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The golden rule of public debt

from Lars Syll

Nation states borrow to provide public capital: For example, rail networks, road systems, airports and bridges. These are examples of large expenditure items that are more efficiently provided by government than by private companies.

darling-let-s-get-deeply-into-debtThe benefits of public capital expenditures are enjoyed not only by the current generation of people, who must sacrifice consumption to pay for them, but also by future generations who will travel on the rail networks, drive on the roads, fly to and from the airports and drive over the bridges that were built by previous generations. Interest on the government debt is a payment from current taxpayers, who enjoy the fruits of public capital, to past generations, who sacrificed consumption to provide that capital.

To maintain the roads, railways, airports and bridges, the government must continue to invest in public infrastructure. And public investment should be financed by borrowing, not from current tax revenues …

The debt raised by a private sector company should be strictly less than the value of assets, broadly defined. That principle does not apply to a nation state. Even if government provided no capital services, the value of its assets or liabilities should not be zero except by chance.

National treasuries have the power to transfer resources from one generation to another. By buying and selling assets in the private markets, government creates opportunities for those of us alive today to transfer resources to or from those who are yet to be born. If government issues less debt than the value of public capital, there will be an implicit transfer from current to future generations. If it owns more debt, the implicit transfer is in the other direction.

The optimal value of debt, relative to public capital, is a political decision. Public economics suggests that the welfare of the average citizen will be greatest when the growth rate is equal to the interest rate. Economists call that principle the golden rule. Democratic societies may, or may not, choose to follow the golden rule. Whatever principle the government does choose to fund its expenditure, the optimal value of public sector borrowing will not be zero, except by chance.

Roger Farmer

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 will be costly.

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 … 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. January 24, 2017 at 11:54 pm

    This whole article is simplistic and misses the most important points. To whom is the debt owed. I am most familiar with Canada’s federal debt and the issue is not the debt but the huge amounts of tax dollars transferred to the well-off in the form of interest (more than 10% or $25.7 billion). The amount of interest is the third highest budget item after seniors and health care and is actually more than defense. How bizarre is that!? And that is in a time of relatively low debt to GDP ratios and in a low-interest environment! When interest rates climb, the growth in the amount of interest to be paid will climb hugely negatively impacting the ability to provide programmes and services to the citizens. It will provide fuel for the government-is-too-big crowd and we are back into austerity budgets. The article also ignores to whom a bond market is valuable. Some pension funds access it but again that is on behalf of those who are well-off and the fiscal cutting hurts those who are NOT benefitting from the interest on the debt. If the debt is held in whole or in part by the Central Bank (The Bank of Canada), the interest is returned to the government instead of being buried in a tax haven or stashed in the cash reserves of the companies buying bonds.

  2. January 25, 2017 at 2:10 am

    If the debt it owed to citizens and if the debt is repaid in goods and services or in pre-payment of taxes we remove the cost of interest. This makes publicly owned infrastructure lower cost. The savings in interest can be given as a higher returns to citizen investors of more goods and services or larger discounts on taxes.

    • antireifier
      February 5, 2017 at 5:11 pm

      Interest is a transfer to private citizens who are well-off and most of whom are unlikely to do any of the things you mention. That interest payment is a line item in a budget that is then used to limit the state’s response to problems such as healthcare or infrastructure spending. Your explanation seems to fit in nicely with other economic theories not connected to reality.

    • antireifier
      February 5, 2017 at 5:15 pm

      As another response, your response has a lot of “ifs” supporting my criticism of your comment. Also, a substantial amount of interest is not to private citizens but to institutions. In Canada, the government has a report suggesting that bond sales to private citizens should be ended.

      • February 6, 2017 at 5:03 am

        Bravo. Governments in debt to private citizens is a bad idea. Governments must remain independent. Otherwise citizens are at risk. Citizens who have no other ally to fight back than the government.

  3. January 25, 2017 at 5:54 am

    I’m no macroeconomist, but besides interest payments and the bond market—which basically can be seen in some ways to be govt debt used to provide a public good for the wealthy (as pointed out by h wiseman above)—another problem is what public goods/spending is for. Too much goes for military, police, prisons, etc. Also even in education, where some goes for students grants or loands, some of that education is just training people who will just maintain the status quo which does not benefit everyone equally. Some get educated to be mainstream economists, etc. Even infrastructure like roads is sometimes a benefit for the wealthy—some people get sort of second rate public transit in semi-shoddy urban areas , while others get big new roads to nice suburbs.

