Towards A Good Samaritan World

Friday, January 05, 2007

THE NEW ARTHUR LAFFER?

Given that one of its authors, Edward Prescott, is a Nobel Prize-winning economist, you can't just dismiss this argument in favor of greater government debt out of hand. But this claim seems really goofy:

Some naively think that government debt is a burden on the young. This is not the case since the welfare of the young and the government debt are both large in the efficient saving-for-retirement system. Indeed, in the inferior tax-and-transfer system, government debt is zero. We go on to show that switching from a pay-as-you-go system to a saving system makes everyone better off and there are no costs of making the switch. All that needs to be done is to stop taxing labor income. In the transition period there would be transfers to old financed by a large deficit. Subsequently the stock of government debt would be at its needed level.


If people want to save more, there need to be assets for them to buy. Government debt is an asset, but it's not the only one. Isn't society better off in the long run if we save and invest, and create capital that generates future wealth, rather than having the government soak up everybody's savings through borrowing? Also, aren't real governments occasionally subject to bank-run type crises? Wouldn't a huge debt make that more likely?

9 Comments:

  • I think the standard assumption of US government debt having a very low risk profile because it controls its own revenues is a good one in much the same way as the rule of 72 works well for investment doubling. That is to say, one can very easily take it too far.

    After all, as debt grows relative to the economy, small fluctuations in US credit ratings have greater and greater fiscal consequences, and on a political basis people will become less and less willing to permit the spikes in taxation necessary to prevent default. I would bet many economists would dismiss this, pointing out that when interest payments spike the income people have to pay their taxes would also spike. The obvious problem with this is that real peoples' budgets are not nearly so fungible.

    Personally, I think as financial markets continue to deepen and sophisticate they'll fill the role filled by US debt today quite adequately, and without the public sector soaking up low risk savings investment.

    None of which fundamentally subverts the paper's position, so far as I can tell. I'm just going off on Lance's tangent about the claim public debt is good, because I find it an irritating idealization.

    By Blogger Nato, at 10:53 AM  

  • Some public debt is better than no public debt (given the market as it stands at the moment); I don't think that's really debatable. Can private investment really take over the role of public debt? The stock market, for instance, isn't really that similar to public debt because the companies aren't borrowing money from investors, but rather investors are buying portions of the companies. If an investor wanted to get her money back, she'd have to find someone to sell her shares to (or in some cases wait for dividend payouts or stock buybacks). But when the government borrows money, it's obligated to pay it all back with interest. So I don't really think private investment can take the place of public debt, unless of course the "investments" behave more like private loans. Even in that case, I think I'd rather loan money to the government than random private citizens/corporations. Economics is not my strongest suit, however, so if there is some flaw in my reasoning, please point it out.

    By Blogger Thomas, at 1:02 PM  

  • Tom, my comment about the financial markets deppening and sophisticating has to do with addressing your risk-related concerns. More on that later, maybe.

    By Blogger Nato, at 1:22 PM  

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