppose we were talking about case 2, where we borrow to build a school. IIRC (I probably don't) the empirical estimates are that it costs about $1.30 in burden ($1 direct, and $0.30 in excess burden due to distortions and collection costs) to raise $1 in tax revenue at the margin. That's on the cost side. On the benefit side, some very brave economists do *try* to estimate empirically the benefits of schooling. The simplest method is to estimate the extra earnings of those with extra education, by running a regression of earnings on years of education. But we know that will overestimate the benefits, because it might be that the brighter kids, who will earn more anyway, stay longer at school, both to signal that they are bright, and because they are bright enough to be allowed to stay. And some very hard-working empirical economists try all sorts of clever tricks (using natural experiments etc.) to try to get around this problem.

So, if I thought I would be any good at doing this, I would research all the empirical public finance literature to check my memory of whether that $1.30 estimate of the costs is correct, then plough through all the empirical education literature to get an estimate of the benefits, subtract one from the other, cross my fingers, and give you an empirical estimate of the net benefits/burden.

But that's not my comparative advantage.

rsj: "In this model, does expansionary monetary policy (e.g. fiscal policy) cause a burden on future generations?"

Yes. Because your model is formally identical to my model. I call them "bonds"; you call them "deposits at the government savings bank".

I'm sorry for repeating myself but I'm really curious about the following possibility where 'Ricardian equivalence' is half true in a way that differs from your suggestion where half of the otherwise homogeneous population is Ricardian and the other half is not.

How about if all taxation is from the wealthy (those who inherit and bequeath the bonds) and deficits arise from government spending on public projects?

primed: If half the population is Ricardian (leaves bequests) and the other half is non-Ricardian (leaves no bequests) it is not obvious (to me, right now) that the economy as a whole will be half-Ricardian (even if those two halves are otherwise identical). That's because the Ricardian half may end up saving *more* than their transfer payment if the non-Ricardian half doesn't have any kids, so the Ricardian's kids will bear the whole burden, not half the burden.

When I was younger I think I got my head around this once, after reading a good paper by Willem Buiter. Now I've forgotten what I once figured out, and can't figure it out again from scratch. (This will happen to you too, one day.) But it may come back to me.

That's why I wimped out in my response to Bob Murphy, and just assumed the economy is half-Ricardian, so that half the bonds are bequeathed, without saying what that meant in terms of people and kids.

Nick: "So, if I thought I would be any good at doing this, I would research all the empirical public finance literature to check my memory of whether that $1.30 estimate of the costs is correct, then plough through all the empirical education literature to get an estimate of the benefits, subtract one from the other, cross my fingers, and give you an empirical estimate of the net benefits/burden."

I'd say the 1.30 # is close enough for jazz. The "marginal cost of funds" (the technical name for the 1.30 #) varies a lot depending upon how the taxes are raised - the marginal cost of consumption taxes may be less than the marginal cost of taxes on investment income, for example, or vice versa. It wouldn't take long to survey the literature - Bev Dahlby has a recent book that looks at it all.

On the benefits of education, though, I think it's really hard to get solid numbers, for the reasons that you mention in your comment. Yes, we can observe how much more, historically, the educated have earned than the less educated. How much of that difference is causally linked to education is really hard to find out (some people have tried to use changes in compulsory schooling legislation to try to find out, but that just gets at K-12 education.) What the returns to education will be going forward is another question entirely, and it will be years before we'll know.

Ricardian equivalence is sometimes true and sometimes not. This is well demonstrated empirically.
So to make an objection on grounds of principle, you need to lay out why you think the empirical evidence is wrong.

Dan: you see, there are good economists, like Frances, who both do empirical work and who have knowledge of the empirical literature. If all economists were like me, economics would be rubbish. Fortunately they aren't all like me. And it's OK for me to specialise in what I do best, because I know there are other economists who specialise in doing all the good things that I don't do.

Worth noting as well that all these arguments about debt being a burden on future generations apply equally well to digging oil and coal and other consumables out of the ground and using them.

Metatone: Damn! Yes, I forgot to mention Ricardian Equivalence in this post. That's because I have spent the last 10 posts on this subject arguing with people who are convinced RE is wrong, but there is no debt burden, because "future generations inherit (sic) the bonds too"!!

