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"If monetary policy were doing its job right, and getting Aggregate Demand where it ought to be, nobody would be arguing for bigger deficits to increase Aggregate Demand"

But fiscal policy may affect the set of feasible paths for aggregate demand. (Of course, it depends how you define monetary policy: if it includes helicopter drops or purchases of arbitrary assets, then it can determine the whole path of aggregate demand.) To the extent that Wallace neutrality applies, monetary policy can only affect aggregate demand at the zero bound by changing expectations about future aggregate demand, which means that some paths (those in which current aggregate demand is different but future aggregate demand is not) are infeasible for any given state of fiscal policy.

Also, does "doing its job right" equal "getting Aggregate Demand where it ought to be." Personally I agree that this should be the objective of monetary policy, but not everyone will, and given that I do agree, I think there are other reasons for caring about the short-run impact of fiscal policy. (For example, low interest rates, due to excessively tight fiscal policy, make long-lived assets harder to value and therefore increase price volatility.)

I think, the way most people talk, talking about "the monetary-fiscal mix" does not exclude the possibility that monetary policy could obtain the optimal level of aggregate demand regardless of fiscal policy, but, in the conventional lingo, it argues that "it would be better to produce this result via fiscal policy rather than monetary policy" or even that "the monetary policy necessary to produce the otherwise optimal level of aggregate demand, given a certain fiscal policy, would have unacceptable side effects and is therefore worse than allowing aggregate demand to be (unconditionally) suboptimal, unless you change the fiscal policy." Now, I could translate this into Market-Monetaristese by acknowledging that, by definition, only monetary policy affects aggregate demand, since we define the stance of monetary policy by the level of aggregate demand (NGDP) that it produces. In that case, though the language is different, the substance is still the same: (1) the optimal level of aggregate demand may depend on fiscal policy, and some fiscal policies may be preferable because of how they affect the optimal level of aggregate demand, and (2) even if the optimal level of aggregate demand does not depend on it, fiscal policy has important short-run consequences that may make one policy preferable to another aside from the long-term issues (r vs. g, investment, distribution across generations, etc.) that you cite

Of course the future generation gets any public capital assets lying around as a freebie: including all of the bridges, roads, sewer systems, public buildings etc.

I think the next generation pays three times: once via debt repayments in the future, once by being unemployed today, and finally the forgone opportunity involved in not acquiring the personal capital one gets from learning on the job.

Good reason to give any stimulus to young workers (jobs and transfers).

This is such an Anglo argument. Living in countries which have never defaulted on (central) government bonds is a different universe than countries where default is historical recurrent reality.

Joe: "Of course the future generation gets any public capital assets lying around as a freebie: including all of the bridges, roads, sewer systems, public buildings etc."

Yup, and in the United States, paved roads are being ripped up and returned to gravel - see e.g. here. The infrastructure argument would have merit if the $$ were being spent on infrastructure. They're not. They're being spent onentitlements to people 65+, the military - schools and roads are not creating the US government debt.

Nick- great post. If I read you right, the zombie stays alive because bad monetary policy means people feel we have to do *something* to increase aggregate demand? Do you think there's any psychological explanations for the undead, e.g. people for some reason really refuse to admit that what they're doing now will cause future harm, e.g. when people argue that, say, spending money on health care now is an investment good, as opposed to a current consumption good?


1. Let n be the target growth rate of NGDP in a level-path policy. Let g be the natural rate of RGDP growth. Let r be the natural rate of interest. Then if you chose n < g-r (I think my math is right there) you would hit the ZLB and that monetary target path would be infeasible. Since g and r are probably positively correlated, I really don't see that as being a binding constraint, for any reasonable (like 5%) target for n. I could *theoretically imagine* an arch-deflationista wanting a loose fiscal policy to keep r high enough so that n could be set very low, but I can't think of any real people who would meet that description.

2. I would say that it is *precisely because* "...there are other reasons for caring about the short-run impact of fiscal policy..." that we want to allocate responsibility for AD to monetary policy. At the very simplest, G has (presumably) diminishing marginal benefits and tax rates have increasing marginal costs (on standard micro public finance grounds), so we want to smooth G and t over time, and not unsmooth them just to target AD when monetary policy could do that job.

Joe Smith: Sure. I am quite happy to add your "...bridges, roads, sewer systems, public buildings etc." to my own "Schools and stuff".

This is depressing. Great post, but it saddens me that it needs to be written at all.

Jim: Good point. I agree. Given that new entrants into the labour force are (from my memory of the data) the most hard hit by the extra unemployment in a recession, plus they are semi-permanently "scarred" by that loss of on-the-job human capital, then adding the burden of the debt on top of that is a triple-whammy.

Lorenzo: Hmmm. I expect you are right. I was ignoring default. But then I don't think default affects my argument. The next generation, that holds the bonds, either pays higher taxes or else suffers default when the bonds they bought turn out to be worthless.

Thanks Frances! "If I read you right, the zombie stays alive because bad monetary policy means people feel we have to do *something* to increase aggregate demand? Do you think there's any psychological explanations for the undead,..."

You read me right. And if you are arguing *for* something, it's really hard to admit that what you are arguing for will have costs as well as benefits, even if you think the benefits outweigh the costs.

