Simon Wren-Lewis has another post on the relevance of
government debt for future generations, explaining a point that Nick Rowe has also made in the past. They both set out clear
explanations, but the issue continues to cause much confusion. It's not hard to see why. The suggestion that public debt can be a
burden on the unborn seems to imply that the future can somehow be drained of
resources for the benefit of the present.
Clearly, this is not what it means and Wren-Lewis is in fact careful to
avoid using the term "burden" in his post.
Actually, I think the debt aspect can be a little misleading
here, as it draws people into thinking that this is all about a requirement for
future generations to cover a repayment obligation. So I thought it would be interesting to look
at this issue by focussing purely on the asset side.
Imagine there are two groups of people, wealthy and poor. The wealthy own $100 of government issued
bonds and money. The poor own nothing. (These discussions are usually cast in terms
of two period overlapping generation models.
The wealthy would then be the old generation and the poor would be the
young. I don't need to be so specific
here.)
Each year the economy produces 100 real
goods. Normally these sell for $1 each, so
income and expenditure are both $100. However, there is more potential purchasing power here than
there are goods. In addition to the $100
of income, there is $100 of wealth. But
there are only 100 real goods.
If the wealthy decide not to spend any of their wealth, then
there's no problem. Alternatively, if
they do decide to spend some of their
wealth, but others decide to save some of their income, that may be OK as
well. So, if the wealthy decide to spend
$30 of their wealth and those earning income decide to save $30, that's still
only $100 being spend on 100 of goods.
So providing $100 of wealth gets carried into the next year (whether
that's with the original holders or new ones), it's fine.
However, the problem does not go away; it simple gets passed
on. That wealth will always represent
purchasing power for which there are no goods.
For there to be surplus goods on which that wealth could be spent would
require the economy to produce more goods than it does income. This is clearly impossible.
But if there aren't enough goods to go around, who loses
out? What would happen in the current year, if the wealthy
tried to spend all their wealth and the earners tried to spend all their
income?
As there aren't then enough
goods to go around, this would push prices up.
This has different effects on income earners and the wealthy. If prices go up, income earners (in
aggregate) are unaffected, since their earnings go up at the same rate. If the 100 goods now sell for $2 each, their
income is now $200. But the wealthy have
no such protection. They still only have
$100 of wealth which will now only buy 50 of goods.
Ultimately, if income earners want to spend all their
income, prices will rise indefinitely and the wealthy will be completely
squeezed out. So if the wealthy want to
be able to cash-in their wealth, they rely on income earners wanting to save
some part of their income (or have the government save for them by running a
surplus). As long as there are savers,
anyone with wealth can use it to claim a share of produced goods, passing the
wealth overhang onto someone else.
How does the generation question fit into this?
People are born with no wealth. If they're lucky they may get bequests from
their ancestors, but otherwise if they want wealth, they have to save. Which means they have to consume less than
they earn today. This gives the
opportunity for the wealthy to spend all their wealth before they die,
acquiring and consuming goods. They will
have managed to swap purchasing power for which there is no corresponding
production into real consumption. And
they will have done so by passing the wealth onto the young savers.
As long as this continues from generation to generation forever,
then this may never matter. But there
will always be more purchasing power than there are goods. And if, for whatever reason, all that
purchasing power goes after the same goods at the same time, someone will lose
out. And it won't be those people that
are already dead.
I find it quite useful to recast the issue this way. But it is not intended to be an
argument that public debt should be reduced because it is a burden on the
unborn. Public debt is not
only a liability but also someone's asset.
You can only get rid of the liability, when people are prepared to do without the asset.
That's nice and clear. Is suspect, the monetarists will insist that, since wealth cannot be spent before it is exchanged of money, that it is the stock of money, not that of wealth plus money, that has the potential to influence the price level.
ReplyDeleteAnd I would disagree with them. If I have $10 money and $90 bonds and do not expect to earn anything else before I die, I'm pretty confident my purchasing power is $100.