  4. January 25, 2017 at 3:56 pm

    “Interest on the government debt is a payment from current taxpayers, who enjoy the fruits of public capital, to past generations, who sacrificed consumption to provide that capital.” – No it’s not, that’s total nonsense. There are at least seven economic fallacies buried in here.

    1. That debt or money is an inter-temporal transfer of value. It’s not. Roads and bridges are an inter-temporal transfer of value. You build them now and they carry value into the future. Money, debt, shares, etc. are not value. They’re claims on value. At best, transferring money into the future allows you to bid against other future people over valuable things that may exist in the future. Money doesn’t transfer value into the future.

    2. That inter-temporal transfer works in reverse. It doesn’t. How is my dead grandmother going to receive payment from current taxpayers for roads built in the 70s? Government debt is not a payment to past generations, it’s a transfer of taxes to the current owners of the debt. More of this later. Nor did my grandmother want to be paid. Her generation left us some roads and bridges as free gifts.

    3. That people sacrifice or shift consumption inter-temporally. The thinking is that people in the past, or in the present, must sacrifice consumption to build roads, airports, the internet, etc. and that they balance this suffering with the joy of higher consumption in the future. This is a gross example of the anthropomorphic fallacy, treating a population as if it was a single person or household, suppressing and then fulfilling their desires. They’re not. Different people are involved, and even individual members of the public don’t make such decisions over decades of their lives. People live, consume, and pay taxes in the present.

    4. That investment crowds out consumption. Aside from the anthropomorphic or household fallacy, did you notice people complain when there’s a lot of money being spent on road-building or tech infrastructure? No, people are happy at times of high infrastructure spending because there are lot of jobs and the economy is booming. Some work on construction, others make good and services, and everyone is better off in the present. National investment powers the economy and boosts consumption in the present.

    5. That our economies are supply-limited. A deeper version of the crowding out fallacy is the assumption that our economy is supply-limited. If labour, or machinery, or something is applied to durable investment necessarily that thing is not applied to present consumption. That might have been a good rule during the industrial revolution: There’s only so much steel or coal to go round. The reason it’s a fallacy today is that our economies are, for the most part, flow-limited. Output is limited by the web of money and how well it manages to tie together producers and consumers at every level and keep everyone confident and employed. If the flow of money is healthy, a modern economy can generally raise output.

    6. That interest payments are inter-temporal transfers of money. Aside from mixing up money and value, interest payments of national debt are not even inter-temporal transfers of money. They’re transfers of money to the current holders of the debt. The whole transaction occurs in the present. If the bondholders are private, national debt is a way to buy into a slice of tax revenue in perpetuity (because bonds are renewed). It’s not an inter-temporal transfer, it’s a distributional transfer from all taxpayers to the richer savers, all in the present. If bonds are held by the central bank the debt is manifest as inflation, and very roughly speaking it’s free up to an increase in debt (deficit) equal to the absolute amount of growth.

    7. That national debt is some day supposed to be paid off. It isn’t. It’s not a household mortgage and it’s not about funding current desires from future income. The stock of debt outstanding in the present is an asset that yields a certain slice of tax revenue (the interest) to whoever owns it. The asset is perpetual. Even though the average maturity of bonds is a few years, the norm is to recycle maturing bonds into new debt. You can argue about how much of this asset is good or bad to have for distributional reasons, but increasing or decreasing the debt is a slow adjustment, not a matter of repayment on a schedule. No country with debt being any significant slice of GDP could afford to pay it suddenly, and even paying it off over decades would be severely damaging.

  5. January 25, 2017 at 7:38 pm

    It was good to see Roger Farmer’s views deservedly taking a battering in three intelligent comments, but Pavlos has added so much of what I wanted to say I’m having to start from Abba Lerner, who was right to try to clear up “this most serious of all semantic confusions”, but fails to do so because he’s still thinking of debt in terms of the confused conventional understanding of money (as is, indeed, Pavlos in (6)). Let me try again.