(I was trying to work that Shawn of the Dead metaphor in here somewhere, where at the end of the movie the hero keeps his useless zombie flatmate around in the garden shed to play video games.)

Richard: Thanks! Yep. Never ending.

(Off-topic: sorry for not replying to your email a few weeks back. Actually, I only got my copy of the book a few days ago! Also, I've been meaning to figure out exactly what GDP *at basic prices* means, and see what your graphs would look like for Canada. Anybody interested in NGDP should click on Richard's name and read his most recent, if now a bit old, post, to see what I'm talking about. That graph is really interesting.)

The interest rate on risk free debt *is* lower than the growth rate, when weighted by maturity, but this does not mean that the economy is in a ponzi state, because the interest rate demanded of risky debt is above the growth rate, when weighted by maturity.

And we have a lot of data to back up that.

rsj: but will it always be that way? A true sustainable ponzi is forever. (That's why I did my trill perpetuities post, of course, trying to get around that problem.)

so the debt which my parents left me from WW II and the debt which still remains from building the interstate highway system are a burden on me...

i imagine i would have grown up in a different word had that war not been fought and we still relied on those narrow state roads with a 20 MPH zone in each small town to move goods across this country...

rsj: yes, the debt is a burden. And the victory in WW2, plus the roads, are an asset. And for some investments the value of the assets exceeds the cost of the debt. And those we should do. And for other investments the value of the assets is less than the cost of the debt. And those we should not do.

See my bit above about "Schools and stuff".

If monetary policy were doing its job right, and getting Aggregate Demand where it ought to be, nobody would be arguing for bigger deficits to increase Aggregate Demand. Obviously.

Your belief in Monetary Policy as a cure for Aggregate Demand woes approaches the level of religious faith, Nick. Really, I am being serious. Your statement is not science, nor does it seem prepared to accept refutation. It is faith.

All the "zombies" are saying is that they believe in a Multiplier an that the Multiplier will always be greater than one. That means that the Government is following precisely the same logic as any other organization with double-entry accounting, that the revenues from debt expenditures with be higher than debt burden itself.

Now, as rsj says, due to abundant historic records, we know that interest rates charged to government are almost always below growth rates. From an insurance view, we have ample information to categorize the risk that the debt will actually be a burden, and that information means that it is very unlikely.

So the zombies have evidence on their side. Maybe a little bit of risk, but that does not falsify their position. Your serve.

National debt is a burden by definition in the neoliberal marginalism. The reason it is a "zombie" idea because outside of marginalism and its diminishing returns, debt is a distributional issue within the political conflict. If you have policies, whether you call them fiscal or monetary, but do not have politics then you ignored the conflict but created an abstract burden. If you stick with politics then you have a conflict but remove the abstract burden. It is not a zombie idea. It is an economic *non*-problem in minds of those people who think of political economics rather than pretending that there is only economics out there.

Determinant: read Dean Baker's post. Nowhere does he mention whether interest rates are greater than or less than growth rates. All he says is:

"A moment's reflection shows why the debt is not a measure of inter-generational equity. At some point everyone alive today will be dead. At that point, the bonds that comprise the debt will be held entirely by our children or grandchildren. The debt will be an asset for the members of future generations that hold these bonds. This can raise distributional issues within a generation. For example, if Bill Gates' grandchildren own the entire U.S. debt there will be important within generation distributional consequences, however this says nothing about inter-generational distribution."

Sergei: "National debt is a burden by definition in the neoliberal marginalism."

Nonsense. It has got nothing to do with marginalism. And it is not true by definition (note what I said about the debt not being a burden if a ponzi scheme is sutainable). And when I hear someone complaining about "neoliberalism", I reach for my shovel. Abba Lerner was wrong about the debt not being a burden.

In that case, throwing out interest rates and just using assets and liabilities, all Dean baker is saying is that you can't talk about debt without talking about assets. Pure double-entry accounting.

If the debt was borrowed and spent on consumption without accumulation of assets, then we have a problem. If the many owe to the few, then we have a big problem.

If the assets are good and hold value, then the debt is good. This is why you took out a mortgage, Nick, and slept so well after you did so.

Nick, when you bought your house, you put downpayment on it. Your payment each month was close to your equivalent rent, so you were fine in the eyes of the bank. At the end of the mortgage, let's assume you sell your home. You get your downpayment back, and them some. But your monthly payments replaced your shelter costs of rent, so they don't count. Now feed the downpayment and the present value of your house into a compound interest table. You'll get a return of say 5% compounded. Was your mortgage a burden you you? No. It sheltered you, and you got a 5% return. And you were never in danger of default because of your debt since you had an asset behind it.

Now take this to an economy-wide level. There's no zombie parade.

Determinant: here is Dean Baker's post's title: "Children and Grandchilden Do Not Pay for Budget Deficits, They Get Interest on the Bonds"

In other words, you can forget about the house that the deficit financed. We know the debt is not a burden, simply because the taxes they pay are returned to the grandkids as interest on the bonds they own! Even if the house burns down they are not worse off, because they pay the interest to themselves!

I say if the house (i.e. school) burns down they are worse off. If the house/school is worth more than what it costs them, then they are better off on net. If it's worth less, they are worse off on net.

Then you're saying the glass is half-empty, and Dean Baker is saying the glass is half-full. I can see the rhetoric Dean Baker is using, it's the same line you take with Chuck Norris.

