January 01, 2012
On the burden of government debt
I didn't have time for a lengthy discussion of this issue, so will have to settle for some quick links of interest.
Paul Krugman and Dean Baker argue that government debt is not as big a burden on future generations as is often argued, to which Nick Rowe and Don Boudreaux respond. I would also add that Krugman acknowledges that debt owed to foreigners, and the high marginal tax rates necessary to meet interest payments on domestic or international debt, can certainly be a burden. And Krugman does not worry much, whereas I do, about the possibility that future creditors will doubt the willingness of the U.S. to raise taxes or cut spending sufficiently to meet the interest burden, the result of which could of course prove to be a huge problem.
Separately, Krugman discusses Ricardian equivalence and stimulus, on which John Cochrane and Mark Thoma offer useful comments.
Posted by James Hamilton at January 1, 2012 07:44 AMdigg this | reddit
Krugman obviously didn't notice how Obama strangled Simpson-Bowles in its crib or how the Republicans caved in on the debt ceiling, continuing resolution, and omnibus, allowing spending of Obama proportions to continue unabated.
Posted by: W.C. Varones at January 1, 2012 08:42 AM
Wish to see you post on this soon.
Krugman also wrote another post saying that net income on the negative net foreign assets is positive and is in the United States' favour and gives the innuendo that the net indebtedness is not problematic.
What Krugman misses is that because the US runs a current balance of payments deficit, at some point the investment income turns negative due to the increase in net indebtedness. In other words , while r(foreign) minus r(domestic) is in the US's favour at present - i.e., the effective interest rate on US assets held abroad is higher than the effective rate paid on liabilities because of low interest rates in the US, at some point
r(foreign)*A(foreign) minus r(domestic)*L(foreign)
turns negative when
A(foreign) minus L(foreign) turns sufficiently negative.
[A(foreign) and L(foreign) are assets held abroad and liabilities to foreigners, respectively]
The net investment income has been surprisingly positive for so many years and it is because of some good luck that it has been so. It is wishful thinking that it won't turn negative and head into deeply negative territory - although to just turn negative may take 4-5 years.
Also, using your point, when foreigners start to be suspicious of the unsustainability of the US net indebtedness, domestic interest rates have to be hiked to keep foreigners lending but it makes the whole process even more unsustainable.
Posted by: Ramanan at January 1, 2012 09:05 AM
Krugman seems to be kind of blind to cost of government debt. Obviously, a society as a whole has to service all debt.
He loves to point to the post WWII era, where government debt was high and we grew out of it. But what he ignores is that by 1949 private debt was unbelievably low--partly because of two decades of deleveraging, partly due to war-time inflation, and partly due to the impossibility of buying the things (cars, appliances, etc) that people previously bought on credit.
We had good growth with very high tax rates because there was so much room for expansion of private debt. For us to reach the level of household debt/GDP we had in 1949, household deleveraging and inflation would need to continue at the present rates until about 2025.
Isn't it obvious we need to look at society's total debt to gdp? That has been rising for 65 years and is now at 2.5, twice what it was in the post WWII era Krugman compares us with.
And this is true in pretty much every society in the West. Japan may have less private debt, but they have a lot more government debt, their ratio isn't that different from ours.
My problem with the Krugman view (and it's really not different from the Greenspan view of 2002 in this regard) is it seems to be based on the idea that there is no limit on how much debt a society an service. That to me is absurd. It seems to assume that interest rates always fall, as they have for the last 30 years.
I think if Keynes were here, he would recognize this problem and try to imagine a way of how to come to terms with it. Not just repeat what he said in the 1920s and 30s as Krugman is so fond of doing.
I'll bet we are near to some new fundamental change in economic thinking. If we instead continue the same policies of the last 60 years, then there is going to need to be a hell of a lot more defaults, or some really sustained inflation.
Posted by: Bob_in_MA at January 1, 2012 09:51 AM
"Krugman obviously didn't notice how Obama strangled Simpson-Bowles in its crib or how the Republicans caved in on the debt ceiling, continuing resolution"
Some people still have not noticed that just the consideration of not raising the debt ceiling was enough to potentially affect our debt, taking us a step closer to not being able to honor our debt payments.
Posted by: steve at January 1, 2012 10:13 AM
Eve the slow kids at S&P acknowledged that the problem is not the debt ceiling but the lack of hope for structural reform.
