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Does Government Debt Burden Our Grandkids?

In late 2011 and early 2012, there was a fierce debate among several prominent economists on the possible ways in which government deficits today could impose a burden on future generations. Specifically, Keynesian economists Dean Baker [1] and Paul Krugman [2] were arguing that right-wing concerns over the debt burden were nonsensical, because (for the most part) our grandkids would “owe the debt to themselves.”

At the time, GMU economics chair Don Boudreaux [3] cited the work of James Buchanan to show verbally why Krugman’s arguments were simply wrong. Nick Rowe [4], a monetary economist in Canada, used simple numerical examples (which would appeal to professional economists) to try to make the same basic point. Many other economics bloggers (and their readers) weighed in, over the course of several weeks, in what was truly a remarkable discussion. I summarized the affair on my own blog in this lengthy post [5], for readers who want to see the complete history.

I was amazed, therefore, when Dean Baker on October 10 [6] kept repeating the same basic mistake that—we had thought!—was cleared up back in January. Paul Krugman [7] too doubled down on the error. Since this is such an important topic, and since the advocates of bigger government deficits keep repeating this incorrect argument in an attempt to make these deficits seem benign, it’s worthwhile to spell out in this forum exactly what their mistake is.

What Baker and Krugman want to explode is the man-on-the-street’s moralistic objection to government budget deficits as being irresponsible and a burden on future generations, who will have to deal with higher government debt. Baker and Krugman think that this is yet another example of where “micro” thinking breaks down when we try to aggregate it into the “macro” economy. They concede that it makes sense for an individual household to worry about irresponsibly running up debts today, and thereby imposing pain in the future when those debts have to be paid off—or at least, when more of the household’s income needs to be devoted to interest payments on the higher debt.

However, so long as future Americans end up holding the Treasury bonds issued by Uncle Sam, Baker and Krugman think that our generation cannot irresponsibly run up the debt today, and pass on a burden to our kids and grandkids. The difference arises (they claim) because all of the interest payments (mostly) stay within America, to the extent that “we owe it to ourselves.” Sure, Baker and Krugman admit that some of the U.S. federal debt ends up being held by foreigners, and to that extent our grandkids will be poorer because they’ll have to make interest payments flowing out of the country. But besides this complication, Baker and Krugman argue that the mere fact of taxing and paying interest on bonds per se can’t burden our grandkids, since (some of) our grandkids will be the ones pocketing the interest payments!

In other words, if our generation today runs up a big government debt, all that means is that the government in (say) 2100 will have to take more from American taxpayers in order to give more to American bondholders. But Americans collectively in 2100 will be neither richer nor poorer because of this; it’s just a greater volume of wealth redistribution at the time. Thus, Baker and Krugman conclude that higher government deficits in the present generation, cannot possibly affect the average standard of living of Americans in future generations, unless we bring in all sorts of side issues like taxes having disincentives on work effort and such.

Now that I’ve carefully spelled out where Baker and Krugman are coming from, let’s see why they are totally wrong. Back in April I wrote a fable in The Freeman [8] that walked through the fallacies, but for our purposes here I can boil it down succinctly:

Suppose the government today borrows an extra $100 billion in order to expand drug coverage for seniors. Assume that the young workers today “pay for it” in the direct sense that they reduce their consumption by $100 billion, in order to invest in the additional $100 billion in government debt that has to be issued. (Thus, we are assuming unrealistically, for the sake of argument, that the higher government debt doesn’t “crowd out” private investment, just so we can see quite clearly why Baker and Krugman are wrong on this issue.) Clearly the older folks are better off because of this deal: they get more drug coverage from government spending, and don’t have to pay higher taxes to finance it.

Now further suppose that the young workers don’t touch their bonds, which happened to be 30-year Treasury securities rolling over at (say) 3 percent. After 29 years have passed, the originally young workers are now old. The original seniors—the ones who benefited from the $100 billion in extra drug coverage—are long dead. A new group of workers—who weren’t even alive when the $100 billion was borrowed—are now on the scene.

