Monday, December 11, 2006

Is Government Debt Good?

Greg Mankiw says he doesn't understand the following point made by a fellow economist:

Myth No. 5: Government debt is a burden on our grandchildren. There's no better way to get people worked up about something than to call on their sympathies for their beloved grandkids. The last thing that I want to do is to burden my own grandchildren with the sins of profligacy. But we should stop feeling guilty -- at least about government debt -- because we are in better shape than conventional wisdom suggests.

Theory and practice tell us that the optimal amount of public debt that maximizes the welfare of new generations of entrants into the workforce is two times gross national income, or GDP. ...

What's going on here? There are not enough productive assets -- tangible and intangible assets alike -- to meet the investment needs of our forthcoming retirees. The problem is that the rate of return on investment -- creating more productive assets -- decreases as the stock of these assets increases. An excessive stock of these productive assets leads to inefficiencies.

See the link for the full context -- that's the key part, though.

So, as I understand it, his point is that there will not be enough places for all the new retirees (i.e. baby boomers) to invest, and thus the rate of return will fall, creating "inefficiencies."

But as one of Greg's commenters notes, "Can't retirees dump savings abroad?"

More generally, it's not clear to me why he believes that we will be at a level where there is an excessive stock of productive assets. Perhaps he has, or plans to, demonstrate this empircally somewhere, which would be interesting to see.

ADDED: I see now that his main point seems to be that the debt is not actually a burden on our grandchildren. That may be the case -- but that doesn't necessarily mean it's good policy to have deficit spending.

No comments: