The Post Is Confused About Interest on the Debt

Print
Thursday, 17 February 2011 06:12

The Washington Post had a front page article highlighted the rising interest payments made by the federal government as a result of its rising debt. It would have been useful to point out that the decision to pay interest to wealthy bondholders is a policy choice, not a fact of nature.

It is possible for the Federal Reserve Board to buy and hold government bonds. In this situation interest on the government debt is paid to the Fed, which then refunds the money to the Treasury, creating no net interest burden for the government. Last year, the Fed refunded nearly $80 billion to the Treasury based on the large amount of mortgage backed securities and Treasury bonds it now holds.

While the Congressional Budget Office projects that the Fed will sell off these assets over the next few years it could opt to buy and hold a large amount of debt (e.g. $3-4 trillion). To prevent inflation when the economy recovers it could raise reserve requirements, the same route that China's central bank is now pursuing to head off inflation in China.

The decision to not have the Fed hold bonds is a policy decision. This policy choice should have been discussed in the article. Having the Fed buy and hold bonds would be one way to avoid imposing a large tax burden on the general public as a result of the countercyclical measures necessary to lift the economy out of this downturn. Readers should be informed about it.

This piece is really an editorial intended to scare readers into supporting harsh measures to reduce the deficit. It makes not effort to place the budget deficits in any sort of historical context and includes scary sounding assertions with no real meaning, such as:

"The borrowing the United States did over the past decade - to pay for the 2001 tax cut, the wars in Iraq and Afghanistan, and propping up the economy during the steep 2009 downturn - is coming due this decade."

There is no way in which this statement makes any sense. Bonds are coming due every month of every year. There is nothing "coming due" this decade that does not come due every decade.

It also would be useful if the Post did not rely exclusively on economists who failed to see the $8 trillion housing bubble as its sources in its economic reporting. 

 

Addendum: It is also worth noting that the ratio of interest payments to GDP is not projected to rise back to its early 90s level until well into the next decade. So the idea that we will be facing an unprecedented interest burden is not accurate. Thanks to Gary Burtless for reminding me of this point.