Exchange between Arrow and Davidson on debt

Linked with Meine Frage vom 29. Juni 2010. – Published on Real-World Economics Review Blog, by Editors, July 24, 2010.

… (Kenneth J. Arrow – excerpt): … There was an argument about the “burden of the debt,” in the 1960s; it was summed up in an excellent paper by Franco Modigliani, who, however, did not go into the implications for future counter-cyclical policy.  Without going into details here, the point emphasized by Modigliani was the displacement of private investment. His model presupposed the absence of the Ricardo effect; if there were a Ricardo effect (prediction of future tax burdens due to debt issuance), then Keynesian policies could not possibly be effective, since people would increase saving to compensate for the deficit. Hence, the same argument that deficit financing is stimulating implies that public debt can be a burden.

I understand your concerns that the argument can be used to decrease social security and government medical support. It can equally well be used to justify increased taxes to pay for them.

In any case, as the proportion of population over 65 increases, it is clear that in fact something does have to be done. There is one obvious step: increase the age of retirement. As people are becoming healthier at any given age, this is a reasonable (to me, obvious) policy. It is a kind of decrease in retirement benefits (including health) but is compensated for by an increase in national income through an increase in labor force participation … //

… (Paul Davidson – excerpt): … In 2001 I had a debate with Tennessee Senators Bill Frist and Fred Thomson regarding privatizing social security. During our debate the Senators raised the issue that in x years there would be some many more elderly per employed worker than currently so that we (the employed population) could not afford to support the elderly in their comfortable social security way. Consequently the Senators argued we had to immediately raise the age of retirement to 70 so as to keep more members of the population working and paying into the fund and therefore there would be fewer retired senior citizens drawing down the fund each year in the future.

I pointed out to the Senators that if this debate was taking place 100 years earlier (in 1901), I could note that for every 20 mouths to feed in the USA at the time, it required over fifteen workers in agriculture and food distribution to provide enough food.  Suppose in 1902 I then told them that 100 years in the future (in 2001), there would be less than 4 agricultural and food distribution workers for every 20 American mouths to feed.  Would they say Americans would be starving to death in 2002 ? [ Bob Eisner , at the time, had a number of articles pointing to the fallacy of the cry that Social Security was doomed to bankruptcy if something was not done to prevent future deficits in the system.]

In fact near the end of your letter you state “”…the past is by no means a reliable predictor of the future”. So apparently you agree that the ergodic axiom is not applicable to our real world economy.  But if the ergodic axiom is not relevant, then what policy implications can we draw from any variant of an Arrow-Debreu-Walrasian intertemporal spot and forward market model –covering the indefinite future?

I hope you do not think I am being to forceful in putting forward my argument but I truly believe that many of our professional colleagues have mistakenly accepted the idea that the federal government’s debt is always a burden– and not , at less than full employment, a blessing to help us get back to prosperity and a civilized society … //

… (full long debate).


Kenneth J. Arrow, on wikipedia, his page at the Pontifical Academy of Social Sciences, his Nobel Prize in Economics Recipient, and his Collected Papers;

Paul Davidson (economist) on wikipedia, his Homepage, also Neglected Phrophets, 7 pdf pages, and Post-Keynesian economics.

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