The now-old retirees sell their 29-year-old bonds at their current market value of $236 billion (that’s the original $100 billion compounding at 3 percent annually for 29 years in a row). At this point, the middle generation—the ones who were young workers originally, and now are retiring and living off of their savings—have been made whole. Yes, they reduced their consumption by $100 billion back when the government ran a budget deficit, but at the time they voluntarily lent that $100 billion to the government, because they thought getting $236 billion in 29 years when they were retiring would make the whole deal worthwhile. They didn’t lose from the whole operation.

Finally, suppose that the young workers (who were recently born) hold on to their government bonds for one more year, when they mature with a market value of $243 billion. In order to pay off the bonds, the government imposes a one-time surtax on current workers of exactly $243 billion. It thus takes the money out of the workers’ paychecks, and then hands it right back to them to redeem the 30-year bonds that they are holding.

The way Dean Baker and Paul Krugman have been “educating” their readers since late 2011 on this issue, they would be forced to argue that in our story above, the young workers weren’t hurt by the original $100 billion borrow-and-spend scheme. After all, the government 30 years later simply took $243 billion from those workers, and then gave it right back to them. So clearly it’s a wash, right?

But we can see it obviously wasn’t a wash. The original, old generation benefited greatly, the middle generation did all right, and the young generation—not even alive at the time of the original $100 billion deficit—got skewered. Yes, they “owed the federal debt to themselves,” but that is hardly consolation to them. They acquired the bonds by reducing their consumption by $236 billion the year before the big tax bill hit. This abstinence was not rewarded with additional consumption at some future point, but instead was necessary just to break even after the government whacked them with a big tax bill to retire its exponentially rising debt.

As this short tale illustrated, the man on the street’s intuition is correct: today’s budget deficits can impoverish future generations, even if future Americans hold all of the Treasury bonds. There really is a sense in which voters today can run up the credit card and stick the bill to unborn future generations.

Robert P. Murphy is author of The Politically Incorrect Guide to Capitalism [9]. His blog is Free Advice [10]. Follow him on Twitter [11].

28 Comments (Open | Close)

28 Comments To "Does Government Debt Burden Our Grandkids?"

#1 Comment By john personna On October 18, 2012 @ 6:40 am

A can certainly see a path by which 100% of current debt is passed to grandkids, but can also see ways in which fractions can be passed off other ways – certainly without “impoverishing” them.

The post-WWII model serves as an example. Many of us enjoyed great fortune in the years 1950-2000. All those years we were paying down our fathers’ debt. Well we paid down part and inflated away part, which is key.

We did it with great growth, prosperity, technological innovation, and improvement to material standard of living.

#2 Comment By libertarian jerry On October 18, 2012 @ 7:53 am

Good analysis. What we have is the ultimate problem with deficit spending and fiat currency. Basically its paper backing paper buying real goods and services. This would have been hard for governments to do if all our currency had to be backed 100% with gold and silver. With that said,the real rip off for future generations is that the money that is paid today out of the workers paychecks to buy bonds that pay say 3%,even if compounded, will lose more than 3% in future purchasing power. In other words,if you take the purchasing power of the 1982 dollar and compare it with the purchasing power of the 2012 dollar,even with interest added in, you would have to have at least 4 to 5 times more 2012 dollars to equal what that 1982 dollar would buy. This is a classic example of the government trying to have its cake and eat it too. Over time the government steals either through taxation and or the hidden tax of inflation the wealth of the citizens who trusted that same government to be a secure depository for the citizens hard earned savings. Instead,we have a bunch of shady politicians who buy votes with other peoples future earnings and a group of Keynesian “economists” excusing and finding alibis for the politicians bad behavior. Eventually this behavior will doom the American Economy to disaster.

