Great Leap Forward

Six “Facts” About Our Debt: Corrections to Robert Solow’s Op-Ed

In yesterday’s NYTimes, Nobel winner Robert Solow tackled the US debt debate, proclaiming that while it is a serious issue, many Americans are not aware of the facts. See here:

Solow is a “neoclassical synthesis” Keynesian, the type of Keynesian economics that used to be taught in the textbooks. He was also on the wrong side of the “Cambridge controversy”, as the main developer of neoclassical growth theory. Still, he’s often on the “right side” when it comes to macro policy questions. And at least part of what he says about the US national debt is on the right track. But he gets enough confused that it is worthwhile to correct the errors.

I’ll list his six main bullet points, and provide my response. You can see his article for his own explanation of each bullet point.

1.       Roughly half of outstanding debt owed to the public, now $11.7 trillion, is owned by foreigners. This part of the debt is a direct burden on ourselves and future generations.

He is correct that debt held by foreigners commits the US government to payment of interest—and principal if foreigners want it when bonds mature. If in the future foreigners decide to use those payments to purchase US-made goods and services, this would be a “burden” in real terms in the sense that we’d have to work to produce stuff we do not get to consume. He’s right about that, too. If we were at full employment at that time, then we’d end up with less domestic output to use at home. Far more likely, we will have excess capacity (as we almost always do), so the extra foreign demand would lead to more employment and production in the US. This is almost never seen by any country as a “burden”, since most countries are demand constrained—so they welcome more demand. That reflects policy errors, since most countries continually leave the proverbial “low hanging fruit” on the trees in the form of unemployed labor and production facilities. The demand from abroad will induce us to “pick” some of that fruit—putting Americans to work.

However, at the same time, it is hard to say how the extra demand for US output might affect the exchange rate of the dollar and our overall trade balance. If the rest of the world has excess capacity, we do not necessarily have to consume less (even if we were at full employment) since we can use our extra income to buy from abroad. Our imports will then “burden” foreigners. So in conclusion we have to say that it is highly likely that if foreigners of the future decide to buy more from us, more Americans will be working to produce exports—presumably something they will want to do—and we’ll probably import more, too. Technically, then, he is right that we’ll have the burden of more employment.

2.       The Treasury owes dollars, America’s own currency (unlike Greece or Italy, whose debt is denominated in euros).

Correct! Glad this has finally gone mainstream! We cannot face involuntary default. We aren’t Greece. Or Italy. Nor are we Germany.

3.       One way to effectively repudiate our debt is to encourage inflation. When prices rise, interest and principal are repaid in dollars that are worth less than they were when they were borrowed.

OMG. That is not a debt repudiation. Except in the case of inflation-indexed bonds, debt is written in nominal terms. It is not a “repudiation” to pay back what you promised: dollars. This is a misuse of words. Most countries have at least some inflation almost all of the time. Creditors know this. They don’t call it a “debt repudiation” every time the CPI clicks up. Only the GoldBugs do, and they stuff their portfolios full of gold, not bonds.

Note that for a sovereign government, inflation makes it no “easier” to pay the interest promised. Payments are always made with keystrokes and it takes no more effort to keystroke “strong” dollars than “inflation-weakened” dollars. However, as discussed in point 1, if foreigners of the future try to buy output from us, their dollars will buy less to the extent that we have inflated our prices. So we’ll probably have fewer jobs created should that come to pass. Less “real” burden.

4.       Treasury bonds owned by Americans are different from debt owed to foreigners. Debt owed to American households, businesses and banks is not a direct burden on the future.

Now hold it a second. Bond holders are going to get interest keystroked into their accounts no matter where they live. They can spend it, “forcing” other Americans to work to produce the stuff they want to buy. If we are already at full employment, more goes to bond holders and less to workers producing that stuff. I suppose if you are inclusive and say that we’re all Americans, whether we work or just collect interest, then it is true that “we” are not burdened because “we” consume what we produce. But from the point of view of those doing the working to support consumption by a “rentier” class (whether foreign or domestic), that is a “burden”. You can’t call it a “burden” when we work hard to send goods and services to the rentiers abroad but then say it is not a burden when the rentiers live within American borders. Either it is a burden, or it is not. Where the rentier class happens to live doesn’t matter.

5.       The real burden of domestically owned Treasury debt is that it soaks up savings that might go into useful private investment.

Oh boy. The “Keynesian” Solow throws out Keynes’s General Theory, which demonstrated that this is nonsense. Investment creates saving. Budget deficits create saving. You need the spending before you get the income that you then decide to save. The second step is to decide what form in which you want to save it. If Solow wanted to argue that treasury debt might be preferred over corporate debt, then we’ve got a portfolio decision that could mean higher interest rates on corporate bonds. That, of course, depends on Treasury’s “debt management” strategy. However, as we know, budget deficits, all else equal, place downward pressure on overnight interest rates (relieved through government bond sales unless the Fed wants ZIRP—zero interest rate policy). So: a) deficits create saving, so cannot reduce the amount that “might go into useful private investment”; and b) deficits place downward pressure on interest rates, not upward pressure.

6.       But in bad times like now, Treasury bonds are not squeezing finance for investment out of the market. On the contrary, debt-financed government spending adds to the demand for privately produced goods and services, and the bonds provide a home for the excess savings.

Not really. Look at it this way. The savings cannot be “excess”, rather they are created by the deficits; indeed you can see those savings as the “accounting record” of the deficits. I do agree, of course, that government deficits are preventing the economy from falling back into deep recession (so far). The private sector has retrenched. The budget deficits are largely nondiscretionary from the point of view of the government, and have grown due mostly from the collapse of tax revenue. The private sector wants to save to restore balance sheets—a good thing—and the government’s deficit allows them to do that.