My sense of the empirical literature is that RE is roughly half true. That sounds roughly plausible to me, though I would say that the extent to which RE is true depends on a lot of things.

Metatone: yep on the oil and coal. One big benefit though, that often gets forgotten, is that we also bequeath technology to future generations. And once the patents have expired, that is a true *bequest*.

@Nick: re #2. Speaking as a non-economist, this makes sense if what gets built is roads, sewage and water improvements, bridges, etc. But since you are looking at bad arguments, we all know that (1) the total costs of operating a school, hospital, etc are many times their construction costs (staff and equipment, to say nothing of value for money and output); (yes I know bridges have operating costs too); and (2) one doesn't have to look far for examples of "infrastructure" funds that ended up being used for such vital economic drivers as statues of dead politicians, tap-dancing museums, and subsidies for yak ranches in New Brunswick.

Nick, OK, your response to me would explain if Dean Baker had taken the current net interest cost and cut it in half. But that's not what he did. He cut it by 80 to 90% I think.

In addition to the point about some bondholders having kids, he also put in something about taxes coming from people who do or don't own bonds. So I still think he believes that if the government taxes you to give YOU interest payments on the bonds you hold, that that's a wash and shouldn't be included when estimating the size of the Nick Rowe Effect.

If that's what he's saying, he's obviously wrong, and is still reverting to the "we owe it to ourselves" fallacy.

But, it was an offhand remark he made, so I am not 100% sure that's what he means.

Didn't DeLong and Krugman do a whole series of post on how R-B equivalence didn't invalidate fiscal stimulus? So, couldn't one, technically, hold both beliefs?

Plus R-B equivalence isn't just about dynastic modeling, but also an absence of liquidity constraints. So if one believed in forward thinking permanent rational agents who face liquidity constraints, deficits could not be a burden but provide macro stabilization.

Nick: It might be workers 20 years from now, or landowners 100 years from now, or people owning bonds 42 years from now...but it's a burden to someone, if taxes have to be increased.

Taxes are not absolute but mostly relative, i.e. in %. An increase in % does not mean that the volume will increase. So if you, say, decrease % but the taxed volume still increases, do you call it an increasing burden? I am very curious.

My point is that the tax system and its interactions with broader economy is way too complex and much more complex to say whether deficits are good or bad. Don't you think that "good" and "bad" in itself depends on the structure of tax system and its interaction with broader economy? And for another tax structure your today's "good" deficit might be "bad"?

Shangwen: yep. There are a lot more costs than I've included. And only people really familiar with the nitty gritty details could really give us a good estimate. All I can do is say whether their estimates would make sense at the macro level.

Bob. I'm not at all sure either. My guess is that he is assuming that 80% to 90% have kids, and that anyone who has kids is Ricardian??? And that bit about where taxes come from (bondholders or not) might indeed suggest he doesn't get it.

OGT: Yep. I did a whole slew of posts on that too. A temporary increase in G *might* (for a given r) increase AD, even under Ricardian Equivalence. (*Might*, because it all depends what the government buys). But if RE were true, you would get that same increase in AD if you increased G regardless of whether you financed that G by increased taxes or by borrowing. So the deficit per se, given G, wouldn't affect AD.

If RE were false because of liquidity constraints, part of the burden might be on our future selves, later in life, rather than on future generations. It all depends when taxes are increased, and whether the forced saving early in life (due to liquidity constraints) affects our bequests.

Sergei: I would say that all taxes (except maybe Pigou taxes) are a burden. Some are a bigger burden than others, for the same $1 of revenue collected, so some will cost a little more than $1 and others will cost a lot more than $1. (Pigou taxes cost less than $1.)

Nick, do I read you right then that if you do not change % but taxes nevertheless increase then you still treat it as increasing burden?

Sergei: I'm probably not understanding you right. (You are not thinking in terms of that old Carl Christ model from the 1970's, are you? The one where the long-run spending multiplier is 1/t, where t is the tax rate????. I hope not!)

You are talking foreign language. So I think it is a safe bet that no, I do not. There are two (somewhat independent and somewhat interdependent) variables in this story: tax rate and taxed volume. Which one is that one that you use for your "good" vs. "bad" deficits story?