#3 Comment By Sean Gillhoolley On October 18, 2012 @ 9:16 am

I totally agree, it is completely ridiculous that our grandchildren will simply owe this money to themselves. For one, a portion of the debt is owed outside of the USA. Secondly, we are talking about money spent now, the benefit of which will be long gone by the time our grandchildren are paying it off…and looking at history, it will be a long, long time before anyone he tries to pay it off. Servicing the debt is what will be done, which mean billions of tax dollars going towards interest payments every year. It is a huge money suck, and should be unconstitutional in my liberal opinion. We should only be allowed to hold a limited (very limited) amount of debt, to give us some flexibility in economic problems. I think a maximum per capita debt level should be codified into the Constitution.

#4 Comment By gaius marius On October 18, 2012 @ 10:33 am

Assume that the young workers today “pay for it” in the direct sense that they reduce their consumption by $100 billion, in order to invest in the additional $100 billion in government debt that has to be issued. (Thus, we are assuming unrealistically, for the sake of argument, that the higher government debt doesn’t “crowd out” private investment, just so we can see quite clearly why Baker and Krugman are wrong on this issue.)”

as a 20-year student of macro finance, i must interject: these are faulty statements of assumption.

please understand, we do not operate under a gold standard. the US does not have to raise gold by selling bonds in order to fund spending. that mechanism is an anachronism that dies decades ago.

we have a fiat currency convertible at a floating rate to other currencies. in this arrangement, the US Treasury creates money when it spends, and destroys it when it taxes.

it can then issue bonds if it likes, which is a simple swap of financial assets — cash is removed from the private sector and bonds are injected in like amount. the Fed can then use its unlimited balance sheet in the open market to dictate interest rates.

this is how the system works. it’s not an opinion or a theory. it’s a fact.

as such, the federal government is enabling net private sector financial surpluses by running deficits. it is creating financial assets ex nihilo for the private sector when it spends money; it destroys those assets when it taxes.

visualize it this way: draw a circle — this is the dollar universe; no dollars can transgress the perimeter. now draw an arbitrary line through it. if we then put one side of the line in surplus, the other side must by definition be in deficit. now label the surplus side “currency users/private sector”, and the other “the federal government”, and you have a basic model that explains why the federal government must generally run deficits for the good of the country.

to address your points specifically: young workers will never “pay for” the federal “debt”. this is a misunderstanding of what the federal “debt” is — it isn’t a debt at all. calling it “debt” is an anachronism of the gold standard age when governments were currency users captive to the amount of gold they could hoard, the same as any household. that is no longer true.

one can also see that conceiving of the private sector as losing $100bn by investing it in Treasuries is specious — they are participating in a straight swap with the government that merely substitutes assets (and very similar assets to boot). nor does that swap “crowd out” private sector investment. again, the level of assets in the system is unaffected by the swap.

indeed, by reducing tax and/or increasing spending rates to increase its deficit, the government — so far from injuring the private sector — adds net cash flow and income to private sector receipts. that income improves the balance sheet of the private sector, dollar for dollar. and whether the assets created are cash or Treasury bond matters little.

again, i’ve said nothing theoretical or opinionated here. i am describing the mechanical function of the system.

but now i will state an opinion: that politicians and economists remain largely ignorant of the monetary and fiscal operational reality of this country is a testament to the power of political disincentive to reinforce delusion in the face of reality.

moreover, this

The now-old retirees sell their 29-year-old bonds at their current market value of $236 billion (that’s the original $100 billion compounding at 3 percent annually for 29 years in a row).

is a stock-flow confusion. the bonds yield coupons, throwing off cash flow over the life of the bond that adds to the federal deficit and the private sector surplus. when the bonds mature, they are swapped for $100bn in cash, not $236bn.

#5 Comment By Rossbach On October 18, 2012 @ 12:34 pm

I can see 3 big problems with running up the national debt:

1) People who have a lot of money to invest buy treasury bonds now, then the government taxes future Americans (many of them low-wage earners who may have received no benefit from the borrowed money) to ensure that interest payments are made wealthy investors. This would exacerbate the problem of income inequality.