DeleteThe interesting thing here is that this discussion is usually couched in terms of government debt, and the need for future generations to repay it. The implication is the state money (not having any repayment obligation attached) does not result in the same "burden". Looked at it my way, that distinction doesn't apply.
What would happen in the current year, if the wealthy tried to spend all their wealth and the earners tried to spend all their income?
DeleteAs there aren't then enough goods to go around, this would push prices up. This has different effects on income earners and the wealthy. If prices go up, income earners (in aggregate) are unaffected, since their earnings go up at the same rate. If the 100 goods now sell for $2 each, their income is now $200. But the wealthy have no such protection. They still only have $100 of wealth which will now only buy 50 of goods.
I think I agree with you, but to wrap my mind around this I'll allow myself to go through some steps and see whether I arrive at the same conclusion:
The act of wealth owners trying to buy goods means they have to buy money first. Assuming first that the money supply is given, i.e. consists of those $100 in oncome earned through production, this constitutes an asset swap. Assuming that the swaps are voluntary, prices of goods will not change, but one person's saving will free up money that the other can now spend on goods. There could never be $200 'chasing' 100 goods. It's just a question of who prefers bonds over goods. I would call this a loanable funds model.
Now, assume that bond holders could freely exchange their bonds for money without having to deprive the original income earners of their nominal purchasing power, say by selling them to banks. There can now be $200 worth of money 'chasing' 100 goods. Would that drive up prices?
I think monetarists are saying that the act of exchanging bonds for money constitutes a desire to spend that money. A desire that can only be influenced by the central bank shaping people's expectations about the future path of their spending power. I.e. by influencing their time preferences, causing them to save either more or less vis à vis what they originally intended (which sounds fishy to me).
I would say the first model, i.e. the one with a fixed money supply, is not admissable because the money supply cannot actually be fixed.
As for the second model, I think the answer is, it depends. People might well be buying money to save it. And preferences in saving vehicles might change quite quickly and abruptly, so the central bank has no choice but to accomodate not only changing desires in amounts but also in types of saving. Any other behaviour could choke up the payments system and / or cause silly interest rate spikes. It isn't really a persmissable model in that it doesn't depict a realistic, counterfactual world.
So I'd say, it's better to assume a money supply that is elastic to saving and spending desires and a passive central bank than to start with an unrealistic model such as the first one, or say a world in which there is no saving. When reading stuff by monetarists, but also others, I never quite understand which of the two worlds they have in mind. Imo, they are mutually exclusive and cannot be mixed.
And so, getting back to the original topic, I think I agree with you that it is not the stock of money (alone) that determines prices, but a mixture of money, wealth, capacity utilisation and saving desires (and probably a gazillion other factors) that does. Otherwise, as you say, bonds would not represent wealth.
I don't think it helps to think about the money supply here. The "same" money can be used sevral times over for purchases.
DeleteLet's say that people always save 30% of income. And normally they spend 30% of wealth. So with $100 of wealth and 100 produced goods, the price that will clear the market is $1 per good.
Now assume that the wealthy decide to spend 60% of their wealth. Now the price that will clear the market is $2 per good. This is the only price at which both sets of spending decisions can be realised. If the money supply is fixed, that just mean the velocity of circulation needs to double.
What the monetarists might say is that holdings of money affects people's spending decisions, but holdings of bonds don't. It's a view, but not one I'd agree with.
Nor would I. I was trying to get into a monetarist's head, but I fear I've strayed somewhat from the topic in attempting to do so.
DeleteThe transfer of wealth from government debt spending is not from tax payers to bond holders. The bond holders are only getting their money back. That is neutral. The transfer is from future tax payers to the heirs of current deficit spending. And so, yes, their is a burden on the future generation of tax payers.
