Arnold Kling on “secular stagnation” theses

He makes some good additional points:

Here are some criticisms that come to mind.

1. If “the” full-employment real interest rate is negative, then why do we need quantitative easing? Why does not the excess of saving over investment not by itself drive long-term rates to zero?

2. Summers wants to claim that full employment has been achieved in recent years because of asset bubbles. However, in a world of negative real interest rates, there is no such thing as an asset bubble. Real assets have infinite value in such a world.

The full post is here.

Comments

I find it fascinating how smart people are slowly tip-toeing up to the truth. Over the last three decades, we have piled on $15 trillion in total debt at the Federal level. That's roughly half a trillion per year. The economy has grown in that period from $6.5 trillion to $15.8 trillion. A little math says we have not had real economic growth in a long time. Instead it has been the systematic pulling forward of GDP to be consumed today. That's just at the federal level. The massive debt overhang in the form of state and municipal pension funds promises to beggar a couple of generations as yet unborn.

There is no such thing as a 'debt overhang' on the macroscale. Every debt is someone else's asset. If a baby today will pay $5,000 in taxes when he is 30 because of debt incurred today then by definition somewhere there is another baby whose going to get $5,000 when he cashes in a bond grandma left him.

That baby with the "asset" is the grandmother who spent in her youth instead of saving for retirement. That's the point. Money borrowed today is spent today. Of course, robbing the future is not just borrowing. Artificially low interest rates robs the lender of future returns.

Whose been robbed? You're telling me in 30 years someone will pay $5K in taxes instead of spending it. But there's someone else who will get a check for $5K to cash in a bond. That sounds like a wash. Where's this 'overhang' in 30 years from debt?

Artificially low interest rates robs the lender of future returns

If the returns are so low whey did grandma save the $5,000? Why didn't she opt to enjoy it herself in the present moment? It's strange to use such moralistic terms like 'robs' when you're talking about a voluntary decision.

"You’re telling me in 30 years someone will pay $5K in taxes instead of spending it. But there’s someone else who will get a check for $5K to cash in a bond"

Government debt never goes to zero just like private debt never goes to zero in the aggregate. So there is no need to assume that all government debt is repaid with taxes. That is not the case. Most of it rolls over endlessly as it constitutes people's savings.

"Most of it rolls over endlessly as it constitutes people’s savings"

This does not mean that individual bonds are not paid off. Of course they are - all government bonds are paid as they fall due. But overall government debt just rolls over as a certain % of GDP. Sometimes it grows, sometimes it shrinks as a percentage of GDP. But overall it is not paid off so there is no reason to say that government debts are all paid off with taxes.

James,

Note that 'rolling over endlessly' is no different here than being paid off in taxes. (And strictly speaking not all debt rolls over endlessly. The gov't was running a surplus at the end of Clinton's term and has run surpluses periodically after WWII. In those periods at least some gov't debt has to end with a cash payment to someone and not simply being rolled over).

If gov't debt is 'rolled over' someone spends $5,000 to buy a new bond which is used to pay $5,000 to someone cashing in a mature bond. Same thing.

"Same thing"

It's not the same thing. If the govt taxes you $100 to pay off a $100 bond the number of financial assets owned by the private sector (i.e. private sector financial wealth) goes down by $100. If the govt pays off a $100 bond by selling another $100 bond (i.e. it rolls over the debt), the number of financial assets owned by the private sector stays the same.

Let me present you with some other cases to challenge you to show me how I'm wrong.

Suppose the gov't never borrows $5,000. In that case grandma never buys the baby the bond which means in 30 years the other person is never taxed $5,000 to pay the bond off. The other person now has $5,000 more but the guy who would have had the bond is not $5,000 better off. Still a wash.

On the other hand, suppose in 30 years a UFO lands and the aliens, in a gesture of good will, pay the tax bill of the poor fellow about to be taxed for the $5K. Now the grandkid gets $5,000 from grandma's bond but the other guy keeps his $5,000. Everyone's better off to the tune of $5,000. Yay.

But again suppose the gov't never borrowed the $5K. Again the aliens give the guy $5K since he has no tax bill to worry about now. The man with the grandmother doesn't have his bond to cash in (-$5K) but the man about to be taxed is both not taxed and has an extra $5K from the aliens (+$10K). Again everyone is, when netted together, better off by $5K. Again whether or not the gov't borrowed money 30 years ago doesn't seem to impact the macrobenefit of generous aliens landing today.

It is a slow day in the small Minnesota town of Marshall , and streets are deserted. Times are tough, everybody is in debt, and everybody is living on credit.

A rich tourist visiting the area drives through town, stops at the motel, and lays a $100 bill on the desk saying he wants to inspect the rooms upstairs to pick one for the night.

As soon as he walks upstairs, the motel owner grabs the bill and runs next door to pay his debt to the butcher.

The butcher takes the $100 and runs down the street to retire his debt to the pig farmer.

