Home > The Economy > Krugman is right — public debt is good!

Krugman is right — public debt is good!

from Lars Syll

The U.S. economy has, on the whole, done pretty well these past 180 years, suggesting that having the Syll-Aug2015government owe the private sector money might not be all that bad a thing. The British government, by the way, has been in debt for more than three centuries, an era spanning the Industrial Revolution, victory over Napoleon, and more.

But is the point simply that public debt isn’t as bad as legend has it? Or can government debt actually be a good thing?

Believe it or not, many economists argue that the economy needs a sufficient amount of public debt out there to function well. And how much is sufficient? Maybe more than we currently have. That is, there’s a reasonable argument to be made that part of what ails the world economy right now is that governments aren’t deep enough in debt.

Paul Krugman


Krugman is absolutely right.


Through history public debts have gone up and down, often expanding in periods of war or large changes in basic infrastructure and technologies, and then going down in periods when things have settled down.

The pros and cons of public debt have been put forward for as long as the phenomenon itself has existed, but it has, notwithstanding that, not been possible to reach anything close to consensus on the issue — at least not in a long time-horizon perspective. One has as a rule not even been able to agree on whether public debt is a problem, and if — when it is or how to best tackle it. Some of the more prominent reasons for this non-consensus are the complexity of the issue, the mingling of vested interests, ideology, psychological fears, the uncertainty of calculating ad estimating inter-generational effects, etc., etc.

In classical economics — following in the footsteps of David Hume – especially Adam Smith, David Ricardo, and Jean-Baptiste Say put forward views on public debt that was as a rule negative. The good budget was a balanced budget. If government borrowed money to finance its activities, it would only give birth to “crowding out” private enterprise and investments. The state was generally considered incapable if paying its debts, and the real burden would therefor essentially fall on the taxpayers that ultimately had to pay for the irresponsibility of government. The moral character of the argumentation was a salient feature — according to Hume, “either the nation must destroy public credit, or the public credit will destroy the nation.”

Later on in the 20th century economists like John Maynard Keynes, Abba Lerner and Alvin Hansen would hold a more positive view on public debt. Public debt was normally nothing to fear, especially if it was financed within the country itself (but even foreign loans could be beneficient for the economy if invested in the right way). Some members of society would hold bonds and earn interest on them, while others would have to pay the taxes that ultimately paid the interest on the debt. But the debt was not considered a net burden for society as a whole, since the debt cancelled itself out between the two groups. If the state could issue bonds at a low interest rate, unemployment could be reduced without necessarily resulting in strong inflationary pressure. And the inter-generational burden was no real burden according to this group of economists, since — if used in a suitable way — the debt would, through its effects on investments and employment, actually be net winners. There could, of course, be unwanted negative distributional side effects, for the future generation, but that was mostly considered a minor problem since, as  Lerner put it,“if our children or grandchildren repay some of the national debt these payments will be made to our children and grandchildren and to nobody else.”

Central to the Keynesian influenced view is the fundamental difference between private and public debt. Conflating the one with the other is an example of the atomistic fallacy, which is basically a variation on Keynes’ savings paradox. If an individual tries to save and cut down on debts, that may be fine and rational, but if everyone tries to do it, the result would be lower aggregate demand and increasing unemployment for the economy as a whole.

An individual always have to pay his debts. But a government can always pay back old debts with new, through the issue of new bonds. The state is not like an individual. Public debt is not like private debt. Government debt is essentially a debt to itself, its citizens. Interest paid on the debt is paid by the taxpayers on the one hand, but on the other hand, interest on the bonds that finance the debts goes to those who lend out the money.

To both Keynes and Lerner it was evident that the state had the ability to promote full employment and a stable price level – and that it should use its powers to do so. If that meant that it had to take on a debt and (more or less temporarily) underbalance its budget – so let it be! Public debt is neither good nor bad. It is a means to achieving two over-arching macroeconomic goals – full employment and price stability. What is sacred is not to have a balanced budget or running down public debt per se, regardless of the effects on the macroeconomic goals. If “sound finance”, austerity and a balanced budgets means increased unemployment and destabilizing prices, they have to be abandoned.

Now against this reasoning, exponents of the thesis of Ricardian equivalence, have maintained that whether the public sector finances its expenditures through taxes or by issuing bonds is inconsequential, since bonds must sooner or later be repaid by raising taxes in the future.

In the 1970s Robert Barro attempted to give the proposition a firm theoretical foundation, arguing that the substitution of a budget deficit for current taxes has no impact on aggregate demand and so budget deficits and taxation have equivalent effects on the economy.

The Ricardo-Barro hypothesis, with its view of public debt incurring a burden for future generations, is the dominant view among mainstream economists and politicians today. The rational people making up the actors in the model are assumed to know that today’s debts are tomorrow’s taxes. But — one of the main problems with this standard neoclassical theory is, however, that it doesn’t fit the facts.