I'm not sure whether you'd consider this a variant of your reason #4, but let me try to propose a very special rule #7. (You can think of it as the W.C. Fields "It is morally wrong to allow a sucker to keep his money" Rule)

7) It is a good idea to issue to run deficits when (a) you can finance them entirely by borrowing from foreigners, and (b) you have no intention of paying the money back -- you'll just effectively default.

Technically, you might claim this is just rule (4) where I'm assuming that the rate of interest on the debt is negative, but here I'm being explicit that I don't care about the rollover problem. Instead, I'm dropping your assumption that investors will never offer a free lunch.

Presently, investors in many countries are offering the US govt. (perhaps others?) the chance to borrow at negative real interest rates in US dollars. It is clear that lenders would have little effective recourse in the event of a selective US default or substantial USD depreciation (as we saw in the 1980s with large-scale Japanese investment in the US followed by a large and rapid USD depreciation from 1985 onwards...followed by a financial meltdown in Japan.) Pretty influential and smart people have argued that foreign tastes for US govt. debt were not rational even before the global financial crisis (e.g. http://www.federalreserve.gov/boarddocs/speeches/2005/20050414/default.htm)

Yes, I understand that this rule is very open to abuse. Yes, I understand that we should not expect this rule to apply often. At the same time, I think the rule merits serious consideration in some important special cases. At a minimum, would we all agree that this should be part of any rational government's strategic thinking?

Isn't #5 just a reformulation of "growth rate will exceed interest rate?"
Which is only a reasonable hypothesis in the short term, and anyone who's using this argument should review Liveo's post about how extraordinary growth rates in the 19th, 20th, and 21st centuries have been. (http://worthwhile.typepad.com/worthwhile_canadian_initi/2012/10/is-the-stationary-state-coming.html)

Personally, I'm a fan of #2 & #3, except that both are contingent on a well-managed government, which could happen, but is certainly unusual.

I remain a big fan of reforming government accounting to stop obsessing about how much cash is being spent and debt being taken on in the present, and start focusing on actual operating costs (including borrowing costs) + amortization of assets (capital cost spread over the expected life of the asset). It creates a much better sense of the sustainability of borrowing.

Sergei: my apologies. I misunderstood your "taxed volume". You are talking about what we normally call "broadening the tax *base*" (taxing some things that didn't used to be taxed).

To answer your original question: yes, it's a burden, no matter whether we pay it by increasing the tax rate or broadening the tax base. But one might be more or less burdensome than the other.

Simon: nice (or nasty, I can't decide!).

Neil: "Isn't #5 just a reformulation of "growth rate will exceed interest rate?"

Yes. Same thing.

"Which is only a reasonable hypothesis in the short term, and anyone who's using this argument should review Liveo's post about how extraordinary growth rates in the 19th, 20th, and 21st centuries have been."

Good point.

Sergei: my apologies. I misunderstood your "taxed volume". You are talking about what we normally call "broadening the tax *base*" (taxing some things that didn't used to be taxed).

To answer your original question: yes, it's a burden, no matter whether we pay it by increasing the tax rate or broadening the tax base. But one might be more or less burdensome than the other.

Simon: nice (or nasty, I can't decide!).

Neil: "Isn't #5 just a reformulation of "growth rate will exceed interest rate?"

Yes. Same thing.

"Which is only a reasonable hypothesis in the short term, and anyone who's using this argument should review Liveo's post about how extraordinary growth rates in the 19th, 20th, and 21st centuries have been."

Good point.

Nick, I do not mean broadening tax base. At least the way I understand it. To give an example - VAT (or sales tax). Here we have it set at 20%. If the volume of transactions expands then taxes increase while both tax rate and tax base stay constant. So my question is - do you consider such situation still as an increasing burden?

I don't get how you're saying all taxes to pay for debt are a burden. If I lend the government money presumably it's because I don't think there is any better spending opportunities available. So the present value of that decision is not based on what else I could have bought now, but on what I can buy in the future. (And remember that by buying *government* bonds I should already be aware I may be taxed to pay my own bond.)

This is why I don't understand your saying if Ricardian inheritance is half-true you'd only get a smaller stimulus because: 1. Bondholders should not be expecting high returns anyway. 2. People buying bonds are not liquidity constrained. They're risk averse. Why else are they buying bonds? Where do they get the cash? Why do people think buying government bonds is a for-profit business like any other?