The pig farmer takes the $100 and heads off to pay his bill to his supplier, the Farmer's Co-op.

The guy at the Farmer's Co-op takes the $100 and runs to pay his debt to the local prostitute, who has also been facing hard times and has had to offer her "services" on credit.

The hooker rushes to the hotel and pays off her room bill with the hotel owner.

The hotel proprietor then places the $100 back on the counter so the rich traveler will not suspect anything.

At that moment the traveler comes down the stairs, states that the rooms are not satisfactory, picks up the $100 bill and leaves town.

No one produced anything. No one earned anything... However, the whole town is now out of debt and now looks to the future with a lot more optimism.

No one produced anything. No one earned anything… However, the whole town is now out of debt and now looks to the future with a lot more optimism

That would certainly seem to imply your 'debt overhang' is a myth. In your example all the debts were wiped out yet the town was exactly the same as it was before! You're trying to tell us if only these people never got into debt things would be so much better. Yet you give us a story demonstrating how paying off all the debts leaves everything in exactly the same position!

Boonton, are you aware of the "Great Debt Debate of 2012" (Bob Murphy's phrasing, not mine)? Bob Murphy, Nick Rowe, and Don Boudreaux laid out a (IMO convincing) case for why debt is not simply an asset for future generations. If you consider a model with overlapping generations, it is possible to show that we can live at the expense of future generations. See http://consultingbyrpm.com/blog/2012/01/the-economist-zone.html, which has links to many parts of the debate. Also, http://worthwhile.typepad.com/worthwhile_canadian_initi/2011/12/debt-is-too-a-burden-on-our-children-unless-you-believe-in-ricardian-equivalence.html from Nick Rowe.

I believe the underlying argument was first put forth by James Buchanan.

The difference between the town of Marshall and the real world is that every debt could be settled. Let's say the guy at the Co-op had not been embezzling funds and owed that debt to the milling company in Minneapolis. In this case the hotel owner has to run back and get his c note back from the pig farmer or just eat the loss. Somehow I suspect that the good burghers of Marshall have nothing other than $100 dollars or the equivalent amount of unprocessed cereals, that the Minneapolis milling company would want.

marris, that was very good, although i find the caveat "unless you believe in Ricardian Equivalence" confusing. I'm a good Ricardian, and this is WHY I see the debt as a burden. The only reason I make provisions against this obligation is because I regard it as a real obligation.

Nick's phraseology is, I think, unhelpful:

"Ricardian Equivalence means that individuals decide to offset the burden by each cohort giving rather than selling their bonds to their kids in the next cohort. So if you believe in Ricardian equivalence, you can consistently argue that the national debt is not a burden."

Wait, what? But Nick then goes on...

"But it's only not a burden because individuals see it is a burden and take offsetting action."

Oh, ah, yes.

@Brian, good point. I believe the idea is "if you believe people today are Ricardians..."

That is, if the people today are willing to save and gift, then there is no net burden on the future. If they are only willing to sell, then there is a net burden.

"A rich tourist visiting the area drives through town, stops at the motel, and lays a $100 bill on the desk saying he wants to inspect the rooms upstairs to pick one for the night"

So you're saying he gives the motel owner a 0% interest loan?

Marris,

Nick Rowe's example doesn't make sense. First of all he assumes no investment and no growth, and yet positive interest rates and full employment. Completely ridiculous assumptions. He also assumes that the debt is in real goods and not money, which doesn't make sense because the debt he is talking about is a monetary debt. He then assumes that at some point in the future all the debt is paid off and goes to zero. This is like assuming that at some point in the future all private debt will be paid off and there will be no private debt any more. That makes no sense. His whole example makes no sense.

Bob Murphy's apple table was so dumb and irrelevant to reality I couldn't be bothered to read through the rest of the text.

According to Boonton, Greece is the most prosperous nation on earth, just look at all their debt. Spain as well.

In the real world, the taxes collected from productive endeavors is funneled to rent seekers. A productive economy can afford quite a bit of that, but at one point, smart folks instead of paying the taxes to pay for the bonds do their economic activity somewhere else so they don't have to pay quite so much. Apple, instead of employing 40,000 US citizens to build their phones, and pay the income taxes that all those people would pay, they employ 40,000 chinese people, and don't pay for the debt. The Boonton's of the political and financial world figure that the solution is to make it easy for debt to be issued, and that it be cheaper. We see the results of that since 2000, where an expensive war was engaged without raising taxes to pay for it, where huge numbers of people bought homes they couldn't afford because of subsidized artificial costs of money. The financial crash ensued, and to allow the prosperity that only borrowing money can bring, the Federal Reserve enacted a price control scheme, keeping the cost of money low to allow the government to borrow unprecedented amounts. If the cost of money hit historical norms, the debt financing costs would rise substantially, taking even more money from the productive for the rent seekers, while the price control scheme distorts the market and removes resources from the economy and gives it to the fools that caused the problem in the first place.