Posted by: W.C. Varones at January 1, 2012 11:03 AM
"Krugman obviously didn't notice how Obama strangled Simpson-Bowles in its crib"
That was obviously because Simpson-Bowles failed to recognize that The US can reduce its deficit fairly easily because our income taxes are far too low. From 1945 to 1980 income taxes averaged near 12% of GDP. Reagan reduced marginal tax rates so much that they fell close to 9%. Clinton increase them back to 12%; and Bush/Obama reduced them again to 9 %(and below). However, on budget expenses have remained 12%(+/-1%)) of normalized GDP throughout. The deficit in income taxes has been financed by borrowing, largely from the Social Security trust fund. But, not only can we no longer continue to borrow from the trust funds, we have to start paying money back as beneficiaries start relying on the trust funds. In the short term, we have to raise income taxes to 12%, simply to cover on budget expenses. In the long term, income taxes must rise above 12% in order to pay back the trust funds.
Posted by: bmz at January 1, 2012 12:36 PM
I have to wonder if some of the commenters here actually read what Krugman said. His point was about the belief by some that public debt is an intergenerational problem; he did not say that there might not be a distributional problem. His point about it being impossible to create a generational burden beyond deadweight costs from higher future taxes is (I thought) relatively noncontroversial. It was something I learned in an undergrad public finance class, so it's pretty basic. Large public debt does carry costs, just not the costs that Fox News pundits like to talk about. The key point Krugman is making is that for each debt intrument there is a corresponding creditor. Across generations there cannot be a net debt burden shift. Folks also forget that slack aggregate demand does impose burdens on future generations because it makes the future economy less productive. It's a no brainer that deficit spending in a ZIRP world will generate a positive ROI. The fact that interest rates may go up in the future is also true with private investment, but I don't hear conservatives say the private sector should not invest because rates might go up. Quite the contrary, low rates today are a signal to increase public deficit spending. When rates do go back up, that will be a signal that there is crowding out. But we are not there yet...not by a long shot.
Posted by: 2slugbaits at January 1, 2012 01:04 PM
2slugbaits: "The key point Krugman is making is that for each debt intrument there is a corresponding creditor."
That would be a fair point if both debt and assets are evenly distributed. And that the assets are fairly valued. Which, of course, is nonsense.
Greenspan made a similar similarly silly pronouncement when he pointed out, repeatedly, that households, on average, had sound balance sheets.
Unfortunately, the asset column fell 30% with no corresponding decease in debt, except through defaults. And how many of us were willing to liquidate our retirement accounts to help out the neighbor who was underwater and looking at foreclosure?
Krugman is a brilliant rhetorical tactician, but I think his big-picture view is just too simplistic.
Posted by: Bob_in_MA at January 1, 2012 01:41 PM
Has the U.S. EVER Defaulted on its Debt???
No and it never will default on its debt unless it starts issuing debt in euros or yen. Even the idiotic tea baggers in Congress cannot force the government to default because the Constitution - 14th Amend., Sec. 4 - expressly prohibits default on the debt.
Posted by: Paul at January 1, 2012 03:26 PM
Bob_in_MA That would be a fair point if both debt and assets are evenly distributed.
Glad you agree, because that was exactly Krugman's point. His argument is that there are distribution effects within generations, but no intergenerational debt transfers.
You have to follow the several threads of Krugman's post. His initial post claimed that the idea of passing the burden of debt onto future generations, as conventionally preached on Fox News and by the GOP, was not only ridiculous, but was logically inconsistent nonsense. It does make sense to talk about distribution effects within generations, but it makes no sense to talk about passing along the burden of debt across generations except through the effects of deadweight losses from higher taxes. He then followed up that point with several other posts arguing that even the intragenerational (note: intra and not inter) distribution burden was not really a major problem because much of the net debt was held domestically, contrary to what Very Serious People would have you believe. He also pointed out that even the deadweight costs of higher future taxes is likely overstated.
Posted by: 2slugbaits at January 1, 2012 04:23 PM
The government doesnt need to get into greater debt to stimulate the economy.
Monetary policy can do the stimulus. The monetary transmision mechanism of commercial banks dealing with the CB directly needs to be circumvented beacause it is innefective. The public should deal directly with the CB instead.