In other words, you can forget about the house that the deficit financed. We know the debt is not a burden, simply because the taxes they pay are returned to the grandkids as interest on the bonds they own! Even if the house burns down they are not worse off, because they pay the interest to themselves!

On a naive first look at macro, then yes. But that characterization is almost a tautology and just as useless.

Taxes have a distributional "net" and if the distribution of assets and incomes changes, then the net has to move to keep the yield up. If 90% of the money winds up in 10 people's hands, we have to tax the hell out of those ten people or live in destitution for a very long time.

A bad worthless road paid cash is a bad worthless road. A good worthy road paid with debt is a good worthy road.
We should not argue about debt when the problem is misallocation now.

What a crazy argument! It's OK to hike interest rates sometimes and lower them at other times without this being "unfair" to the generation that gets the rate hike. Yet it is somehow unfair to deficit spend on some occasions but not others.

The insurance value of using fiscal policy to stabilize demand is a benefit that accrues to *all* generations ex-ante, even if some "lucky duckies" get to pay less in taxes because they happen to be working in a period of depressed demand.

Or, to say it another way, what difference does it make to tax away 10% of someone's wealth, or to reduce their wealth by 10% via a rate hike?

In both cases, they are poorer, they have less money to spend, and they are "paying" for whatever the previous policy errors were in which rates were too low or spending was too high.

Nivk: Nonsense. It has got nothing to do with marginalism. And it is not true by definition (note what I said about the debt not being a burden if a ponzi scheme is sutainable)

Your argument about interest rates rotates around the "burden" which you try to justify with some added value associated with this debt so that on the net basis it can get either negative or positive. The debt is a constraint *by definition* in *your framework* which is why I made my comment. The debt is such because you have constructed the problem like that. You also claim that this framework is not subject to any possible political changes in the future.

And it has everything to do with marginalism because the existence of (national) debt constrains optimization process of private agents. So debt is a burden and is so by definition. Your "net value" argument comes in here as well but in a different form.

Neoliberalism come in because in your "monetary policy for all" framework if a representative private agent owns its own debt it is not a problem. However when this representative agent elects a representative government and this government incurs debt by refusing to print more money then you somehow change your thinking to consider what it means for you agent. Why such asymmetrical attitude to debt? Why it does not matter in one case and matters in another?

Well, Nick, I was going to say that you always smuggle in the premise that the older generation simply consumes whatever it is that the younger generation paid for the bonds, but then you seemed to concede that point back to rsj and recognized that need not be true. So I'm not sure what you are exorcised about. Some of the wealth used to purchase the debt is simply saved, and then handed right back to the youngsters at the death of the oldsters, and some of it is invested, the value-added products of which become the assets of the youngsters. If either of these things happens in sufficient abundance the next generation either gains or suffers no loss.

You are also really changing the terms of the debate. When people say that our debt is a burden on future generations, they mean the debt itself is a burden on the young. They are almost always thinking of the debt liabilities that comes into the collective possession of the young, and ignoring the debt assets that comes into their possession too. What you are arguing is not that the debt is a burden on the next generation, but that the price the next generation has to pay to acquire those debt assets is net loss to that generation. But as already mentioned you are not entitled to that empirical assumption. Much of that purchasing price is spent on things that then benefit the next generations. Even some of the consumption demand of oldster's that is financed by the debt has multiplier effects in fixed capital generation which benefit the next generation. (And of course some of the consumption is done by young people themselves - food stamps for example - who are going to acquire the debt instruments.)

These phenomena are lost if you persist in thinking of mental models of apples and such. Apples can't be invested or saved very well. So they are only consumed. But other goods are both saved and invested. So you can think of scenarios in which all of these transactions might harm the next generation; but you can also think of scenarios in which the next generation is benefited by the transactions. You haven't discovered a proof that debt harms them next generation - whether it does or not depends on highly contingent and variable premises.

And the benefit scenario I am suggesting has nothing to do with Ricardian equivalence. The Ricardian equivalence line, as I understand it, is that the public borrowing of resources accomplishes nothing, because people then save more than they otherwise would in anticipation of paying back the public debt. But apart from the psychological unrealism of this picture, this plays no role in the intergenerational picture that both you and your critics are entertaining. The older generation, you are assuming, borrows from the young and spends the borrowings in some way (consumption, you say; I say a mix of consumption, investment and saving.) The older generation does not save more to pay the debt, because they know they will be gone. And the younger generation does not save more on net, because they have both the debt assets and the liabilities.

So we are just back to what happens with the wealth that is transferred initially from the young to the old to buy the debt. Why believe this is either a net loss or a Ricardian wash? Why not think of the older generation as a kind of company, and the younger generation as investors in that company? You are assuming that the investment represents a net loss to the investors, because too much of it is burned up in Bacchanalian binges for the company's directors and workers. But I think it is just as plausible that the investors receive a profitable return on their investment. You can't just assume that the wealth transferred to the oldsters to purchase the debt instruments goes up in smoke along with the cremated carcasses of the oldsters. They employ that wealth in many ways to produce outputs that are passed on.

Nick's article ends by saying “If recovery gets postponed much longer, I'm going to start to worry whether fiscal authorities will be able to afford a recovery.” Whaaaat?