Debt is fine up to a point. It isn't the paying of it back that is the issue. Debt issued below cost (the financial crisis was largely a failure to appropriately price risk) allows fools to do stupid things. The burdens of the stupid things done at below cost debt in Greece and Spain has crippled those countries, possibly beyond repair for a generation.

Why with unprecedented debt and government borrowing does the US have close to 8% unemployment, kept at that number only by hundreds of thousands leaving the work force?

derek

According to Boonton, Greece is the most prosperous nation on earth, just look at all their debt. Spain as well.

Greece isn't prosperous because they don't make a lot of goods and services, period. Their debt has nothing to do with it in that regard. Just like Z's example of the sleepy town where the only thing produced is a single hotel night by a visiting tourist. The towns problem is lack of output, not debt. As Z's illustration demonstrated, when everyone's debts are paid off nothing gets better. Everyone is free of debt, but everyone also has fewer assets since no one owes them anything.

The burdens of the stupid things done at below cost debt in Greece and Spain has crippled those countries, possibly beyond repair for a generation.

Spain was running a budget surplus until the crises. In fact since 1995 it's been decreasing it's yearly deficit until it achieved surplus from about 2006 until the crises blew everything apart. Care to explain then how Spain is one of your leading examples of debt being bad for an economy?

You seem to be arguing a strawman position. I'm not arguing that debt is a magic good for the economy, I'm arguing that in the big scheme of things it's largely irrelevant. Z's example demonstrated that as well. In his hypothetical town would it have made a difference if everyone owed each other twice as much? Ten times as much? Nothing?

@James

> He then assumes that at some point in the future all the debt is paid off and goes to zero.

I hope you're trolling. :) These assumptions are chosen largely to make the marginal impact equal to the total impact. Otherwise, you can avoid these assumptions and study the marginal *burden* on future generations.

Same response for the other "they don't make sense" objections. The point is that it's possible to consume today through borrowing at the expense of future generations. Given your comments about "it's only monetary debt," I'm not sure how carefully you are thinking about this, so forgive me if I don't respond to future posts.

Modifying Z's story a bit:

The guy at the Farmer’s Co-op takes the $100 and runs to pay his debt to the local prostitute, who has also been facing hard times and has had to offer her “services” on credit.

This economy has been producing GDP! Everyone's been doing it on credit!

Imagine a few years ago zombies broke out and this quite little town happened to put up a giant wall to keep out the hoarde of flesh hungry zombies. Sadly the ATMs stopped working in the town and the local bank was just outside the wall. Since this town had previously did everything on plastic, no one had any cash. So when the hotel owner need some hogs, he wrote the butcher an IOU, the butcher wrote an IOU to the pig etc etc with everyone waiting until civilization is reestablished.

Z's town then essentially has simply changed it's currency from pieces of paper that say $100 Federal Reserve Note for pieces of paper that say "IOU $100". Z laments that there is no real production in this town, yet the hog farmer is raising hogs, the butcher is butchering them, the hooker is hooking, and the hotel is providing rooms.

marris

I hope you’re trolling. These assumptions are chosen largely to make the marginal impact equal to the total impact. Otherwise, you can avoid these assumptions and study the marginal *burden* on future generations.

This objection to the objectin works for the assumption that all debts are paid off at some point in the future making all balances zero but does not address the assumption that all borrowing is done in 'real goods' rather than monetary notes.

Z's town example illustrates that it's quite possible for monetary debt to expand dramatically as well as contract dramatically (the $100 'borrowed' from the visiting hotel guest wiped out the entire towns collective debts in less than 24 hours) without having any impact on the actual goods and services produced in either the present or the future.

Boonton and James,

Krugman killed his own argument in that debate with Rowe and Murphy by offering the caveat about internal vs external debt. If one really believes it is only matter of redistribution in the future between the debtors and the creditors, then why would one offer such a caveat? The beautiful thing about Murphy's OLG model was that it show precisely why some future generational cohort could never be made whole without making some other future generational cohort worse off. In other words, the debt cannot be a wash- ever, and the fundamental reason was that you can't change the past.

And this fallacious argument is the variant on what James offers below about endless rollover- the gifting of bonds forward rather than the selling of them forward.

Here is the point- if the lenders of today never take payment in cash for these bonds, then yes, and only then, is the future not burdened by the debt- the future can then just say, "We are defaulting on those gifted bonds," and none alive at that time or in the future is actually made worse off than they would have been if the debt had never been originated. However, most such bonds eventually get sold to someone in the future, by the original lender or the person to whom they were gifted, or they get redeemed (by taxes or new bonds sold to new people). If the bonds aren't paid back by someone in the future, they are the ones who were burdened by the past debt, and they can never be made whole without making someone else in the future worse off.

> Does not address the assumption that all borrowing is done in 'real goods' rather than monetary notes... Z's town example illustrates that it's quite possible for monetary debt to expand dramatically as well as contract dramatically.

