Fiscal sustainability and generational equity are two of the most pressing policy issues of our times. Yet these two highly related concerns are difficult to clearly define, let alone measure.
The standard metric of long-term fiscal imbalance is official government debt (Reinhart and Rogoff 2009). But, as shown in Green and Kotlikoff (2009), official debt, like time and distance in physics, is not a well-defined economic concept.
In physics, the measurement of time and distance depends on one’s frame of reference, which can be viewed as one’s language. Measurement of debt is also language dependent.
Unfortunately, language is highly flexible. And there is an infinite number of ways to label an economy’s fiscal policy in neoclassical economies with rational agents, no matter how well or how poorly such economies function. Each labelling convention results in a different history and projected future time path of official debt. The same holds true of taxes, transfer payments, disposable income, personal saving, private saving, government saving, private wealth, and government wealth. Each of these measures is devoid of economic content.
With the right labels, unsustainable fiscal policies are compatible with huge and exponentially growing reported surpluses. Likewise, sustainable policies are compatible with huge and exponentially growing deficits.
The timing of policy is also up for grabs. There is no use saying our fiscal problems lie in the future. They do with one set of words (our short-run cash flows look great) and don’t with another (our short-run cash flows look terrible). On the contrary, our fiscal problems lie in the state-contingent policy path being followed, and its analysis defies truncation..."
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