If citizens decided they needed an extra billion dollars each before they were willing to go out and spend, there is precisely and exactly nothing to stop a monetarily sovereign country printing and spending hundreds of trillions into the economy in order to meet citizens needs and effect recovery. The word “afford” is wholly irrelevant.

And as we are all piling on Nick, I want to also point out that if anything is an example of an inter-generational transfer, it would be cutting interest rates in order to stimulate household debt growth and real estate prices. Future generations have to pay more for land now and the incumbents take delivery of windfalls in gains that can be converted to consumption.

How is that different from a transfer as a result of deficit spending?

Moreover, why is the resulting overhang of increased private debt as a result reductions in interest rates OK, but the resulting overhand of government debt as a result of more deficit spending is not OK?

Seriously, I think there is a lot of asymmetrical thinking going on here. In both cases, whether encouraging the private sector to borrow more as a result of cutting rates or whether directly having the government borrow more, there are both good and bad cases to be made for both stabilization policies. I would tend to be more worried about former and perhaps Nick is less worried about it. But the preference for one or the other has nothing to do with direct government deficit spending being less sustainable than private sector deficit spending as a result of rate cuts.

And I am very worried about how the Canadian economy, for example, can afford a robust recovery if everyone is leveraged to the hilt with adjustable rate mortgage debt.


You concede that “the debt really isn't a burden on future generations if the old generation makes sure it isn't a burden by giving the bonds to their kids as a freebie.” Quite. So the $64k question is: “If government gives cash rich individuals government bonds in exchange for cash, will those individuals significantly alter the amount they plan giving to the next generation (rather than send youngsters down coal mines or whatever)?” I can’t for the life of me see why they should.

And if I’m right there, your argument falls apart.

As to Ricardian equivalence, I fail to see the relevance. Of course the extent to which RE works influences how effective fiscal policy is, but I don’t see the relevance for the above “coal mine” point.

I think we had all agreed last time around that 'debt is a burden too' basically depends on what you do with the money?

Plus, if you see fiscal policy as being able to push the economy from a bad time path to a good one (higher wealth vs lower), debt is a burden and not a burden, depending on what benchmark you're defining it relative to. The increase in wealth can be shared by the two generations.

It's precisely how tax-payers might also make a profit when the CB steps in to rescue a failing asset market.

In general, I think discussions of AD policy that neglect multiple equilibria (or multiple solutions to the coordination problem) will keep running into these Wittgenstein-ian troubles.

The debt is essentially owned by the 0.1 percenters and retirement funds. The 0.1 percenters are into empire building rather than consumption, and will actually give most of it away rather than sell it, and for the retirement funds:

Assume that in state A people cannot work and thus do not hold any bonds. In state B they do work and get paid in bonds which they will redeem as they retire. Your argument is that they will acquire significantly more resources in their old age in state B. I think you are wrong. I think the old generation will receive about the same amount of resources in both cases.

Brad DeLong responds.

OK, now, finally, we're seeing some real action!

Here is my comment in reply to Brad:

Assume a bog-standard OLG model with NO capital whatsoever. No storeable goods (except government bonds). GDP is exogenous and constant. Rate of interest is positive.

1. The government gives bonds as freebies to cohort A.
2. Cohort A, when old, sells those bonds to the young in cohort B, and consumes the proceeds.
3. Cohort B, when old, sells those bonds to the young in cohort C.
4. The government notices that the debt/GDP is growing, because it has been rolling over the debt+interest, and that this is unsustainable, because eventually some future cohort's young won't have enough income to buy the debt, and so taxes cohort C to retire the debt.

In 2, we see that cohort A is better off. It has higher lifetime consumption and utility.

Cohort B consumes less when young and more when old. Its lifetime utility is not lower, because exchange is voluntary. It pays no extra taxes (by assumption).

Cohort C consumes less when young, and the same amount (as baseline) when old. Cohort C is worse off.

The gains to cohort A came at the expense of the grandkids in cohort C. It is as if the government made real goods travel back in time, out of the mouths of unborn cohort C into the mouths of cohort A.

There are only three logically coherent views on the burden of the debt question:

1. Barro-Ricardian Equivalence. "The debt is not a burden, because private intergenerational transfers from old to young exactly offset government transfers from young to old. People see the debt is a burden on their grandkids, and take offsetting action to prevent it being a burden".

2. Samuelson 1958(?) Exact consumption loan model. The rate of interest will always be less than the growth rate, so the government can rollover the debt+interest forever, so there never is a cohort C that has to pay higher taxes.

3. James Buchanan/the economically illiterate rube on the street, who thinks that the higher taxes to repay interest and principle on the government debt is a burden on whichever future generation has to pay them. That economically illiterate rube is totally right.

There are only three logically coherent views on the burden of the debt question:

Nick, what about Kervickian Non-Equivalence:

4. "The debt is not a burden, because private and government intergenerational transfers from old to young exceed government transfers from young to old. People perceive and understand this, and thus do not take offsetting action to prevent the debt from being a burden.

You're leaving wealth creation completely out of the picture. The wealth that the young transfer to the old might be used to create wealth that is greater in value than what was transferred, and that new wealth might be transferred right back to the young. Schools, roads, etc.

Also, the Buchanan one makes absolutely no sense. Yes, the taxes that have to pay the debt will fall on whatever members of the next generation pay the taxes. But the taxes go to the public - and the public consists of the next generation also. The Buchanan view treats the government as though it were some sun god in the sky that is not itself part of the public.

