The moral concerns of defaulting on government-issued debt

In his recent blog post, Noah Smith gives full life to a point I think Paul Krugman has been subtly making for a while – at a political level, the best policy is very irrelevant: 

This means that politics’ response to policy is highly nonlinear – give the enemy an inch, and they take a mile. It also means the response is highly path-dependent; precedent matters.

This discussion is a response Krugman’s take on Miles Kimball’s piece here. There’s a beautiful essay by Margaret Levi in this compilation. The better analogy, she claims is a tree, not a path: 

Path dependence does not simply mean that “history matters.” this is both true and trivial. Path dependence has to mean […] that once a country […] has started down a track, the costs of reversal are very high. There will be other choice points but the entrenchments of certain institutional arrangements obstruct an easy reversal of the initial choice. Perhaps the better metaphor is a tree […] From the same trunk, there are many different branches […] Although it is possible to turn around […] from one to the other – and essential if the chosen branch dies – the branch on which a climber begins is the one she tends to follow

Noah tackles the path dependence from a behavioral perspective, that technocrats like Kimball offer solutions that will ultimately be rejected by a public that thinks debt is bad: 

In other words, finding optimal, first-best technocratic solutions might be far less important than simply embedding “AUSTERITY = BAD!!!” in the public consciousness. 

The more salient point, one that Krugman makes, is that the political will doesn’t exist to mold to a more adept public. That is, Osborne and Cameron are highly averse to real stimulus because their careers have been staked on the virtue of austerity. Keynesians aren’t any better (except in that they are probably right). Krugman’s reputation would be forever stained if Eurozone austerity suddenly kickstarted private demand for investment, churning with it economic growth. 

Levi makes a striking point, “it is possible to turn around form one to the other, and essential if the chosen branch dies”. Embedding the idea that austerity is bad within the public conscious won’t do anything, precisely because his own point that politics are path dependent. More importantly, convincing the public that deficits are okay for now is a lot harder than it seems. The reason for this, of course, is many politicians and pundits have a reputation predicated on deficits being bad. So long as they are the source of information for much of America, much of America will never be convinced otherwise. This idea is here to live, because we can’t kill that branch. 

Now for the economics. 

The question at hand was the worthiness of so-called federal lines of credit, or FLOCs. The idea that government will lend to consumers directly, ensuring that every dollar is spent unlike ARRA. Noah’s concern is valid – FLOCs would increase only aggregate demand, government investment in infrastructure and education would have huge supply-side pay dirt too.  

I also think it’s highly presumptuous that the whole dollar would be spent by the borrower. This policy, as Mike Konczal notes, is clearly not intended for AmEx cardholders. The demographic that would benefit most from federal credit is likely in serious debt already. Chances are, beneficiaries would be paying insane interest on credit card debt (or even moneylenders), which would just be rolled over to the government. 

Another example of socializing financial sector risk. 

Now, FLOCs will stimulate the economy without increasing deficits assuming defaults are controlled for (more on that later). However, the government would have to initially allocate the funds for credit, for which it will have to sell bonds. So from a political perspective, spending still increases (and from an economic perspective we know short-run cyclical deficits aren’t a bad thing but, as Noah points out, no one cares about the economic perspective). There is also the very murky issue of ensuring repayment.

The government, unlike any bank, can ensure repayment. There is also the moral issue that it shouldn’t do so. Doing so could imply freezing of assets and use of its monopoly on law enforcement. It can have you fired, it can do what it wants. This would be highly immoral, as the social risk falls to the neediest.  

However, it would be equally immoral to lend out money knowing full well that you are not ensuring its return. This, in turn, would encourage mass default. I also highly doubt there is any civic responsibility, anymore, to repay a loan (especially when you see the inequality all around you) to a government that, according to you, is doing a disservice.

If default becomes publicly acceptable, FLOCs become glorified stimuli, which will be no different from ARRA. I take issue with Konczal’s assertion that the burden of this scheme would be unfairly felt by the poor and needy. This would be true if, but only if, the government became a repo man. However, it’s a false dilemma to compare a federal line of credit with progressive taxation: 

This means that as the bottom 50 percent of Americans borrow and pay it off themselves, they would bear all the burden for macroeconomic stability through fiscal policy. Given that the top 1 percent captured 93 percent of the income growth in the first year of this recovery, that’s a pretty major transfer of wealth. One nice thing about tax policy, especially progressive tax policy, is that those who benefit the most from the economy provide more of the resources. This would be the opposite of that, especially in the context of a “”relatively-quickly-phased-in austerity program.”

If the program works as intended, this would help the people with highest credit bills the most. However, spending and progressive taxation are a false dilemma. That 93% of income goes to 1% of the people is a structural flaw of our recovery, and will exist so long as income inequality grows the way it does. I fully support policies to avert this trend, but that’s another story. Investing in the Northeast Corridor would also help our Beltway elite the most. 

Noah’s right, we should probably spend more on infrastructure, but Kimball tries to suggest a policy that wouldn’t require long-run spending. But there is no way a government with a monopoly on law and military can extract deficit in a moral way.