Posted by: dannyb2b at January 1, 2012 04:38 PM
Paul: Are you serious? You don't really believe that the US government has some sort of iron-clad respect for the Constitution that prevents them from violating it, or that an event being unprecedented means that it can't happen, right?
I do, however, tend to agree with you that the government is unlikely to technically default on its debt - in a situation of rising interest rates and difficulties in repaying debt, inflating it away is much more likely.
Posted by: Anonymous at January 1, 2012 04:53 PM
I am completely serious.
"The validity of the public debt of the United States, authorized by law, . . . shall not be questioned." 14 Amend., Sec. 4.
When the Congress passes an appropriations bill that is signed by the President, it becomes the law of the land and part of the public debt. Period. No court has ever ruled otherwise.
That debt cannot be questioned by any court and is absolutely payable. Nothing the tea baggers do can change that.
We can and do print our money in infinite amounts. There is no limit on the Fed and nothing the tea baggers do can change that either.
For these reasons, and many others, we pay 2% interest on 10 year bonds with no collateral. Default on the U.S. debt is not possible because the tea baggers Wall Street masters will not allow it.
Posted by: Paul at January 1, 2012 07:52 PM
2slugbaits: "His [Paul Krugman's] point about it being impossible to create a generational burden beyond deadweight costs from higher future taxes is (I thought) relatively noncontroversial. It was something I learned in an undergrad public finance class, so it's pretty basic."
That's what I learned too, as an undergraduate, many years ago. 30+ years ago I think it was (relatively) uncontroversial. Then Buchanan argued it was wrong. I thought it is now seen as uncontroversially wrong. I was surprised to see Paul Krugman say it. I think it is wrong. I argue it is wrong.
Posted by: Nick Rowe at January 1, 2012 08:15 PM
Edifying outcomes,when streched to absurd, economies are not interlinked,exchange rates are not a mechanism of transmission,countries are living in autarky and provide for themselves with natural resources, input prices are endogeneous.Let us expand more, the whole debt burden is simplified to interest payments, that is to eventually keep them current.Let us forget the exponential of the interest debt service etc..The blessing of the outcome, G8 or G20 or Gn do not need to take place since countries may endogenously monitor their domestic debts.
One caveat debts are a measure of productivity, of economic efficiency.May I suggest the following measures KW/H,Joule,Ampere,etc to be treated the same.They may or may not make our life,safety,payment bills better.
Posted by: ppcm at January 2, 2012 01:29 AM
should have my parents allowed the government to go into debt to build the interstate highway sytem?
since they did, are those highways a burden on me?
or would i have been better off using the back roads & alleyways they travelled on it the 50s?
Posted by: rjs at January 2, 2012 02:04 AM
Has the U.S. EVER Defaulted on its Debt???
Yes... The definition of default is when a borrower changes the terms of debt repayment at the detriment of the lender.
I believe both cases (post Civil War/FDR surprise surprise) involved the servicing of bonds which the terms of debt repayment was to be in gold. Instead of gold, fiat currency was used.
Posted by: Babinich at January 2, 2012 03:59 AM
Cognitive Dissonance on a Global Scale?
IMO, we continue to see a massive global refusal to acknowledge resource limits. The underlying premise seems to be that we can have a virtually infinite rate of increase in our consumption of a finite fossil fuel resource base.
As I have pointed out several times, the supply of globally (net) exported petroleum liquids available to importers other than China & India, what I call Available Net Exports or ANE, fell by 12.5% from 2005 to 2010. This translates an annual ANE decline rate of 2.8%/year, but I suspect that we are consuming what I call CANE, post-2005 Cumulative Available Net Exports, at about 8%/year.
This ongoing decline in ANE was the primary contributor to the doubling in annual global (Brent) crude oil prices that we have seen, from $55 in 2005 to about $111 in 2011.
Following is the "Thelma & Louise" metaphor that I described in late 2010 (updated for 2010 export numbers). My suspicion is that most OECD countries that are running deficits will curtail their borrowing from private sources only when they can't afford the interest rates, leaving central banks as the "lender" of last resort.
Incidentally, does anyone have the percentage of the net increase in US federal debt over the past three fiscal years or so that was acquired by the Federal Reserve?
