'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.  

Is government spending ‘crowding out’ private sector? No

By Kevin G. Hall

March 20, 2013 | McClatchy Newspapers

URL: http://www.mcclatchydc.com/2013/03/20/186450/is-government-spending-crowding.html

Waiting for a left-wing POTUS

I'm sorry to shatter your illusions, my tea-partying friends, but we don't actually have a real left-winger in the White House.  But boy, how we need one right now!...

I mean, Obama and the Democrats are so clueless and spineless that they have let Republicans seize on the economic disaster in the EU as evidence for gutting federal spending, mostly on entitlements, education and poverty alleviation.  When in fact the EU has embraced austerity measures, and most of the pain they're suffering now is a direct result of their spending cuts -- cuts that Republicans want to emulate!  It's mad and absurd.  But we reasonable, rational, evidence-based Americans have let them twist the truth and get away with it.  We have failed to educate our fellow citizens, and point to the EU's spending cuts as a mistake to avoid.

It was thanks to the Occupy movements that our national dialogue shifted back toward the interests of the 99 Percent, at least for a few months.  Yet Obama avoided them like kryptonite and most elected Democrats followed suit.  

Waiting for Lefty

By Robert Kuttner

July 8, 2012 | Huffington Post

The economy is plainly stuck in second gear. For the third month in a row, new job creation in June, at just 80,000, was barely enough to keep the unemployment rate from rising, and not nearly sufficient to accommodate new entrants to the labor market and unemployed people looking for work.

Not only did the private sector fail to create enough jobs. With the crisis in state and local budgets and the absence of federal aid, the loss of public sector jobs continued. Ordinarily in a slump, public employment takes up some of the slack. In this recession, government has shed 627,000 jobs.

Here's the deeper worry. Not only could a weakening economy cost Barack Obama the election -- this slump could literally go on indefinitely.

In the aftermath of a financial collapse, the economy gets stuck in a downward spiral. Banks are too traumatized to lend, businesses see too few customers to invest, and there is too little purchasing power among consumers who are either out of work or who haven't seen a raise in a decade. The housing bust only adds to the downward drag.

Exports have been a bright spot, but as Europe succumbs to a similar vortex of recession compounded by austerity, Europe's even worse economic woes are likely add to America's.

Something similar happened in the late 1930s. Though economic growth returned, it wasn't strong enough to repair the damage of the Great Depression or create enough jobs. Despite the New Deal, unemployment remained stuck at around 12 percent.

World War II solved the problem -- it was the greatest accidental economic stimulus in economic history. It put people back to work, retrained the unemployed, and recapitalized industry. But today, there is nothing in the wings waiting to play the role of the Second World War.

During the war, federal deficits averaged more than 25 percent of GDP, nearly triple today's deficits.  But that's what it took to blast out of the depression. After the war, high growth rates paid down the accumulated national debt.

What's needed today is a massive investment program, to shift the economy to a clean energy path, modernize infrastructure, increase productivity -- and along the way create millions of good jobs and restore consumer purchasing power.  Then, the vicious circle could be reversed.

The problem is that neither party is proposing such a program. It is entirely outside mainstream debate.

President Obama is willing to have the federal government spend more money. But he has partly bought the story that deficit reduction has to come first. The Republicans would further gut the public sector.

Contrary to the conventional view that deficit reduction would somehow "restore confidence" and increase business investment, that's not how economies work. Businesses invest when they see customers with open wallets.  Though the Congressional Budget Office projects higher growth returning around 2014, it bases these projections on a "return to trend." There is no plausible story about where the higher growth will come from.

If we don't get a drastic change in policy, we will be stuck in this rut for a generation or more.

The best case for November is that Obama is re-elected and somehow the Democrats take back the House and hold the Senate. If this happens, it will not be due to green economic shoots or a persuasive Democratic program but because Mitt Romney is such a dismal candidate.

However, with dozens of Senate Democrats senators committed to the folly of deficit reduction first, there is no prospect of an investment program on a scale that could make a difference.

I am an optimistic by temperament, but I don't see much to make me optimistic about either economics or politics. Though the recession nominally ended in June 2009 when weakly positive growth returned, there is little doubt that the economy is stuck in a long-term slump that could well deepen between now and November.

Frankly, the best hope is that whether Obama wins or loses, progressives take back the Democratic Party so that a candidate genuinely committed to full employment runs and wins in 2016. But that's an awfully long time to wait. And in the meantime, as government fails to improve things, more people are likely to give up on politics or to turn to demagogues.

