Year: 2025
Type: article
Abstract: Your retirement portfolio likely holds some bonds.In the hypothetical absence of federal government debt, those bonds would be corporate debt invested in capital ventures that yield future returns.You receive a return because an actual capital investment is made into the economy.That investment increases capital per worker and wages while lowering borrowing costs for a home mortgage.In reality, of course, 40% of your bond allocation likely holds various denominations of U.S. government debt.Naturally, those assets represent actual savings from your perspective.However, most government debt is used for spending programs or tax cuts that benefit current and past generations, rather than investing in long-term public assets like early childhood education or infrastructure.You earn a return simply because the U.S. Treasury must offer it to compete with alternative investments.So, most government debt redirects savings from actual investments for the future to support past and current consumption.Government debt "crowds out" private investment.But crowding out is just one problem.As debt grows, as it is projected to do for the United States, bond markets eventually lose faith in the ability of the government to make full payments in real terms.Such "bank runs" are infrequent but violent.They are fully rational and so they cannot be educated away or mitigated with financial regulation.Debt crises have brought down superpowers.It is tempting to immediately inquire about the exact empirical evidence-How much does debt crowd out private investment?What is the nation's fiscal capacity before a bank run emerges?-but it would make little sense without having a solid model for interpretation.Unfortunately, serious modeling of government debt on the economy is largely absent inside DC policy circles. 1 But the tools have existed for a long time and are widely used in academics.Paul Samuelson (1958) and Peter Diamond (1965) introduced the lifecycle overlapping-generations (OLG) model that accommodates a wide range of government policies.The OLG model requires being explicit instead of using heavy discretion to map from policy to non-OLG model input.Welfare analysis is also rigorous.Both "crowding out" and "bank runs" (fiscal limits) naturally emerge.OLG is the workhorse model of modern public finance and macroeconomics, so much so, that the top five general interest journals 1 The Joint Committee on Taxation uses the OLG model but does not regularly publish longer-term analysis extending beyond 10 years.The Congressional Budget Office has an OLG model in its Macroeconomics Analysis Division, but it appears to be rarely used these days.
DOI: 10.1002/pam.70040
Author: Kent Smetters
Institution: University of Pennsylvania
Language: English
Subfield: Economics and Econometrics
Domain: Social Sciences
Open Access status: hybrid
Estimated APC paid: $3,770
OpenAlex ID: W4413284306