The OECD “Thelma & Louise” Race to the Edge of the Cliff
“Thelma and Louise” is an American movie that ends with the two main characters committing suicide by driving off the edge of a cliff. I’ve often thought that this cinematic moment is an appropriate symbol for the actions of many developed OECD countries that are in effect borrowing money to maintain or increase current consumption. The central problem with this approach is that as my frequent co-author, Samuel Foucher, and I have repeatedly discussed, the supply of global net oil exports has been flat to declining since 2005, with “Chindia” so far consuming an ever greater share of what is (net) exported globally. Chindia’s combined net oil imports, as a percentage of global net exports, rose from 11.2% in 2005 to 17.6% in 2010.
At precisely the point in time that developed countries should be taking steps to discourage consumption, many OECD countries, especially the US, are doing the exact opposite, by effectively encouraging consumption. Therefore, the actions by many OECD countries aimed at encouraging consumption in the face of declining available global net oil exports can be seen as the OECD “Thelma & Louise” Race to the Edge of the Cliff. I suppose that the “winner” could be viewed as the first country that can no longer borrow enough money, at affordable rates, to maintain their current lifestyle. So, based on this metric, Greece would appear to be currently in the lead, with many other countries not far behind them.
Posted by: Jeffrey J. Brown at January 2, 2012 05:26 AM
My "fearless" prediction has been that we would see a series of oil price doublings, but given the demand uncertainties, it was impossible to predict the time periods between the doublings.
However, from 1998 to 2011, Brent has shown three annual "doublings," from $13, in 1998 to about $111 in 2011. Note that the time periods between the doublings has been increasing, from three years (1998 to 2001), to four years (2001 to 2005), to six years (2005 to 2011).
Annual data table:
Note the pattern of higher highs and higher lows. The post-1997 annual year over year price declines were 1998, 2001 and 2009. Note that each successive year over year decline, after 1998, was to a level that was at least twice the low reached during the prior year over year decline.
If this pattern holds, the next annual year over year decline in Brent prices will bring it down to an annual average price of about $130. Time will tell.
Posted by: Jeffrey J. Brown at January 2, 2012 05:51 AM
Note that the time periods between the (approximate, Brent crude oil price) doublings has been increasing, from two years (1998 to 2000), to five years (2000 to 2005), to six years (2005 to 2011).
Posted by: Jeffrey J. Brown at January 2, 2012 05:55 AM
Nick Rowe I think we're talking past each other. First, the strawman that Krugman is slaying is not that debt doesn't matter to the government's ability to borrow in the future, but that the total burden of the principal is not a generational burden. The problem with your thought experiment is that about midway through you quietly substituted "government" for "generational cohort." Yes, the government's future debt servicing costs go up, but so too will the incomes from those who receive those debt service payments. Second, none of this says that there aren't intergenerational costs because there are. And Krugman clearly pointed that out. He clearly said that there were deadweight issues and important effects on future productivity because of higher tax rates.
Imagine the government borrows at zero interest rate, so debt equals principal only. If the economy is operating at full employment, then the burden is entirely on the current period cohort because it is that cohort that gives up real resources to satisfy government demand. The next cohort will be taxed "X" amount to pay the principal and as heirs of the initial cohort they will receive exactly "X" amount in payments. In other words, it's a complete wash. No generational transfer of debt. If the economy is not operating at full employment and if at least some of that government borrowing goes into capital investment, then the production possibility curve for the next generational cohort will be pushed out and that cohort will be better off. Additionally, since there were initially unemployed resources the opportunity cost to that initial generation will be less.
To put this another way, what Krugman is getting at is that the costs to future generations are interest costs, not principal costs. Now interest costs are a burden on future generations, but the reason they are a burden is because of intragenerational distribution effects and the deadweight & efficiency effects due to higher tax rates to pay the interest. I think that is Krugman's actual argument. But what gets reported in the press and what Tea Party rubes scream about is the principal component of borrowing. You don't hear Fox News pundits screaming about passing along deadweight costs and tax inefficiency costs to fund a 2% interest stream. Instead you hear them screaming about passing along the principal. That's what I was getting at when I used the phrase "the idea of passing the burden of debt onto future generations, as conventionally preached on Fox News and by the GOP, was not only ridiculous, but was logically inconsistent nonsense."
Posted by: 2slugbaits at January 2, 2012 06:51 AM
2Slugbaits: At time 1, the government makes a transfer payment of 100 apples to generation A, who are at that time young. The government obtains the resources necessary to do so by borrowing 100 apples from those same young people. So at the end of period 1, generation A has eaten 100 apples and also owns an asset in the form of government debt that is also worth 100 apples.
