Is debt a burden on future generations? It depends.

Does government debt impose a burden on future generations? Paul Krugman says no. Nick Rowe says yes. But they're talking about different things.

Paul Krugman asks: If we wake up in 2012 and find ourselves with $9 trillion in government debt, are we any worse off than if we wake up and find ourselves with zero government debt? Assuming that all of our government debt is held domestically (so that we don't have to slave away for foreigners), and assuming that we don't default on our debt (which causes economic disruption), the answer is "no." Some people (creditors) are better off and some are worse off, but overall it's a wash.

Nick Rowe asks: If, starting now in 2012, we rack up some more debt over the next decade, will that make our descendants in 2042 worse off than they would be if we didn't rack up any more debt? Rowe's answer is "yes." To show how this works, Rowe makes an "overlapping generations" model where all goods are perishable and debt temporarily grows faster than GDP. In the model, the government uses debt to give extra consumption to the older generation, then taxes the younger generation to pay back the debt. Voila! A burden is imposed on the young.

But see, here's the interesting thing about Rowe's model: the government doesn't need to use debt to impose this burden on the young. It can achieve exactly the same result with zero debt, just by taxing the young directly and spending on the old (i.e. a Social Security system with unsustainably large contributions). In Rowe's model, debt is just an accounting system that keeps track of how much consumption has been transferred from the young to the old. But the debt itself doesn't really matter; only the consumption transfer matters.

So I think this tells us something important about debt in the real world. What matters is not debt, it's intertemporal choice. The important question is not how much debt we rack up, but whether we want to move consumption from the future into the present or from the present into the future.

In the real world, the way we move consumption around through time is through investment. In Nick Rowe's toy model there is no investment (because all consumption goods are perishable), but in the real world, the way we move consumption into the future is by investing in productive assets, like buildings or machines or education or ideas. The way we move consumption from the future to the present is by reducing investment and consuming more today.

So when the government takes out more debt, does it move consumption from the future to the present, or from the present to the future? The answer: It depends on what the government spends the money on!!!

("Aha!", you say at this point. "But investment = savings, and debt is negative saving, so more debt always means less investment!" And here is where I invoke Krugman: For the government to borrow money, someone has to save money by buying the government bonds. Objection overruled!)

It depends on what the government spends the money on. If the government borrows money and then invests it in productive assets - building or repairing infrastructure, researching new ideas, improving schools - and if those productive assets have real rates of return that exceed the rate at which the government borrowed, then the debt (or rather, the debt-financed spending) transferred consumption from us to our descendants, not the other way around. And note that this is true whether the government borrows domestically or from foreigners. But if the government spends the money on consumption - for example, buying everyone in the country a birthday cake - then the debt-financed spending has transferred consumption from our descendants to us...it has imposed a burden on future generations.

Now, it's also true that the private sector can act to neutralize some or all of this intergenerational consumption transfer. If increased public debt is spent on consumption goods (birthday cake), then the private sector can choose to invest more of its own money in productive assets (e.g. office buildings or trucks), thus negating the burden imposed on the future generations. To what degree that actually happens is an open question.

But the basic point is this: When asking whether running up our debt will impose a burden on future generations, the key question is what the government will do with the money it borrows. I personally believe that the U.S. is currently underinvesting in the kind of productive assets that only the government can cheaply create - roads, bridges, electrical grids, broadband infrastructure, and basic research. That means that if our government borrows to invest in those things, it will be doing our grandkids a favor, not imposing a burden.