It is also possible that Barack Obama in a second term, freed of the need to win re-election and looking to his legacy, could become more of the leader we thought we were electing in 2008, shaming Republicans and rallying Democrats to back a true recovery program. Nobody would be more surprised or pleased than your faithful writer.

Stiglitz on austerity: 'Willful ignorance of the past is criminal'

This one is still worth reading, from my other favorite bearded liberal Nobel economist.

After Austerity

By Joseph E. Stiglitz

May 7, 2012 | Project Syndicate

This year's annual meeting of the International Monetary Fund made clear that Europe and the international community remain rudderless when it comes to economic policy. 

Financial leaders, from finance ministers to leaders of private financial institutions, reiterated the current mantra: the crisis countries have to get their houses in order, reduce their deficits, bring down their national debts, undertake structural reforms, and promote growth. Confidence, it was repeatedly said, needs to be restored.

It is a little precious to hear such pontifications from those who, at the helm of central banks, finance ministries, and private banks, steered the global financial system to the brink of ruin – and created the ongoing mess. Worse, seldom is it explained how to square the circle. How can confidence be restored as the crisis economies plunge into recession? How can growth be revived when austerity will almost surely mean a further decrease in aggregate demand, sending output and employment even lower?

This we should know by now: markets on their own are not stable. Not only do they repeatedly generate destabilizing asset bubbles, but, when demand weakens, forces that exacerbate the downturn come into play. Unemployment, and fear that it will spread, drives down wages, incomes, and consumption – and thus total demand. Decreased rates of household formation – young Americans, for example, are increasingly moving back in with their parents – depress housing prices, leading to still more foreclosures. States with balanced-budget frameworks are forced to cut spending as tax revenues fall – an automatic destabilizer that Europe seems mindlessly bent on adopting.

There are alternative strategies. Some countries, like Germany, have room for fiscal maneuver. Using it for investment would enhance long-term growth, with positive spillovers to the rest of Europe. A long-recognized principle is that balanced expansion of taxes and spending stimulates the economy; if the program is well designed (taxes at the top, combined with spending on education), the increase in GDP and employment can be significant.

Europe as a whole is not in bad fiscal shape; its debt-to-GDP ratio compares favorably with that of the United States.  If each US state were totally responsible for its own budget, including paying all unemployment benefits, America, too, would be in fiscal crisis. The lesson is obvious:  the whole is more than the sum of its parts. If Europe – particularly the European Central Bank – were to borrow, and re-lend the proceeds, the costs of servicing Europe's debt would fall, creating room for the kinds of expenditure that would promote growth and employment.

There are already institutions within Europe, such as the European Investment Bank, that could help finance needed investments in the cash-starved economies. The EIB should expand its lending. There need to be increased funds available to support small and medium-size enterprises – the main source of job creation in all economies – which is especially important, given that credit contraction by banks hits these enterprises especially hard.

Europe's single-minded focus on austerity is a result of a misdiagnosis of its problems.  Greece overspent, but Spain and Ireland had fiscal surpluses and low debt-to-GDP ratios before the crisis. Giving lectures about fiscal prudence is beside the point. Taking the lectures seriously –  even adopting tight budget frameworks – can be counterproductive. Regardless of whether Europe's problems are temporary or fundamental – the eurozone, for example, is far from an "optimal" currency area, and tax competition in a free-trade and free-migration area can erode a viable state – austerity will make matters worse.

The consequences of Europe's rush to austerity will be long-lasting and possibly severe.  If the euro survives, it will come at the price of high unemployment and enormous suffering, especially in the crisis countries.  And the crisis itself almost surely will spread. Firewalls won't work, if kerosene is simultaneously thrown on the fire, as Europe seems committed to doing: there is no example of a large economy – and Europe is the world's largest – recovering as a result of austerity.

As a result, society's most valuable asset, its human capital, is being wasted and even destroyed. Young people who are long deprived of a decent job – and youth unemployment in some countries is approaching or exceeding 50%, and has been unacceptably high since 2008 – become alienated. When they eventually find work, it will be at a much lower wage.  

Normally, youth is a time when skills get built up; now, it is a time when they atrophy.

So many economies are vulnerable to natural disasters – earthquakes, floods, typhoons, hurricanes, tsunamis – that adding a man-made disaster is all the more tragic. But that is what Europe is doing. Indeed, its leaders' willful ignorance of the lessons of the past is criminal.