2) US dollars are still the world’s “default currency”, so nations with lots of surplus money to invest (China) buy as large a share of US treasury bonds as they can. We essentially mortgage our children’s future by issuing these bonds, and our children then discover that the mortgagee is the totalitarian government of China. We need to consider how China might use that kind of leverage.

3)The government would find it hard to resist the temptation to pay down the debt and pay the interest with cheaper dollars (inflation). This is a “hidden tax” (and a cruel one) on low-wage earners and persons with fixed incomes.

I guess that I am just not smart enough to understand how spending money that we don’t have can ever be a good idea. I suppose that’s why we need Paul Krugman.

#6 Comment By EasyARB On October 18, 2012 @ 3:05 pm

Mr. Murphy, I do not believe your reasoning works out.

Your argument falls apart in the second to last paragraph where you state that the young generation must forgo consumption to “acquire” the bonds for $236B.

What you are talking about is an inter-generational transfer of assets (dollars to the elderly and bonds to the young). What happens to that money? It doesn’t disappear. Instead, the elderly will spend it buying goods and services from young workers, or they will die and gift the money to the young (as inheritance or taxes).

In any and all cases, the $236B will return to the young. They are not impoverished.

#7 Comment By Borrow and Spend vs Tax and Spend On October 18, 2012 @ 3:05 pm

gaius marius is confusing the roles of the Treasury and the Fed.

He’s nit-picking your example and assuming there is no such thing as a zero coupon bond.

He’s also essentially saying there is a free lunch. Lulz.

#8 Comment By Sam On October 18, 2012 @ 3:27 pm

LOL, both Murphy and the Keynesians are wrong here, although Murphy is far more wrong than Krugman and Baker. Bonds, shmonds. They’re not issued to finance the government, they’re used to affect interest rates.

Gaius is the only one here talking with a lick of sense. The US doesn’t borrow a DIME from China.

#9 Comment By Andrew Bissell On October 18, 2012 @ 4:37 pm

gaius marius: If you’re uncomfortable with an assumption that the government borrowing $100 billion will be paid directly by reduced consumption, then offering that it could be paid indirectly by inflating the currency in which it’s issued hardly changes the fundamental case. Someone will lose from that inflation — and we can argue about whether they’re more or less deserving of those losses than Murphy’s young workers and therefore whether monetization is a better way for the government to finance its deficit — but someone takes a loss all the same.

Or do you believe $100 billion in new real assets (not “net financial” ones) is literally conjured into the economy the moment the bonds are issued?

#10 Comment By john personna On October 18, 2012 @ 8:47 pm

Andrew, gaius marius will probably give a more patient and extensive answer than I, but I think he mainly describe mechanisms, a range of mechanisms, and did not suggest inflating it all. In my own comment above I remind that the 1950 debt was partly paid and partly inflated away. Probably some of that debt was eliminated in less obvious ways. I still think that despite some pinches, 1950-2000 were good times.

#11 Comment By Major_Freedom On October 19, 2012 @ 1:26 am

gaius marius:

please understand, we do not operate under a gold standard. the US does not have to raise gold by selling bonds in order to fund spending. that mechanism is an anachronism that dies decades ago.

we have a fiat currency convertible at a floating rate to other currencies. in this arrangement, the US Treasury creates money when it spends, and destroys it when it taxes.

MMT rears its ugly head once again.

The above statements are irrelevant to the losses incurred on future generations of people.

Why do MMTers keep repeating the same talking points against EVERY economics argument made, no matter how irrelevant they are?

it can then issue bonds if it likes, which is a simple swap of financial assets — cash is removed from the private sector and bonds are injected in like amount. the Fed can then use its unlimited balance sheet in the open market to dictate interest rates.

The “asset swapping” that consists of printing money to buy bonds decreases the value of the already outstanding dollars. It isn’t costless. There are more people in the world other than politicians.

as such, the federal government is enabling net private sector financial surpluses by running deficits.

