Public debt: the generational angle

Updates on Aging Populations

Inheritance is a word that has taken on positive connotations: the implication is that something of value is passed down from generation to generation. In wealthy societies, the debate is usually limited to whether and by how much it should be taxed.

But that’s not always how it works. Debts can also be inherited. In extreme examples, such as North Korean prison camps, political responsibilities are passed down from generation to generation.

What does this have to do with public debt? A new IMF working paper, “Reasons for Borrowing,” covers a wide range of issues, in particular the reasons for excessive debt (we strongly recommend the entire document, here).

What jumped out at us, however, was a brief section on the generational angle (emphasis added):

Individuals can leave positive legacies to their offspring, but private negative legacies cannot be imposed by law. However, individuals who would like to leave a negative legacy can use public debt to redistribute resources from future generations to current generations.. Cukierman and Meltzer (1989) use a nested generations model to study an economy with two types of individuals: citizens who wish to leave a positive legacy for their children and constrained citizens who wish to leave a negative legacy. The first group only cares about public debt in terms of its effect on the economy, because individuals who belong to this group can fully reverse the intergenerational effects of higher public debt by increasing their bequests. The individuals constrained by the bequest would rather wish to issue more debts because this relaxes their constraint. In such a configuration, the level of indebtedness depends on the legacy constraint faced by the median voter.

So, among many, many other angles, public debts can be seen as a kind of collective negative inheritance. Obviously, part of it depends on how the debt is used – you can also argue that they often represent positive legacies, in infrastructure or other public goods.

To put this in context, public debts to GDP have risen sharply since the crisis. In advanced economies, the average debt-to-GDP ratio rose from around 60% in 2007 to over 90% in 2016. Only three euro area countries – Germany, the Netherlands and Malta – have ratios lower. This year than they did in 2008.

The article then summarizes the literature on public debt and intergenerational transfers.

Song et al. (2012) instead study a model in which the young and the old have different preferences for public goods and taxation is a source of distortion. In this context, the level of indebtedness is determined by these preferences (which may vary from country to country) and by the political power of the two groups. Jackson and Yariv (2015) show that if there are two groups of individuals and one group (the old) cares less about the future than the other group (the young), a government that aggregates preferences of these two groups may suffer from a present bias. Yared (2018) shows that the theory is consistent with the fact that there is a positive correlation between the rate of growth of public debt and the aging of the population.. It should be noted that the Standard Social Planner Model would predict the inverse correlation.

Just as one might say that older people care less about the future than younger people, they might counterintuitively care more about the present than younger people (due to a higher need for health services, government pension distribution and other services). While public debt is a preference for current consumption over future consumption of public services, it aligns conceptually with the incentives of the former. (It’s important to distinguish between public and private debt – when it comes to credit cards or mortgages, which meet the current constraints of consumption, but not utilities, the roles are reversed. )

It would be a stretch to attribute the recent trajectory to higher levels of public debt to an aging population only, given the number of other factors, including the global financial crisis and unprecedented monetary policy experiences.

But in the aftermath of the crisis, it was political movements associated with youth that generally called for higher levels of public debt. As the IMF document makes clear, there are many, many reasons why politicians might want to increase debt. But it would be ironic if the radical appeals to the young were also a coded signal for the old.

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