It seems like your arguments only apply to the Volcker recession: with high inflation we should raise rates and taxes (or cut spending) at the same time if the budget deficit is increasing.

Yes. Because your model is formally identical to my model. I call them "bonds"; you call them "deposits at the government savings bank".

Great! Now, sticking with this assumption, the "burden" that the government must pay each period is the number of deposit accounts * interest rate on those accounts. In a static (no recession) analysis, as the number of deposit accounts goes up, the interest payments must go up, to preserve price stability.

But if the savings demands are changing -- say in even and odd periods, then in even periods savings demands are high, and the government must either increase the number of deposit accounts, or decrease the interest paid. In odd periods, the reverse must happen.

Now, are you are saying that the operation of changing the interest paid per dollar in the account (e.g. interest rate policy) does *not* impose burdens, but the operation of changing the quantity of deposit accounts *does* impose burdens?

It seems to me that the situation is perfectly symmetrical. Fiscal policy has intergenerational burdens if and only if monetary policy does.

There is no disadvantage to fiscal policy vis-a-vis monetary policy as a result of an increased risk of inter-generational transfers. You are multiplying two numbers together to get the interest obligation, or "burden", and government can change either one at will.

Why the preference for the second number instead of the first? Why is one safe and the other risky?


Moreover, the argument that Noah gave can be interpreted in this model as saying that if there is any unwanted transfer between generations that are alive, the government can simply mark down the deposit accounts of one cohort and mark up the deposit accounts of another cohort to ensure that both cohorts carry whatever burden we want them to carry, relatively. This operation is deficit neutral.

So via a combination of changing the total quantity of accounts across time, and then changing the distribution of accounts among generations in each period, you can effect as situation in which shifts in *aggregate* savings demands are counterbalanced and consumption within each cohort is also stabilized across periods, with no individual cohort gaining at the expense of any other.

Nick I don't think Dean Baker was assuming 90% kids, I think he was doing the "if you pay taxes to retire a bond you yourself hold, it's not a burden" thing in conjunction with the kids thing.

You know Nick, sometimes I think that not even you are as fanatical about this issue as I am. I am the only one in this generation who really cares.

The liquidity issue strikes me as a relatively important one. It's why I tend to conceive of deficits as being akin to Miles Kimball's Federal lines of credit, you're helping with consumption smoothing liquidity constrained people can not do themselves.

Reasons 3 and 6 are the best. However, in an austerity situation like Spain's it seems to be education and infrastructure that are getting cut, possibly further aggregating the long term burden. Not sure how your counter factual model resolves itself if the CB never corrects its mistake.

Bob: "You know Nick, sometimes I think that not even you are as fanatical about this issue as I am. I am the only one in this generation who really cares."

You are right. And you have just bags more energy than I have. God only knows, after Daniel's latest posts! They grind you down. I did all those posts showing yes, you *could* get a burden on future generations, and some people said "that's only because you are assuming full employment!". So in my last post I construct a New Keynesian model, with unemployment, and show you can *still* get a burden! And now they really really really don't want to understand that model, even though it's an absolutely bog-standard NK model, except with OLG.

Like this:

rsj: Look at the model! Set r=n, and F=0, and Look! No recession! No burden!

I need a drink.

Bob and Nick,

I don't think Dean was just talking about bequests but also people spending directly (or indirectly) on their kids now. "Direct" things like buying them food, computers, beds, cars, dance lessons, summer camp, college tuition, whatever. Or "indirect" like maybe, I'm guessing, a family swimming pool or central air and heating?

If you think debt is a burden because it might, just might, someday, have to paid down, then debt is not the measure of the burden because a real mercantilistic government would not be satisfied with paying it off but insist on amassing a hoard and there is no limit on the size of that.

Nick, I am saying that you do not need to use monetary policy to stabilize the economy, you can use fiscal policy to do the same thing.

If you screw up the fiscal policy, you can use monetary policy at the risk of passing a burden onto future generations.

If you screw up the monetary policy, you can use fiscal policy at the risk of passing a burden onto future generations.

If you screw up both, you can pass a burden and/or have a recession.

The situation is symmetric. This has nothing to do with assuming r = n. r can be anything.