The private sector does not need “net private sector surpluses” in order to increase standards of living. People don’t work for money because they want to eat it. They work for money to buy other goods and services.

Inflation financed deficits takes real wealth out of the economy, and puts diluted dollars back in. This doesn’t increase general standards of living. Indeed, it decreases it via distorting economic calculation, which is a concept MMTers do not grasp or take into account.

it is creating financial assets ex nihilo for the private sector when it spends money; it destroys those assets when it taxes.

Calling paper dollars “financial assets” is misleading.

visualize it this way: draw a circle — this is the dollar universe; no dollars can transgress the perimeter. now draw an arbitrary line through it. if we then put one side of the line in surplus, the other side must by definition be in deficit. now label the surplus side “currency users/private sector”, and the other “the federal government”, and you have a basic model that explains why the federal government must generally run deficits for the good of the country.

Non-sequitur. The accounting tautology does not speak for itself. It has to be interpreted. Your interpretation derives from a flawed understanding of money and government activity.

to address your points specifically: young workers will never “pay for” the federal “debt”. this is a misunderstanding of what the federal “debt” is — it isn’t a debt at all. calling it “debt” is an anachronism of the gold standard age when governments were currency users captive to the amount of gold they could hoard, the same as any household. that is no longer true.

In the real world, the government taxes people, and a portion of those taxes goes to paying back the money it borrows. Just because the state doesn’t have to do this, it doesn’t mean they don’t.

one can also see that conceiving of the private sector as losing $100bn by investing it in Treasuries is specious — they are participating in a straight swap with the government that merely substitutes assets (and very similar assets to boot).

Nobody said “losing”. The key is that in order for non-printers of money to invest in $100 billion of bonds, they cannot consume using that money. They must forgo that consumption.

nor does that swap “crowd out” private sector investment. again, the level of assets in the system is unaffected by the swap.

False. If one buys bonds, one does not invest in productive enterprise. The debt is not merely nominal. It carries with it real resource redirections.

indeed, by reducing tax and/or increasing spending rates to increase its deficit, the government — so far from injuring the private sector — adds net cash flow and income to private sector receipts.

That doesn’t increase real standards of living. Indeed, it decreases standards of living to the extent that the printed money is not a gift, but used to purchase assets and consume resources. That reduces what is available to the private sector.

that income improves the balance sheet of the private sector, dollar for dollar. and whether the assets created are cash or Treasury bond matters little.

Every dollar is worth less when more is printed. Those who receive the new money last have their wealth DECREASED, because while they pay higher prices, their incomes do not rise as fast.

again, i’ve said nothing theoretical or opinionated here. i am describing the mechanical function of the system.

False. You have very much introduced theory, by claiming more dollars to some people in the economy, benefits “the private sector”, as if every individual is lumped together into one group.

but now i will state an opinion: that politicians and economists remain largely ignorant of the monetary and fiscal operational reality of this country is a testament to the power of political disincentive to reinforce delusion in the face of reality.

You forgot to add MMTers to that mix.

moreover, this

“The now-old retirees sell their 29-year-old bonds at their current market value of $236 billion (that’s the original $100 billion compounding at 3 percent annually for 29 years in a row).”

is a stock-flow confusion. the bonds yield coupons, throwing off cash flow over the life of the bond that adds to the federal deficit and the private sector surplus. when the bonds mature, they are swapped for $100bn in cash, not $236bn.

It is not confusing stocks and flows. It is assuming vanilla, coupon-less treasuries for the sake of simplicity. There is no loss of generality doing so. Adding in coupons won’t change the substance of the argument.

#12 Comment By William Leach On October 19, 2012 @ 3:40 am

Thanks to the complexity of the Keynesian argument, I will admit I dont feel like I can refute the argument definitively. However, I feel the complexity and cleverness of the Keynesian argument, as well as its predictive nature, actually makes their case weaker. Yes, if the Keynesians are 100 percent right then future generations will not be worse off of we run off the debt. But what if they are not 100 percent right? Are we really wanting to bet the fortune of future generations on a belief in a prediction of something as distant and complex as decades of future political economy?

