Not all the paranoia about fiscal deficits has been exorcized. Jim Hamilton tells us that, if interest rates rise, the interest burden on the federal debt will swallow us whole, or nearly. Where will we get the cash to service this monster?
The short answer is: from the same folks who are collecting all this interest. Lord knows, there’s plenty of room for tax increases on the wealth-holding class, and there’s no reason why we can’t have a private-to-public flow of tax transfers to offset any increase in public-to-private interest transfers. More even. If our economy ever gets back on its feet and away from the ZLB, fiscal multipliers will be small again, and smaller still at the highest income brackets.
The key is to remember that, if the increased government debt is held domestically, we are simply seeing a shifting of net credit positions between the private and public sectors. If the balance shifts too much toward private net wealth and public net obligation, we have ways to rebalance again. If interest rates rise, lean on the tax lever; if not, go a little easier.
I hear you ask, what if a significant portion of new public debt ends up in the hands of foreigners? If they are simply substituting public credit assets for private, our domestic wealth-holders have increased their portfolios of something else, and we can tax them just the same. If there is a sizeable net increase in foreign holdings of US assets, public and private, then we have a widening payments imbalance to deal with—and that’s the problem, not the fiscal deficits. (Yes, I hear some say, and fiscal deficits cause current account deficits, which sounds fine as long as you don’t look at the evidence.)
However, we are saddling future generations with difficult problems because of our political shortsightedness today. They will have more poverty and broken lives to repair because of this endless slump, a less educated society and an infrastructure shortfall because of funding cuts, and above all a climate change problem that may well be intractable. If we care about future generations, this is what we will deal with today. Deficit paranoia is not a harmless quirk if it prevents us from spending the money to do what needs to be done.
"I hear some say, and fiscal deficits cause current account deficits". The current account deficit by definition is the difference between national savings and investment. OK if fiscal stimulus raises consumption relative to potential GDP and crowds out investment via higher real interest rates, then it lowers net exports. But in today's economy fiscal stimulus could raise GDP relative to potential without an increase in interest rates, which potentially could raise national savings by even more than that it raises investment. And yes it is true that higher GDP means more imports but there is nothing to rule out policies that would also raise exports.
ReplyDeleteJust to be clear, pgl, the "twin deficits" types see causation running from low net savings (of which fiscal deficits are a component) to high interest rates to high exchange rates to trade deficits. It is not primarily about differential growth rates. But the evidence for the transmission mechanisms is paltry, and no consideration is given to the opposite (Keynesian) causation from the trade balance to GDP to savings. That is what I argued in the article to which I linked, but in this context it's something of a tangent.
ReplyDeleteI'm a novice at this bond thing, but I'm pretty cure that higher interest rates will only apply to newly issued debt. The current outstanding long term debt generated over the past several years at pathetic yields should lose a bundle of market value, Doesn't Dean Baker address this issue here? http://www.cepr.net/index.php/blogs/beat-the-press/reinhart-rogoff-one-more-time-why-the-90-percent-never-should-have-been-taken-seriously
ReplyDeleteFrom that article:
"I have often pointed out that the value of long-term debt fluctuates with the interest rate. I didn't think this is a secret, but apparently few economists have followed what happens to bond prices when interest rates change. The point is that the value of our debt will plummet if interest rates rise, as the Congressional Budget Office and other forecasters expect. This means that we could buy back long-term debt issued today at interest rates of less than 2.0 percent for discounts of 30-40 percent. This would sharply reduce our debt-to-GDP ratio at zero cost."