Monday, December 11, 2006

Now I am confused

In today's Wall Street Journal, economist Ed Prescott (subscription required) writes about five macroeconomic myths. This passage left me scratching my head:

Myth No. 5: Government debt is a burden on our grandchildren. There's no better way to get people worked up about something than to call on cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365ir sympathies for cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365ir beloved grandkids. The last thing that I want to do is to burden my own grandchildren with cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 sins of profligacy. But we should stop feeling guilty -- at least about government debt -- because we are in better shape than conventional wisdom suggests.

Theory and practice tell us that cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 optimal amount of public debt that maximizes cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 welfare of new generations of entrants into cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 workforce is two times gross national income, or GDP. This assumes 1% population growth, 2% productivity growth, 4% real after-tax return on investments, and that people work to age 63 and live to age 85. Currently, privately held public debt is about 0.3 times GDP, and if we include our Social Security obligations, it is 1.6 times GDP. In eicá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365r case, we could argue that we have too little debt.

What's going on here? There are not enough productive assets -- tangible and intangible assets alike -- to meet cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 investment needs of our forthcoming retirees. The problem is that cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 rate of return on investment -- creating more productive assets -- decreases as cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 stock of cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365se assets increases. An excessive stock of cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365se productive assets leads to inefficiencies.

Total savings by everyone is equal to cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 sum of productive assets and government debt, and if cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365re is an imbalance in this equation it does not mean we have too little or too many productive assets. The fix comes from getting cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 proper amount of government debt. When people did not enjoy long retirements and population growth was rapid, cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 optimal amount of government debt was zero. However, cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 world has changed, and we in fact require some government debt if we care about our grandchildren and cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365ir grandchildren.

If we should worry about our grandchildren, we shouldn't about cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 amount of debt we are leaving cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365m. We may even have to increase that debt a bit to ensure that we are adequately prepared for our own retirements.

Usually, even when I disagree with a fellow economist, I can understand his point of view. But I am puzzled about this passage. Ed must have some model in mind, but I am not sure what it is.

To some degree, it sounds like Ed is worried that cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 U.S. economy might accumulate more capital than what Ned Phelps called cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 "Golden Rule" level. As I discuss in my intermediate macroeconomics textbook, Phelps used a Solow growth model to show that an economy can potentially save beyond cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 point that maximizes steady-state consumption. Peter Diamond subsequently showed that such excessive saving can arise even when overlapping generations of consumers make individually optimal saving decisions. This situation is sometimes called "dynamic inefficiency." When an economy is dynamically inefficient, government debt can have cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 virtue of depressing cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 capital stock toward its optimal level.

Andy Abel, Larry Summers, Richard Zeckhauser, and I once wrote a paper on this topic. We concluded that while dynamic inefficiency is possible in cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365ory, it is not a problem in practice. Is Ed now coming to cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 opposite conclusion, or does he have something entirely different in mind? I am not sure.

Update: Click here.