To me the question is not one over what economist has a bigger brain its a question of what kind of country do we want to be? Do we want to strive for breaking evem with our progeny, or are we still the kinf of counrty that wants our children to be better off?

#13 Comment By john personna On October 19, 2012 @ 8:28 am

I think William might be labeling fiat money mechanics as a “Keynesian argument.” Basically if fiat money is our playing field, we have to make policy for it. Even if we’d prefer a gold standard or similar, we can’t make policy as if we had one now.

#14 Comment By Ben, Okla. City On October 19, 2012 @ 9:38 am

Keynes made a distinction between 2 different kinds of economic circumstances. The first circumstance is when we have full employment. Under those conditions he had no problem with the classical economic model. However, he felt that circumstance was not always in fact reality. Hence, he came up with a GENERAL THEORY, rather than a theory that addressed only the full employment scenario, which was a subset of the set of possible circumstances.

IF you are below full employment…AND the labor market is not returning by its own devices to full employment…..THEN it makes sense to have the government intervene to create jobs, purchase materials, let contracts, build stuff. Now whether those jobs are temporary or permanent, whether the activities financed are useful or not…those things are up to us.

So yes, in a FULL EMPLOYMENT scenario, going into debt to provide seniors with drugs (consumption, rather than investment)is questionable. But what about the circumstance we find ourselves in today? Less than full employment and with low interest rates and low costs of construction. Why not pull forward into the present infrastructure projects that we were going to do anyway…do them now at lower costs, employ people, put money in contractors hands, let them purchase capital goods…leaving an economy with better roads, bridges, ports, schools, hospitals, etc…and thus a more productive environment for those future generations the author is concerned about?

#15 Comment By jb On October 19, 2012 @ 4:47 pm

I’m a little confused about something. When the middle generation dies, the $236 billion paid by the young generation becomes part of their estates. And who inherits the estates? The young generation! Granted, the middle generation may have used some of the money for their own consumption. Still, it seems a little more complicated than you are saying. Can you elaborate on this point?

#16 Comment By Andrew Bissell On October 19, 2012 @ 5:46 pm

john: Yes, it’s possible to use a mix of inflation and foregone consumption to finance budget deficits. And yes, it’s possible for budget deficits to overlap with prosperous economic times (1950-2000), or for prosperous economic times to occur without them (as during several boom times in the 1800s).

None of these things changes the fact that “we’re not on a gold standard” and “the government doesn’t have to tax or borrow money to spend it” are not some kind of gotchas against Robert Murphy’s fundamental case, as much as MMTers like to try and use them that way.

I suspect Murphy carefully chose a form of consumption spending to be financed by the public deficit to help his case. I think there is a legitimate (though likely wrong) argument that government deficits invested in needed infrastructure spending can provide a net boon to future generations by raising their productivity and income. I do *not* think there’s a legitimate argument to be made that government borrowing to pay for consumption-type spending such as drug coverage for seniors does not ultimately place a burden on someone else in the economy.

#17 Comment By john personna On October 19, 2012 @ 7:42 pm

Andrew, I absolutely agree that borrowing for investment and borrowing for consumption are two different things. That’s not to say you should never borrow for consumption, but your back should certainly be against the wall … as it possibly was in 2009.

But, as some econ wag said recently, the short run is over. We are in the long run now, and should look for a tax/spending ratio that is appropriate for the long run. Ideally that would mean small surpluses in each year, but small deficits would not be so bad, or not as bad as large ones.

#18 Comment By Andre Kenji On October 19, 2012 @ 10:37 pm

I live in Brazil, and I can say that my generation is paying the debt from earlier generations. Something like 10% of the entire GDP is used every year just to service the debt, one of the biggest government expenses. In part that´s why the country has very high taxes and relatively poor public services. The Debt Default on 1987, 25 years ago, is one of the reasons that even today interest rates are very high.

