Wednesday, February 19, 2014

Government Debt Increases Less-Private Debt More

For years, the U.S. has had a sharp rise in its government debt, at a rate of more than a trillion dollars per year while household debt, particularly mortgage debt (largely due to debt writedowns), fell.

In 2013 the government deficit fell sharply due to higher taxes, lower spending and the economic recovery, but at the same time private debt stopped shrinking and started to increase again, particularly in the fourth quarter.

Is there a causal connection? Yes, at least partially. While Ricardian equivalence doesn't hold fully, people will save more (and borrow, which is a form of dissaving, more) when deficits are high, as they fear that in the future they will have to pay more to and/or receive less from the government. And so when the deficit falls they will save less, and borrow more.


Blogger netbacker said...

You have that opposite. You need understand sectoral balance. When government sector moves toward surplus or reduces deficits, some other sector needs to go into defict to make up the difference. With more taxes and less government spending, the private sector has to go into deficit I.e. Borrow from their savings to keep up with their needed spending.

6:46 AM  
Blogger stefankarlsson said...

netbacker: Well, I did in fact argue that there was a connection between the decreased government deficit and the decrease in private savings.

However, the connection isn't quite as necessary as you argue. A decrease in the government deficit could just as well result in higher investments and/or a decreased current account deficit.

7:32 AM  
Blogger Ralph Musgrave said...

If the average household does save more given a high government deficit (which I very much doubt) then households are behaving in a totally irrational manner. Reason is that it doesn’t make sense for government to raise taxes and repay debt unless there’s excess demand: a situation in which raised taxes do not reduce living standards – they simply ameliorate inflation. So “saving to repay debt brought about by deficits” is a farce.

However, numerous so called professional economists believe in the “saving to repay debts arising from deficits” idea. Which ironically means the average household has more sense than the average so called professional economist.

7:16 PM  
Blogger stefankarlsson said...

Ralph, what are you talking about? Governments raise taxes all the time without there being "excess demand". And tax increases reduce net income regardless of whether it's excess demand or not.

1:36 PM  

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