At time 2, generation A is now old and generation B is young. To pay back generation A, the government imposes a tax on the young generation B of 100 apples, which it uses to pay the debt it owes to generation A.
The end result is that generation B has paid 100 apples in taxes and received nothing, while generation A has received 100 apples in transfer payments for which it did nothing. The debt represents a benefit to generation A and a burden to generation B.
The fact that the 100 apples received by the debt holders (generation A) at time 2 is exactly equal to the taxes collected from the young at time 2 (generation B) does not matter at all for the statement that the debt is a burden on generation B.
Posted by: JDH at January 2, 2012 07:25 AM
I thought 'debt burden' included the net burden associated with principal, intereset, taxes, distributional effects, externalities, etc.
I don't think anyone is arguing the debt trajectory that developed over the past few decades is optimal.
If it was not optimal, then the growth rate of debt should have been lower. Correct?
If so, then the issue reduces to whether or not taxes were to low, spending too high, or some combination.
I don't think there are many who want to argue that the growth rate of government spending was too low, or optimal. Therefore, the growth rate in government spending needs to be lower in the future to offset the above optimal spending rate of the past.
Posted by: tj at January 2, 2012 07:47 AM
The only cases where a greater burden isn't created (don't forget interest, interest rate risk, and deadweight loss) is when highly productive capital equipment is created. This would included roads, water treatment and delivery, cheap energy production, etc. These things also make up a rather insignificant part of the the budget an deficit spending. Most of it is spent and simple transfers and bureaucracy.
Posted by: aaron at January 2, 2012 07:58 AM
JDH At time 1 half the living adults borrow apples from the other half of the living adult population. The lending half gets an IOU and the borrowing half gets a full stomach. At time 2 the heirs to the lenders collect extra apples from the descendants of those who borrowed. The heirs to the borrowers get a bellyache and the descendants of the borrowers go hungry. Across generations (i.e., across time periods) there is no net burden on the latter generation. Within each generation there is a burden between the haves and have nots, but not across generations.
The problem with your example is that it misstates the initial borrowing relationship. The government has to do something with those apples that it borrows. If they are all immediately consumed in time 1, then as a group those alive at time 1 have still consumed 100 apples. True, within time 1's cohort there may be an unjust distribution of apple consumption, but total consumption is no less at time 2. If the apples are not consumed but stored (assuiming no storage loss...roughly equivalent to interest in this case), then the generational cohort in time 2 will simply redistribute the apples. Again, there may very well be an unjust distribution of apples within each time period, but across time periods there is no additional burden. Of course, because of the anticipation of collecting IOUs and the physical fact of spoilage as well there will be some adverse productivity effects that affect welfare between generations, but Krugman has already conceded that point. He is just talking about the 100 apples.
In your example you are creating multiple generations within each time period. That is clearly not what Krugman has in mind. When he talks about generations he is obviously talking about cohorts living in each time period. I think Krugman has something different in mind when he talks about generations. He is talking about distinct time periods and not the kind of overlapping generation model you seem to have in mind.
Posted by: 2slugbaits at January 2, 2012 08:19 AM
Oil prices will not double, not in the short term at least.
Right now, oil prices are above the carrying capacities of both the US and Europe. Consumption is declining in both venues. Meanwhile, according to Barclays Capital (in their truly excellent half yearly surveys), oil companies budget number for approving projects is $87 for WTI and $98 for Brent for 2012. Thus, oil companies are now approving projects requiring oil prices above the carrying capacities of the OECD economies! Do you think that ends well? I don't.
By the way, the EIA sees the oil supply increasing just 0.3 mpbd to the three months ending Dec. 2012 over the same period 2011 (ie, now). We'll see what the shale (tight) oils can do. But if we were having an office pool to peak the peak oil year (all petroleum liquids), I'd be inclined to pick 2012.
Posted by: Steven Kopits at January 2, 2012 08:27 AM
I'm on the same page as JDH.
2slugbaits: "First, the strawman that Krugman is slaying is not that debt doesn't matter to the government's ability to borrow in the future, but that the total burden of the principal is not a generational burden."
I think that "strawman" is correct.
"The problem with your thought experiment is that about midway through you quietly substituted "government" for "generational cohort." Yes, the government's future debt servicing costs go up, but so too will the incomes from those who receive those debt service payments."