I don't follow why real vs. nominal makes a difference in the town example. The key is that the debts and receivables are denominated in some homogeneous unit. If the town debts had been in terms of apples, and the town visitor had dropped a bag of apples at the front desk, then the deleveraging can still happen. Homogeniety is what lets the town deleverage so easily, not "real vs. monetary."

Also, I don't think the town deleverage example can capture the "debt burden" argument without cohorts. The deleveraging is a single-cohort event which removes payables and receivables from each person's balance sheet. Everyone's net worth is the same.

To apply this to the town, imagine the town visitor persuaded the town council to issue a bond and use the proceeds to buy him lunch. He then eats the lunch and leaves. Someone town member will be taxed in the future to pay off that bond. It doesn't matter that the bond is also *held* by a town member. The net impact on the town is negative.

marris

To apply this to the town, imagine the town visitor persuaded the town council to issue a bond and use the proceeds to buy him lunch. He then eats the lunch and leaves. Someone town member will be taxed in the future to pay off that bond. It doesn’t matter that the bond is also *held* by a town member. The net impact on the town is negative

To keep it simple, let's say it is the owner of the diner that takes the bond:

Present moment: Diner owner works for free, gets bond in return. Visitor gets lunch.

Future moment: The town butcher/baker/hooker/candlestick maker is taxed $25 to pay the bond. Town diner owner (or his kid) receives $25 as the bond is cashed in.

Notice in the present moment the town's 'GDP' expanded by 1 lunch. In the future though GDP doesn't go down by 1 lunch. In fact nothing happens to GDP at all. Yes the purchasing power of the diner owner has expanded by $25 but that has been perfectly offset by a $25 decline in the purchasing power of everyone else.

So explain how exactly this scheme caused some type of time hole to open up, suck a lunch out of the future and bring it to the present?

@Boonton, the visitor took the *lunch* from the town. And to the extent that he bid labor away from some other use, he took that too.

The "time hole" arises if the older generation alive now consumes a marginal amount more than the younger generation alive now. They are living at the expense of the younger generation. Further, if the younger generation *reacts* to this by consuming from *their* younger generation (when they are born), then the burden can be pushed further down time. Resource reallocation is done between adjacent generations, but the next impact keeps being transmitted through time until some generation bites the bullet and breaks the chain.

marris

The town in the present moment produced 1 lunch. There is no reason why, in the future, the town would produce 1 less lunch to 'pay for' the debt.

You're right, the visitor took a lunch from the town....a lunch that could have been consumed by someone in the town. So from that perspective the visitor's lunch wasn't free. But in terms of economic growth (which is what things like GDP and employment are measuring), actual production is not effected.

No one ever argued that debt doesn't shift consumption. Of course it does. A borrower is borrowing to expand his power to buy things now, a saver is forgoing the power to buy things now in exchange. But production is different from consumption.

In terms of consumption those who buy bonds today are giving up the power to buy things and those selling bonds are getting the power to buy things. Tomorrow those selling or cashing in bonds are gaining back the power to buy things while those redeeming the bonds are giving up the power to buy things (either taxpayers if debt is paid off or other bond buyers if rolled over).

We can debate the ethics of this state of affairs but ultimately the whole 'debt overhang' argument is that something more happens here than simply one person gets to consume more and another consume less, the debt overhang argument is that somehow having lots of debts will cause us to make less stuff, have fewer things to buy regardless of who has more power to buy by his checking account balance.

So because we borrowed a lot of money to make foolish mortgage loans up to about 2007, we must now have 7% unemployment and have fewer people in the labor market? Why does this make any sense? If anything the burden of such past debts should require us to have more people in the labor market and much lower unemployment.

First, the resources used to make the lunch are *lost*. No one will ever get to eat *that lunch* again. I don't see why you think otherwise. If the lunch *had not* been made, the resources would still be available. This is certainly a "shift in consumption" ... from the town to outside the town. That's my point!

Further, you shouldn't confuse yourself by conflating production, GDP, and employment. If you want to argue that the visit increased GDP, reduced employment, created spending ripples, turned lead into gold, etc, *go ahead*. Now let's analyze a counterfactual. Suppose the town had taken out the debt and simply *given* the money to the diner owner? We don't get the GDP increase, we don't get the employment increase, but everything in this scenario is *better* for the town! No work needed to be done, no lunch resources needed to be lost, and all after-effects can still happen!

In practice, it is possible to increase GDP with transfer payments. Doing benefits the tranfer recipients at the expense of the tranfer non-recipients. If you're going to play this GDP-increase game, better to shower *everyone* with money. That's a monetarist solution, and no debt is required.

First, the resources used to make the lunch are *lost*. No one will ever get to eat *that lunch* again. I don’t see why you think otherwise. If the lunch *had not* been made, the resources would still be available.

Time is a resource too. Assume the cook can only make one lunch a day. If he doesn't cook on Jan 1st, that doesn't give him the ability to make two lunches on Dec 31st. So if he was otherwise not doing anything on Jan 1st (i.e. unemployed), the 'borrowing' has indeed expanded production on Jan 1st to the tune of 1 lunch. If he was employed then the borrowing has shifted not the making of the lunch but the eating of it. The saver could have eaten the lunch, instead the borrower eats it.

