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Rowe Row

December 29, 2011

This post is in reference to the discussion on the comments section here.
“Debt is too a burden on our children (unless you believe in Ricardian Equivalence)”

There are several issues that are being intermixed. I don’t think there is a substantive disagreement, so much as a miscommunication. If you read Krugman’s post with a “representative agent” in mind, instead of cohorts, it will make more sense. Individual cohorts can be screwed, but the entire population as a whole cannot be.

1. Do government transfers cause the current young cohort to pay for the old cohort’s retirement spending? Yes. You don’t need Ricardian Equivalence for this. It’s a distraction. All you need are transfers, and it doesn’t matter how they are financed. Everyone agrees that taxing Peter to pay Paul hurts Peter.

2. Does creating an ever-growing welfare state for the elderly burden our grandchildren? Yes. Rowe is entirely correct on this point, but it’s not what Krugman is saying. In the real world, government spending is primarily welfare spending for the elderly. It is entirely reasonable to assume debt financed government spending will disproportionately help the current elderly, but it’s not what Krugman assumes. The representative agent gets all the transfers and pays all the taxes.

3. Debt is an asset to the lender and a liability to the borrower. At the moment it is created, it benefits the borrower exactly as much as it costs the lender. When it is destroyed (paid back), it costs the borrower exactly as much as it benefits the lender. There are no aggregate income effects from debt creation or repayment. Debt creation seems to increase the velocity of money, but if you have a good central bank or assume price flexibility, this doesn’t matter. This is Krugman’s core point.

4. All goods must be produced before they are consumed. There is no way to avoid this using finance. You can use inventories and capital to forgo consumption to increase consumption tomorrow, but the reverse, in aggregate, requires time travel. Issuing and paying back debt uses no labor, does not require new innovation, and uses up no natural resources.

5. “The economically illiterate rube who thinks that the national debt is a burden on our children or grandchildren is basically right.” Yes, the rube is right, but he is right because of the deadweight losses from taxation, which Krugman acknowledges. Krugman’s point is that there are no income effects. That’s why he puts the graphs in at the bottom which show foreign debt. Presumably, when the foreigners receive their debt repayments, they will buy exports and make claims on domestic productive capacity.

I think JKH does a good job covering the finance side of things, which is not my comparative advantage. I agree with most of his comments.

You can’t tax people who aren’t born yet for the same reason you can’t tax Warren Buffett. They don’t consume anything. The tax incidence must fall on someone who can pay today: either C or I must fall if G goes up and the economy is at capacity.

Further Reading:
Mankiw comments.
Bill Woolsey comments.
Don Boudreaux writes an open letter to Krugman.
Karl Smith comments, and again here. His second article is my favorite of this debate.
Daniel Kuehn comments.
Jim Hamilton comments.
Noah Smith comments.
Yglesias comments.
Nick Rowe writes another post.
Mark Thoma comments, mostly to quote Krugman approvingly.
Bob Murphy comments, again here, and then gives a great and funny summary of the whole debate.
Steve Landsburg comments, and again here, here, and here. Later articles are better.
Econtalk on this topic. Overall, I liked it, but I wish they had mentioned that the actual economic resources are used up at the time of the borrowing, not at the time when the debt is paid back.

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6 Comments leave one →
  1. January 3, 2012 6:07 pm

    My example showed that you *can* tax people who aren’t born yet. They are the ones who will have the lower lifetime consumption.

    • January 4, 2012 1:37 pm

      Thanks for commenting.

      Your model:
      Period 1: GDP = 1000 apples.
      Period 2: GDP = 1000 apples.
      Period 3: GDP = 1000 apples.

      I’m saying that this is impossible to do using government debt:
      Period 1: GDP = 1200 apples.
      Period 2: GDP = 1000 apples.
      Period 3: GDP = 800 apples.

      Leaving aside the cohort issue, do you think it is possible to increase GDP now at the expense of GDP later? I’m not sure if you disagree on this point.

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