When should we — really — care about public debt?

9 Mar, 2015 at 19:28 | Posted in Economics | 2 Comments

Nick Rowe has a silly question for those who oppose austerity … would you still advocate fiscal stimulus in a liquidity trap (with interest rates stuck at some lower bound – the ZLB) if government debt was ten times annual GDP? …

There are four main potential costs associated with high government debt. The first is that, by generating high real interest rates, it crowds out private capital. However at the ZLB long term real interest rates are likely to be low, not high. Second, paying the interest on that debt requires higher distortionary taxes … However if there is an output gap the possibility that people are not supplying labour because income taxes are too high is not a current problem either.

55446682A third issue with debt is the ‘burden on future generations’. How real that is or not, dealing with excessive debt is going to screw the current generation (who have to suffer the higher taxes or lower spending to get debt down), so asking them to also suffer continuing unemployment is hardly fair.

The final problem is that the markets might suddenly take fright that the tax burden implied by the debt is too large in political terms, and as a result the government may default …

Suppose … the funding does dry up. You have your own independent central bank, so you print the money to cover the stimulus and any debt rollover required. That might require a lot of money creation – perhaps as much as central banks have actually undertaken as a result of Quantitative Easing (QE)! Just as with QE, the world does not fall in. Will that not lead to massive inflation? No, for exactly the same reason QE does not. The moment the output gap has been eliminated, and interest rates are off the ZLB, you can start the austerity programme that begins to roll back money creation. That stops the output gap becoming positive and therefore stops inflation …

So I think the answer to Nick’s question is not the answer he thinks. The logic is that every time and whatever the numbers you first eliminate the output gap and get off the ZLB. Only when that is done do you start taking action to reduce deficits.

Simon Wren-Lewis

I notice again and again that on many macroeconomic policy issues I find myself in agreement with people like Wren-Lewis and Krugman. To me that just shows that they are right in spite of and not thanks to the kind of neoclassical models they ultimately refer to. When discussing austerity measures, Ricardian equivalence, euro problems, or public debt, they actually, as far as I can see, are not using those models, but rather (even) simpler and more adequate and relevant thought-constructions much more in the vein of Keynes.

So — has Wren-Lewis turned into MMT-Functional Finance? Probably not, but it sure sounds a lot like Abba Lerner …

national debt5One of the most effective ways of clearing up this most serious of all semantic confusions is to point out that private debt differs from national debt in being external. It is owed by one person to others. That is what makes it burdensome. Because it is interpersonal the proper analogy is not to national debt but to international debt…. But this does not hold for national debt which is owed by the nation to citizens of the same nation. There is no external creditor. We owe it to ourselves.

A variant of the false analogy is the declaration that national debt puts an unfair burden on our children, who are thereby made to pay for our extravagances. Very few economists need to be reminded that if our children or grandchildren repay some of the national debt these payments will be made to our children or grandchildren and to nobody else. Taking them altogether they will no more be impoverished by making the repayments than they will be enriched by receiving them.

Abba Lerner The Burden of the National Debt (1948)


  1. A broken clock is right twice a day. But what makes you still draw the conclusion that the clock is broken when it’s right “again and again”?

  2. A long time ago the UK government issued “war bonds” to help finance the second world war effort. I could just about understand why Abba Lerner would say that repaying this debt would make no difference as it would put cash into the hands of UK citizens.

    But that was a long time ago and a particular form of “national debt.” These days national debt more often than not means international debt – something owed by one country to another (or to citizens of another country). Abba Lerner’s analysis fails when considering this sort of debt.

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