It´s true that Brazil can´t print dollars, but I´m seeing the same things that happened in Brazil happening in the United States.

#19 Comment By Andre Kenji On October 19, 2012 @ 11:10 pm

“In my own comment above I remind that the 1950 debt was partly paid and partly inflated away.”

No, that´s different. After 1950 the GDP grew a lot, in part because the population was booming, in part because there was the reconstruction in Europe after World War II.

Considering today´s economy it´s unrealistic to expect the same thing to happen again. The United States has an older population and less people in the working age.

By the way, I don´t see any correlation between inflation and a smaller Debt to GDP ratio.

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#20 Comment By Daddy Warbucks On October 20, 2012 @ 2:04 am

Jb,

you are missing the point. SOME young people will benefit from what is basically a transference of wealth, i.e. those whose parents or grandparents leave them bonds, etc. as you and poster EasyArb describe. But how does that benefit other young tax payers who don’t stand to inherit? And inflation hits the poorest hardest, the very people least likely to inherit. So we have young poorer taxpayers taxed through a variety of payroll taxes and sales taxes and inflation, whose wealth is taken from them, and paid to wealthier citizens and foreigners and ultimately their progeny.

#21 Comment By john personna On October 20, 2012 @ 5:17 pm

Andre, I accept the demographics but have high hopes for 50 years of innovation.

#22 Comment By Andre Kenji On October 21, 2012 @ 12:18 am

John, we are talking about more than 100% of Debt to GDP ratio, and the baby boomers are just beginning to retire and to be covered by Medicare. There is no innovation that can pay that.

#23 Comment By jb On October 21, 2012 @ 10:55 am

@Daddy Warbucks

It’s true that there will be winners and losers. But isn’t it still possible that, when averaged out, it’s a wash?

That was the point that Murphy was arguing against — the idea that since we “owe the debt to ourselves” the country neither gains or loses on average — and it’s not clear to me that he has made his case. Even Krugman would not claim that no one in the young generation is worse off, just that the young generation on the whole is not worse off. It does seem to me that Murphy’s argument does ignore inheritance, and is therefore at minimum incomplete.

#24 Comment By Andre Kenji On October 21, 2012 @ 1:53 pm

There is an important point missing here: a problem of high deficits is that investors spend money buying the so called “treasuries” instead of lending to businesses or investing in the economy.

Deficit spending usually means a disproportional financial sector, in part because of that.

#25 Comment By gaius marius On October 22, 2012 @ 10:18 am

Why do MMTers keep repeating the same talking points against EVERY economics argument made, no matter how irrelevant they are?

because, stunningly to me, no matter how often some facts are repeated, many people refuse to learn them. i often feel like i’ve been telling people “2+2=4” for years, only to be met with “hyperinflation!!!” i’ve come to realize that most people have not only little idea about how the system works, but even less will to learn about how it does work because learning would mean admitting that they did not know before.

The “asset swapping” that consists of printing money to buy bonds decreases the value of the already outstanding dollars

no it is not, even though most of the rest of your argument is predicated on this point, and i’ll explain why. what drives inflation is the addition of amounts of net financial assets — either bonds or cash — that increases demand to levels that exceed the capacity of the economy to supply. when that happens, you WILL get inflation. that is the limiting case, the point at which government deficits become a negative for the economy and should be scaled back.

but how can anyone credibly argue that we are anywhere near that point today? with so many still unemployed? with cap utilization still well below peak?

it is important to note that the swap itself has nothing to do with this — much is made by people who don’t understand how the system works about the swapping of bonds for cash, as though the cash were somehow more “spendable”. it isn’t; Treasuries can be infinitely repoed and act exactly as cash. and that is why QE has done so little to effect either spending or inflation.

the important part is not whether the assets being created by federal deficits are cash or bonds — it is that the assets are being created, as that creation flow is private sector income, no matter what the assets are.