The bondholders' incomes go up from the debt service payments, but they already paid for those debt service payments when they bought the bonds. If they had inherited those bonds as a free gift, as in Barro-Ricardo, it would be different.
Posted by: Nick Rowe at January 2, 2012 08:37 AM
2slugbaits: No, I am simply trying to explain Nick Rowe's example to you, which you make more complicated than it is. Everybody in generation A is alike-- they are both the bondholders and the recipients of the time 1 transfer payments. They simultaneously (i) deliver 100 apples to the government at time 1 in order to purchase a government bond (which promises to pay them back 100 apples at time 2), and (ii) receive a transfer payment from the government at time 1 in the form of 100 apples, which they eat on the spot.
Total output in this economy is always fixed, and that was by assumption. By construction of the example, government spending and tax policy never have anything to do with determining the total amount that gets produced or consumed. The question is entirely about distribution.
If you tax one group in order to benefit another, it is a burden on the group that is taxed. It is generation B, which is taxed to pay back the debt, that carries the burden in this example. Generation A gets to consume 200 apples (100 in time 1 from their transfer payments, and 100 in time 2 from their maturing bonds), whereas generation B gets to consume nothing.
Posted by: JDH at January 2, 2012 08:59 AM
The always wonderful Krugman-in-Wonderland weighs in.
Posted by: W.C. Varones at January 2, 2012 09:35 AM
Steven, to quote myself (as they say, predict a price or a time, but not both):
"My 'fearless' prediction has been that we would see a series of oil price doublings, but given the demand uncertainties, it was impossible to predict the time periods between the doublings."
Regarding oil importing OECD countries in general, and the US specifically, my position for some time is that we are headed toward "freedom" from our reliance on foreign sources of oil--as we are forced to continue to consume a declining share of a declining volume of Global Net Exports of oil.
However, one point to keep in mind is that discrete sources of demand within oil importing OECD countries is not the same as aggregate demand, e.g., what oil price would force Bill Gates to conserve oil?
I actually think that the progressively higher oil price lows are more interesting than the higher highs. As noted up the thread, if the "doubling" pattern in higher annual lows continues, the next year over year decline will bring us down to an annual average Brent price of about $130.
Given (so far) increasing aggregate demand in many developing regions, e.g., Chindia, and among the net oil exporting countries, with higher, or level, discrete demand within oil importing OECD countries, I think that it is more likely than not that we will see something like $130 Brent for the next year over year decline.
As I said, time will tell.
In any case, to return to the primary topic, I assume that you agree that we are seeing "Cognitive Dissonance on a Global Scale" constrained global oil supplies?
Posted by: Jeffrey J. Brown at January 2, 2012 10:06 AM
JDH: "It is generation B, which is taxed to pay back the debt, that carries the burden in this example. Generation A gets to consume 200 apples (100 in time 1 from their transfer payments, and 100 in time 2 from their maturing bonds), whereas generation B gets to consume nothing."
But the debt need not ever be paid back. Generation B doesn't need to give apples back to Generation A. The only cost to the the next generation is the carrying cost of the interest, which is what Krugman pointed out. Growing productivity can ameliorate the interest costs.
The fact that generation A consumed 100 apples does not prevent generation B from producing and consuming 100 more apples any more than their consumption of cars, houses or computers prevents the next generation from enjoying cars, houses and computers.
You seem to imply that generation A has somehow deprived or "stolen" 100 apples from generation B. That is not the case. They may have burdened them with some interest payments, but they haven't deprived them of 100 apples. Nothing prevents generation B from consuming 100 apples if they choose.
Perhaps it is the apple analogy that that is confusing, because we are really talking about dollars and dollars are not consumed. Each generation produces what it consumes, and it does not consume dollars. Generation A's consumption of apples is irrelevant to generation B's consumption of apples (to first order).
Posted by: Joseph at January 2, 2012 10:14 AM
Hey Babinich, We Are NOT on the Gold Standard Now
So your worries that the Government will renege on its debt by not paying in gold is irrelevant.
"You shall not crucify mankind upon a Cross of Gold!" (Ron Paul take note.)
