Home > Economics > Taking the biscuit – Paul Krugman edition

Taking the biscuit – Paul Krugman edition

January 22, 2012 Leave a comment Go to comments

‘Take the biscuit’ – British idiom meaning “to be particularly bad, objectionable, or egregious” (Wiktionary)

Like Bob Murphy, I’m almost rendered speechless by Paul Krugman’s new post on debt*. The whole economics blogosphere went through this great big massive argument about Krugman and Dean Baker‘s claim that debt cannot by definition be a burden to future generations. Almost anyone who is an anybody wrote about it, and a whole lot of nobodies as well (including myself). A lot happened in that time. Nick Rowe showed very clearly that the apparent identity claim they were making was wrong, and Bob wrote a whole semi-Socratic dialogue on the subject, with like 12 different parts (and enough wit to fill a full sitcom run on NBC**). For those of you who missed out, here’s a quick recap of the arguments. Krugman and Baker make the observation that debt is money someone owes to someone else. It is an asset as well as a liability. So, as long as debt is held domestically, it doesn’t make any sense to say that debt can be a burden to future generations, because it’s just some of them paying money to some of the others. Within a closed system, it’s a tautology to say that the debt cannot be a burden to the people within the system, because the assets equal the liabilities.

But when you introduce overlapping generations, this identity breaks down when we make the distinction between cohorts and time periods. Here is my version of Nick’s argument, which I posted last week

Assume any person alive produces 100 apples a year. In year 1, Annie is the only person alive. The government says ’100 free apples for Annie’! This is financed by the government borrowing Annie’s apples, promising to give her 110 next year (10% interest). Annie produces and consumes 100 apples.

At the beginning of year 2, Annie gives berth to Bessie, and there’s been a 10% increase in apple productivity to 110 apples. Annie and Bessie each produce 110 apples. Annie’s bond matures and needs to be paid back. The government finances the 110 apples it owes to Annie by issuing a bond bought by Bessie. In year 2, Annie eats 220 apples, Bessie none. At the end of year 2, Annie dies of old age.

In year 3, Colin is born to Bessie, and apple productivity increase by 10% to 121 apples each. Bessie’s bond matures, but since Colin is a man and can’t give birth to anyone, and Bessie will die at the end of the year, there’s no market for a bond as there’s no prospect for it being paid back. Therefore, the government taxes Colin and takes his 121 apples and gives them to Bessie. Colin gets no apples, and Bessie gets 242. Bessie dies at the end of the year.

In year 4, apple productivity increases by 10%. Colin produces and consumes 133.1 apples and dies at the end of the year.

Had the government not issued any bonds, Annie would have eaten 210 apples rather than 320. Bessie would have eaten 231 instead of 242, and Colin would have gotten 254.1 apples rather than 133.1. The debt accomplishes a transfer of consumption from Colin to Annie even though they weren’t alive at the same time, and even though (in any given year) the output was exactly the same and was consumed only by people alive at that time.

When you factor in multiple overlapping generations, it can too be the case that no output is transferred between time periods, but future cohorts lose out. In my example, Annie really does eat apples at Colin’s expense. The only way that this wouldn’t be the case is if the bonds were voluntarily bequeathed from Annie to Bessie and Bessie to Colin, rather than them purchasing the bonds. Which is basically assuming Ricardian equivalence, an assumption which Krugman never made and believes is dubious anyway. Game, set and match.

Krugman didn’t respond at all to this line of argument. And that’s OK, if a little annoying as he was responsible for the whole debate in the first place (not that I’m complaining, I initially would have been in full agreement with him until Nick Rowe showed me the error of my ways). But then yesterday he criticized an op-ed which plainly misunderstood his original argument. Now I would be the first to say that Krugman was obviously well within his rights to point out that the piece completely misunderstood his argument, but he then merely repeated the original assertion, as if nothing else had happened in the interim!

What I was actually saying, of course, is that debt is a liability that we pass to the next generation — but it’s also an asset that we pass to the next generation.

No. This only works if you don’t have overlapping generations, as Nick’s/Bob’s/[my] examples clearly demonstrate. In order for the debt to be harmlessly ‘passed’ to the next generation, it requires an actual voluntary bequest, with the older generation deliberately foregoing consumption.

Now, I’m a nobody and I don’t expect what I write to make any difference to anyone. But as primarily a consumer rather than producer of blog posts, it is still completely exasperating when this was what everyone was talking about and the person who started the whole thing (and said that to hold any other position was ‘nonsensical‘) failed to respond at all, except to criticize the seemingly weakest possible example of someone challenging his position.

If anyone else sees it any other way, I’d really like to know because I don’t think I’m being unfair here – unless my expectations about  academic civility in the blogosphere are unreasonably onerous.

 _______________________________________________________________________________________________________

*Still managed to crank out 943 frustrated words, though…

**I mean this as a complement compliment (woops!) to Bob

Categories: Economics
  1. January 22, 2012 at 5:35 pm

    I see it the same way as you. This is really depressing. Paul Krugman has been throwing stones, and he’s living in a glass house. And he is busy repeating the error.

    In a comment on one of Dean Baker’s posts (today I think) Robert Waldmann said that this mistake is as bad as Cochrane’s.

    I suspect that either: people are afraid to take on Paul Krugman; or they want a deficit, and are prepared to attack any argument against a deficit, even if their attack on that argument is invalid.