    Roger: “Nation states borrow to provide public capital”. No they don’t. National governments do, and if they printed their own money they wouldn’t have to pay themselves interest. If their different ministries each paid with their own credit card for the employees, resources and sub-contracts their services needed, the nation would provide the food, materials and equipment necessary from that already available and be paid back by receiving the respective government services. Is there anything confusing about that?

    Roger: “enjoyed not only by the current generation of people, who must sacrifice consumption to pay for them …”. Very rarely. With a bit of help from those of us who earn our living that way, Nature provides more food than we need and factories can produce what we need as we need it (as was evident during the World Wars) rather than scrapping serviceable (i.e. repairable) goods in desperate and inefficient attempts to sell what we have already greatly overproduced.

    Roger: “public investment should be financed by borrowing, not from current tax revenues”. Who needs taxes if those realising the investment have their own credit cards so they can “borrow” directly from those (like shop-keepers) who have something to lend?

    Roger: “The debt raised by a private sector company should be strictly less than the value of assets, broadly defined. That principle does not apply to a nation state”. Why not! It seems to me there are two semantic confusions (or deliberate obfuscations) here, for why else call a monetary debt an “asset”, and in what way does the government of a state providing services differ from a company providing them, particularly when the services are – as now – increasingly being contracted out? No mention here of companies as well as governments needing to be responsible for providing what they are being resourced for.

    what Abbe Lerner said in 1948 may have been true of national economies then, when international currencies were tightly controlled, but is certainly not true in today’s global economy, in which when a government binds its nation us to paying interest to foreign bond-holders and allows companies to do this and worse: to buy from and sell to foreigners shares of ownership of the nation’s real assets, usually by borrowing money and gambling on exporting more interest than they need to pay on foreign loans.

    When shares were first issued, largely to finance the construction of railways, a large part of the finance was made available on the same basis as Britain’s preserved railways now: to get the railways built, with little prospect of getting anything back beyond the satisfaction and convenience (and – it turned out – delight) of having the railway.

    The golden rule of public debt as I learned it was to give freely and expect nothing back – though you will often be pleasantly surprised. Are the delights of Alexander McCall Smith’s “First Lady Detective Agency” available outside the UK? This from “The lady who walked in sunshine”: ” ‘There are many more kind people than not so kind people’ , says Mma Ramotswe”. Sure there are a few free-riders – most of them rich and growing fat from not doing enough – but most people invest because they have a surplus, not by “sacrificing consumption.

  6. January 30, 2017 at 6:56 am

    Money lenders and economists tend to treat debt as a matter of exchange. It is more than that. Debt in a moral judgement. Sometimes on those who borrow or obligate themselves through debt. But more often on moneylenders, bankers, etc. and in more recent times hedge fund operators, stock salespersons, and financial advisers. In fact, looking through world literature it is almost impossible to find an instance of sympathetic representation of a moneylender, especially professional moneylenders (those who charge interest). In contrast with this consistent moral judgement, historically professional moneylenders rank among the richest and most powerful people in their communities. This juxtaposition is made even more confusing today. Economists and others have worked for the last 50 years to change the moral judgement about professional moneylenders (of all sorts). So much so that today many people whose lives have been decimated by professional moneylenders cannot bring themselves to morally condemn them. But they feel they must condemn something or someone for their destroyed lives. And who is that? Government and government workers, immigrants, liberal elites, and just about anybody who looks different. Personally, I think we ought to return to the historically most common view of moneylenders.

    Nations and governments should never obligate themselves to moneylenders. They’re fools if they do. And they’re bigger fools still if they pay interest on the money obtained to operate government. Government was one of the first inventions of homo sapiens. It gave humans the security and protection to invent better ways to obtain the resources they need to live and live take care of themselves. So, in my view there should be no “national debt” to discuss. The money and other things need to operate a government should come from the people who are governed, without interest. If not from them then from the actions of the government itself. Moneylenders should not be involved with government. Moneylending is a modern curse. The judgement of history is clear.

  7. February 5, 2017 at 5:11 am

    Concerning just the United States, and not Europe or other countries:
    Of the Fed Budget of about $3.8 trillion, the largest government program is Social Security at approximately $900 billion per year and incurs no debt. Second is the Defense Budget at around $600 billion. Next is MediCare at around $500 billion and I think about 40% of that is financed by payroll taxes. The pure welfare programs total about $1 trillion for MediCaid, housing, and food. And you can put the rest for Ag, foreign affairs, parks, infrastructure, science, medicine, etc. to include R&D.

