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.