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A public policy blog from AEI
Phil Gramm and Steven McMillin are certainly correct in worrying about the potential downside of the large and growing national debt. But in their Wall Street Journal op-ed today, they make the following claim: “Once the Federal Reserve’s easy-money policy comes to an end and interest rates return to their post-World War II norms, the cost of servicing this debt will explode.”
In other words, it sounds like some sort of debt crisis is pretty much just around the corner. Thoughts:
1. This is an argument for doing what exactly? Getting the debt on a downward trajectory toward historical levels over a couple of decades? Yes. Balancing the budget ASAP even it means tax hikes or slashing government research spending? No.
2. Concern about what may happen to rates when the Fed winds down its bond buying may be overstated. A recent analysis by JP Morgan concludes “tapering Fed asset purchases from $85bn down to $0bn should cause 10-year yields to increase by 25-30bp.” That’s not so much.
3. Higher yields would likely be accompanied by higher growth which would make servicing the debt easier. Rates are low — both here and globally — because economic growth is weak. The reason debt servicing is such a problem for, say, Italy is due to a collapse in growth.
4. Will rates return to their post-WWII levels? I don’t think that’s a done deal. Much has been written about the “mystery” of low interest rates. Perhaps it reflects global aging and birth rate declines. As economist Scott Sumner said at a recent AEI event on market monetarism:
If you look at a graph of real interest rates on 10-year Treasury bonds from the last 30 years, they start around 7, 7.5 percent. These are real interest rates and they cycle downward, almost on a linear trend line for 30 years into negative territory. That’s a phenomenal drop in real interest rates that’s been going on for 30 years. That means it involves more than this cycle. This cycle played a role. It involves more than easy money because it’s been a 30-year period of falling inflation. If it was easy money, we would have seen rising inflation.
So something odd is going on with the credit markets globally in terms of real rates. It’s been going on for 30 years. There’s all these theories, you know, savings, and age, and everything. But I think we have to recognize that interest rates just aren’t a good indicator and we don’t fully understand why they’re so low, but certainly it’s partly the weak economy now, but it’s also probably other mysterious things that at some point in the future, we’ll better understand.
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