Suppose the town had taken out the debt and simply *given* the money to the diner owner? We don’t get the GDP increase, we don’t get the employment increase, but everything in this scenario is *better* for the town! No work needed to be done, no lunch resources needed to be lost, and all after-effects can still happen!

Suppose your dad keeps a $100 bill hidden at the bottom of the dresser that he never checks or uses. You take the $100 and hide it in your brother's dresser. Your brother never notices it so he never makes use of it. Does anything happen to the economy? No. Suppose your brother asked your dad to borrow the $100, he keeps it in his dresser for a year then just gives it back. Same thing, nothing has happened.

You can't say the scenario is 'better' for the town unless you first ask does anything actually get done with the money borrowed and given to the owner.

In practice, it is possible to increase GDP with transfer payments. Doing benefits the tranfer recipients at the expense of the tranfer non-recipients. If you’re going to play this GDP-increase game, better to shower *everyone* with money. That’s a monetarist solution, and no debt is required.

See my previous hypothetical where this sleepy town has survived the outbreak of zombies by putting a huge wall up around it. Since there's no cash anymore, the towns people, hoping civilization will soon come back, start writing up IOU's and doing work for each other and paying for them with IOU's. In essence IOU's and money are the same thing. If money is essentially neutral then so is debt.

As near as I can tell, you're scrambling for answers here. What part of my aalternate scenario denied that time is a resource? In one example, it was allocated to work (making a sandwich). In the other, it was allocated to liesure. The diner owner still got him money and could spend it as if he had worked. Of cpurse, if he likes making sandwiches, he could have done that too and thrown it away. I repeat, this scenario is at least as good for the "town" as the visit. Until you point out why it's not, I'm going to assume you concede this point.

If/when you *do* concede this point, it follows that the visitor can consume at the *expense* of the town. That is, he can show up, consume (get better off), and leave the town worse off than in my scenario. That is what the debt as burden people are saying.

QED.

As near as I can tell, you’re scrambling for answers here. What part of my aalternate scenario denied that time is a resource?

That would be:

First, the resources used to make the lunch are *lost*. No one will ever get to eat *that lunch* again.

The question is not whether someone would eat the lunch but would someone make the lunch. If the cook didn't make the lunch today, then that lunch could never be made again as that potential output is lost as time moves forward.

In one example, it was allocated to work (making a sandwich). In the other, it was allocated to liesure.

You're making an assumption of full employment all the time here. An assumption that essentially means there are no recessions, only variations in how much leisure people want versus work. An assumption most people don't buy and you haven't provided a defense for it here.

If the town is at full employment and the lunch is going to be made anyway then the borrowing/spending causes no change in GDP. The town produces one lunch in time period 1, period. The borrowing changes who gets to consume that lunch.

If/when you *do* concede this point, it follows that the visitor can consume at the *expense* of the town. That is, he can show up, consume (get better off), and leave the town worse off than in my scenario. That is what the debt as burden people are saying.

If the town was not at full employment, the debt 'cost' the town the 'leisure' of the unemployed.

If the town was at full employment, the debt 'cost' the consumption enjoyment of whoever would have otherwise eaten the lunch.

Your problem is that:

1. This has no impact on GDP, except in the first case where it would increase it.

2. I've been very clear, debt has an impact post-production, post GDP. Debt impacts who gets to consume GDP in any time period. The problem is the claim that debt itself impacts GDP, that 'debt overhang' has any real meaning. It does not and essentially cannot 'pull consumption forward' in time. The town in the future does not 'pay back' the loan for the lunch by putting a turkey club into a time machine. Nor is the loan 'paid back' by having the cook take a day off from making lunch in the future. Even if you don't care about the well being of the stranger who got the lunch and only care about the enjoyment by residents of the town then in the future the 'paying back' simply let's some other town person enjoy lunch (by cashing in his bond) versus another. To be clear if by cost you mean someone in the town not getting to enjoy lunch, it happens when the stranger eats the lunch, not because of 'debt'.

GDP is the value of all goods and services produced in an economy. That means that GDP is a flow of actual services being performed, and actual goods being built over a year. Explain how you can "pull that production forward" using government debt.

This is the key. Once you appreciate this point the debt overhang crap because transparent nonsense.

There are actually sensemaking points on the debt overhang side of things. If people with good investment ideas have a lot of debt since before, they might lack the net wealth necessary to get financing for new projects.

Of course, these explanations reside in a different conceptual universe from "all our GDP was borrowed from future generations."

