'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

Dems must fight any 'grand bargain' (aka austerity)

As Bill Black notes, it can only be Obama's "vanity" making him promise a "grand bargain" on spending and tax cuts if he is re-elected.  In fact, we are now in a classic period of debt-deflation, the only answer to which is more public spending.

Sadly, it sounds like Obama has swallowed the Republican Kool-Aid that we're facing a fiscal "crisis," and that something must be done now to dismantle or privatize Social Security, Medicare, SNAP and a host of federal agencies, or else somebody's grandchildren will have to pay higher taxes.  

(In fact, the CBO estimates that the Budget Control Act that the Right so desperately wanted will turn about 4.4 percent projected GDP growth in 2013 into a recession in 1H 2013 with measly 0.5 percent GDP growth for the year. Much like what is happening in Europe: see below).  

In other words, Obama seems to have embraced austerity, even though the U.S., which partially embraced fiscal stimulus, has been growing consistently since July 2009 (albeit slowly), and partly because of the stimulus and not despite it.  By contrast, the EU is sadly realizing that austerity has been self-defeating: in the EU, debt-to-GDP ratios are growing; GDP is shrinking; and unemployment is growing.

If you still don't understand how that could be so, read this:

Why is [the EU's] fiscal consolidation so much more damaging now? Under normal circumstances a tightening in fiscal policy would also lead to a relaxation in monetary policy. However, with interest rates already at exceptionally low levels, this is unlikely or infeasible. Moreover, during a downturn, when unemployment is high and job security low, a greater percentage of households and firms are likely to find themselves liquidity constrained. Finally, with all countries consolidating simultaneously, output in each country is reduced not just by fiscal consolidation domestically, but by that in other countries, because of trade. In the EU, such spillover effects are likely to be large.

[...] The result of coordinated fiscal consolidation is a rise in the debt-GDP ratio of approximately five percentage points.  

P.S. - This makes 2001 posts to my blog, all-time, not counting the shit I deleted. So cue Strauss's Sunrise!:  "Buuum-buuum-buuuuuuuuuuum BUM-BUM! Boom-boom boom-boom boom-boom boom-boom boom-boom boom-boom boom!"

Baker: Failing arithmetic on national debt

Baker is the first pundit I know of who has made this point:  

While our debt to GDP ratio is approaching levels not seen since the years immediately following World War II, there is another key ratio that has been going in the opposite direction. This is the ratio of interest payments to GDP. This fell to 1.3 percent of GDP in 2009, its lowest level since World War II. While it has risen slightly in the last couple of years, the ratio of interest payments to GDP is still near a post-war low.

This gives us yet another example how the U.S. Government is not like a household.  How many of us can pay a lower interest rate as our debts grow bigger?  You and I can't.  But the USG can and does.    

Baker goes on to illustrate how interest owed on the national debt is more important than the absolute dollar value of outstanding debt, or the debt-to-GDP ratio:

Suppose that we issue $4 trillion in 30 year bonds at or near the current interest rate of 2.75 percent. Let's imagine that in 3 years the economy has largely recovered and that long-term interest rates are back at a more normal level; let's say 6.0 percent for a 30-year bond.

In this case the bond price would fall by over 40 percent meaning, in principle, that it would be possible for the government to buy up the $4 trillion in debt that it issued in 2012 for just $2.4 trillion, instantly lowering our debt burden by $1.6 trillion, almost 10 percentage points of GDP. If we had been flirting with the magic 90 percent debt to GDP ratio before the bond purchase, we will have given ourselves a huge amount of leeway by buying up these bonds.

Of course, this would be silly. The interest burden of the debt would not have changed; the only thing that would have changed is the dollar value of the outstanding debt. Fans of the 90 percent debt-to-GDP twilight zone theory may think that the debt burden by itself could slow the economy, but in the real world this doesn't make any sense.

Let's recall that America's debt-to-GDP ratio was nearly 120 percent after WWII.  "Yeah, but that was WWII!" you might say, "And after the Great Depression! No comparison!"

Well, yeah, it's hard to compare a war that lasted four years with two simultaneous wars that have lasted about 10 years and counting.  Meanwhile, the Great Recession wiped out $15.5 trillion in U.S. wealth -- about equal, coincidentally, to one year of U.S. GDP, and our total federal debt.  

And Dubya's Great Recession cost us 8.8 million jobs (more than the previous four recessions combined); as a result, many of those jobless people have qualified for "income security" payments built into our system that didn't exist in the 1930s, such as unemployment insurance, disability pay, food stamps, housing assistance, etc. Income security outlays increased from $431 billion in 2008 to $533 billion in 2009 to $622 billion in 2010 to $597 billion in 2011.  Next, more people opted for early Social Security benefits, plus they got a 5.8 percent cost of living increase in 2009, and for the first time the program ran a deficit.  Social Security outlays jumped from $617 billion in 2008 to $683 billion in 2009 to $706 billion in 2010 to $731 billion in 2011.  And let's not forget national defense spending, which increased from $616 billion in 2008 to $661 billion in 2009 to $693 billion in 2010 to $705 billion in 2011.

Finally -- and this is the factor so many people, especially on the right, overlook -- decreased economic activity -- combined with an extension of Dubya's tax cuts -- led to lower income and corporate tax receipts (and FICA receipts): down $419 billion in 2009 and $360 billion in 2010, compared to 2008.  

Meanwhile, overall spending increased $535 billion in 2009 (most of it thanks to Dubya) and $475 billion in 2010, compared to 2008.  

(See all the OMB's historical spending and revenue data here.)

So there are objective reasons why our deficits and debt have climbed.  It's ludicrous to blame it all on $475 billion in stimulus spending.

Next, let's look at the GAO's historical picture of annual net interest paid on the federal debt as a percentage of annual federal spending.  In 2011, interest payments were 6.4 percent of federal outlays.  From Reagan thru Dubya, that figure never fell below 7 percent.  In the decadent '80s it never fell below 8.9 percent.  In the dot-com '90s it never fell below 13.5 percent.  

Sure, interest rates will eventually go up as the economy recovers.  But first it has to recover.  Economic recovery should be our top priority right now, not paying off our debt when we enjoy historically low interest rates and suffer historically high unemployment.  Debt reduction now, which would cut GDP and raise unemployment, is putting the cart before the horse.

Just trying to put things in perspective.  Not that my Tea Partying friends will care....

Debt Worries: Economists Fail Arithmetic, Again

By Dean Baker

September 24, 2012 | Huffington Post

URL: http://huff.to/UzBh4o