From a more theoretical point of view, one may also strongly criticize the Ricardo-Barro model and its concomitant crowding out assumption, since perfect capital markets do not exist and repayments of public debt can take place far into the future and it’s dubious if we really care for generations 300 years from now.

Today there seems to be a rather widespread consensus of public debt being acceptable as long as it doesn’t increase too much and too fast. If the public debt-GDP ratio becomes higher than X % the likelihood of debt crisis and/or lower growth increases.

But in discussing within which margins public debt is feasible, the focus, however, is solely on the upper limit of indebtedness, and very few asks the question if maybe there is also a problem if public debt becomes too low.

The government’s ability to conduct an “optimal” public debt policy may be negatively affected if public debt becomes too small. To guarantee a well-functioning secondary market in bonds it is essential that the government has access to a functioning market. If turnover and liquidity in the secondary market becomes too small, increased volatility and uncertainty will in the long run lead to an increase in borrowing costs. Ultimately there’s even a risk that market makers would disappear, leaving bond market trading to be operated solely through brokered deals. As a kind of precautionary measure against this eventuality it may be argued – especially in times of financial turmoil and crises — that it is necessary to increase government borrowing and debt to ensure – in a longer run – good borrowing preparedness and a sustained (government) bond market.

The question if public debt is good and that we may actually have to little of it is one of our time’s biggest questions. Giving the wrong answer to it — as Krugman notices — will be costly:

The great debt panic that warped the U.S. political scene from 2010 to 2012, and still dominates economic discussion in Britain and the eurozone, was even more wrongheaded than those of us in the anti-austerity camp realized.

Not only were governments that listened to the fiscal scolds kicking the economy when it was down, prolonging the slump; not only were they slashing public investment at the very moment bond investors were practically pleading with them to spend more; they may have been setting us up for future crises.

And the ironic thing is that these foolish policies, and all the human suffering they created, were sold with appeals to prudence and fiscal responsibility.


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  1. Tom Welsh
    August 24, 2015 at 11:31 am

    A rather unusual frank and honest confession that economists haven’t the faintest clue about even the very simplest issues of financial policy. If they can’t tell us whether a large and growing national debt is good, bad or indifferent, what earthly use are they to anyone? (Except of course themselves and their bank managers).

  2. August 24, 2015 at 3:01 pm

    Two arguments proving deficits are a negative drags come from fields more rational than economics;

    1) Deficits destroy democracy by allowing governments to do things human intelligence wouldn’t pay for with taxes. (For example, US citizens have killed 1,200,000 innocent Iraqi citizens using a credit card).

    2) Deficits stimulate growth in economies already consuming and polluting at above the one planet rate.

    • August 24, 2015 at 4:54 pm

      1) Insofar as wars are temporary, one can agree. The US state of endless war is a standing political choice.

      2) Deficits break the planet if they’re a transfer from the future. They’re not. Digging up and burning oil is a real transfer from the future. Debt isn’t, it’s a distributional shuffle between people in the here and now.

      Debt is only an inter-temporal transfer in the micro. There’s no inter-temporal finance in the macro. What look like inter-temporal macro transfers are in fact distributional effects.

      • August 24, 2015 at 11:10 pm

        Pavlos, Everything you say makes economic sense. My point is that economic and financial sense is contrary to basic accounting principles.

        Endless war money that is never expected to be paid back under managed inflation is part of the the jargon used to destroy democracy in the neocolonial austerity being imposed on the United States.

        Debt to do things contrary to life is possibly more like a moral transfer than a temporal transfer.

  3. August 24, 2015 at 3:35 pm

    Public debt is not an inter-temporal transfer or something that has to be paid back. It’s a form of money that’s protected from inflation. Before issuing debt the state offers one monetary instrument:

    – Currency that loses value at x% inflation.

    After issuing debt the state offers a choice of money instruments:

    – Currency, fully liquid, loses value at >x% inflation.
    – Bonds, less liquid, lose value at <x% inflation (maybe gain value)

    That's all public debt should be. When the state increases the debt pool it takes investor's cash and spends it one more time. In exchange it issues a new instrument called bonds that's less liquid and holds value better than cash. Bonds may have positive or negative real return, all that's promised is less inflation than cash.

    Governments may fund this by taking taxpayers's money and giving it to bondholders, or by having the central bank print money and keep the bonds (that's better). Either way cash ends up with more inflation than if debt wasn't there.

    When talking about country debt a household is a bad metaphor. Company stock that yields dividend is a better metaphor. States are immortal. They don't pay off debt any more than companies buy out the totality of their shares to avoid paying dividend. It can happen, but it's the exception, not the rule.

    In the long run, government debt yield is conditional on a healthy economy, just like company dividend, whether creditors like it or not. Creditors can upend economies by raising interest when they should be suspending it, but eventually reality knocks.

    So public debt is not a loan to be returned. It's a seignorage operation where government takes back cash and issues a new form of money called bonds. And it shifts inflationary pressure from the money that became bonds to money that stays as cash.