But I would very much like to see the post

"Six (maybe) good arguments for monetary policy" with obsessive attention paid to the fact that some generations can take delivery of too little or too much interest income than they should, effecting a transfer from one generation to another. Why the double standard?

rsj: Aaaarrgh! Look at the model! This is why we build models! Set r=n in each period (so r moves up and down with n), and keep F=0, and there is no recession, and no burden!

The scotch hasn't kicked in yet.

Nick, try Ardbeg.

In your equil #4, tax the old in every period (except the first by F) and give F to the young.

This is deficit neutral so it has no bearing on whether fiscal policy is used or not.

Now, everyone's consumption is the same every period, and the recession is avoided via fiscal policy. Am I getting something wrong? Where is the burden due to fiscal policy?

Or, another way to think about this:

The CB is setting the interest rate, r, too high. People are willing to accept a lower rate, s. So one thing that fiscal policy can do, by spending more now and taxing the older generation later is to reduce post-tax rate back to s, even though the pre-tax rate is r.

Another reason from Ed Prescott:

You can use government debt to lower distortionary taxes.

http://www.minneapolisfed.org/research/qr/qr3111.pdf

"Some naively think that government debt is a burden
on the young. This is not the case, since the welfare of
the young and government debt are both large in the
efficient saving-for-retirement system. Indeed, in the
inferior tax-and-transfer system, government debt is
zero. We go on to show that switching from a pay-asyou-
go system to a savings system benefits everyone
and incurs no costs. All that needs to be done to make
the switch is to stop taxing labor income. During the
transition period, transfers to the old would be financed
by a large deficit and the stock of government debt would
rise to its needed level."

Whoever said he thought Baker was including stuff like old people now using their government transfer payments to live in a nice neighborhood, thereby benefiting their kids, etc., you're right I agree Baker was thinking of stuff like that too.

Lord, I agree with you that it's not just the servicing of the debt, but paying the debt down, that is the crucial thing.

Nick, you aren't going to believe this, but I'm taking a giant step toward the MMT camp on this. Before, I thought the issue was future generations being taxed to service the debt, but now I'm thinking the only way you make them poorer on net is if the taxes to deal with the debt are higher than the interest payments to the debtholders. So that means, only if the debt is shrinking. In the examples I cooked up--and I think you too?--the way you make everybody alive in period X poorer, is you have net debt reduction. I think if middle generations just floated the debt without moving it up or down, then they break even collectively.

Gasp, dare I say it, they break even because they are paying the interest to themselves? Real GDP is unaffected so total income is unaffected?

I am not going to do a formal post until Monday, Nick, so if you think I'm being seduced by the Dark Side you have the weekend to save me...

Bob: "...but now I'm thinking the only way you make them poorer on net is if the taxes to deal with the debt are higher than the interest payments to the debtholders."

Nope. If taxes = interest receipts, then lifetime *consumption* is unchanged, but lifetime *utility* is lower. You can see that from your own examples, or mine, with U=log(C when young) + [1/(1+n)]log(C when old).

Think about it: if I persuade you to postpone some of your consumption by offering you interest, and then take that interest away, you are worse off.

Or, think about it: if paying taxes made an individual better off, you wouldn't need the IRS.

(Actually, you could really upset Daniel here, if you wanted, by showing that utility *in any given year* is also lower in this case, even though aggregate consumption in that same year is the same.)

(And that wouldn't be turning MMT anyway. When I see you mumbling "apples bought = apples sold" to yourself, then I will know you've turned MMT. You were much closer to MMT one year ago, when you belived, like they do, in Abba Lerner's Functional Finance view on the non-burden of the debt.)

Join me in a Scotch, Bob.

rsj: Suppose the government gives the young a bond worth F in period 1, then tax the old F(1+r) in period 2. If they know you are doing it, it makes no difference whatsoever to what happens. Look at the Euler Equation: (consumption when old/consumption when young)=(1+r)/(1+n). They save all the transfer payment. Full-blown Ricardian Equivalence in that case, because the individuals in cohort A know that they themselves will be paying for the transfer payment when they are old. It doesn't cure the recession.

Ardbeg, eh? Grant's was on special, so I'm drinking that.

Nick

If g < n < r, known & forever, then debt is trivially a burden. OLG is needed only to show how the pain is being 'pushed forward'. Gov bonds and private capital are substitutes, and govt borrowing when the private sector won't is a pure redistribution. The recessionary shock in period 1 is unrecoupable, by construction.

