Thursday, 12 February 2015

More on the Inter-Generational Implications of National Debt



There's been some more stuff recently on the role of public debt in inter-generational transfer, including from Nick Rowe, Roger Farmer and Simon Wren-Lewis.  It is remarkable that this topic causes so much disagreement, but in my view it is a good issue to discuss because it highlights the important role of asset balances.

I think one of the things that causes so much confusion here is that this inter-generational transfer cannot happen without the willing participation of the private sector.  Some people object to the notion on the basis that they cannot see how those alive today can be bound by what happened in the past.  But actually what is happening here is to a very great extent driven by the choices made by private individuals.

For a start, government debt can only arise in the first place if people wish to save.  It is quite correct that we cannot take resources from the future.  Some people can have more today, but only if others are willing to go without today, in the anticipation of more tomorrow.

Secondly, there is only ever a question of a burden on future generations if and when people wish to dissave, i.e. to spend out of their savings.  If people are prepared to hold on to public debt forever, then there is no great consequence.  (This is what happens in the Ricardian equivalence world, where planning over the infinite horizon means spending only income and not principal, from investments).

What gives rise to the potential burden is the possibility that at some point people will wish to reduce their bondholdings, by spending out of their savings.  If they do so in some future period, then real resources will have to be found for them in that period.  Maybe this can come from persuading others to save, but maybe it has to come by taxing them.  This is when the inter-generational transfer bites.

So the transfer arises from private decisions to save and dissave.  These are being made the whole time.  There is a continual turnover of some people accumulating financial assets and others running theirs down.  In general people do not want to spend in any period the exact amount they earn in that period.  All these plans ultimately have to tie up, which means that in some periods there will be increased competition for available resources and in others there will be less.  If you are unlucky enough to be living at a time when there is increased competition for resources then you will be squeezed and they may have to be through higher taxation.

Recognising the key role of private decisions in this process is important, because it helps us see that, whilst public debt is part of the mechanism through which the inter-generational transfer happens, it is more of a symptom than a cause.

(This idea of public debt as a symptom is one of the things I hoped to bring out in my previous two posts on the Diamond model here and  here.)

17 comments:

  1. Nick,

    The elephant in the room is always the external sector. Anthony Thirlwall emphasizes that the greatest disservice Keynes did to the profession is to not start with an open economy.

    To confuse matters, the phrase national debt is used for public debt. Indebtedness to foreigners (if the net international investment position is negative) is where the main burden part is.

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    1. I agree. Certainly, additional issues come in when we consider this is an open-economy context. In fact I think that this way of looking at it helps a bit in considering the external sector. In other words, foreign desire to accumulate or run down this debt is an important part of what is driving things.

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  4. The confusion comes from incorrectly identifying how the transfer of cash occurs in Government debt spending and repayment. Its not from tax payer to bond holder, which is how it is often described, its from tax payer to the recipient of government spending. The bond holder is only getting their cash back, and so it can't be netted off with the loss to tax payers. So where does the money go? it goes to the recipients of government spending of course. All debt spending and repayment transactions have a time span, and if the time span is a Generation then the burden occurs over that period.
    When people talk about a burden on the next generation they mean the next generation of tax payers. And its very simple to show that that does occur.

    For example lets say everyone in the UK lends the Government £100 and receives a £100, 30 year gilt. The heirs then inherit this bond instead of the cash. Then after 30 years the gilts are repaid by taxing everyone by £100. And so the bond redemption and the tax net to zero, The heirs , the next generation of tax payers, have lost their inheritance. So where did the money go - it went to the recipients of government spending in the previous generation and was inherited by their heirs. And so it is correct to say that government debt spending is a burden on the next generation of tax payers.

    Or another example focused on interest - if a government spends x Billion a year on interest payments that is money that could have been spent on some government service .That money is a burden on tax payers. It comes from debt taken out in the past. And likewise it illustrates that debt taken out today will be a burden on tax payers in the future.

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    1. In your example the government of the old generation is spending (which might be a benefit for either generations) but also saving to to gilts. That's a wash (if only the old generation is benefiting from the spending). The next (younger) generation is inheriting the gilts and is taxed to pay them back, that's a wash. So where was the burden?

      In Nick Rowe's example (http://worthwhile.typepad.com/worthwhile_canadian_initi/2015/02/debt-does-have-intergenerational-distributional-implications.html) the older generation is not giving up the gilts for free but sells them forward. Then it is not a wash but I fail to see why the government debt is here important. The older generation gets the same effect by selling any asset, like equities. So the burden of assets?

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  5. Is it even necessary to bring the government into it? I guess it would be possible to think of an alternative where people didn't save with government debt but instead by owning say ancient Ming vases. Then the price of those vases would be steady if the current generation was saving/dis-saving to the same extent as previous generations but if demographics or saving propensities were different, then any given generation could do better or worse. I can remember seeing something suggesting that stockmarket valuations were pushed around by such demographic effects.

