Eric M. Engen and R. Glenn Hubbard (2004), "Federal Government Debt and Interest Rates" (Cambridge: NBER: June 2, 2004 draft):
Does government debt affect interest rates?.... Taken together, the bulk of our empirical results suggest that an increase in federal government debt equivalent to one percent of GDP, all else equal, would be expected to increase the long-term real rate of interest by about three basis points [i.e., three-hundredths of a percentage point]...
This is a low number based on a crowding-out-of-investment and a marginal-product-of-capital analysis. The international economist next door beats up on me every time I make such an analysis: "What about inflation risk premia generated by a the fact that a higher debt makes inflation more attractive?" he asks. "What about rapidly-rising debt as a signal of general government incompetence? What about the fact that future taxes to service the debt will not only be high but also are uncertain?" To these I would add, "What discontinuities in the effects of deficits take place when a country shifts from a sustainable to an unsustainable fiscal policy?" But the Engen-Hubbard estimate is an in-the-ballpark number: the low end of the Gale-Orszag range I am used to.
This number means that if you run a 4% of GDP deficit for the next decade--as in, say, the Bush administration post-2009 baseline numbers that were not publicly released and that the press has paid next to no attention to--you are likely to push up interest rates by 4 x .03% x 10 = 1.2%.
And Engen and Hubbard end their paper with a plea that nobody take it to be a claim that, as Richard Cheney put it, "deficits don't matter":
Our findings should not be construed as implying that “deficits don’t matter.” Substantially larger, persistent, and unsustainable levels of government debt can eventually put increasing strains on the available domestic and foreign sources of loanable funds, and can represent a large transfer of wealth to finance current generations’ consumption from future generations which much eventually pay down federal debt to a sustainable level. Holding the path of non-interest government outlays constant, deficits represent higher future tax burdens to cover both these outlays plus interest expenses associated with the debt, which have adverse consequences for economic growth....
How adverse are the Engen-Hubbard consequences for economic growth? In their simplest model (which produces results that are, I think, in the ballpark but likely to be too large), pushing up the debt-to-GDP ratio by 40%--the result of the ten-year four-percent-of-GDP-deficit scenario--pushes down the county's capital stock by 14.4%, and makes the country 4.8% poorer.
Posted by DeLong at July 4, 2004 11:23 PM | TrackBack | | Other weblogs commenting on this postIt is clearly very hard to find a reliable base point for measuring this. I imagine that this also applies in measuring the effects of the different rate on growth. If so I have a few questions:
Is a linear rule what you would expect?
Is it likely that estimates and common understanding of the impact of raised real interest rates are low because they will not separate different components of the real interest rate? (In this scenario the 3 basis points are clearly the bad kind of contribution)
Do growth estimates include the effect of introducing the taxes to finally pay off the deficits? Debt shorter dated than the anticipated start of corrective action may be shielded from the full effects.
What do they assume about foreign ownership of debt? I believe the biggest problem in running a debt now compared to the 1980s is that financial markets are more well developed internationally so the US isn't the only game in town for foreign investment. So if China is persuaded to stop defending the yuan, we could find very high costs indeed.
Second, how do they take into account the fact that the Medicare and Social Security trust funds will soon stop being an automatic sop for deficits?
Posted by: Rob on July 5, 2004 04:33 AMThe debt-GDP (62% in US in 2003) and the debt-service/GDP ratio would steadily rise over a decade of sustained deficits of that size under any reasonable US GDP growth scenario. It seems hard to believe the effect on interest rates would be linear.
Posted by: Jonathan on July 5, 2004 08:30 AMPlus the deficits cause a net transfer of wealth from the poorer half, or three fifths, to large financial asset holders, since the retirement of the instruments is paid out of general revenue (or Social Security, if you like). Wouldn't that more lopsided distribution of wealth also impact long-term growth, by slowing the building of local infrastructure as state and local taxbases get strapped, and human capital growth via education continues to take a turn for the worse?
Posted by: Lee A. on July 5, 2004 09:09 AMIn 2004 we'll pay about $352,765 billion for debt interest. (See http://www.gpoaccess.gov/usbudget/fy04/sheets/fct_2.xls) (The Republicans like to report NET interest, which is about $176,395 billion.)
This is about 19% of the budget. That is a lot of money, just going to those with the means to loan trillions to the government. Never mind the effect on interest rates, we are being taxed to pay this to the rich and it increases every year. (It decreased under Clinton because the surplus paid down the debt.)
Posted by: Dave Johnson on July 5, 2004 03:49 PMWhy does Brad say that "pushing up the debt-to-GDP ratio by 40%--the result of the ten-year four-percent-of-GDP-deficit scenario?" If NGDP were to grow by 4% per year, a 4% deficit would keep the dept/NGDP ratio constant. Or is this a primary, net of interest deficit we're talking about here?
Posted by: Mark on July 5, 2004 04:47 PMProf Delong left this out...
http://pep.typepad.com/public_enquiry_project/2004/07/prof_delong_can_1.html
Posted by: Adrian Spidle on July 6, 2004 07:19 AMCreative minds always have been known to survive any kind of bad training.
Posted by: William Henry on July 7, 2004 01:01 AMWith newer medicines there is often no formal dish network information about safety in pregnancy. Nowadays, loan when new drugs are tested, soma women who directv are or might become pregnant are not allowed insurance to take part in the safety tests. This means direct tv that we do not have the same information credit card on safety in pregnancy which we have for people mortgage who are not pregnant.Probably just as well satellite tv for Mark's blood pressure that American Idol satellite tv
Posted by: job on July 25, 2004 03:50 PM2038 You can buy viagra from this site :http://www.ed.greatnow.com
Posted by: Viagra on August 7, 2004 07:48 PM2057 Why is Texas holdem so darn popular all the sudden?
http://www.texas-holdem.greatnow.com
1129 Get your online poker fix at http://www.onlinepoker-dot.com
Posted by: online poker on August 15, 2004 06:20 PM1598 black jack is hot hot hot! get your blackjack at http://www.blackjack-dot.com
Posted by: blackjack on August 17, 2004 01:26 AM