Occasionally people say that government debt represents borrowing from our collective economic futures. This is usually wrong. Michael Pettis has a nice thread explaining why.
In the following excerpt from The Economics of Imperfect Competition and Employment, Robert Eisner uses a neoclassical framework to explain why an extra dollar of government debt today is not a dollar taken from the pockets of our grandchildren. If we're at full employment, prices will rise proportionally with new debt, so the actual burden of the debt is not greater. If we're not at full employment, output will rise with new debt, as tax cuts or increased government spending put more money in the hands of workers and entrepreneurs, so the nominally larger debt actually shrinks as a proportion of the economy. Good for us, good for the grandkids.
"But once we get entangled in a world of government debt and changing price levels, the going gets treacherous. A number of widely held positions prove untenable. And many of the usual assertions about the effect of public debt and deficits become misleading at best and, at worst, particularly in presumed policy applications, egregiously wrong. Take the notion, for prime example, that an increase in the public debt will involve a transfer of wealth from the current to a future 'generation'. But surely, this proposition, if true, must relate to an increase in the real value of the public debt. Under what circumstances will government budget deficits lead to increases in the real value of the debt?
"Assume again a market-clearing, full-employment equilibrium. Then have the government cut taxes, thus producing a budget deficit which is financed by a mixture of interest-bearing debt and fiat money in the same proportions as the already existing value of government interest-bearing debt and money. In this situation, we should expect a new equilibrium -- with rational expectations, an immediate new equilibrium -- in which the general level of prices had increased in the same proportion as interest-bearing debt and money. There would hence be no increase in the real public debt or the real quantity of money and no change in any real magnitudes. And, of course, with no change in the real value of public debt, there is no transfer from one generation to another.
"Now assume, in good Keynesian fashion that, for whatever reason, markets are not clearing and that there is an excess supply of labor so that output is below its 'natural' rate. The cut in taxes and resultant budget deficit, again financed by a mixture of interest-bearing debt and money in the same proportions as the existing debt and money, will increase effective demand. Output will rise so that prices will rise less than in proportion to the increase in interest-bearing debt and money. Indeed, the increase in wealth that agents in the private sector perceive in the form of their government bonds and money may be viewed, in good neoclassical fashion (cf. Haberler, 1941; Pigou, 1943, 1947) as the forces increasing demand and output.
"But with increased output, we can expect more current consumption as a consequence of the increased wealth of households and also plans for more future consumption in accordance with the life-cycle hypothesis (Modigliani and Brumberg, 1954). Then in accordance with a conventional, neoclassical production function and rational expectations, there should be more current investment as well, as agents undertake to acquire the capital to be used in producing the goods and services to meet the expanded future consumption demand.
"We find therefore that the deficit and increase in the public debt result in an increase in capital and the provision of more output both currently and in the future. We are not increasing current consumption at the expense of the future generation. We are rather increasing consumption for both generations."
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