I'm unclear how this would work. Let's say I borrowed a lot of money in the mortgage boom and now I'm in debt $500M. Woe is me. But suppose I suddenly get an idea for the next Harry Potter size franchise. It's worth $1,000M! Wouldn't I simply sell my idea for $1B, pay off my debt and enjoy $500M? Granted if I hadn't have been so foolish back in the boom I could have enjoyed the full $1B but in terms of the economy as a whole the ability to generate $1B in new GDP by making the next Big Harry Potter type thing isn't disrupted by 'debt overhang'

(Of course you also left unsaid exactly why and how all the people with good ideas for innovations in the present moment happened to be the people who burdened themselves with too much debt in the past moments? What mechanism causes reckless borrowers today to become tomorrow's innovators?)

Sure, once you believe in magic, everything is possible and those grumpy old skeptics are spouting transparent nonsense. My goodness.

Think about it, the people in the colonial era of the US had much less per capita than people of, say, 1910. If there was some way to magically 'pull production forward' by using debt then not only would debt not be bad, it would be the greatest thing in the world. You could have doubled the standard of living of people in 1790 and the cost to people in 1910 would have barely been noticeable. Likewise today if we could magically 'borrow' from our grandkids we'd be fools not to do it.

First, everyone's debt is someone's asset is too simplistic. The thing all those who ignore debt miss is that the value of the debt is based on the ability to repay. If the ability to repay is called into question, the assets value can collapse all the way to the collateral behind it.

Second, there is a fixed amount of goods and services (at the very shortest time scale) in the economy. Credit creates new money and allows people to bid away today's goods and services, repaying tomorrow. The lender does not wish to consume today, so it's a match.

The system works well if the interest rate is accurate and the debt is put to productive use, for instance to build a factory that will produce enough goods and services to repay the debt and then some, increasing the wealth of society.

The concept of a debt "overhang" happens when the interest rate was set too low (the asset value is set too high as well). The credit is used for consumption or projects that do not return enough to repay the debt. This debt, which is also an asset, is now a millstone. The person with the debt is stuck paying for their mistakes. What the "market" would like to do is wipe out the debt and the asset in order to free up the goods and services. Maintaining "bad debt" means people, goods and services are trapped in amber, trapped in an economic relationship that is not efficient.

When the total systematic debt gets to high, there is a risk of systematic collapse. It's not that people are borrowing from future generations, it's that a lot of your assets aren't worth what you think they are because you've invested poorly. Your children and grandchildren will be poorer when interest rates rise and asset values collapse.

Ability to repay? You mean there's a finite number of dollars that can be printed by a printing press?

You are correct that ability to repay is very important when it comes to debt, but you neglect to actually consider ability to repay. My ability to repay a debt of 'ten Blockbuster rentals' is limited by whether or not Blockbuster is in business and whether I can then pay for rentals for my friend. Likewise "I owe you 3 Starbucks coffess" will become impossible to repay if some blight causes the coffee bean to go extinct.

Notice a debt of '3 coffees' by itself my be disconnected with anything 'dumb' on my part. In normal times it's no big deal if I owe you a few cups of coffee. If the coffee bean goes extinct, though, my 'debt' to you may become crushing to me financially if the last remaining beans become as expensive as diamonds.

In that case, though, debt remains neutral still. I may have to sell my house to buy you 3 cups of coffee, but what was a trivial asset to you (3 cups of coffee, not even worth $10) has now become a major asset. Your gain is my loss.

I owe my mortgage company $300,000. My ability to repay depends upon my ability to somehow get other people to give me $300,000 dollar bills and then pass that onto my mortgage company.

But the US gov't has no cap on it's ability to create dollars hence no cap on it's ability to repay. Greece and Spain are interesting counter-examples since there is no cap on the number of Euros that can be printed, neither country has the ability to force the EU Central bank to print Euros.

But the US gov’t has no cap on it’s ability to create dollars hence no cap on it’s ability to repay

Hence, you are advocating making someone in the future worse due to a debt from the past. It isn't a wash after all, was it? Either the US government returned real value with interest, or it didn't. In either case, someone in the future is burdened by a debt from the past.

Hence, you are advocating making someone in the future worse due to a debt from the past

If someone in the future is made worse, then by definition someone else in the future has to be made better.

Either the US government returned real value with interest, or it didn’t. In either case, someone in the future is burdened by a debt from the past.

If the US gov't takes something of value from person A to pay a debt owned by person B, then person B is better off by no more and no less than person A is made worse off. You can't get around that equality. If the US gov't defaults on the debt, then person B is worse off since his bond is now worthless, but person A is better off since he is never taxed his things of value to pay it.

Excess saving has led to very low real rates. One factor is that demand is low because baby boomers have to save for the coming retirement years, and their numbers are large enough to move rates. This factor will reverse in the next couple of decades when enough of them leave the labor force and they switch to dissaving.

I agree with Arnold that Summers is wrong about bubbles. I think what really happened was that assets - homes being the clearest example - rose toward infinity as a reasonable reaction to such low long term real rates. This caused the Fed to be too tight. The wealth effect from higher home prices made up for this until 2006, when real rates rose enough to cause home prices to pull pack slightly. The Fed's tight policy was exposed by late 2007, and we were sucked into a liquidity crisis.

