Memo to younger readers: in an era of rising interest rates, deficits DO matter very much
Memo to younger readers: in an era of rising interest rates, deficits DO matter very much
If you are under about 45 years of age, the odds are that you agree with one statement made by Dick Cheney: that “Reagan proved that deficits don’t matter.”
As I mention from time to time, I am a fossil. I remember the “guns and butter” inflation of the late 1960s (Google is your friend) and the stagflationary 1970s.
Here is a graph of the interest yield on the 10 year bond from 1981 through 2013:
In an era of declining interest rates, deficits don’t matter — or at least very little.
Suppose the national debt runs up from $20 Trillion to $25 Trillion while at the same time interest rates decline from 4% to 3%. In that situation annual interest due on the debt goes from $800 Billion to $750 Billion — an actual decline of $50 Billion a year. That can cover a multitude of sins.
Now here is a graph of the interest yield on the 10 year bond from 1961 through 1980:
In an era of increasing interest rates, deficits DO matter very much.
Suppose in that era the national debt runs up from $20 Trillion to $25 Trillion while at the same time interest rates rise from 3% to 4%. In that situation annual interest due on the debt goes from $600 Billion to $1 Trillion — an increase of $400 Billion a year. That’s $400 Billion that can’t be spent on infrastructure or social or insurance programs.
Even if interest rates remain relatively stable as they have for the last five years:
Then the annual interest due in our example rises from $600 Billion to $750 Billion — a deadweight loss of $150 Billion per year.
Now look at those three graphs again. I would say that the odds of a further decline in interest rates of any significance is close to zero. So the choices are whether interest rates over the next decade or two go sideways from here, or rise.
Since I am a fossil, I may not live to see it. But, dear reader, if you are 45 years old or younger, it is high time you disabuse yourself of the “wisdom” of Dick Cheney.
How does this work considering:
““Interest rates on bonds currently issued are at historically low rates but are projected to rise in the future. If the United States were to buy back bonds at the market price in 2017, based on the interest rates projected by the Congressional Budget Office for that year, it would reduce the value of the outstanding debt by $458 billion dollars or 2.3 percent of projected GDP,” said Dean Baker a co-director and founder of CEPR. ”This measure is conservative since it assumes no savings on debt issued after March of 2013, yet it is still more than the projected reduction in defense or domestic spending for the years 2013-2021 resulting from the sequestration.”
The issue brief, “Financial Engineering: The Simple Way to Reduce Government Debt Burdens,” calculates the potential savings if the U.S. government were to buy back bonds issued at low interest rates during the downturn in the higher interest rate environment projected when the economy recovers. The calculations are based on Congressional Budget Office (CBO) projections of interest rates for 2017.
While this bond buyback would substantially lower the official value of outstanding debt, the interest burden on the U.S. Treasury would not change through these transactions. But if the argument is that growth will be impeded by a high ratio of debt to GDP with debt measured at its book value, then a debt exchange of this nature is an effective policy to address the problem.
“There is little obvious reason that the United States or other countries should continue to be concerned about as arbitrary a measure as debt-to-GDP ratios,” continued Baker. “But since the idea of a high debt burden remains an obstacle to taking stronger steps to boost economies out of the downturn and spurring job growth, there is no less costly way to eliminate close to half a trillion in debt”
Maybe you saw the post from Grumpy Economist John Cochrane as it was featured over at Mark Thoma’s place. Take note he went from not being concerned about deficits – more tax cuts for the rich – to a complete flip flop over how we cannot afford entitlements. His flip flop was motivated by something Jeffrey Miron wrote. I reviewed this over at Econospeak – and Angrybear featured my review. Miron may have the financial economics basically right but my view goes back to Domar who basically noted that our past accumulation of debt simply means we have to pay a wee bit more in taxes – not that we should be slashing entitlements. Yes interest expense matters but one should not be freaking out so badly that we tell retirees that those Social Security benefits they paid into since 1983 are not theirs any longer as some rich dude needs to take more vacations with his gold digging trophy wife.
