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Fun With Debt and Deficits

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Monday, 08 April 2013 15:25

Dylan Matthews had a nice piece explaining why we need not worry about current deficits and the relatively high debt to GDP ratio. He left out one very important reason, probably to avoid making prominent economists look stupid.

The debt to GDP ratio is to some extent an arbitrary number. The point here is that the price of long-term debt (e.g. 10-year and 30-year bonds) fluctuates with the interest rate. Currently bond prices are very high because interest rates are very low. However if interest rates rise back to more normal levels, as the Congressional Budget Office and others project, then the price of bonds issued at today's low rates will plummet.

This can be seen by playing with any standard bond calculator. This would mean that we could buy back the bonds we issue in today's low interest environment at discount rates of 20 percent, 30 percent, possibly even 40 percent. This would allow us to instantly shave hundreds of billions fo dollars, maybe even trillions, off the size of the debt. (Matthews' colleague Allan Sloan made this point in a slightly different context a few months back.)

Of course there would be no point to this sort of bond buyback since it would leave the country's interest burden (now near a post-World War II low) unchanged. However, for those economists and politicians who worship debt-to-GDP ratios, such bond buybacks should be a godsend. So, we can promise them that we do this sort of bond back and then we can spend what is needed to get the economy going again without having these annoying people getting in the way.

Comments (3)Add Comment
question
written by pjm, April 08, 2013 6:10
When bonds are bought back, it obviates the need to make further interest payments. Why does not effect the interest burden? Are you just saying the effect on interest burden very small even when the debt could be reduced by large amounts?
...
written by JSeydl, April 08, 2013 6:39
pjm, there would be no change in the interest burden because the debt issued to buy back the bonds would be issued at a higher interest rate.

But I've been thinking about this example more, and something else came to my mind. The reason the debt-to-GDP ratio is a futile measure is because its not marked-to-market. When we say the ratio XX%, that counts the price of all the bonds issued by the government when they were issued. If the ratio included in its numerator the price of bonds in the market, it would be a reasonably good measure and would stand up to Dean's criticisms.
Effect on SS Trust ?
written by john h, April 08, 2013 7:50
could someone comment on effects such interest rate changes would have on SS outlook since bonds constitute some portion of SS "assets" please ?
seems like it might have adverse effect if interest rates go up significantly, no?

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

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