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June 26, 2005

Yes, Virginia, Demand Curves for Bonds Slope Down

On the Wall Street Journal editorial page, Glenn Hubbard writes that if the U.S. budget deficit were not so big--i.e., if domestic savings were higher--that would put downward pressure on interest rates:

> WSJ.com - A Paradox of Interest : While the U.S. needs to raise domestic saving gradually to fund entitlement promises in Social Security and Medicare, getting America's fiscal house in order provides little short-term solution to global saving and investment imbalances. Increases in U.S. saving, with unchanged investment opportunities or financial system efficiency around the world, puts further downward pressure on the world real interest rate...

In the fall of 2002, you will remember, Glenn Hubbard had a different view--that changes in the budget deficit had little or no effect on interest rates. Let me quote from Bob Davis:

Bob Davis: To sell a package of tax cuts that will further deepen the budget deficit, the White House says that deficits don't matter. Is that true? Certainly, says Glenn Hubbard, chairman of the White House's Council of Economic Advisers. He derides the "current fixation" with budget deficits, and labels as "nonsense" and "Rubinomics" the view espoused by former Clinton Treasury Secretary Robert Rubin that higher deficits lead to lower growth.... By labeling the deficits-matter argument as "Rubinomics," the White House hopes to give a partisan edge to the fight...

And let me quote from Brookings's Bill Gale:

Bill Gale: Glenn Hubbard recently stated, "I don't buy that there's a link between swings in the budget deficit of the size that we see in the United States and interest rates. There's just no evidence." This is not an isolated comment on Hubbard's part. In a series of speeches, articles and interviews he's ridiculed the notion that deficits matter. He's called it Rubinomics, called it nonsense, and so on. So this is part of what appears to be a pretty concerted Administration effort to downplay the cost of budget deficits... [argue] that the change in fiscal status is not a concern...

The ever-gullible Washington Post even wrote big articles giving prominent place to all the economists saying that the effects of changes in U.S. budget deficits on interest rates were small and unimportant:

washingtonpost.com: Reagan Policies Gave Green Light to Red Ink : By Jonathan Weisman Washington Post Staff Writer. Wednesday, June 9, 2004; Page A11: [W]hen Vice President Cheney allegedly declared, "Reagan proved deficits don't matter," he summed up an enduring argument from the former president's economic legacy.... [S]ome economists... [say] [t]he argument against deficits is more about self-righteous moralism than economics.... With rising global prosperity, even a federal deficit as large as the United States' would present little competition for would-be investors.... Eric M. Engen and Columbia University economist R. Glenn Hubbard.... "The world's capital markets are lot more sophisticated and flexible than they were then," said N. Gregory Mankiw, the current chairman of Bush's economic council. "That probably means that other things being equal, changes in domestic fiscal situations have less impact."...

Still, it is nice to see that there are still some economists who call themselves Republicans who will admit that demand curves for bonds slope down.

Posted by DeLong at June 26, 2005 08:01 PM