Posted by: Paul at January 2, 2012 10:14 AM
Joseph: You apparently would have generation B go ahead and push the debt on to generation C, and so on. It is true that one can construct examples in which generation A can enjoy a free lunch-- remember that they consumed 200 apples here-- from the device of government borrowing funds that are never paid back. However, I disagree that this is the kind of example Krugman had in mind. Instead, I believe he was choosing to characterize the payment of generation B to generation A as "money we pay to ourselves". And I also agree with Nick Rowe and Don Boudreaux that this characterization is not the right way to look at this question.
Posted by: JDH at January 2, 2012 10:28 AM
JDH, if we can agree that generation A has not taken 100 apples from generation B, how can there be an inter-generational transfer?
Posted by: Joseph at January 2, 2012 10:39 AM
Joseph: I agree that you could set up the example such that generation A instead takes the apples from generation C, or from generation D, or a bit from each generation. I disagree that it is a standard outcome that generation A could get 100 extra apples for which nobody anywhere down the line has to pay anything. It requires special and controversial assumptions to set up a model with a free lunch of this form, and I repeat that this is not the example Krugman has in mind and not an example on which you and I could claim to be in agreement.
Posted by: JDH at January 2, 2012 11:43 AM
2sb, your definition of a strawman is a bit mixed up.
Posted by: aaron at January 2, 2012 11:47 AM
I understand the doubling concept. But that only works when you still have a consumer surplus. We blew through that in 2011.
In this article by Chris Skrebowski (http://www.odac-info.org/newsletter/2011/09/16), scroll down to Graph 1. The doubling of oil prices to which you refer is largely captured by the gray line, refiners' average acquisition cost (RAC). And the distance between the RAC and the red max tolerance line is, in some sense, the consumer surplus, ie, how much the US economy would have been willing to pay for that oil, but didn't have to.
Now, when the red line and the gray line meet, then the consumer surplus (as construed here) is fully exhausted, and additional price increases will be met with reductions in consumption. At that point, you cant' continue to raise oil prices beyond GDP growth plus dollar inflation, by this line of thinking.
Of course, you can get short-term price spikes due to demand price inelasticity. Such inelasticity-caused spikes are normally resolved through recessions (which provides the necessary elasticity, ie, it's a break-not-bend model), and why I predicted a recession back in April (which looks to hold up for Europe).
Jim, by contrast, predicted a slowdown in GDP growth without a recession, and for the US, he's been right to date. However, a slowdown requires oil demand price elasticity (higher prices lead to a fall in consumption without requiring a recession). This in fact has been in the case in the last year. The US has shed pretty significant consumption without a recession. Europe has shed consumption at twice the rate (could the difference be shale gas and oil?), and it is in recession.
So, it's not that I disagree with you in terms of historical analysis. But looking forward, at some price, people will choose to consume less rather than pay more. Beyond that point, price elasticity begins to approach 1 (or more properly, -1, no?) and growth in spend on oil consumption (P x V) will tend to be at around demand income elasticity of 1 as well, for the world economy as a whole. That is, if we assume the oil supply (V) is constant, the prices will increase with global GDP and dollar inflation, plus or minus. That's Chris's whole point of peak oil as an economic, rather than geological, phenomenon.
Posted by: Steven Kopits at January 2, 2012 12:04 PM
"Paul Krugman and Dean Baker argue that government debt is not as big a burden on future generations as is often argued"
"Not as big as is often argued" is pretty vague. A huge rise in interest rates could turn what Krugman believes to be a small burden into a huge one for future generations due to short maturity profile of US debt. It's a rather large misguided gamble, i.e. the US treasury debt for bank rescue gamble. I personally believe US treasury printed money for infrastructure would have been a safer gamble.
Posted by: Craig Jackson at January 2, 2012 02:10 PM
"if we assume the oil supply (V) is constant"
Following are two scenarios for Global Net Exports (GNE) and for Available Net Exports (ANE, or GNE less Chindia's net imports).
For the first scenario, we extrapolated the 2005 to 2010 rates of change in key metrics. For the second scenario, we assumed a 1%/year production decline among the top 33 net oil exporting countries.
The first scenario results in a projected ANE decline rate of 5%/year for 2010 to 2020, while the second scenario results in an 8%/year ANE decline rate for 2010 to 2020--versus an observed 2.8%/year ANE decline rate for 2005 to 2020.
