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Interest Burdens and Debt

Saturday, 27 April 2013 07:27

Since the NYT is doing Reinhart and Rogoff 24-7, I suppose BTP should follow suit. One point that some of us keep making that continually disappears into the ether (as opposed to eliciting a response from our Harvard duo or their accomplices) is that rather than being high, the interest burden of the debt is near post-war lows. It is currently less than 1.5 percent of GDP. In fact, it is less than 1.0 percent of GDP if we subtract the $80 billion that the Fed refunds to the Treasury from the assets it is holding. This means that rather than being an extraordinary burden right now, the debt is actually a very low burden.

Insofar as this point draws a response, it is generally that interest rates will rise in the future as the economy recovers. That may well be true, but we will have contracted large amounts of debt at very low interest rates. This means that even in a story where the Fed does raise interest rates as the economy recovers, the interest burden will just be rising back to levels we have seen before. In fact, in the Congressional Budget Office's projections we will not get back to the early 1990s interest burden of more than 3.0 percent of GDP until 2021. It is also worth remembering that this interest burden did not prevent the United States from having strong growth through the decade of the 1990s.

Again, the interest burden can be lowered by more than half of a percentage point of GDP if the Fed continues to hold assets, refunding the interest to the Treasury. This would require an alternative mechanism for restricting the money supply, specifically raising reserve requirements. While there are reasons for not wanting to go this route, given the large potential savings to the government (@ $80-$100 billion a year), it is an option for budget savings that Congress certainly should be considering.


The obvious point about debt burdens that the Reinhart and Rogoffs of the world refuse to address is that the value of debt changes in response to changes in interest rates. Specifically, the price of long-term bonds issued at today's low interest rates will fall sharply if interest rates rise, as is predicted. This means that if there is some growth curse associated with crossing their 90 percent debt-to-GDP threshold then we can just buy back these bonds at much lower prices when interest rates rise and cut hundreds of billions, if not trillions, off the value of the debt. 

This would of course leave our interest burden unchanged, so there would be no point in carrying through this exercise in the real world. But this sort of debt management would have enormous payoffs to those who accept the Reinhart-Rogoff cliff. As I have also argued endlessly, we could do large asset sales as well to reduce the debt burden. For believers in the Reinhart-Rogoff cliff, selling off assets to get the debt-to-GDP ratio down would be great policy since only debt affects growth in their calculations. 

Reinhart-Rogoff write as though they have been unfairly treated in the public debates since their spreadsheet error was exposed. Given the poor quality of their analysis and the harm it has done to people across the planet, they have gotten off easy.

Comments (8)Add Comment
written by liberal, April 27, 2013 8:54
That may well be true, but we will have contracted large amounts of debt at very low interest rates.

Yes, but the term structure of the debt is an important issue.

The more short-term debt as a fraction of the total, the less this is a big benefit if rates go up.
Why is "debt" so bad anyway
written by Jennifer, April 27, 2013 8:55
It never ceases to amaze me how "bad" government "debt" is considered. Never mind that private companies as a matter of course carry significant debt and the banks are, as I write this, actively lobbying to hold as little assets, i.e. "real money" as possible and to "leverage" i.e. borrow as much as possible. As many progressive economists have pointed out, when you consider how low interest on the government debt is right now, and how much good could be done with more borrowing--i.e. increasing employment and therefore increasing GDP and ultimately decreasing the debt--its really criminal that these anti-debt screeds get any traction whatsoever.
They Have Gotten Off Easy
written by Paul Mathis, April 27, 2013 9:02
Indeed they have! What would they have done to a grad student who turned in such sloppy work? Do we even need to ask?

Keep up the great work Dean!
interest on excess reserves
written by Peter K., April 27, 2013 9:44
"This would require an alternative mechanism for restricting the money supply, specifically raising reserve requirements. "

Is this the same as raising the rate on excess reserves? AFAIK, the Fed has said this is what they'll do. The "exit strategy" will be unproblematic as it was in the early 90s (except that we'll probably get another bubble somewhere!) Tax revenues will go up with growth too.
IOR and Reserve Requirements
written by Steve Roth, April 27, 2013 10:29
"This would require an alternative mechanism for restricting the money supply, specifically raising reserve requirements. "

Or raising interest on reserves? Doesn't IOR put us in a whole different game?
Unemployment burden
written by bakho, April 27, 2013 11:34
R&R also fail to mention that whatever the future debt burden, it will be more difficult to pay if we have a high "unemployment burden"- a class of people who become unemployable because they failed to get "on the job" training during the Great Recession. Future debt burden would be easier to pay if the soon to be permanently unemployed were learning jobs skills so they would be producing future goods and services rather than relying on future transfer payments. Workforce development is critical to a modern economy. We are way underinvesting. My suggestion is to quit focusing on debt and start focusing on the creation of a large underclass in the near future.
Why don't economists learn finance?
written by Nate O., April 27, 2013 4:05
Why is Dean Baker (apparently) the only economist that understands how bonds are valued? For some reason, a troubling number of people with letters after their name think US debt = a variable rate mortgage.
written by Paine, April 28, 2013 3:52
Let's face the option of financial repression
We have a choice here

Wage rate repression or interest rate repression

After thirty or forty years of wage rate repression
Let's spin the flip side

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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.