Sunday, January 22, 2012

Public Debt

This is based on comments I made here.

Bob Murphy has a terrific (and funny) post on public debt and in what (if any) sense it is collective burden using producing, spending and receiving apples as the base economic activity. It establishes that if the public debt is being paid, it is not a burden on future generations (though the distributional effects between cohorts may be significant).

I do have two major caveats, however. The first is that we are not paid in apples, we are paid in money to buy apples (in econ-speak, debt is a nominal not a real variable) and the central bank can drive down money incomes so it becomes much harder to service the debt. The second is that the real issue with public debt is the "room to manoeuvre" issue:

(a) how much of current taxes are consumed to service it?;

(b) how much extra-debt raising ability remains available for emergencies?;

(c) implications of what the debt is spent on for future income (and so future [a] and [b]).

These are the reasons why Australia is in a good position because the Howaard-Costello Government paid off so much public debt while Greece is screwed. (In particular, why Greece’s pathetic revenue-raising record is a crucial problem, aggravated by the European Central Bank’s “tight money/lowered incomes” policies.)

In other words, the key issue government as intermediary. Yes, debt is both a liability and an asset: an asset to bondholders and a liability to taxpayers (these being overlapping groups). Using public debt-to-GDP ratios as the most common measuring metric for public debt is a bit odd; but not completely so, since the thing being borrowed against is the taxing capacity of the government.

Debt is basically a structure of promises. The larger the (public debt promises) structure compared to GDP, the greater the difficulty in keeping the promises (to pay); the more risk that promises will not be kept; and the more difficulty in making further promises (to pay). Hence interest rates on government bonds vary between polities and over time.

If the welfare state systematically generates more debt (i.e. promises to pay) while also putting pressure on revenue (ability to pay), there is a potential problem. There is a difference between public debt at 15% of GDP and public debt at 150% of GDP. There is also a difference between debt when (money) income is rising and debt when income is falling (and the more so the more it falls).

Any story about debt that does not include risk rather misses the point. After all, risk is the most single important variable in valuing debt. Because debt is a structure of promises (to pay) and, in valuing promises, what is going to be more important than their expected reliability?

To put it another way, the larger the structure of promises to pay, the more difficult it is to keep all the promises, the more likely there will be some unravelling and the more the likely damage when it occurs. The issue is not debt as such, it is the state-as-intermediary, as manager of the structure of promises.

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