Dan: (What's the right word for "negative burden"?)

No problem. I see that as a perfectly correct position, that's just the same as 3. The debt is a burden, but any assets it *may* be used to buy *may* be a 'negative burden', and it is possible that the negative burden could be bigger than the debt burden. That's why it can be OK to deficit-finance schools and stuff, provided the schools really do benefit the kids more than the debt burdens them. A perfectly commonsense position.

Ritwik: "Plus, if you see fiscal policy as being able to push the economy from a bad time path to a good one (higher wealth vs lower), debt is a burden and not a burden, depending on what benchmark you're defining it relative to. The increase in wealth can be shared by the two generations."

Yep. But if monetary policy could do the same thing, then a deficit would impose a burden relative to the "good monetary policy" benchmark.

rsj: if you think that low (or high?) interest rates (or a bad harvest, or anything whatever) makes one cohort poorer relative to previous or future cohorts, then sure you might want to transfer wealth from one cohort to another.

I believe that Sergei @ October 11, 2012 at 10:06 PM has it exactly right: "Debt is a distributional issue within the political conflict."

I will stipulate that Nick is correct in his apple example that there is a net burden on the last generation. But what does that have to do with the real world?

In any given year, the production of goods and services has to be allocated among all then-living people. What an old person consumes, a young person cannot consume, so there always is a tradeoff. The way I see it, there *always* is a burden on the young then-working people to support the old, no matter how this is organized. The *debt* as such is not a burden, it is just one way to allocate who gets to consume what. Barring questions of prudent investments of the funds in the first place, its existence or absence has no bearing on how much gets produced and can be distributed. The debt is only an instrument in allocating the production.

In the apple example: *Of course* the last generation gets to consume less, if they have to give apples to the older generation (that then promptly dies). This is only a *burden* if you assume that there is an alternative, i.e. if there is a world in which they could not have given the "old" generation some apples, and have eaten all of them themselves.

But this is not our world: We can hardly not give the old generation anything out of our current production and let them starve. Obviously, the burden always exists, at a minimum out of moral considerations. There is no way to not share any of the production. So this is purely a distributional issue, and of course who holds the debt certificates has quite a bit of influence on the outcome.

But the existence or the absence of a national debt *itself* is not a burden! If you assume that otherwise there is no distributional question, and the re-distribution can only take place through means of these bonds, then yes, obviously they are a burden. However, in our world, assuming away this distributional instrument, the *problem* of allocating resources between all people living at any one point in time does not go away!

FWIW, I understood your original position very clearly from your previous posts. The numerous specific (unrealistic) assumptions you've made to clarify the issue are unfortunately being used against you. The only thing I would add to your 3 views is that mixed states are possible. As I said in a comment to one of your previous posts, it is possible to think of a world where some members of each generation are credit constrained (thereby violating Ricardo-Barro equivalence for the economy at large) while government debt itself is mostly held by a few families who bequeath it to the next generation.

I have a quick question: Is there a way to safely start and end a Ponzi scheme if interest rates are less than growth rates for 10 generations but greater than the growth rate beyond?

Nick, I refer you to this post of mine from last year:

Any "burden on future generations" is imposed entirely through intertemporal choice. Increased government consumption today (and decreased consumption tomorrow) can happen with or without a fiscal deficit.

In other words, it is possible to change the federal debt while holding intertemporal consumption constant. If this is done, then debt imposes no burden on future generations.

Primed: "I have a quick question: Is there a way to safely start and end a Ponzi scheme if interest rates are less than growth rates for 10 generations but greater than the growth rate beyond?"

You call that a quick question?! That's the $6.4 trillion question I've been beating my head against these last few months. This post on trill perpetuities is as far as I have got.

Yep, they are using my simplifying/clarifying assumptions against me.

Nick, I think a negative burden is called an "asset".

Assuming that AD can be increased by either printing money and giving it to people who will spend it, or by borrowing from people who are not spending it and giving it to people who are - then why does borrowing money create a (potential) burden on future generation where printing does not ?

You can use OLG models (a la Bob Murphy) to show how govt borrowing can cause all future generations to have lower utility than they otherwise would have, but this depends upon building favorable assumptions into the model. I'm pretty sure you could also build different assumptions into an OLG model that would show that money printing (which also causes wealth redistribution in current and future generations) equally causes a burden on the future.

My point is that the OLG models that underpin the view that "debt can burden future generations" argument are useful because they show that its not just the size of the future pie that matters but how that pie is divided in terms of how individual utility is determined.

However I'm not seeing how these models help us choose between fiscal and monetary policy because they could be used in support of either just by changing the model.


1. Your argument about n vs. g-r is convincing for the long-run provided that we have NGDPLPT, but (a) in the long run we are all dead -- which is to say, there is nothing to guarantee that the optimal path of AD can be attained, even if we know that the optimal level can always eventually be attained, and (b) given that short-run r can deviate severely from long-run r, NGDPLPT itself limits the available options in such a way that even the preferences of a normal central banker (not an arch-deflationista) might be violated -- in particular, it may require that the inflation rate temporarily exceed a threshold of acceptability.

2. I appreciate the theoretical argument for smoothing, but having lived through the past 25 years, I think that what it misses is more important than what it catches. It's hard for me to think that unsmoothness is a big deal, given that we have the example of WWII -- an extreme of fiscal unsmoothness that didn't seem to have bad macroeconomic consequences. Unstable asset prices, on the other hand, are something that has seemed to present a very big problem, first in Japan and then in the US and Europe.

Look at it this way: the short-run natural interest rate varies a great deal from year to year. Demand management policy, in its idealized form, consists of assuring that the actual interest rate follows the same path. But is it realistic to think that we shouldn't have preferences over the path of interest rates apart from its effect on aggregate demand?

If you want, you can frame this as a money issue by defining the natural level of the money stock as the level that's consistent with the short-run natural interest rate, and you can say that the job of AD management is to set the actual money stock equal at its natural level. But it seems to me we don't really care much about the level of the money stock apart from its impact on aggregate demand, whereas we clearly do care about the level of interest rates.

The gov't builds a bridge out of general funds: Burden or no burden?
................................ a special issue of bonds: B or NB?
..........................by a special agency with their own bonds: B or NB? Does it matter if the agency enjoys the explicit or tacit backing of the gov't?
The gov't ( or its dedicated agency) sells the bridge to a private company. They assume the debt: B or NB?
Reading Nick, they get guilty of bequeating debt: At a stroke of a pen, bondholders transform them into equity. B or NB?
A finance professor comes in and tell them an ideal financing structure comprises both bonds and equity. Equity is converted back into bonds. B or NB?
M-M walk by and tell them it doesn't matter. Owner's and bondholders heads spin worse than Linda Blair's in "The Exorcist". B or NB?

Rework each proposition as to whether there is a toll covering a) operating expenses or b) operating expenses + amortization. B or NB?
The toll is or is not set at the MC, but expenditures are covered. B or NB?

Rework everything assuming foreigners hold either the bonds or the equity. B or NB?

Rework everything as to whether the foreigners paid with yours or their currency. B or NB? Does it matter if they paid in foreign currency directly or exchanged it at the bank before?

Assume the bridge is inceasing commerce and the resulting taxes cover either exploitation or amortization. B or NB?
Assume the bridge imposes tolls that captures the gain from trade. B or NB? Does it matter that the brige is owned by the gov't, a Crown Corp., a private company (internal or foreign)?

The bridge leads nowhere and is a pure political pork. B or NB from the financial side of it ( becaue we agree that it was a waste of resources)?

Linda Blair should not intrude in an economic discussion...


And I am very worried about how the Canadian economy, for example, can afford a robust recovery if everyone is leveraged to the hilt with adjustable rate mortgage debt.

Dude, I shall have to have a glass of water after that one. I thought you knew that Canadian and American mortgages are different creatures, apples and oranges. All Canadian mortgage rates float, they are only fixed for at most five years and this has been the case since 1975. We've had a few economic cycles since then and it hasn't been a problem. Mostly because Canadian underwriting standards are and always were robust.

All Canadian mortgage rates float, they are only fixed for at most five years and this has been the case since 1975.

Nick was making the point that if the government takes on a lot of debt because it is using fiscal policy to fight a prolonged slump, and the CB decides rates need to go up because the economy is booming, then there can be a problem with the government servicing that debt. We may not be able to afford a recovery.

I am saying that using monetary policy during a prolonged slump in which households take on a lot of private debt due to the low rates can lead to an even worse problem. We may not be able to afford a recovery.

ARM make things worse, not better.

Just walk away, Nick. If people don't want to see the difference between "using plausible assumptions to reach conclusion X" versus "using a completely bogus argument to reach conclusion X that can be refuted with a simple counterexample" after this much effort on your part, putting in another 10 hours on your end won't matter.

To summarize this post in another way, Nick is arguing here that it is possible to manage demand via fiscal policy.

One period consumption as a result of government policy goes up, and in another period it is lowered. Just as what happens with changing interest rates. But the change in interest rates, if done well, happens to counteract private sector swings. Households want to save more and consume less, so rates are lowered to encourage them to consume more and save less. Alternately, households want to save more and consume less, so deficit spending occurs to encourage them to consume more and save less. In the next generation, the reverse occurs.

The question is then not just "what does government do with the money" but also when does it deficit spend and tax. If it deficit spends when private sector demand is low and taxes when it is high, then it is using deficit spending to manage aggregate demand.

Which is exactly what we do with our current tax and benefits policy.

It's what we've been doing since Keynes. Since then, we've always been using fiscal policy to manage aggregate demand. The first line of defense and primary tool of demand management has always been that taxes are paid as a proportion of income received, but benefits are paid as a function of need.

But Nick is simultaneously assuming that the deficit spending happens for no reason whatsoever -- that privately induced consumption (and income) is constant in both generations, leading to total consumption being a function of government deficit policies.

This is the strawman used against deficit spending *now*. Which is why I called it a crazy argument.

The bonds are an asset to the bondholder and a liability to the Treasury, so, for accounting purposes, it is a "wash."
For cash purposes, the asset part has already been spent, hopefully on productive endeavors.
The liability part remains , and must be paid back with new general revenues, just as all government expenses are paid.
So, the future generations inherit the liability part in terms of cash purposes, and the asset part only in terms of accounting purposes.
Which part is morerelevant - the accounting part or the cash part?
Don Levit

At the risk of repeating myself: if the argument is about effectiveness of either monetary or fiscal policy, it should never mention the words "burden of debt". These are loaded in a bad Chamber-of-Commerce way and distract us from the real discussion.
Never mentionnong these words again will save the lives of countless innocent electrons.