12 Responses to “Six “Facts” About Our Debt: Corrections to Robert Solow’s Op-Ed”

RonTMarch 1st, 2013 at 12:20 am

5) is really terrible for a mainstream economist to say. It is accounting, not some general equilibrium between intertemporally maximizing robots mumbo jumbo. It should be really simple to show once and for all, as it requires almost no questionable assumptions.

Rob RawlingsMarch 1st, 2013 at 12:34 am

"Note that for a sovereign government, inflation makes it no “easier” to pay the interest promised. Payments are always made with keystrokes and it takes no more effort to keystroke “strong” dollars than “inflation-weakened” dollars"

This is a little mis-leading. It may be just as easy to make the electronic payment but it surely is harder for governments to not spend as much so they don't have to borrow so much – and don't end up having to inflate the money supply to reduce the value of the debt.

Rob RawlingsMarch 1st, 2013 at 12:42 am

"You need the spending before you get the income that you then decide to save"

Surely at full employment this is not the case. Everyone who wants one has already got an income at full employment – so if the government starts to spend more where can that come from the except from reducing private investment and consumption ?

Neil WilsonMarch 1st, 2013 at 8:17 am

"Where the rentier class happens to live doesn’t matter"

I think this is the key viewpoint argument that we have out here in the real world.

If your mental model is the entire world with a set of currency areas trading with each other 'endogenously' as sub components within your closed model of the planet you can see the rentier behaviour for what it is.

However if your mental model is just your current economy with a mystical 'external sector' that seems to act like some Deus Ex Machina then you'll have a completely different viewpoint.

The interesting issue is why people get fixated on a particular view point in their modelling.

jan andreassenMarch 1st, 2013 at 9:49 am

Two thoughts.

This also a ''list of effects'' article. The full genrel equlibirum treatment is needed.

US deficits affcet other contries prospects their policies etc. Pluss commodity prices and share values.

Solow should be wise enough to be cautious about long term predictions – of anything. at the least ''the real long term'', must be based on heroic assumptions about demography.

jonf34March 1st, 2013 at 2:15 pm

"Technically, then, he is right that we’ll have the burden of more employment. "
Little snarky there, chief, eh?

You economists give me a headache. To save or not to save, that is the question. It's good: it's bad, who can say?

Philip PilkingtonMarch 1st, 2013 at 5:34 pm

"The real burden of domestically owned Treasury debt is that it soaks up savings that might go into useful private investment."

And THAT is where the stupid Solow growth model comes roaring back in.

Philip PilkingtonMarch 1st, 2013 at 5:41 pm

This is where the Cambridge Controversies come back in. They ALWAYS do. After all, how can you say anything bad about rentiers when income distribution is simply done through marginal productivites and remtiers are just "patient consumers"? Some Post-Keynesians say "Oh, neo-Keynesians like Solow, Tobin and Krugman are fine. The debates are over minor issues that are only theoretical. We're all buddies after all…".

I totally disagree with this. Certain aspects of the neoclassical synthesis are strongly ideological and are founded on logical inconsistencies and outright lies. And when I say "ideological" I don't mean political. You can be a right-wing Post-Keynesian who engineers the economy to produce high profits and low wages. What I mean by ideology is more insidious. More so something that literally blinds you to the real features of the world around you.

Philip PilkingtonMarch 1st, 2013 at 6:57 pm

The spending/investment still creates income. However, real income will be eroded. Some call this "forced saving" but its this term that is misleading. The investment is driving the saving and the effects of inflation are eroding the value of the money. They are two logically distinct steps. Blending them together in your mind simply displays fuzzy reasoning.

jack strawMarch 2nd, 2013 at 6:40 pm

"fuzzy reasoning" maybe but not "fuzzy logic." the fact that i "missed a step" doesn't mean i missed the outcome.

jack strawMarch 2nd, 2013 at 6:52 pm

more like "the real features of the world bind you to it." anywho "this is all very hard to wrap one's mind around" given it's very "unnatural" vibes. This is not to say i disagree with it…either as a portrayal of reality or conclusive in living in it. Indeed "is not what is said here what the Large Scale Asset Purchases" is all about? to "lend liberally to good credits" (with the best being the Federal Government itself)? i think the basic foundation for preventing a deflationary collapse was created in 2008. having said that i find nothing that has been done to have prevented a deflation from happening anyways. this is an OUTLIER view i understand…and having been fully invested in the "conventional" approach to recovery (with the "weird numbers"–as in TRILLIONS–caveat) i can't say why i've moved to the outlier position…but i have (that we are still going to get the deflation—perhaps mild, perhaps major.) it's really hard to factor in all the "variables" when talking policy–we ALL are just shooting into the dark here–i'm a history guy and this is why i am confident of hitting my target even though the future is by its very nature "opaque" at best. basically "we have constraints" going into the policy making process itself which only allow for a certain set of outcome based judgements to begin with. the USA had a lot of flexibility because in 2008 we were perceived and the WORLD perceived us as solvent. it looked for a while there (2009/10) that this might not in fact be the case actually…but once the Chinese started the buying the rest of the world followed…and "the rest they say is History Making" and not just history. there is no doubt that the recovery has been the worst in post war US history…the cataclysm was avoided however…and that in and of itself is confidence inspiring indeed. in other words we can be "forward leaning" as none of the basic functionings of the Federal largesse were impacted by 2008…so we have CHOICES we can make…something not available quite frankly to the rest of the world. great article, well presented…look forward to more like it.