    Most of our debt finances consumption, rather than investment in productive enterprises. And that is why we have been in a declining trendline of productivity growth since the 1960s, when we enjoyed our greatest peacetime economic growth (while still having fed govt debt) in U.S. history. Debt-to-GDP declined during the 1960s because of modest Fed Govt deficits in relation to a high performing economy. When you neglect economic growth and emphasize consumption over investment in productive enterprises you get what we now have — and in a democratic process leave yourself vulnerable to a demagogue like Trump.

    • February 6, 2017 at 5:19 am

      Two questions. 1) what is a “productive enterprise.?” 2) Where is it written that economic growth is basic or even necessary?

      • February 6, 2017 at 6:15 am

        Check a basic economic text book and a history book. Look up the 1960s. For question #2 — BEA also has a primer on GDP & productivity addressing growth.

      • February 6, 2017 at 9:01 am

        In 2011 I wrote a report for a group of clients entitled, “The ‘Stationary State’ (‘No Growth’) Company: Is It Possible? My conclusion, yes it is possible. That report rejects the need for “productive investments” in the sense of investments that produce a profit. I cite John Stuart Mill and Robert Solow to support that conclusion. I stick by that conclusion.

        I’ve also authored several reports on GDP. To quote one of those, “GDP is a jumbled mess of this and that, as Shakespeare said, “signifying nothing,” or anything that catches an economist’s fancy.

      • February 6, 2017 at 4:16 pm

        Martin Wolf had an op-ed last week (Jan 27th) — starts out with a quote from Paul Krugman: “Productivity is not everything, but in the long run it is almost everything.”

      • February 7, 2017 at 11:06 am

        I read Wolf’s piece. He and Krugman are wrong. Herman Daly is the economist who explains what’s wrong with endless growth from an economics perspective. I prefer Wendell Berry, a novelist, essayist, and poet. He writes regarding our responses to the end of the era of cheap fossil fuel,

        The dominant response, in short, is a dogged belief that what we call “the American way of life” will prove somehow indestructible. We will keep on consuming, spending, wasting, and driving, as before, at any cost to anything and everybody but ourselves. (Wendell Berry, “Faustian Economics,” in What Matters?: Economics for a Renewed Commonwealth, p. 41.)

        This is what Krugman is advocating.

      • February 7, 2017 at 4:50 pm

        Human progress as a species (evolution) is dependent on technological advance; and, technological advance is dependent on economic development — technology becomes the driver of economic development. The “American way of life” has been to provide the leadership in the world for that striving for human progress.

      • February 8, 2017 at 4:19 am

        Vic, yes tools (technology) is an element in human evolution. But more important is human imagination and emotions. One drives human action. The other guides it. The earliest invention of humans after the intellect revolution 70,000 years ago was agriculture. Followed by government. Economics beyond just living in an agricultural society did not come till much later. And the notion of progress, economic or otherwise did not come along till the 16th century. The ancient Greeks, wise as they were could not envision a world with progress, with evolution.

        Speaking historically, the “American way of life” is a result of Enlightenment notions, life in a “frontier” geography, and the economics of slavery. Its freewheeling spirit, clash of cultures, every person his own master (note: person has a limited and focused definition that omits many “persons”), ultra technology focus, belligerence, and extreme use of natural resources makes it unsustainable and dangerous for both cultural and biological life. “Following” its path must ultimately end in disaster and dystopian existence for humans on a wrecked planet. The American way of life is not an evolutionary advantage.

  8. Syed Abbas
    August 23, 2017 at 5:31 am

    This article does well to explain the motive for debt issuance. It is quite right to argue that the ratio of public debt -to- public capital is a political decision. If the ratio is above (below) 1, the young (old) are impoverished relative to the old (young).

    However what is not clear is the statement about the golden rule in terms of growth and interest rate. Does their equivalence (which is presented as the optimal condition for economists) mean the same thing as the above ratio of public debt -to- public capital being 1.

    Would be great if you could clarify!



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