The pain that Europe, especially its poor and young, is suffering is unnecessary. Fortunately, there is an alternative. But delay in grasping it will be very costly, and Europe is running out of time.

Krugman: Europe is cautionary tale for U.S., but not how you think

We in the U.S. have a bit of time to see how austerity and high interest rates help Europe's economy before we ourselves go into full austerity mode, but so far the effects in Europe have been dire. Soon to be catastrophic.

In the U.S. we also have too many who irrationally fear the inflation bogeyman -- primarily those who are living comfortably and don't want to see the value of any of their assets fall on some distant and undefined future date. We cannot let them rule the present day.

Killing the Euro

By Paul Krugman

December 1, 2011 | New York Times

Can the euro be saved? Not long ago we were told that the worst possible outcome was a Greek default. Now a much wider disaster seems all too likely.

True, market pressure lifted a bit on Wednesday after central banks made a splashy announcement about expanded credit lines (which will, in fact, make hardly any real difference). But even optimists now see Europe as headed for recession, while pessimists warn that the euro may become the epicenter of another global financial crisis.

How did things go so wrong? The answer you hear all the time is that the euro crisis was caused by fiscal irresponsibility. Turn on your TV and you're very likely to find some pundit declaring that if America doesn't slash spending we'll end up like Greece. Greeeeeece!

But the truth is nearly the opposite. Although Europe's leaders continue to insist that the problem is too much spending in debtor nations, the real problem is too little spending in Europe as a whole. And their efforts to fix matters by demanding ever harsher austerity have played a major role in making the situation worse.

The story so far: In the years leading up to the 2008 crisis, Europe, like America, had a runaway banking system and a rapid buildup of debt. In Europe's case, however, much of the lending was across borders, as funds from Germany flowed into southern Europe. This lending was perceived as low risk. Hey, the recipients were all on the euro, so what could go wrong?

For the most part, by the way, this lending went to the private sector, not to governments. Only Greece ran large budget deficits during the good years; Spain actually had a surplus on the eve of the crisis.

Then the bubble burst. Private spending in the debtor nations fell sharply. And the question European leaders should have been asking was how to keep those spending cuts from causing a Europe-wide downturn.

Instead, however, they responded to the inevitable, recession-driven rise in deficits by demanding that all governments — not just those of the debtor nations — slash spending and raise taxes. Warnings that this would deepen the slump were waved away. "The idea that austerity measures could trigger stagnation is incorrect," declared Jean-Claude Trichet, then the president of the European Central Bank. Why? Because "confidence-inspiring policies will foster and not hamper economic recovery."

But the confidence fairy was a no-show.

Wait, there's more. During the years of easy money, wages and prices in southern Europe rose substantially faster than in northern Europe. This divergence now needs to be reversed, either through falling prices in the south or through rising prices in the north. And it matters which: If southern Europe is forced to deflate its way to competitiveness, it will both pay a heavy price in employment and worsen its debt problems. The chances of success would be much greater if the gap were closed via rising prices in the north.

But to close the gap through rising prices in the north, policy makers would have to accept temporarily higher inflation for the euro area as a whole. And they've made it clear that they won't. Last April, in fact, the European Central Bank began raising interest rates, even though it was obvious to most observers that underlying inflation was, if anything, too low.

And it's probably no coincidence that April was also when the euro crisis entered its new, dire phase. Never mind Greece, whose economy is to Europe roughly as greater Miami is to the United States. At this point, markets have lost faith in the euro as a whole, driving up interest rates even for countries like Austria and Finland, hardly known for profligacy. And it's not hard to see why. The combination of austerity-for-all and a central bank morbidly obsessed with inflation makes it essentially impossible for indebted countries to escape from their debt trap and is, therefore, a recipe for widespread debt defaults, bank runs and general financial collapse.

I hope, for our sake as well as theirs, that the Europeans will change course before it's too late. But, to be honest, I don't believe they will. In fact, what's much more likely is that we will follow them down the path to ruin.

For in America, as in Europe, the economy is being dragged down by troubled debtors — in our case, mainly homeowners. And here, too, we desperately need expansionary fiscal and monetary policies to support the economy as these debtors struggle back to financial health. Yet, as in Europe, public discourse is dominated by deficit scolds and inflation obsessives.

So the next time you hear someone claiming that if we don't slash spending we'll turn into Greece, your answer should be that if we do slash spending while the economy is still in a depression, we'll turn into Europe. In fact, we're well on our way.