The private sector does not need “net private sector surpluses” in order to increase standards of living.

i agree. real growth is about population, productivity and (shorter run) resource utilization — and the private sector can get no help from the Treasury in the first two.

but the trouble is that a financial system denominated in the unit of account overlays this real economy in order to apportion income — and that system can and does have real impact on resource utilization. we are seeing it today in this balance sheet recession — unemployment is high and resources are lain fallow because income once directed to consumption (and boosted by a massive expansion of endogenous money from the banks) is now being redirected to loan repayment (and a concominant deflationary reduction in endogenous money).

topping up private sector income with deficit spending in order to avoid a deflationary spiral is what we’re halfheartedly doing these days, running large deficits as we are. but we could push more income into the system to create the demand that would put people back to work — would push cap utilization back to normal levels, would speed up private sector balance sheet repair, all without inflation because resource supply is not being strained (except, i would argue, in cases of actual nonfinancial scarcity — such as oil, where supply seems to have topped out. even there, fracked natgas can relieve total energy demand concerns.)

one last thing —

gaius marius is confusing the roles of the Treasury and the Fed. … He’s also essentially saying there is a free lunch.

i’m more recognizing that the two are operationally integrated into a single monetary entity, no matter how they are departmented.

but more importantly — there’s nothing free here. we have suffered a massive private sector debt boom and bust, where bank-created endogenous money growth ran wild for many years and ultimately destroyed the US household sector balance sheet. we’ve already been FIVE YEARS in this hole of little/no growth and high unemployment. short of some kind of debt jubilee (the ancient solution for these kinds of problems), it will be several more years on top of that of simply repairing the private sector balance sheet. anyone who thinks of that as “free lunch” isn’t paying attention.

that said, there is a difference between solving the problem as best you can — and shooting yourself in the face, as the Hoover Administration once did in this country by relentlessly attempting to balance the federal budget to stay on the gold standard, as the euro countries now are to stay within the Maastricht limitations of their quasi-golden euro, out of a lack of understanding.

either way, the US private sector balance sheet recession will resolve itself with many years of higher federal deficits because that (again, short of a debt jubilee, which in the end is really just a large slug of currency creation to deleverage and recapitalize the private sector all at once) is the only way it can be resolved. the only real question is whether we attempt to destroy the private sector along the way, multiplying its solvency problems by constricting its income streams and touching off a debt-deflationary collapse, because of an addled misconception of the flexibility of fiat currencies.

#26 Comment By robby On October 22, 2012 @ 10:19 am

“There is an important point missing here: a problem of high deficits is that investors spend money buying the so called “treasuries” instead of lending to businesses or investing in the economy.”

yet, if the deficits aren’t there and interest rates are higher, investors won’t be looking to invest as much b/c of the higher rates (or cost) to invest, correct? to say that all investor money would automatically go to lending to business b/c they aren’t buying bonds, etc. is not reality.

#27 Comment By Spencer Smith On October 22, 2012 @ 10:28 am

Krugman obviously isn’t an engineer. Nothing is free. There’s always a trade off. That’s the first thing you learn in engineering. I think it also applies nicely to economics as well.

#28 Comment By Tim On October 25, 2012 @ 7:17 pm

I don’t understand why John Personna says “Many of us enjoyed great fortune in the years 1950-2000. All those years we were paying down our fathers’ debt. Well we paid down part and inflated away part, which is key.” The WWII debt was not paid off. Debt increased from $43 billion in 1940 to $219 billion in 1950 to $236 billion in 1960. It’s been rising ever since. Just because the gov’t cut spending and lowered the budget deficit doesn’t mean they actually paid off the debt. And you can’t inflate it away. The gov’t doesn’t print money. If it wanted to pay off foreigners and individual US citizens who owned the debt by inflating, it would have to borrow the money from the FED. So it would technically still have a huge debt on the books.