I suspect the problem with 'excess savings' is the economy has the ability to manufacture paper assets to asorb savings. As a result the 'real interest rate' does not actually fall as much as it should.

Doesn't the time frame for the negative real interest rates matter? Are we talking about a negative real interest rate for a bond that matures in 15 years or 30 years, or an infinite number of years into the future (which is nonsensical). What specific yield curve are we talking about?

Just more attempts to defend free lunch economics.

TANSTAAFL

Economics is zero sum. labor + capital = production = consumption = labor consumption + capital consumption.

The economy is stagnant because labor income has been declining propped up only by ever increasing debt since 1980, while capital consumption has fallen, with the excess profits going into funding debt that can not be serviced by the borrower which are individuals and government. Meanwhile, in the US, the capital assets have been depreciating at rates higher than investments, but the myth of capital gains and the myth of price equals value have propped up the lending for bad debt.

The bad debt is either charity or taxes, but the date of the charity and taxes is deferred so far in time from the act that the behavior of the lender is distorted because they are so confused, or they are not confused, but are actively engaged in pump and dump.

Goldman was actively engaged in pump and dump, and thought it was smarter than everyone else, and thus able to control its destiny so when its feeders of its pump and dump enterprises, the mortgage originators and complementary firms, suddenly hit the wall and suddenly became cheap, Goldman bought them, thinking the bubble would pop and then the Fed and government would do as they did in the 80s, 90s, and 00s, pour in cash to get asset prices going up. Goldman didn't expect conservatives to have the power to shutdown government spending to boost consumer spending. Real estate prices are not going up because the Chinese are not snapping up houses in Detroit and Cleveland, just the 50th floor condos in NYC.

The excess cash from high profits is not directed at consumption, but at pumping up the prices of intangible assets. The owners of the intangible assets are demanding the corporations drive up share prices or distribute the cash to shareholder so they can pump up share prices. Obviously everyone expect to pump and dump to extreme wealth. On the false believe that in economics, negative entropy is an iron law of capitalism.

Meanwhile, capital assets depreciate, and in some, cases decay and fall into the rivers, or leak spilling thousands of gallons of oil into the river or field destroying their value. Or in other cases become Detroit, Tens of thousands of homes that are worthless but to the "capitalists" were worth hundreds of millions so they loaned money on that basis - capital gains ensured that those decaying Detroit houses would generate profits on the loans larger than the loans that built them.

The negative interest rates were 8-12% on houses that based on the myth of capital gains would be worth twice as much as the loan in seven years max because real estate always increases in value no matter how much it decays. That was the business that Goldman had mastered to earn great profit. And now cost it $13B in a government settlement, a cheap price for its profits from pump and dump. And those 10% mortgage interest rates ended up being negative because capital gains are impossible in the real world, just tricks of accounting in fraud by obfuscation.

Having real assets be infinite value requires two assumptions that are very strong:
1. Real rates are negative forever, as opposed to 5-10 years like we've seen recently.
2. That you can create an asset which can hold value forever. How many structures last more than 100 years without significant investment? Or companies? Land has to be mixed with capital to keep up its value. There are clearly good investments, but that doesn't mean there is a large supply of assets that easily maintain value for very long periods of time.

Are long-term real interest rates really negative? I suspect price inflation for goods is a good bit lower in most countries than price inflation for services (they have been in Canada, where I live, for some time now). How good the return is on a particular investment depends on your consumption basket. If you plan to consume mostly goods over the life of the investment, you're in better shape than if you plan to consume mostly services.

Of course, an aging population increasingly favours services (i.e. health care) more than goods, at the same time the working population begins to level off or even shrink. That's the real problem---an economy where the working population is static or falling can't sustain as high a rate of growth, or as high a real rate of return on capital as before.

The complaint that people won't be able to afford a comfortable retirement if real interest rates remain this low is really a complaint that there won't be enough younger people to sustain all the retirees at the level of comfort the retirees would have wanted. That's the real political issue; older, wealthier voters are convinced the Fed's fiddling them out of their pension with near-zero interest rates so politicians can pay for handouts to younger, poorer people whom the older and richer think don't deserve help. Well, no. To not put too fine a point on it, they fiddled themselves out of their pension by not having enough children and making it much harder for able-bodied working-age people to come to the developed world to work than it absolutely had to be.

(This, I suspect, is the real reason Japan hit the ZLB first, and why it has stayed there so long---birth rates plunged first and Japan admits very few immigrants.)

Get used to low real interest rates for a long time. Life will go on. People currently working age will gradually adapt to permanently lower real interest rates, and save more for retirement. Private debt levels (compared to income) will be permanently higher, but that is because of higher private savings rates---the savings have to be lent out somehow.

Far better this than policymakers offering more free lunches to the elderly that they aren't absolutely sure the young can pay for.

