Monthly Archives: January 2012

“Greek workers work 48% more hours than Germans”


From credit writedowns


Understanding public debt

Paul Krugman on debt:

Deficit-worriers portray a future in which we’re impoverished by the need to pay back money we’ve been borrowing. They see America as being like a family that took out too large a mortgage, and will have a hard time making the monthly payments.

This is, however, a really bad analogy in at least two ways.

First, families have to pay back their debt. Governments don’t — all they need to do is ensure that debt grows more slowly than their tax base. The debt from World War II was never repaid; it just became increasingly irrelevant as the U.S. economy grew, and with it the income subject to taxation.

Second — and this is the point almost nobody seems to get — an over-borrowed family owes money to someone else; U.S. debt is, to a large extent, money we owe to ourselves.

This was clearly true of the debt incurred to win World War II. Taxpayers were on the hook for a debt that was significantly bigger, as a percentage of G.D.P., than debt today; but that debt was also owned by taxpayers, such as all the people who bought savings bonds. So the debt didn’t make postwar America poorer. In particular, the debt didn’t prevent the postwar generation from experiencing the biggest rise in incomes and living standards in our nation’s history.

But isn’t this time different? Not as much as you think.

It’s true that foreigners now hold large claims on the United States, including a fair amount of government debt. But every dollar’s worth of foreign claims on America is matched by 89 cents’ worth of U.S. claims on foreigners. And because foreigners tend to put their U.S. investments into safe, low-yield assets, America actually earns more from its assets abroad than it pays to foreign investors. If your image is of a nation that’s already deep in hock to the Chinese, you’ve been misinformed. Nor are we heading rapidly in that direction.

Now, the fact that federal debt isn’t at all like a mortgage on America’s future doesn’t mean that the debt is harmless. Taxes must be levied to pay the interest, and you don’t have to be a right-wing ideologue to concede that taxes impose some cost on the economy, if nothing else by causing a diversion of resources away from productive activities into tax avoidance and evasion. But these costs are a lot less dramatic than the analogy with an overindebted family might suggest.

And that’s why nations with stable, responsible governments — that is, governments that are willing to impose modestly higher taxes when the situation warrants it — have historically been able to live with much higher levels of debt than today’s conventional wisdom would lead you to believe. Britain, in particular, has had debt exceeding 100 percent of G.D.P. for 81 of the last 170 years. When Keynes was writing about the need to spend your way out of a depression, Britain was deeper in debt than any advanced nation today, with the exception of Japan.


Matt Yglesias adds:

I think the point can maybe be more clearly made in reverse. Imagine a country with a balanced budget  and a large outstanding debt, all of which is held domestically. Tax revenue, in other words, exceeds spending on programs but the extra revenue is needed to pay down the existing debt. If the stock of debt is burdening the country, then it ought to be able to enrich itself by defaulting. Will that work?

Well, no. Certainly a default could set the stage for enriching specific people, since it would create budget room for a tax cut or new spending on a shiny supertrain. But the funds flowing into the pockets of taxpayers or train-builders would be coming out of the pockets of bondholders. A government borrowing money from its own citizens doesn’t gain access to any resources that wouldn’t have been available by conscripting them or raising taxes, and by the same token a country doesn’t enrich itself by refusing to make promised interest payments to its own citizens. It’s only when borrowing from or repaying foreigners that the country as a whole is gaining or losing access to real resources. None of which is to say that debt dynamics are a matter of indifference. Obviously people care quite a lot about which specific people possess the real resources, and how you arrange them can have profound implications for human welfare and long-term growth. But it’s bad growth policy or natural resource depletion that can immiserate the next generation, not the prospect of the next generation’s taxpayers transferring money to the next generation’s bondholders.


And finally, there is Nick Rowe giving us a helpful illustration:

I visit Matt Yglesias’ house (HT JeffreyY). I drink one litre of milk from his fridge. I write Matt an IOU for one litre of milk.

1. If Matt subsequently tears up that IOU, then I am richer and he is poorer. Taking the two of us together, in aggregate we are neither richer nor poorer if Matt tears up the IOU. Tearing up the IOU doesn’t bring the milk back.

2. Therefore there is no aggregate cost to me and Matt of me drinking more milk from Matt’s fridge and writing Matt another IOU.

1 is of course true. But 2 does not follow from 1. 2 is false.

We can’t do anything about the existing stock of national debt. “It’s no use crying over spilt milk”, even if it was spilled down my throat rather than spilled on the floor.

But that doesn’t mean there is no cost to spilling more milk. True, there’s also a benefit, if I’m thirsty, and it’s spilled down my throat rather than on the floor. But there’s a cost too. If the government runs a deficit now, there is a cost to future taxpayers. Sure, there’s a benefit too, depending on what the government does with the funds it borrowed. And we should compare those benefits to those future costs. But we shouldn’t pretend those costs don’t exist.

The existing stock of debt represents the costs of past deficits that cannot be undone. We can’t turn back the clock. But the fact that we cannot turn back the clock on past deficits says absolutely nothing about whether we should run a deficit now. We need to compare the benefits to the cost to future taxpapers.