Something of a blogosphere explosion occurred last week. What caused it? A largely correct post by Paul Krugman that had the gist of arguing that the amount of US federal government debt is a misleading indicator of how serious the US debt problem is. Here is my colleague Steve Landburg illuminating and buttressing the point. Many bloggers have since chimed in, including some who dispute that Krugman’s initial claim is right.
I don’t want to summarize the arguments here, you can click through the links, starting with the Krugman one above, then Steve’s and then following the Boudreaux one, to get the economic intuition behind the arguments. I am strongly in the corner of my colleague’s model of whether debt is ipso facto an issue. It’s not, as I think his parable here makes clear. His entirely correct point is that government spending indeed imposes a burden on someone. But from the fact that it is financed with debt says nothing about whether that burden necessarily is imposed on future generations. Current generations have complete control over who the burden of their spending falls upon. What remains unsaid in the debate, but implied, is that the spending indeed can cause harm, and irrespective of whether it is tax financed or debt financed it can cause harm to future generations.
I guess my only quibble with my colleague’s point above is what the term “complete control” means and it is here that I will add my one cent. Assume for simplicity’s sake that all tax collections today and in the future are non-distortionary. It is possible to structure taxes this way, though we are unlikely to see it in practice. What is the problem with transferring resources from some citizens to others? If we ignore prices perhaps nothing. But don’t be a priceless economist. When resources are transferred from Peter to Paul, this will distort the relative prices in an economy from where they would be if Peter had command over the resources himself. And these relative price distortions have ramifications not just for current production and consumption (by others) but also out into the future.
So, if there is a reason to be apoplectic about the level of the public debt, it should be retrospective. It seems to me an indicator that market prices were likely to have been heavily distorted in the past and that the adjustment process in the future of prices getting “more right” is going to be painful. I would note, however, that this position does not follow ipso facto from the fact that governments spend, I suppose one could write down a model where such government spending is price neutral, but again I find that to be an implausible assumption to make.
Debt is not per se good or bad, but the argument from Keynes and Krugman that we owe it to ourselves revives a dismissive cliche that was fashionable long ago. It is a tautology, really, and for that reason it is logically true. The US debt is denominated in dollars. Amid all the fuss last summer over the debt limit, there was never any question whether the US would default, since if push came to shove, the ultimate option was and is to create more money.
We sophisticates know that such problems are not impeded by hundred-dollar printing press capacity. When you add three or four zeroes, it is not a paper currency problem. When the Federal Reserve wants to increase money, they have better tools.
Right now I am watching Ron Paul, who is not wrong every time vilify the Federal Reserve, which he wants to abolish along with our Navy. Just so all of Rizzo’s readers know, I am not an apostle of Ron. Milton Friedman had deeper, more salient criticisms of the Federal Reserve, who today are trying to control long-term interest rates by buying bonds from favorite banks, and they have a new program set to buy up more bad real estate loans.
My biggest quarrel with Paul Krugman, however, is how he sets the terms of the debate: that it is about taxation versus spending, ergo, we have to ramp up spending (the stimulus was puny!) and leech taxes from everybody who has any money left.
The preferred solution during my lifetime to repudiate our debt has been inflation, which screws creditors and rewards debtors, and requires no one to reduce spending on one’s favorite causes.
A few days ago, I read that the Federal Reserve would release its expectations for inflation and interest rates, which formerly they had not disclosed, and this is supposed to help us handicap what they and others might do, given the majority view of the Phillips Curve and its efficacy. For this reason, I harken back to Friedman, who thought a computer could do a better job, provided that you gave the computer a few simple non-contradictory rules.
Any of us who use credit cards have debt, and it costs you zero if you pay everything off at the end of the month. That in my book is not a debt problem.
If you are young and have saved some money, deciding to buy a house where the mortgage payments are a bit less than the monthly rent is a good long-term idea.
Debt is also a good idea to finance a business, assuming you have a plan to pay it off, and then some.
Should government launch an enterprise, like building a bridge or a road, there is no reason why that enterprise be financed with debt maturing over the life of the bridge or road.
And should the country go to war, debt may be necessary.
But what Paul Krugman misses is that in general we would all be better off if we had less or no debt. No debt will never happen for government, nor will it happen for many businesses. (Fun Fact: in 1986, American Home Products had zero debt.) Less burden is always better.
I would add that the US Treasury is the banker, not the Federal Reserve, an instrument in the transaction when we lend ourselves money. The Treasury conducts the auctions. The Federal Reserve buys Treasurys in its operations. Today, the Federal Reserve pays high prices for ten-year Treasurys, and they also want to take even more sub-prime loans off the hands of banks too big to fail.
I would also add that big states like California and New York do not owe their debt and other fixed obligations “to themselves” since they cannot create California or New York dollars. A bunch of the money in the last 800 billion spending spree merely postponed their big day of reckoning.
The difference is between digging a hole to find a truffle, and digging a hole to fill it up. Paul Krugman sees both as worthy of stimulus. Don’t forget the multiplier!