ReplyDeleteit's funny. You're determined to end your comments with "so, yes, their is a burden on the future generation of tax payers", no matter what. It doesn't really matter to you what comes before that sentence, whether it makes sense, whether it's a proper argument or whether it's just a half-assed nonsensical assertion. It could just be "flying pigs love the taste of bananas, so yes, there is a burden on the future generation of tax payers".
Delete"That wealth will always represent purchasing power for which there are no goods."
ReplyDeleteThis is not true in your example, or in general. In order to realise that wealth someone else must pay for that asset. Hence, it's value is always equal to the amount of purchasing power removed from the economy in order to purchase it.
Think of it another way. Covering that asset into an income stream is a liability on the poor (young generation). This is the same a all pension scheme, fully funded or not. They are merely a continual transfer - a liability to the young and an asset to the old.
What I mean by that is something like this:
DeleteEach year income must equal expenditure, in aggregate. There is exactly enough income to spend on all the stuff that is produced. There is no extra stuff for outside wealth to be spent on. And since, every year is like this, no matter how long we look into the future, there never will be.
That is not to say that individuals cannot spend wealth. I'm talking here about what happens in aggregate.
I don't think there's any contradiction with what you are saying in your second paragraph.
Also, as we look further into the future, the amount of current wealth relative to cumulative income may become vanishingly small. This is essentially the same point that there is no problem here, providing the transfer continues indefinitely. This does take us into the r<>g question, though.
However, my main point is that although I can see the relationship between public debt and intergenerational transfer, I think it is wrong to interpret this as the former causing the latter.
My initial reaction to your headline is a one word article: "No.". But more seriously, I think there's a lot of talking past one another in this "debt burden" debate. Obviously, current policy can effect the future. At the same time, goods and services are not sent through time machines. But once we get past those truisms, I do not think people are talking about the same thing. (Although this is useful for generating material for blogs; if everyone agreed about economics, we'd have to write about sports or something.)
ReplyDeleteThis post (and some of the links) has caused me to finally start working on a multi-part article on this topic. Since it will be a draft of material that I intend to reuse, I may not be able to directly comment on the points within this article, but I will try.
Well, my headline was intended to be a little provocative. I'd agree there is a lot of talking past one another. The problem, I think, is when this analysis is used as an argument for raising taxes to reduce public debt. I don't think it is valid to draw that conclusion.
DeleteThe harder "burden" question is the crowding-out one. For a given stock of savings (based on some stock-flow norm), then higher public debt seems to imply lower holdings of productive capital, and therefore less efficient production in the future. Of course, this still leaves open the question of direction of causation. I might do a further post to look at this.
Isn't that assuming that government investment is unproductive per definition? The 'Golden Rule' of fiscal poilcy comes to mind.
Deletehttp://en.wikipedia.org/wiki/Golden_Rule_(fiscal_policy)
Yes. Strictly speaking, that should be public debt less the value of public capital.
DeleteNo time machine is required . Debt is a temporal process. Taxation is by its nature a shifting around of financial assets and the creation of burdens and incomes . If debt, is used to involve a temporal element to that shift and the time span is more than one generation then therefore the burdens where they exist, span generations.
DeleteI guess you can frame the crowding out question in terms of private vs. public sector, as it usually is. Or, more neutrally, one could also divide the stock of outstanding public and private debt into that which funds capital accumulation and that which doesn't, whereby the latter crowds out the former in that it leaves assets without corresponding goods 'floating' around the economy. But, per your reply to me above, both views ignore (by implicitly assuming a constant velocity of money) that spending is a flow and therefore subject to changes irrespective of stocks of either assets or goods. So, any putative burden, apart from ignoring the corresponding wealth as your title and closing sentence suggest, also cannot be measured solely in stock terms.
DeleteI'm not sure I follow. But I don't think this has anything to do with assuming a constant velocity of money.
DeleteI had a feeling my comment might have been muddled. I'll try to think it through again - or just wait for your next post.