At the absolute very least, you have to allow for:

g < n < r(private).
r(gov) < r(private).

Then, the welfare calculus becomes interesting because we have to first choose a benchmark to evaluate public debt and then compare r(gov)&n.

[Edited to put spaces both sides of < symbol. NR]

Nick, right, I am OK with what you are saying now, but for sure I didn't quite have it before. I didn't realize how essential DMU was. I am not saying you were wrong in anything, I'm just saying the generalizations I was drawing before, weren't quite right.

Here's what's tripping me up Nick: Is "poorer" interchangeable with "lower utility"? It seems like it is--if you were just as wealthy (after tax) you could buy the same bundle, and achieve the same utility. And yet, it seems weird that we have to insist of DMU to get that result. Something is just not clicking with me...

Bob,

You can have positive taxes that aren't a burden in the growth case. Here is an example, where I augmented Nick's original example. I held the debt at

For g = 10%, r = 5%, Debt = 100, Taxes = 5

Generation 1: consumes 300 (as opposed to a 200 endowment)
Generation 2: consumes 215 (old (110+100+5) young =0 + as opposed to 210)
Generation 3: consumes 226 (old (121+100+5) young = 5 as opposed to 221)
...

The third generation gets 110 when young, but transfers 105 to pay and service the debt. Then when old they get endowed with 121 and receive 105.

I haven't tried solving for prices with concave utility, though, but it should be possible since consumption is increasing across generations. It would require a smaller initial transfer though.

You might be able to do it in the no growth case with a certain interest rate path as long as you don't transfer 100 at the beginning. Just don't let all the old get the benefit spread it out over generations.

For example:

Year 1 transfer 50
Year 2 transfer 75
Year 3 transfer 87.5
...

That way every generation has higher lifetime consumption rather than just the first old generation. The first full generation, transfers 50 but gets 75, the second transfers 75 but gets 87.5...

Bob: Let "n" be the rate of time preference proper (von Mises Pure rate of time preference): such that lifetime utility = U(C when young) + 1/(1+n)U(C when old).

If we do not have DMU, then this becomes Lifetime Utility = C when young + [1/(1+n)]C when old. And r must = n at all times. So lifetime Utility equals the present value of lifetime consumption. Taxes equal to interest payments will mean the present value of lifetime consumption will be lowered, even if the undiscounted sum of lifetime consumption is unchanged.

Nick,

I'm drinking Four Roses small batch now and have had a few. The Giants are staying alive so far.

Not sure how you are turning RE off and on like an emergency light. I thought we were not assuming it in this game of inter-generational warfare.

Point being, do you agree that if the CB sets rates too high, the. Treasury can lower them via taxation, fixing the CBs mistake? We are assuming the market clearing rate is lower, so the investors are OK with being taxed.

rsj: "Not sure how you are turning RE off and on like an emergency light."

It's in the model. RE works within the cohort, because they are lifetime utility maximisers. But it doesn't work across generations, because they don't care about the kids.

"Point being, do you agree that if the CB sets rates too high, the. Treasury can lower them via taxation, fixing the CBs mistake?"

In the model yes. Because you just replace r with r(1-t), where t is the tax rate on interest from the central bank, and set t such that r(1-t)=n. But that's identical to just lowering r. And this only works because of the representative agent setup in the model. If people were different, there would be private borrowing and lending too, and taxes on interest income would cause welfare losses by distorting private lending and borrowing.

Well, as long as you believe that fiscal policy can undo the mistakes of the CB, preventing the recession without causing inter-generational transfers, I am happy.

Nick,

I don't think this example works. If you try to solve for the interest rate path, there is no solution.

"Here is a second example, where all future cohorts have lower lifetime utility, even though their lifetime consumption stays at 200:

Same as the first example, except the government only borrows 50, and then taxes all future generations to pay the interest on the debt, but leaves the debt unchanged at 50 forever. So all future cohorts consume 50 when young and 150 when old. But they have a utility function U=consumption when young x consumption when old. So their lifetime utility will be 50×150, which is less than 100×100."