    Isn't the important thing to ensure that good real use is made of real resources. So we need to ensure that when there is net saving, there is not unemployment and if there is ever excessive net dis-saving, pensioners get helped out if their savings have been eroded to nothing or whatever. Historically, when have people suffered due to excessive demand? I can only think of when war time disruption has impeded supply. I guess if things get bad like that, then rationing has to be used as in WWII but again, in peace time, there is typically vast capacity for supply to grow to meet any increase in demand.

    Simon Wren Lewis wrote about how pensioners could do well versus younger generations by net dis-saving once they got old. In practice I wonder whether that is actually very unrealistic. It seems to imagine that there is typically a surfeit of demand and that the pensioners have savings all in the form of short term inflation protected bonds or something like that. In practice, I think it would be the young generation that would benefit if a generation of pensioners dis-saved more than normal. The young generation would be able to demand good wages. Then pensioners would see asset prices fall due to net selling. The young generation would get to buy more shares etc with a given amount of wages.
    The real problem I see is when a generation of pensioners chose to dis-save LESS than normal. Then a generation of young people have to wait on the sidelines unemployed and consume less than they would like whilst young and learn less and equip the world less well with machines and new technology or whatever to deal with the future. That real waste is a real burden on future generations.

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    1. I agree with most of what you say here. With regard to whether other assets can have a similiar effect, I'd give a hesitant agreement. This raises the issue of what drives the value of such assets, related to the distinction between commodity monety and fiat money. But in general, yes, and housing is the obvious example of where inter-generational transfers have taken place. Today's older generations have done very well, but if house price rises are reversed at some distant future time, future generations may bear the cost.

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    2. Housing seems especially weird because high house prices especially force younger people to save more than they would have done if house prices had not boomed. Furthermore older people don't do all that much "equity release" from housing. As far as I can see the net gain and the net loss amounts to a transfer from younger people paying more for houses to bankers receiving interest on mortgages. Old people aren't really affected one way or the other. What "society" gains is an enlarged banking sector. Perhaps that has knock on effects due to capital flows as foreigners invest in our banking sector. So perhaps a tea grower gets fewer GBP per kilo of tea because the oligarchs in her country own our bank shares and bonds and so we get more tea.

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  6. "if and when people wish to dissave, i.e. to spend out of their savings."

    Ok, it's late and I may be widely off but: Is that actually possible in real terms? Would that not mean that people want to consume more than they are producing? I cannot see how that would be even possible especially on a generational level.

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    1. Yes, that is what I mean, but obviously not everyone can do that at once. Some people can only do that if others are saving. I was talking about what happens if more people try to dissave at once and how this works itself out.

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    2. Thanks Nick, your answer helped me to figure out why I don't think government debt is really a burden for future generations. I left a longer answer at Roger's blog but it all goes back to that a society can only consume what they produce irregardless of the nominal size of their financial assets. I think your model nicely illustrates that and therefore pretty much refutes the other examples. I am looking forward to your future posts.

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  7. Here is a more concise example showing the burden on the future generation of tax payers.

    The government borrows £ 1 Billion from the central bank and pays that to its employees. 30 years later the government repays that debt by taxing the then current generation of tax payers.

    The result is that the heirs of the government spending either,directly through inheritance or indirectly through commerce, have more money and the tax payers have less money.

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    1. OK. I think I see your point.

      Most people would understand how the government can transfer between different groups at the same time. They just tax one group and give to the other. It is also possible for them to transfer between groups at different times, but that requires people being willing to hold debt, ie to defer spending.

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    2. There is no requirement for people to hold debt ie to defer spending, if the initial debt spending is of newly created money. However, I see you get my point about the transfer between groups over long time spans.

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  8. The issue of "public debt in inter-generational transfer" is forcing an evolution in my thinking. The evolution is not yet complete.

    There seems to be a tension between micro-economics and macro-economics as we logically discus the issue. From a micro-economic perspective, debt is the lending of money which needs to be repaid. On the other hand, from a macro-economic perspective, debt is a macro-economic currency that is created in parallel to the creation of money.

    From a micro-economic perspective, the "role of public debt in inter-generational transfer" is seen as a future repayment event destined to occur with consequences.

    From a macro-economic perspective, a currency (debt is a macro-currency) once created will exist until un-created so why worry? The role of public debt in inter-generational transfer is a non-issue.

    But, and this is a big BUT, most economist will deny that government debt is money. Most economist will deny that debt is currency in any sense.

    Still, we have the issue of public debt as an inter-generational transfer so how should we rationalize the issue?

    My thoughts are still evolving but most of my writing has supported a model with 'debt as a macro-currency'. I find it easy to think of debt as slow moving money, very appropriate for macro-economic thinking which relies predominately on a one year measurement period.

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    1. Even if the debt is not re-paid there is still an affect on how money is distributed amongst the individual members of the population after the of the government debt spending, as some people are in receipt of the spending and others are not.

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