Friday, January 6, 2012

More Diamond (1965)

First - I figured my readers were aware, but in case you weren't this guy was the one of the three 2010 Nobel laureates.

In the last post I agreed strongly with Gene's conclusion that Bob actually disproved what he set out to prove. Transfers of consumption from young people to old people by definition impose burdens on young people. If we then ask "how does our method of financing this affect the burden?" we find that in a simple model, it doesn't affect the size of the burden at all, although it can shift the burden forward in time if we finance it with deficits. But the point is, a burden isn't imposed by deficit financing. Deficit financing is a way of manipulating the incidence of a given burden (Krugman's initial point). And of course, if we were financing new apple trees rather than apple consumption there might not even be a net burden on future generations to speak of.

Diamond (1965) actually notes that we should be careful to make this distinction, shortly before the passage that I cited earlier.

He writes:

What Bob and Nick have been doing is what Diamond refers to as "balanced budget incidence". That's fine - that sort of analysis is important when we make decisions about policy. We find that a consumption transfer from young to old introduces a burden on the young, and so we have to ask ourselves "is that worth it?". I would say yes. I'm guessing Bob would say no. That's a balanced budget incidence question.

Diamond (1965) argues that if we're interested in the question of whether deficits burden the future, we should restrict ourselves to analysis of differential incidence.

That way, we wouldn't make Bob's mistake of looking at the burden of a transfer and mistaking it for the burden of a deficit.

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