Sunday, March 24, 2013

'Inconclusive' link between public debt, interest rates

Empirical data refutes the conservative mantra that higher government debt always leads to higher interest rates, thereby "crowding out" private investment:  

In a paper published by the National Bureau of Economic Research in April 2005, Columbia University economist R. Glenn Hubbard and Federal Reserve economist Eric Engen declared as “inconclusive” the link between government debt and interest rates. Hubbard headed George W. Bush’s White House Council of Economic Advisers from 2001 to 2003.

“While analysis of the effects of government debt on interest rates has been ongoing for more than two decades, there is little empirical consensus about the magnitude of the effect, and the difference in views held on this issue can be quite stark,” they wrote.

In fact just the opposite can happen:

Deficits as a share of the U.S. economy have risen sharply at times with little to no discernible impact on the level of U.S. interest rates. In fact, just a cursory look at periods when the U.S. ran large deficits as a share of (the total economy) – 1983, 1991-92, 2008-2012 – we actually saw declines in nominal long-term (lending) rates,” said [Scott] Anderson [chief economist for Bank of the West in San Francisco].

He noted that the yield, or return on investment for bondholders, has not and did not rise sharply. “So the link between high levels of government spending and borrowing does not appear to raise the cost of money during these periods and therefore would not crowd out private consumption and investment,” Anderson said.

Just to show how fair & balanced I am, here's a recent WSJ op-ed that warns against a "fiscal dominance" scenario in the U.S., where debt-to-GDP consistently exceeds 80 percent, interest rates shoot up, debt increases even more, interest rates shoot up even higher, and a "fiscal death spiral" ensues.  Theoretically this is possible, but since this scenario depends a lot on "investor confidence," that means everything is relative.  Take Japan for example. Its debt-to-GDP ratio has been over 150 percent for years. It's now 225 percent. Yet Japan's borrowing costs remain low because of real deflation and the relative strength of the Japanese yen.  


By Kevin G. Hall
March 20, 2013 | McClatchy Newspapers

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