Bob: yep. you are probably right. And I do have exams to grade. They just don't get the counterexample idea, and keep throwing out red herrings.

But hey, if I convinced you to change your mind!

Right, the point of doing it is to convince onlookers. But probably it hurt your cause when I joined your side...

Bob: Too late!

"If monetary policy were doing its job right, and getting Aggregate Demand where it ought to be, nobody would be arguing for bigger deficits to increase Aggregate Demand. Obviously."

Is that real aggregate demand?

Two points
1. While war may be politically necessary and even good, I had thought economically they and the destruction they cause were always bad, but I am having second thoughts about that. I am beginning to think war can be better than depression. Costs are great with both, but may be even greater with the latter.
2. If you feel debt can be a burden on future generations, wouldn't an appropriate response be to literally print money and not just finance an increase in government debt? No one is confused whether debt represents an asset or not as none is created and there can be no future burden. It wouldn't increase inflation under current circumstances but would shorten the time to return to normality. Simply zeroing out the deficit or declaring a tax free holiday on the fiscal side could do this. While some will be concerned about fiscal discipline over the long term, the monetary side could reinforce it and focus on what it does best, fighting inflation.

Sorry, Nick, your article is just a bunch of nonsense.
You mix up the "real world" (motorways, houses, etc.) with the financial world (IOUs). In the real world, savings are good and debt is bad - savings here means more unused resources available for the future (such as oil, or unharmed nature), debt implies, for instance, bequeathing a contaminated river or deplented fisheries or damaged roads and houses to your kids.

In the financial world, though, more savings means less consumption, and very often (depending on "animal spirits") less investment, since investment is demand-determined. Financial savings will, therefore, probably undermine the future production capacity (the PPF boundary changes).

It is obvious, that an economy can never run out of "money", it can only run out of "real resoruces".
The amount of "real resources" available in an economy is, however, dependent not just on their sheer volume, but also on the available production technologies. More spending NOW can make (and, actually, typically makes, as other commenters have pointed out) the lot of the next generation better (depending, of course, on what you spend the money on, but that has NOTHING whatsoever to do with debt), as it improves the infrastructure (repairs roads, etc.) and technology used for the extraction of resources (more efficent plants, etc.).

Financial debt is only a distributional issue. But not, as you mistakenly assume, a problem of intertemporal distribtion between the present and the future, but a problem of distribution here and NOW (some people get interest payments from someone else). In double entry accounting, each liability has an asset to it. And to every debtor, there is a creditor. The net financial value of assets - liabilities is always zero. But in the process of taking out credit and paying it down, lots of very useful REAL stuff gets produced, making people better off materialilly.

BTW. Ricardian equivalence is balderdash.

I read your post with interest after reading Dean Baker's post of 10/12. You are obviously frustrated at having to knock down what you call Zombie ideas. Let me suggest that instead of speculating about why Brad DeLong failed to respond to an earlier post and using it as evidence of his views, and presenting arguments by tone of voice, you try to respond to the points made specifically and on their own terms and try to demonstrate why they are wrong. By way of example, Baker argues that borrowing in the current economic environment can boost demand, increase investment and thereby increase the wealth of future generations. As you are aware he has numerous other arguments. they are generally presented in common language. You may believe them wrong but your post is unconvincing as you don't deal with them on their own terms. "They don't inherit the bonds, they damned well pay for them" -- Means?? The future generation will find itself citizens of a society created by their forebears. Are they better off or worse off if their forebears borrowed to create roads? Borrowed at 2% rather than 4%? It seems somewhat ridiculous to maintain they are inevitably worse off because the principal amount of debt is greater. Try a thought experiment: A constitutional amendment is passed allowing the government to disclaim all existing debt but leaves all currency outstanding. It becomes virtually impossible for the government to borrow in the future excect, perhaps, at exorbitant interest or unusual security arrangements. The amount of debt the future generations are left with is sharply reduced or theoretically eliminated. Are they better off?

Debt's 'burden' is measured by the debtor's income. Income is the dog that wags the tail. Want to make debt a 'burden?' Just toss a lot of people out of work and lower the pay and benefits for the remainder.

In absolute terms our government has an immense capacity to retire debt. Much more than is possible in the private economy simply because it can lower rates and devalue currency. No one really knows the upper boundaries here, either. Everyone's just guessing. But no matter what the limits are, the determinant is debtor incomes.

Oxbird: I very happily agree, and have said so several times, that deficit spending may have benefits on future generations too, and that in some cases those benefits will exceed the costs. Like schools or roads.

Nick Rowe wrote, the "next generation is paying twice." How is that? One payment is a consumption (tax), the other is an investment (in bonds).

ZDENPR wrote:
In the financial world, more savings means less consumption and very often less investment, since investment is demand-determined.

If people consume less, then it seems logical to infer they are saving more.
And, their savings, typically, would not go under a mattress.
Granted, today's options are severely limited, due to the Fed's low interest policy, and debt is encouraged, rather than saving.
But the saving from less consumption will be put somewhere, to earn interest or some type of growth.