  2. January 22, 2012 at 10:10 pm

    I mean this as a complement to Bob…

    I hesitate to say this to a guy who names his blog after Wittgenstein, but I’m pretty sure you meant “compliment” ?

    • January 22, 2012 at 10:27 pm

      Well, that is an embarrassing error, although I like to think that later Wittgenstein would point out that the meaning conveyed was not confused…

      • January 22, 2012 at 10:35 pm

        That being said Bob, I think a full sitcom run on NBC would complement your blog nicely, perhaps with Steven Landsburg as the wacky neighbour and Paul Krugman as your arch nemesis a la ‘Newman’

      • January 23, 2012 at 12:29 am

        “Hellooooo KRUGman.”

  3. January 23, 2012 at 12:08 pm

    Richard, Nick’s whole argument is based on the ASSUMPTION that youngsters are made to buy bonds (Bessie in the above illustration). And clearly if oldies sell bonds to youngsters, a burden is passed on to the next generation. So that’s a very convenient assumption for Nick to make, isn’t it?

    What very few of the participants in this debate seem to be interested in is the exact extent to which this “bond selling” actually takes place in the REAL WORLD. I realise a significant proportion of academics are more interested in angels and pinheads than in reality, but there you go.

    Well oldies ACTUALLY DO sell bonds to youngsters via pension schemes. That is, people pay into pension schemes while in their prime, and those schemes buy bonds amongst other assets. Then in retirement, oldies withdraw money from pension schemes (effectively selling bonds and other assets to youngsters who are building up their pension entitlements).

    But the $64k question is whether in the absence of government bonds, there’d be any change to the incomes people planned for their retirement. My answer is “no change” or “little change”, and for the simple reason that those planning retirement would just use different assets (shares, houses, etc) or they’d go for pay as you go or “unfunded” schemes. And the latter have exactly the same “burden passing” effect as government bonds.

    Ergo, government bonds IN THE REAL WORLD, have little effect on the total amount of burden passing: they are not a “burden” on future generations.

  4. January 23, 2012 at 1:22 pm

    Peter: You are implicitly assuming that the bonds are bequeathed as a free gift to the next generation (otherwise the oldies’ consumption would necessarily be higher in their retirement). Granted that assumption, there is no burden on future generations. But then all the bond-financed tax cut or transfer is saved by the oldies, so there is no Keynesian multiplier either.

    • Kevin Donoghue
      January 23, 2012 at 2:15 pm

      Nick, what makes you think Peter is implicitly making that bequest assumption? The fact that the oldies’ consumption would otherwise be higher doesn’t prove that. It’s possible that their increased consumption, financed by the sale of newly-issued bonds, is a Pareto improvement.

      I’m not saying you’re wrong, only that your argument is incomplete; i.e., you are apparently making an implicit assumption of your own which I’d like to see.

      • January 23, 2012 at 6:27 pm

        Kevin: because I can’t think of any other assumption that would generate Peter’s results.

        OK, let’s assume the current cohort have a choice between investing in real assets (like houses) rather than bonds. If there is a bond-financed transfer, they build fewer houses and buy more bonds. And the sell fewer houses to the next generation and sell more bonds. So far it’s a wash. But when the government has to increase taxes on the next generation to pay the interest on those bonds, it’s not a wash. So the bonds create a burden on the next generation.

  5. Henderson David R.
    January 23, 2012 at 3:54 pm

    Richard,
    I think you mean “birth,” not “berth.” BTW, you’re not a nobody.

  6. January 23, 2012 at 8:00 pm

    Sorry to be tardy to the party, day job is more like a day and evening job…

    Peter: I can’t speak for Nick, but I see the dialectic as Krugman/Baker making an argument from identity, which was subject to counter-examples and therefore invalid. The extent to which the debt is *in fact* a burden depends on empirical matters, including how bondholders actually behave and what the rate of NGDP growth is.

    Kevin and Peter: Let’s try thinking of it this way. Imagine a cohort wants to fund a transfer payment to themselves. Whether they fund it with debt or tax, it’s a wash (a phrase I’d really like to retire from the economics blogosphere) with regards to consumption in that particular time period. If it’s a tax, they’re taking from one hand and giving to the other, in the debt case the outstanding value of the assets equals the outstanding value of the liability.

    However, if the first cohort gives birth (H/T David Henderson) to a new cohort and they form an equal part of the tax base, part of the liability to the first cohort caused by the debt is extinguished and is taken on by the new cohort. So we’re now in a situation where the first cohort has never had to reduce their consumption, but now also have a net asset in the form of the bonds and the new cohort has a net liability (as they are part of the tax base and don’t have bonds). If the new cohort purchases the bonds from the previous generation, they have reduced their consumption in order to own the bonds. But the first cohort owned bonds without having to reduce consumption, which is not true for the ensuing generations.. Obviously depending on the specifics of the tax regime when we relax the distributional assumptions, things could work out differently.

    David: Not sure whether you’re making a definitional or substantive point with the second sentence…

    • January 23, 2012 at 8:08 pm

      If you want to take into account the pensions bit, assume the first cohort has no income after the second cohort is born. Whether or not they are working when they ‘live off’ their assets makes no difference to the argument

  1. January 24, 2012 at 8:38 pm
  2. January 25, 2012 at 8:31 am
  3. April 12, 2012 at 10:35 am

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