Mankiw and Prescott

In his blog, Mankiw says:

In today's Wall Street Journal, economist Ed
Prescott (subscription required) writes about five macroeconomic myths.
This
passage left me scratching my head:

Myth No. 5: Government debt is a burden
on our grandchildren.
There's no
better way to get people worked up about
something than
to
call on their
sympathies for their beloved grandkids. The last
thing
that I want to do is
to burden my own grandchildren with the
sins of
profligacy. But we should
stop feeling guilty -- at least about
government debt
-- because we are in
better shape than conventional
wisdom suggests.
Theory
and practice tell
us that the optimal
amount
of public debt that maximizes the
welfare of new
generations
of entrants
into the workforce is two times gross
national
income,
or GDP. This
assumes 1% population growth, 2% productivity
growth,
4% real after-tax
return on investments, and that people work to age 63
and
live to age
85. Currently, privately held public debt is about
0.3 times
GDP, and if we
include our Social Security obligations, it is
1.6 times GDP.
In
either
case, we could argue that we have too
little debt.
What's
going on
here? There are not enough productive
assets -- tangible and
intangible
assets
alike -- to meet the
investment needs of our forthcoming
retirees. The problem
is that the
rate of return on investment --
creating
more productive assets --
decreases as the stock of these
assets increases.
An excessive stock
of these
productive assets leads to
inefficiencies.
Total savings by
everyone is
equal to the sum of
productive assets and
government
debt, and if there is an
imbalance in
this equation it does not mean we have too little or too many
productive assets. The fix comes from
getting the proper amount of government
debt. When people did not enjoy long retirements and population growth was rapid, the optimal amount of government debt was zero. However, the world has changed, and we in fact require some government debt if we care about our grandchildren and their grandchildren. If we should worry about our grandchildren, we shouldn't about the amount of debt we are leaving them. We may even have to increase that debt a bit to ensure that we are adequately prepared
for our own retirements.

Usually, even when I disagree with a fellow economist, I
can understand his point of view. But I am puzzled about this passage. Ed must have some model in mind, but I am not sure what it is. To some degree, it sounds like Ed is worried that the U.S. economy might accumulate more capital than what Ned Phelps called the "Golden Rule" level. As I discuss in my intermediate macroeconomics textbook, Phelps used a Solow growth model to show that an economy can potentially save beyond the point that maximizes steady-state consumption. Peter Diamond subsequently showed that such excessive saving can arise even when overlapping generations of consumers make individually optimal saving decisions. This situation is sometimes called "dynamic inefficiency." When an economy is dynamically inefficient, government debt can have the virtue of depressing the capital stock toward its optimal level.

Ochigdor Wall St Journal iig unshaad, Prescott iin ene hesgiig sain oilgoogui. Mankiw iin tailbariig unshaad l Prescott "dynamic inefficiency" iig heleh gsen yum bolovu gj oilgoloo. Harin busad 4 myth iig bol ihenh ediin zasagch sanal negdeh bh.