04 January 2015

The Problem with Government Debt (Part II)

While trying to understand why government debt is a bad thing, the second thing I found was this.  The author, Keith Hennessey, states that he is an economics policy teacher at Stanford's Graduate School of Business.  You would think that a teacher of Stanford graduate students would be able to make clear, concise arguments.  Apparently not.

Mr. Hennessey quotes four problems with government debt from a CBO report.  Summarized:
1) Interest payments will rise as interest rates return to normal;
2) Federal borrowing reduces capital stock and wages;
3) “Lawmakers would have less flexibility … to respond to unanticipated challenges;”
4) “A large debt poses a greater risk of precipitating a fiscal crisis"

We would hope that Mr. Hennessey would help us understand some of the background behind these statements, particularly (2): How does borrowing reduce capital stock and wages?

Mr. Hennessey "expands" on each of the points.  His expansion of point #4 is particularly instructive, but not in a way we would expect.  Primarily we learn that Mr. Hennessey has really poor communication and reasoning skills:

Those on the left who argue that high debt isn’t a problem like to (a) pretend that this increased risk is the only consequence of high debt, and then (b) dispute that the higher risk is significant enough to cause concern. I worry that when the U.S. has doubled its debt/GDP in five years, and when our future debt path looks like it does, that the risk of a fiscal crisis is significant. But this risk is unknowable, and even if we could somehow measure this risk, we can never know when that crisis would occur. My stronger arguments are (1) fiscal crisis risk is undoubtedly higher at a higher debt level; (2) the risk is only going to increase on our current path as debt increases; and (3) there are three other costs to higher debt, so even if you’re not worried about crisis risk, you need to address those other costs.

Hennessey's statement that "fiscal crisis risk is undoubtedly higher at a higher debt level" is content free.  The argument has already conceded this point; the question is whether or not the increased risk is significant.  The sun is a finite source of energy, but that isn't something we need to worry about in practice today.  Is increased fiscal crisis risk with higher debt levels similarly a theoretical issue along those lines?

The statement "the risk is only going to increase on our current path as debt increases" is also content free.  Yes, if risk increases as debt increases than risk will increase as debt increases.

Finally "there are three other costs to higher debt..." is a non-sequitur.  We are expanding on point #4.  Arguing that point #4 is a problem because there are three other problems makes no sense.

Point #3 is a circular argument.  Hennessey implies that we shouldn't run deficits during a fiscal crisis because it limits our ability to respond to a fiscal crisis by running a deficit.  This argument is also self-contradictory.  Presumably the reason we want to run a deficit during a fiscal crisis is to reduce the impact of the fiscal crisis.

Point #2 is never explained.  Hennessey says "lower government debt means more shiny new factories with high wage American jobs."  But, in the current context of a fiscal crisis, that is not true.  The reason interest rates are low is because the private sector does not want to build shiny new factories.

Point #1 makes no sense.  The argument is that we must reduce borrowing today while interest rates are low because if we don't change our current behavior, then when interest rates rise, we will be borrowing money at high interest rates.  However, if we can change our behavior today, then we can also change our behavior tomorrow.  Instead of stopping borrowing money while interest rates are low, we should stop borrowing money when interest rates are high.

Also, high interest rates imply that the economy has normalized.  Interest rates will be high because the private sector will want to build shiny new factories.  Employment will be high.  Spending on safety nets will be reduced.  Reducing the debt then when spending is already falling makes more sense.

I find it shocking that a Stanford Graduate School lecturer cannot explain the model he is using in clear language, but must resort to simply repeating ideological idioms without any evidence and even without a compelling explanatory narrative.


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