Saturday, October 13, 2012

The Agony and the Ecstasy, And the Government Debt

Whoow boy. A big hubub in the blogosphere about whether government debt imposes a burden on "future generations." Lots of input from high places. Check it:

And now for some input from a low place, featuring my hat in the ring.
I've basically made this argument before, in my post about the stance of fiscal policy. Noah Smith spells it out well by framing the situation in terms of the effect on the capital stock, or the K term in the Cobb Douglas Production function.

Y = A(t) Ka Nb
The budget deficit affects the economy by absorbing funds that would otherwise have been invested in private capital. To the extent that the budget deficit "crowds out" this private investment, it does it by raising the real interest rate faced by borrowers. It makes sense that a larger budget deficit would raise the interest rate more than a small one, so that as the deficit grows, it increases the "burden" of future generations. Here's an ad hoc rule of thumb I just invented. It's basically an interest rate elasticitiy of the budget deficit:

(% change interest rate / % change in budget deficit)  < 1 no net "burden" on future generations

(% change interest rate / % change in budget deficit) > 1 net "burden" on future generations

Maybe I'll develop this further later. Perhaps something about future taxes.

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