I'm pretty much on board with this take. My concern is the world as a whole is becoming Japan-like demographically. By late this century the world population will be in decline, and aging. And unless we allow Martian guest workers we can't bring in young workers. How does capitalism work if the whole world is Japan? I guess we look to Japan for that, they are 'stagnating' I guess, but it's still a pleasant first world country. Robots will be the 'young' workers, and with fewer and fewer people each year there will be fewer ZMP mouths to feed.

All the discussion about US Government debt not being real debt because it's actually assets of the future generation ("Every debt is someone else’s asset. If a baby today will pay $5,000 in taxes when he is 30 because of debt incurred today then by definition somewhere there is another baby whose going to get $5,000 when he cashes in a bond grandma left him) so it's not making a beggar of the future generations seem to forget that $5.724 trillion of debt are currently held by foreigners. It's "just" 30% GDP, but it's american debt that will constitute assets of a FOREIGN "foreign" future kid.

The foreigner got US bonds because he exported real goods or services to the US in exchange for dollars, and then decided to save those dollars rather than spend them. Unless the US government debt is completely paid off and becomes zero, which it never will because in the aggregate debt just rolls over as it constitutes people's savings, then the foreigner just has a dollar savings account at the Fed which he was willing to exchange real goods and services for.

Not really, foreign investors are known to expect payment, rather than rollor-over, at some point, which means the FED, aka the future taxpayers, will effectively have to pay that debt at some point.

GC, you are wasting your time with people like James. They think that as long as diners just stay at the table eating forever, they never have to pay a restaurant bill.

Foreign bond holders have no more legal rights than domestic bond holders. They can only be paid in US dollars, not actual goods and services.

So their choices are accept US dollars, which they can use to buy goods and services (mostly from the US). In that case the US trade deficit becomes a surplus. Our standard of living will actually decline since we will consume less and work more (since we're selling our output to foreigners for US dollars) but US unemployment will decline. Or they can accept the debt be 'rolled over' into new debt.

Our standard of living will actually decline since we will consume less and work more

Which should put to rest the belief the future can't be burdened by a debt from the past, right??? Your sentence is the caveat Krugman offered in that debate with Murphy and Rowe- a caveat that completely undercuts the argument that the debts are a wash. If debts are wash between future Americans, they are surely a wash between future Americans and future foreigners.

Right now many Americans bemoan the trade deficit. Poor America, we buy lots more goods from abroad than we sell to them. If only we could balance our trade we coudl create X millions of jobs thereby solving unemployment and so many other problems.

But right now our unemployment problem is 'their' employment problem. They are working 24 hours a day making ipads yet they can't afford to decent living while we play with the gadgets they make. If in the future we 'pay back' our debt by running a trade surplus we will swap an 'unemployment problem' for an 'employment problem'.

The only way you make debt 'not a wash' is by purposefully declaring one side of the equation will not be examined.

Simply unreal, Boonton. You are the one leaving one side of the equation unexamined.

Look at what you wrote:

They are working 24 hours a day making ipads yet they can’t afford to decent living while we play with the gadgets they make. If in the future we ‘pay back’ our debt by running a trade surplus we will swap an ‘unemployment problem’ for an ‘employment problem’

"They" in this paragraph are the people of today, in China for example. "We", "who play with the gadgets they make" and the "We" who "pay back our debt by running a trade surplus" are not the same people!!!, Boonton. You keep overlooking this point.

So let me give you another slightly different story. A new Dali Lama convinces the entire nation of China that there's no pleasure in gadgets, only in hard work and giving. AS a result the whole contry devotes itself to making iphones and giving them to the US for free. Result has to be the US gets to live beyond it's means. The US may make only 80 iphones yet use 280 since it is enjoying China's gifts.

Suppose a generation later a Chinese Christopher Hitchens wakes up and says this whole thing is absurd. All in the sudden Chinese people cease working for free and giving away the stuff they make. What would have to happen in the US is that our standard of living will fall since we'll no longer enjoy that free stuff from China. If we wanted to continue to consume the same amount, we'd have to make the iphones ourselves. Therefore what was China's employment problem because our employment problem and vice versa. In other words, the debt itself has nothing to do with it.

And Yancy,

Another problem is the whole premise of the 'debt overhang' argument is the 'punishment' for taking on too much debt is unemployment, recession and slow growth. You're jumping on a model that predicts a dramatic increase in employment and GDP as the 'price' of debt.

This, of course, makes more sense when you think about it. You don't 'work off debt' by increasing unemployment, you pay down debt by working more!

Yours was an excellent post. Arnold also makes good points, too. But I find it surprising that you chose this as strong:

"Why does not the excess of saving over investment not by itself drive long-term rates to zero?"

It is precisely in answering a question like this that IS/LM comes in handy. An 'enhanced' IS/LM, if you will.

Saving is not financing, the LM curve matters too, its shape is a function of the current rate of interest, John Bull and 2%, yada yada. Pick any half-decent financial-Keynesian explanation (esp. circa Treatise of Money, especially as interpreted by Leijonhufvud) and this is answered.

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