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Friday, October 12, 2012

Bogus Arguments about the Burden of the Debt

The first time I ran across the point that Dean Baker makes here about the burden of the debt was in the late 1980s teaching principles of economics from Baumol and Blinder's textbook. Here's a summary of the point from this old post (and a later, but dated, edition of the text -- the point Dean makes is Argument 1 -- there is quite a bit more, including an example to illustrate the point and additional comments from Dean Baker, in the post):

... Let's start with a textbook treatment from Baumol and Blinder's Macroeconomics text (9th ed.):

Bogus Arguments about the Burden of the Debt

Having gained some perspective on the facts, let us now turn to some of the arguments advanced by those who claim that budget deficits place an intolerable burden on future generations.

Argument I Our children and grandchildren will be burdened by heavy interest payments, which will necessitate higher taxes.

Answer It is certainly true that a higher debt means higher interest payments and, therefore, higher taxes on our children and grandchildren. But think who will own the bonds and therefore receive the higher interest payments as income: our children and grandchildren! Thus, one group of future Americans will be making interest payments to another group of future Americans. So we conclude that:

As long as the national debt is owned by domestic citizens, as the majority of the U.S. debt is, future interest payments transfer money from one group of Americans to another. These transfers mayor may not be desirable, but they hardly constitute a burden on the nation as a whole.

However, this argument is valid-and worrisome-for the portion of our debt that is held by foreigners, a share that has been growing rapidly... Paying interest on this portion of the debt will burden future Americans in a concrete way: For years to come, a portion of America's GDP will have to be sent abroad to pay interest on the debts we incurred in the 1980s, 1990s, and 2000s. For this reason, many thoughtful observers are becoming concerned that the United States is borrowing too much from abroad.

Another valid element of this argument is that the taxes that will have to be raised to pay interest even to U.S. citizens may reduce the efficiency of the economy.

Argument 2 Repaying the enormous debt will ruin the nation.

Answer A first answer to this argument merely rephrases the answer to the previous one: Most of America's debt is owed to Americans. But this argument raises an even more fundamental point. Unlike a private family, the nation need never payoff its debt. Instead, each time the principal is due, the U.S. Treasury can simply "roll it over" by floating more debt. Indeed, that was done routinely for decades.

Was this a bit of chicanery? How could the U.S. government get away with making loans that it never intended to pay back? The answer lies in the fallacy of comparing the U.S. government to a family or an individual. People cannot borrow in perpetuity, because they will not live that long. Sensible lenders will not extend long-term credit to very old people because their heirs cannot be forced to pay up. But the U.S. government will never "die" - at least, we hope not! So this problem does not arise. In this respect, the government is in much the same position as a large corporation. GE never pays off its debt. It, too, rolls it over by floating new debt all the time.

Argument 3 Like any family or any business firm, a nation has a limited capacity to borrow. If it exceeds this limit, it is in danger of being unable to pay its creditors. It may go bankrupt with calamitous consequences for everyone.

Answer This is another false analogy. While private debtors and many foreign governments have to worry about defaulting on their debt, the U.S. government does not. Why not? First, because it has enormous power to raise revenues by taxation. If you had such power, you would never have to fear bankruptcy either.

But once again, the statement raises a more fundamental point - one that distinguishes the U.S. debt from that of most other nations. The American national debt is an obligation to pay U.S. dollars: Each debt certificate obligates the Treasury to pay the holder so many U.S. dollars on a prescribed date. But the U.S. government is the source of these dollars. It prints them! No nation need default on debts that call for repayment in its own currency. If worse comes to worse, it can always print whatever money it needs to pay off its creditors. This option is not open to countries whose debts call for payment in U.S. dollars, as a number of Southeast Asian countries learned in 1997 and Argentina learned in 2001.

It does not, of course, follow that acquiring more debt through budget deficits is necessarily a good idea. Sometimes it is a very bad idea. As we know, printing money to pay the debt will expand aggregate demand and cause inflation. In addition, as we will learn in Chapter 18, printing more dollars should make the international value of the dollar fall. We may not relish either of these outcomes. The point is not that budget deficits are either good or bad; they can be either under the appropriate circumstances. Rather, the point is that worrying about a possible default on the national debt is unnecessary and even foolish. ...

Nick Rowe take issue with the claim in Argument 1 here:

The burden of the (bad monetary policy) on future generations

Brad Delong responds:

The Intergenerational Burden of the Debt: Nick Rowe Tempts Fate Weblogging...

Dean Baker also responds:

Brad DeLong Beats Me to Responding to Nick Rowe

    Posted by on Friday, October 12, 2012 at 07:31 AM in Budget Deficit, Economics | Permalink  Comments (64)


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