The Phantom Menace

Robert Waldmann

The one by Paul Krugman is a must read.

what I hear is that officials don’t trust the demand for long-term government debt, because they see it as driven by a “carry trade”: financial players borrowing cheap money short-term, and using it to buy long-term bonds.


the remedy should be financial, not fiscal. Have the Fed buy more long-term debt; or let the government issue more short-term debt.

That does sound rather obvious doesn’t it ? Why aren’t they doing that ?
My guesses after the jump.

I assume you have read Krugman’s post. The very brief recap is that someone in the Obama administration does not want to count on carry traders to short short term bonds and hold long term bonds, yet they are not arguing that the Fed or the Treasury should do that directly.

I can only guess that the Treasury has strict taboos against this sort of thing and I further guess that the origin of the taboo is that fiscal honesty requires the Treasury to act like a private firm.

A private firm that issued a huge amount of short term debt to finance medium and long term liabilities is vulnerable to bankruptcy. The firm has to roll over it’s short term debt. A prophecy that it will fail to do so will be self fulfilling. For a private firm, issuing a huge amount of short term debt and counting on being able to roll it over is reckless.

I guess that some permanent employees at Treasury have a very strong rule that the correctly stated Federal deficit is the deficit it would have if it followed similar rules to a private firm. Counting the cost of carrying debt long term at the short term interest rate is cheating. The Treasury has to constantly fight politicians who want to cheat and understate the deficit. This temptation can only be resisted by strong taboos and bogus arguments based on wildly overstating the risk the Treasury will go bankrupt.

Another issue is the perpetual war between the political staff which wants high spending and low taxes and economic advisors and the Treasury and which wants a low deficit. Polls are showing strong public concern about the deficit and a desire for lower deficits causing the political staff to switch sides. Economists who have been warning of the dangers of deficits are reluctant to reverse field. In particular, people are reluctant to admit that arguments which they made in support of low deficits are and were bogus. Economists are reluctant to admit that their predictions were dead wrong. They are tempted to argue “It hasn’t happened yet, but it will soon.” A well known Obama administration economist has been predicting a sharp rise in interest rates on Treasury bonds for a while now.