0.1%/year Production Decline (2010 to 2020), Top 33 Net Oil Exporters:
1.0%/year Production Decline (2010 to 2020), Top 33 Net Oil Exporters:
Given an ongoing decline in GNE & ANE supplies, my point is that it takes a progressively higher price to eliminate additional demand, absent widespread recessions, which is certainly possible. But it's instructive to remember that it appears that global crude oil demand in the Thirties fell only one year, in 1930, with a steady increase in demand after 1930.
And as noted up the thread, the GNE/ANE topic is all but ignored, while most OECD governments seem to be proceeding on the premise that high oil prices, and constrained supplies, are a temporary problem, and we will soon be back to a virtually infinite rate of increase in our consumption of a finite fossil fuel resource base.
Regarding US crude oil production, it appears that 2011 production is going to average between 5.6 mbpd and 5.7 mbpd, versus a pre-hurricane production rate of 5.4 mbpd in 2004.
Posted by: Jeffrey J. Brown at January 3, 2012 04:49 AM
From Nick earlier:
"The bondholders' incomes go up from the debt service payments, but they already paid for those debt service payments when they bought the bonds. If they had inherited those bonds as a free gift, as in Barro-Ricardo, it would be different."
Maybe an unimportant observation Nick, but the price of the bond purchase is an estimate of what was paid for. Although the coupon is guaranteed, the coupon is merely an estimate of value, at one point in time. That's why creditors typically hate inflation.
Krugman has pointed out the circumstances of the borrower is very important in debt relationships. From a policy standpoint, maintining real incomes is a key requirement in the dynamic of bond guarantees. Austerity measures that lower real incomes, and they apparently usually do exactly that, weakens the bond guarantee. The result there: bondholders take haircuts in the secondary market and/or inflated dollars at maturity.
Posted by: Anonymous at January 4, 2012 10:01 AM
This might be the scariest thread I've ever read here! (Though when so many people believe in the Ricardo Fairy, I find myself sympathizing with the Tea Partiers.) 2slugbaits is demonstrating some sanity, thankfully, but still missing the forest for the trees, e.g.: "JDH At time 1 half the living adults borrow apples from the other half of the living adult population. The lending half gets an IOU and the borrowing half gets a full stomach..."
While I largely agree with this view, the example describes a (massive) *private sector* credit transaction, when the issue is USG debt; which is, operationally speaking, an entirely different animal (or fruit).
A quick thought experiment...
Under a gold standard, net financial assets (assets unencumbered by a corresponding liability) came from where? Gold mines, correct? And when gold standards were operational, no one ever argued that the gold mines would one day have to rebury all or even some of the gold they had produced. They also didn't call net additions to the monetary stock "printing," or assume that every addition would inevitably prove inflationary, etc.
Fast forward to today's soft currency systems. In the US, where the Fed has historically targeted an interest rate via open market operations, in which it swaps one asset--either an interest bearing or non-interest bearing govt liability--for another, in what are essentially *credit transactions* (they're targeting an interbank lending rate, and removing an equivalent govt liability in the process)--are they in any way adding to the stock of net financial assets?
If not, who's playing the role of the gold mines today? Besides open market and private and non-federal-govt credit transactions--and with what appears to be a secular period of falling velocity and slowing credit growth, this question has suddenly become immensely important--where the heck does money come from? Or are we all Rothbardians now??? :)
A Treasury security is simply an interest-bearing liability of the USG that was *preceded* by the issuance of a non-interest bearing liability of the USG (USG being Fed and Treasury combined, as it should have been, starting in 1973). If the USG issues too many of either form of liability in the aggregate, the result is inflation, which can admittedly have 2nd+ order effects on future generations. That seems the far more relevant risk than abstract notions about how much govt "debt" is too much. And I don't see much out there in the way of (pure) inflation risk in the coming years.
To follow the path indicated by Jim and most commenters would almost guarantee we follow in Japan's footsteps, where debt/GDP has risen despite periodic bouts of austerity. Simpson-Bowles was a horrific idea from the get-go. Despairing its early demise is like mourning Rosemary's Baby (though I doubt it's really dead, just hibernating).
Posted by: Art Patten at January 5, 2012 04:04 PM
Debt service on US govt debt is @ 30 yr lows! "DEBT THREAT" NOT imminent! "HYPERINFLATION" NOT iminent!
I have heard the crowding out nonsense from about '08! Krugman has made me money. I stayed long the 10yr. Even Bill Gross briefly doubted Krugman and had his worst year ever.
Posted by: gman at January 7, 2012 12:31 PM