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Friday, February 13, 2015

Understanding The "Debt Burden" Debate

Looking at my previous article, I realise that it is possibly unclear what the "debt burden" debate is about. I provided links, but my feeling is that the linked articles are probably more complex than necessary. In this article, I provide a quick primer on the debate, without attempting to answer which side is right.

In order to avoid debates about the nature of government debt, I will replace "debt" with "government liabilities", which includes money and government debt (which I like to refer to as "forward money").

The side that argues that "debt is not a burden" argue that we cannot transfer resources across time. Future generations do no ship goods to the current generation via time machines in order to meet "obligations". Conversely, the side that argues that "debt is a burden" typically argue by constructing examples, where there is an effect that mimics such "time travel".

In order to understand the debate, we need to understand those examples. They generally look like this.
  • At some initial time, the government spends money, and increases its liabilities. Typically, this is a transfer to an "older generation" (think of government pensions), which spends the money and then promptly dies.
  • The government liabilities are rolled forward for a number of "generations".
  • The government raises taxes on the future "young generation" to eliminate those increased liabilities. ("Paying off the debt.")
Therefore, it looks like the future "young generation" is penalised with higher taxes as a result of the increased government liabilities that was used to transfer resources to the present day "old generation". Government liabilities appear to act as an intermediary in a transfer between those generations.

The flaw with these examples is that there is no justification as to why the government liabilities have to be reduced in the future. This is just an arbitrary government action that is imposed by the person giving the example. In the real world, government money and debt grow along with nominal GDP, so one could easily have an alternate story in which the tax hike never occurs. (My previous article gave such an example.) That said, it appears safe to say that is impossible to grow liabilities faster than GDP "forever", and so actions may eventually be needed to limit liability growth.

The fact that the "burden" is actually the result of what appears to be an arbitrary government policy was observed earlier. The Austrian economist Robert P. Murphy gives a good summary of the debate in this article, which discusses this point. He also lists the positions of the various economists involved.

The Real Question

The question that the debate is really about is: does increasing government liabilities now (above some "normal level") imply an obligation to reduce them back to some "normal level" (with some form of austerity policy) in the future?

From the perspective of mainstream economists, this question does not appear to be answerable. They only recognise two modelling approaches as being valid, and neither gives a useful answer to this question.

  1. The "representative household" models, which are the standard mainstream models used by central banks, are characterised by households that live forever, and so they cannot tell us anything useful about inter-generational equity.
  2. The overlapping generations models which are being used are too far removed from reality to tell us anything useful. The time increments are "one generation long", whereas fiscal dynamics move much quicker. Debt ratios can move a lot within a decade, never mind a "generation". 
Since they lack a model framework that can answer this question, mainstream economists will be debating this question for a long time.


(c) Brian Romanchuk 2015


  1. "and so actions may eventually be needed to limit liability growth."

    That's not necessarily the case. It very much depends upon the propensity to save in the future. If it continues to increase - because people feel they need an ever greater 'rainy day fund' then there is no limit to liability growth at all. It's entirely arbitrary - particularly if you remove the voluntary government spending associated with holding it.

    But that's beside the point.

    The key issue is that the state of the economy is always a current period issue. Is the spending in the economy at present operating the economy at 'Goldilocks' temperature. If it is too cold you add liabilities. If it is too hot you take them away. Preferably automatically via the stabilisers.

    Do that and there is no more risk of an issue than there is a risk of all the Oxygen molecules in the air spontaneously leaping to one corner of the room for sufficient time to suffocate you.

    Both are possible according to the know rules. Neither are probable.

    1. Agreed; "short-term" (within one business cycle) effects are dominant. But what I am trying to do here is setting out the argument in a way that makes sense to me, without imposing my preferred answer to the question.

      To be fair to the other side of the debate, there presumably are "limits" to desire to hold government liabilities (based on propensities to consume, etc.), under the standard working assumption of inflation remaining close to target. This would create some form of limit to fiscal policy. (My view is that these limits would show up immediately, in the form of higher inflation, but that turns into an empirical question.)

  2. It's a good question as to what this debate is really about.

    At one level, it is just a mechanical issue. Most people would agree that the government can impose a burden on one group of people now for the benefit of another group. They can easily doing this by taxing group A and giving a handout to group B. The inter-generational examples then show how the government might be able to do the same thing with groups who are living at different times and why this involves debt. I say "might be able to" because, as my own post discusses, unlike the simultaneous tax and transfer, this can only happen with the willing participation of private participants.

    The problem is that the issue is taken beyond the mechanical one and that people draw unwarranted conclusions. In particular, the mechanical analysis does not generally lead to the conclusion: "the debt is too large - we need to get it down for the sake of future generations".

    1. To me, a lot of the arguments look like silly word games. What I want to do here is extract an argument that is not purely a question of semantics, that is, find an underlying policy issue.

      The only way the issues can be properly debated is in the context of a model or framework that corresponds to real world issues. Once we do that, we see that how the private reacts to policy (as you suggest) matters. But once people start talking about a mutliple generations picking apples from an orchard that always produces the same number of apples (and there are no investment expenditures associated with running that orchard...), I find it hard to map the discussion to issues facing modern economies.

    2. Well, I find the models useful to help me think about the mechanics, but my view on all this is that really isn't a major policy issue here. So, yes - debt is part of the process by which different generations reconcile their different planned spending profiles - and it's good to understand what is going on here - but the level of debt is not important in itself. If we deal with the immediate issues, the debt will look after itself.

  3. I submitted a comment for Nick Rowe's blog "Teaching, OLG models, and the phenomenology of perception" which I will copy and repeat here. I do this because it could be the basis for another model looking at the time effects of debt on later generations.

    "The infinitely long line of beer holders, each passing his beer forward, ignores the effect of time. This is a serious departure from economic reality.

    Assume the infinite line of beer holders, each with a beer in hand. The first in line shouts the order to "Pass Beer Forward!" The order travels down the line at the speed of sound . As the order travels down the line at the speed of sound, each beer begins movement when the order reaches the beer location. It is obvious that beer movement begins later in time when the beer holder is farther from the front. The effect can be considered as a traveling hole . Each beer holder becomes beer deficient when he makes the transfer of his beer.

    The effect of debt is the traveling hole that each person in the line experiences. Except for the first in line, there is always a period where the beer holder actually has no beer."

    The concept of a moving hole, i.e. a gap moving forward with the generations, might be exploited for another way of building a model for debt.

    The existence of public debt owed to the private sector does not need to in a state of reduction to have effects upon the private sector. The present complications imposed on the Central Banks are just one example of the perils of huge public debt. Management of the debt influences the size of the banking sector and their influence on public policy.

    The United States Social Security program provides yet another example. Here we can think of one sector of the private society moving forward in time with a 'hole in income' while a second sector moves ahead with a 'bubble in income'. The bubble comes with a cost to those in the hole, and result is a shift in ability to accumulate and use capital for assets such as real property.

    1. I am unsure what point Rowe is trying to make: that the apparent transfer over time of resources is an illusion. That seems to be proving the point of those who argue debt is not a burden on future generations.

      The more I read these articles, the less I understand what their point is. It just looks like pointless word games at this point. This is what happens when you rely on models that have no correspondence to reality.

    2. Amen Brian. These people are completely unhinged.


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