Tuesday, October 8, 2013

Do Government Deficits Harm Future Generations?

John McCain tried to run his campaign by arguing that government deficits are like stealing from future generations.  That did not enable him to win the election but the GOP has been sticking with that message in the hope that it will eventually convince the public to vote for them in general elections.  The argument hinges on selling the public on a fallacy.  At an individual level the money that we borrow and spend today does affect our ability to spend in the future.  At the population level, however, that is not true.  Government borrowing creates assets for those who purchase government debt and liabilities for a different group of people.  This is difficult for most people to understand so this article is posted to explain how government debt differs from individual debt.

If we assume a closed economy, in which the government sells bonds in order to fund a deficit, the government can run surpluses in order to redeem the bonds as they mature.  Those who purchased the bonds have new cash that can be used to purchase something else.  The money came from the government surplus that was provided by taxpayers who did not purchase the bonds.  They have no liabilities for future interest payments.  That happens rarely in the US.  Most of the time the government issues new debt in order to redeem bonds as they mature.  The current generation pays the interest on this debt immediately; it is not passed on the future generations.  This assumes that the government is creditworthy and able to issue new bonds at reasonable interest rates.  This is pretty much what is happening today in the US.  Some countries are not able to turn over their debt as it matures.  That could happen in the US if the government were less fiscally responsible than it has been in the past.  Actually, the government debt to GDP ratio has been declining for several years.  The GOP's focus on deficit reduction in a period of declining deficits seems to be misplaced.

In an open economy, the government does borrow from international investors.  The level of borrowing from foreign investors, however, is not closely related to the size of US budget deficits.  It is more closely related to our current account and our capital account.  We borrow from international investors to fund our current account deficits which occur when we import more than we export.

One of the problems that we have with our focus on deficit reduction is that we may refrain from making investments that would have a positive effect on future generations.  Our grandchildren may face a future will less education than they require and with a deteriorating infrastructure that leads to slow growth in productivity.  Some forms of government spending are investments in the future.  It would be foolhardy to cut back on important investments as we are doing today with our focus on deficit reduction.  What kind of environment and economy do we want to leave to our grandchildren?

No comments:

Post a Comment