Posted by: Dirk | August 1, 2014

Kotlikoff revives the old myth that a government spends like a household in the NYT

In a NYT article, Laurence Kotlikoff gives us his account of economics as it used to be: a science to confuse the public about what a government can and can’t do:

HOUSEHOLDS can’t spend, on a continuing basis, more than they earn. Countries can’t either, at least not over the long run. But countries can certainly leave the bill for their current spending to the young and to future generations. Official borrowing is the old-fashioned way to do this: Sell Treasury bonds, and other securities, and spend the proceeds. But borrowing in broad daylight has a drawback: The more you do it, the more lenders worry about repayment, and the more interest they charge for their loans.

This might sound very logical, except that there is a problem: a government is not a household. Why not? Well, households don’t have an account at the central bank, as the US Treasury has. Households also cannot sell treasury (or household) bonds that are risk free, because if push comes to shove the central bank will buy these bonds on the secondary market to an extent that all actors on the primary market will engage in arbitrage. If banks buy treasury bonds (and bills and notes) directly from the government, and they know that they can turn around and sell them to the Federal Reserve Bank for a profit, then there should be no doubt about one thing: the US government cannot go bankrupt. Which household can say that?

Kotlikoff continues:

The fiscal gap — the difference between our government’s projected financial obligations and the present value of all projected future tax and other receipts — is, effectively, our nation’s credit card bill.

Right. If the US government spends more than its tax income in the future, then it is charged to ‘our nation’s credit card bill’ today. As I have described above, the US Terasury does not have to rely on bank loans or credit card companies to finance its expenditures (above taxes). Let’s jump to his conclusion:

What we confront is not just an economics problem. It’s a moral issue. Will we continue to hide most of the bills we are bequeathing our children? Or will we, at long last, systematically measure all the bills and set about reducing them?

That is utter nonsense. We will not bequeath any bill to our children. If government spends more than it collects in taxes, it issues treasury bonds. These treasury bonds are bequeathed to our children, too. Somebody will be quite rich, as there are quite a lot of government bonds outstanding. Inequality can be a problem, because the future tax payers transfer money to those that are holding the bonds. Conveniently, Kotlikoff overlooks this issue.

The framing used by Kotlikoff to talk about US government debt is misleading. It is based on false analogies, starting with the idea that government spends just like a household. One could argue for lower social security payments, but not on the basis that the US government can’t afford it.

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