He also wrote:
Financial savings will, therefore, probably undermine the future production capacity.
More spending now has nothing whatsoever to do with debt.

It is obvious you are of the bent toward living for today, rather than sacrificing for tomorrow.
If spending has nothing to do with debt, then how what was the over $1 trillion of government debt last year spent on - nothing?
Don Levit

O.K., Nick, I give up. How many angels?

The state borrow (from local investors or foreign investors) in the form of bonds bearing a fixed interest for a stated period of time)
With the tax paid by economically ACTIVE citizens it pays interest on the bonds
The question now remains on what has the borrowed money been spent on:
If spent on infrastructure that has helped in growing or maintaining economic activity AND that infrastructure is still valued at the same value of the bonds to be repaid, then the generation that repays the bonds is practically paying for the infrastructure. If the perceived value of the infrastructure is higher than the value of the bonds, then the next generation has a bargain.
If though the original income from the bond sale is used to pay pensions or unemployment benefits, then very little intrinsic value is left in the economy when the bonds become due, therefore the next generation is left with burden to have to pay for something that has no value.

Don Levit wrote:

"If people consume less, then it seems logical to infer they are saving more.
And, their savings, typically, would not go under a mattress.
Granted, today's options are severely limited, due to the Fed's low interest policy, and debt is encouraged, rather than saving.
But the saving from less consumption will be put somewhere, to earn interest or some type of growth."

Well, you can ask any businesswoman if she is going to increase the productive capacity of her business in the face of DECLINING sales. The problem is that if you save (financially), there is no way for the others to find out what you will be spending your money on!
And yes, "financial saving" will be put "somewhere", but even under the best of financial systems, the delay (before the bank finds a borrower; today, for instance, no one wants to borrow at rates that are record low!) in spending MIGHT by itself set off a negative feedback loop resulting in smaller (financial) expenditure (and thus income, and thus savings!) across the economy! (In the face of a slight drop in sales, business A might order less machines it uses to manufacture it products and fire some employees; faced with decling sales, business B (machine manufacturer) might buy less raw materials and fire some people; business C (say a mining company) may decide to mine less iron or whatever and also fire a couple of employees because its principial client, businesses B, just canceled some orders; fired employees may decide to cut on their expenditure and will not buy any of the products they used to from business A, which experiences another drop in sales, etc.).

Moreover, in the financial system that we have, you have tons of possibilites of non-employment inducing investment (shorting stock of a company, for instance) which reduce income for people and entities with a higher propensity to spend (basically making the delay discussed above longer).
Plus, investment via the financial system is connected to debt - and people or companies might not be willing to take out credit (in the face of dropping sales, for example)!
So in an economy far from full employment, saving is a problem, not a benefit!
(We are talking finance here, NOT real resources).

The only way that an economy can provide for the "rainy day" is by building something REAL and REASONABLE (not by accumulating IOUs of somebody else, in an economy, there is no "somebody else").
This way, REAL saving is, economically speaking, positive (i. e. you do not stay in bed - that is you are not consuming you "free time" -, but go and make something useful - a table, for instance). But this is something completely different.

BTW - Uneymployment benefits or pensions are normally spent on and generate demand for very useful things (such as food, housing, transport, etc.). If it were not for the spending coming from unemployment benefits and pensions, a lot of the productive capacity for these items would not be arround.

As far as government debt is concerned - the government does not need to borrow its own IOUs from somebody else. It can just spend by issuing them. So government bonds are just a political convention; a product of, in my view, confused economic theory.

Frank Nes wrote, paying for "pensions or unemployment benefits" then... "the next generation is left with burden to have to pay for something that has no value."

As ZDENPR wrote, paying for pensions and unemployment benefits "generate demand." This demand creates jobs. Who is most hurt if these jobs are not created? It's the NEXT GENERATION (i.e. the twenty-somethings that are currently facing very high unemployment). So many people NOT having a job in their twenties is the greatest destroyer of the NEXT GENERATION. Skills not being developed is a huge loss in human capital, not to mention a loss in financial growth by the twenty-somethings (salary increases and savings). Umemployment in one's twenties destroys one's wealth for the rest of one's life.

Could you compare the size of the intergeneration transfer due to debt with the intergenerational transfer due to Social Security and Medicare?

Jeffrey: in principle, they are the same thing. Empirically, which ones are bigger? I don't have a clue about the US. For Canada, IIRC, and very very ballpark, I think all three are around the same sort of size. I would have to do some digging to get a better estimate than that, and it's not my comparative advantage. Somebody else reading this can probably give a better answer.

While the public debt of a country is important, what's more important is the total debt burden(both public and private). In the US (and most of the developed world), it seems like much of the rise in public debt has come from the fall in private debt. If we try to cut the public debt(austerity), this will not only be painful and deflationary, but could cause the debt/income ratios to stop falling the way they have been(at least in the US). Wouldn't a better solution just be to keep monetizing the government deficits until we see inflation (and interest rates) rise? Then, we could start practicing austerity.

There has been a little bit of deficit monetization(QE), but I'm talking about monetization on a much larger scale. If it becomes inflationary, we cut this back. It seems to me that austerity doesn't even succeed very well in fiscal terms because it causes output/incomes to fall in a deleveraging which makes it harder for the debt/income ratios to fall.

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