DeleteNick: I was following you right up to your last sentence. "You can only get rid of the liability, when people are prepared to do without the asset."
ReplyDeleteYou lost me there.
I was just saying that it is important to bear in mind that the amount of public debt the private sector holds is the amount it wants to hold (except perhaps when full Ricardian Equivalence applies). It is the net of the amount of savings people want to hold less the amount others want to borrow. If the state wants to reduce public debt it must find a way to reduce the amount people wish to hold. Maybe that's just a question of interest rates, maybe not.
DeleteThinking in terms of lump sum taxes or assuming full employment tends to obscure this a bit, because it makes it look a simple matter for the state to determine the deficit. But in real terms, it still matters. Even if the state can fix the nominal level of debt, it may not be able to stop prices changing if that is inconsistent with the real level of debt the private sector wants.
Nick: Ah! OK. I get you now.
DeleteYes, interest rates and asset prices will (in general) need to change, when the government raises taxes. But the CPI doesn't need to change, if the central bank doesn't want it to change. (E.g. when Canada turned a big deficit into a big surplus in the 1990's, the Bank of Canada kept CPI inflation on the 2% target.)
Yes, but I'm talking about if the nominal stock of debt changes, when the private sector does not want the real stock to change. I would say (bearing in mind that I know very little about the Canadian economy) that at least part of what was going on there was that the private sector's real demand for public debt was falling.
DeletePerhaps a burden comes because those owning the bonds will campaign for policies that protect the value of those bonds rather than for policies that lead to full use of our real resources. Basically bond holders will want much of the economy to be sitting on the sidelines wasting time and everyone loses out as a result. I had a go posting about that:
ReplyDeletehttp://directeconomicdemocracy.wordpress.com/2013/03/24/political-consequences-of-risk-free-financial-assets/
Maybe, but within the limited model I'm looking at here, I'd expect the opposite. Existing holders of wealth need savers, people who are producing real goods now, but want to save some of this for the future. The more production that is going on, the more likley this is.
DeleteDon't bond holders need plenty of slack in the system so as to ensure that nominal prices don't rise? Economy wide austerity is perfect for them. The bond holders obviously need enough stuff to be made to avoid a total collapse but they also need all workers to be wanting more work than they can get. They need a certain level of underemployment.
DeleteI think that's generally true in the real world, even if there's not enough in the very limited model I have here to really conclude that.
Deletethe burden is some people benefit less from government spending than others, its as simle as that is it not. The monetary system involves the temporal shift of claims on resources over time by its nature. If how the claims on resources lie amongst the population is partly made up from the historical interventions of government then there it is.
DeleteThinking more on stone's point, what my analysis looks at is how wealth holders need saving to take place. This can be private saving, but it would also include public saving, i.e. the running of surplusses. So we could say here that wealth holders want tight fiscal policy - austerity - because it contributes to overall saving.
DeleteDon't forget that there is not just saving and spending there is also what is termed borrowing . Spending that does not involve prior earning or saving.
Deleteie. what is often termed borrowing is actually credit.
DeleteNick Edmonds, I think I understand what you mean about surplusses. Basically bond holders need the financial impetus towards production to be maintained RELATIVE to the financial impetus towards consumption. The absolute amount of production overall is perhaps less important for them. If half the population is working hard and living frugally and saving and the other half is unemployed and in poverty and consuming nothing then that is nivarna for treasury bond holders. However, if half the population is working hard, living frugally and saving BUT the other half is also working but also consuming a lot so that there is pressure on resources, then things are bad for treasury bond holders.
DeleteI think I read something by Wayne Godley where he seemed perplexed that people considered Thatcher's policies to have "worked". I think he was only considering things from the perspective where the overall level of production was the be all and end all. Instead perhaps those policies were aimed at making our economy a good place to hold savings, and so to entice inward capital flows and so to improve our terms of trade.
Yes - that's about it.
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