    We probably shouldn't even call it "debt". The term is unhelpful. A bond to fund a stadium which you intend to repay is debt, yes. Perpetually rolled over bonds are not debt, they're a less inflationary money pool.

  4. August 24, 2015 at 4:46 pm

    It isn’t the public debt… it’s SAVINGS that are the problem.
    Money is created as a debt on a schedule to a bank.
    That same money is then deposited in a savings account and REPLACED with new debt.
    Now you have P of money and 2P of principal debt of that money.
    Try to get out of debt without default. You cannot.
    Economist ignore this simple FACT pf BANKING entirely, which is why economists are worse than useless.

  5. macroambiente
    August 24, 2015 at 7:20 pm

    In his text posted here, “Who owns the public debt?” (July 18, 2015), Jonathan Nitzan refers to the work by Sandy Brian Hager, who provided a positive answer to the question. Giving a very small example Nitzan presents a chart from Sandy Hager´s 2013 article (http://www.tandfonline.com/doi/full/10.1080/13563467.2013.768613), in the New Political Economy. This chart shows “the share of the U.S. public debt held by the Top 1%. This share follows the general historical contours of the overall distribution of wealth, and is currently hovering around 45% – approximately the same level as at the turn of the twentieth century”. Additionally, “Equally startling is the extreme concentration of debt holdings by corporations”. This is not “theory of conspiracy” but real life facts.
    The concentration found by Hager may be seen as evidence that the political power, always connected to the monopoly of money emission, is not democratically distributed but concentrated in a “bondholding class”. Of course members of this class use their power to issue money for their own sake.
    It follows that, as argued in “Public Debt Is Economic Nonsense”, a paper presented at the WEA conference “Ideas towards a new international financial architecture?“ governments cannot issue money; governments and people must borrow from the private issuer and pay interests. This paper suggests that the interest rent on the public debt collected by the bondholding class expands indefinitely the credit supply thus generating GDP growth. However, this interest bearing money creates no more than “chicken flight GDP booms” for common individuals´ cannot expand their demand for credit indefinitely; someday they must stop borrowing and a crisis is settled.
    Moreover, the interest expenditure on the public debt grows as the debt grows and hence the deficit grows and thus the debt grows to pay interests and therefore the interest expenditure grows and so on. The most important contribution of the paper “Public Debt Is Economic Nonsense” is the difference equation approach demonstration that more probably the public debt follows an explosive trend that cannot be tamed through primary surpluses. An experiment made with US data does not allow for the rejection of the paper’s hypotheses and assumptions.
    Gerson P. Lima

  6. August 24, 2015 at 10:42 pm

    The crux of the problem is to whom the debt is owed and to whom the interest is paid in the context of the balanced budget mythology espoused everywhere today.

    In Canada the current so-called balanced budget is transferring $25.7 billion tax dollars in interest to the money-lenders while leaving a shortfall with infrastructure and programme spending. If we look at the growth of debt and superimpose the debt curve over the wealth curve would we see a correlation? Every year since the mid 70s and even during balanced budgets years, larger amounts than this have been transferred to the wealthy (relatively speaking). It is my hunch that part of the reason for the inequality we see today is due to governments transferring wealth from the taxpayer to those who can avoid taxes and hide their money in tax havens. There is a moral question here that seems ignored in the above.

    How do you justify enriching the well-off or better-off using tax dollars while depriving the poorly-off of needed services, programmes and infrastructure?

    I do not argue here for austerity and debt repayment but rather pick up from where Pavlos noted that “Governments may fund this by taking taxpayers’ money and giving it to bondholders, or by having the central bank print money and keep the bonds (that’s better).” I have deliberately excluded his inflation comment because that is debatable and poorly measured or understood. When the central bank in Canada held a substantial part of the public debt, less money was transferred to the well and better off from tax dollars and there was more tax dollars available for programmes, services and infrastructure. Indeed that may be what accounts for the prosperity of the 50s and 60s not the debts per se.

  7. pd
    August 24, 2015 at 11:52 pm

    This whole argument is ridiculous. Neither increasing nor decreasing the public debt will do anything to address the current issues a modern global economy faces.

    Just like QE, another amoral tool that was given messianic powers (constructive and destructive) by both sides of the debate, it does nothing but allow orthogonal problems to captivate the masses and fuel religious wars between economic tribes (while maybe having the side effect of creating cool looking graphs that can either prove or disprove whatever confirmation bias is currently in vogue).

    Our entire economic system is built upon shifting sand, we must address systemic and overwhelming failures (lack of trust in a centralized system, rampant abuse at the extremes, regulation induced monopolies, a fundamentally broken tax code, the ball-and-chain of healthcare costs, a welfare system that’s being supported by duck tape and accounting trickery, rapid automation with little redistribution of the wealth gains, social and generational gaps in the work force, etc. etc.) in it’s very architecture or we will continue to have this argument with sticks and stones rather than iPhones and laptops.

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