The first generation with Cy*Co utility needs to get a return of 100 to lend 50 apples when young (the interest rate must be 100%. Why? Because 50*200 = 100*100 (consumption young)*(consumption old). If it's not clear look at the FOCs. So to lend 50 apples, they need to get a transfer of 100 when old. 50 to pay of principle and 50 to pay off interest. You said, use taxes to pay the interest. Fine, so the next generation has 50 apples left to buy government debt. The government needs to raise 50 to roll over the debt. What interest can they offer? They have to offer an infinitely high interest rate, because the next generation only has 50 apples left and giving up all 50 will leave them with a utility of zero no matter how much they get to eat when old.

The old generation knows it will never get paid back, so it wouldn't buy 50 apples worth of government debt. My conjecture is that you can't get the first generation to buy debt without increasing their lifetime consumption, if they have concave utility. [unless the future is valued more than the present]

rsj: ahem. You know that's not what it means. It means the fiscal authorities taxing the interest rate that the Bank of Canada pays on reserves. It's just monetary policy, with a different name.

Charlie: Nope. Cohort A consumes 100 when young, and 150 when old. The government borrows 50, then gives them 50. It is exactly as if the government gave them a bond for 50 apples.

Nick,

I'm talking about what you'd call cohort B. The buyer of the bonds. Think about it. They need a return to buy the bonds.

Generation A is better off, 150*100, surely you weren't talking about them being worse off.

If you don't believe me, tell me the interest rate on the bonds.

Charlie: OK. I thought you were talking about cohort A. But you were talking about cohort B, who consume 50 when young and 150 when old. So in equilibrium for cohort B, (1+r)=(MUwhen young/MUwhen old) will be 150/50, or r=200% right? (I don't trust my arithmetic.) No worries, just stick a lump sum tax on them. The government can afford to pay any interest rate it likes, if it gets the revenue from lump sum taxes.

And (1+r) for cohort A will be 150/100, or r=50%.

rsj: ahem. You know that's not what it means.

No, no, and NO. But I think this point illustrates why you don't believe in a fiscal theory of the price level. You really believe that the government comes and confiscates your chickens for taxes.

It does not.

The government merely marks down your money holdings. That's it. It's just a monetary transaction, and that is how the public views it. And when the government sends out benefit checks, it is not giving anyone chickens, either. It is merely increasing their deposit holdings. Another monetary transaction.

Fiscal policy happens with monetary transactions vis-a-vis the private sector. All monetary adjustments that can affect interest rates, the price level, etc. No chickens are harmed in the tax collection process. So fiscal policy can accomplish everything that monetary policy can do plus other, more targeted things that monetary policy can not do, such as breaking the zero bound, effective transfers of nominal income, etc. What it can do in the real sense is more complicated, but this is fiscal policy.

Plus, the Giants won.

Plus, the debt incurred by the government is nominal in nature and not real. No one knows what the real debt will be (that also depends on future fiscal policy). There is no real government budget constraint, there is only a nominal GBC. And before you chime in with "if the CB does its job then the nominal GBC is a real GBC", I would point out that many are calling for above average inflation during the recovery, which means that we don't really know what the real burden of debt will be by looking at current nominal interest rates.

Nick,

"The government can afford to pay any interest rate it likes, if it gets the revenue from lump sum taxes."

No, unfortunately there is a resource constraint, so the government cannot pay any interest rate. Also, the tax rule will be in the FOCs in equilibrium. There is no uncertainty in this problem. So the agent knows he will pay a lump sum tax when old, which will change the required interest rate. You have to solve for prices given the tax rule.

For the interest rate, with no taxes when old only taxes on the young, generation B needs to get 100 apples for the 50 they give up. So if call the first 50 interest and the second 50 repayment of principle, then the interest rate is 100%

If you think about optimality:

max Co*Cy

Cy + b = 100
Co = 100 + (1+r)b

FOC:

Co = Cy(1+r)

100 + (1+r)b = (100-b)(1+r)

Solving for b with some algebra it appears you get:

b = 50r / (1+r)

I thought I could get that generation B to lend, but I think I had an algebra mistake. It looks like the interest rate needs to be infinite to get them to lend 50 apples. (set b = 50 and solve)

It will be hard to do a lump sum tax of infinity, no?

Nick,

You picked the consumption stream you wanted and then solved for the interest rate using the FOC, but that consumption stream isn't optimal. At that interest rate, the agents would prefer to lend 33 and a third apples. You actually have to make it optimal for them to pick that consumption stream by picking the interest rate.

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