EMichael – nice discussion from Dean Baker. Now you likely saw the rant over at the comment section at Mark Thoma’s place from JohnH. JohnH needs to read this piece from Dean Baker over and over again until it sinks in.
But Dean baker is only showing why – all else being equal – the level of debt does not matter. All else is not equal; deficits and interest rates are both forecast to rise. So the interest burden would increase just as Newdealdemocrat calculates.
i’ll have to disagree with the presentation of this part: annual interest due on the debt goes from $600 Billion to $1 Trillion — an increase of $400 Billion a year. That’s $400 Billion that can’t be spent on infrastructure or social or insurance programs.
interest on the debt does not limit other spending….if it’s in the budget to spend that amount on infrastructure & social insurance programs, the money will be spent….the impact of your rising interest rate will be a greater deficit and ultimately greater debt..
Arne – granted that in a world where real interest rates are higher and the debt/GDP ratio is higher, avoiding what we used to call back in 1981 the bankruptcy path becomes more difficult. But the key is whether the present value of the primary surplus is enough to cover the interest costs on our existing debt. Jeffrey Miron and I agree on the basic framework. And both of us assume that the real interest rate is likely 1% higher than the long-term growth rate. So both of us would set the tax/GDP ratio at the level of future non-interest government spending/GDP plus an additional 1 percent.
Where we differ is how we would do this. He wants to assume that the Federal tax/GDP ratio cannot remain above 17.5% so we must slash government spending. Dean Baker and I would take a very different view. If Federal spending/GDP in the future is say 20%, there is nothing wrong with raising Federal taxes/GDP to 21%.
To frame this as too much debt and too high of interest rates is sort of silly as other nations have much higher levels of taxes relative to GDP in order to fund things like health care. But the deficit hawks here want to scream we cannot afford that as the rich fat cats cannot give up their life styles.
Cheney just looked at the wrong thing to conclude that deficits did not matter. He should have looked at the dollar rather than interest rates. He made the mistake of looking at the US as a closed economy. The deficit played a major role in the weakness of manufacturing after 1980. We had crowding out, it just worked through the dollar rather than rates. The republican tax cuts were a major factor behind the weakness in manufacturing.
“interest on the debt does not limit other spending” – Rjs. Thank you. Interest on the debt must be financed in the long-run but this is what Domar discussed back in 1944. The Burden of the Debt as he puts it was the extra taxes we would have to pay to cover the agreed upon path of spending. And the point was simply that the government budget constraint is a very long-run issue that should always be framed in terms of a share of GDP over the long-run. Ah but an extra 1% does not sound as awful as trillions of dollars! Someone call Dr. Evil!
Spencer – the only thing Dick Cheney cared about was winning the White House in 2004 so he could continue to abuse power. Deficits did not matter to him politically as the general well being of the public did not matter to him. After all – he is the one who lied to get us to attack Iraq in March of 2003.
I find it odd that we look at the debt and deficit as if the US is not an ongoing concern.
The problem is not the actual debt and deficit, the problem is how we have spent the money. We have little actual national, We the People greater tangible or intangible equity growth for the money we have spent.
The intangible has been declining for year. That is our justice system has become less equitable in doling out justice and our education system has become less equitable in it’s access. We are now in an actual period where aspects of our government are working hard to remove reason and science from our daily lives while the trust required for a just justice system is purposefully being attacked to minimize it.
If the World bank is correct and legal/justice with education is 76% of our wealth generation, then the discussion of debt/deficit become almost moot other than to note we are getting deep into the realm of inability to pay.
Selfishness is the current guiding character. Those who believe we have to cut government to get us out of the ever rising debt to GDP are showing their selfishness which is a character trait that limits visual fields to that of having blinders on.
At the same time, show me a company (being the conservative/libertarian model so likes to base everything on the private sector) that has grown without debt, one that is carrying no loans. So me a business that has laid out a plan to borrow money to pay to the stockholders and then said they needed to cut back production because it is too costly and they can’t afford the debt.
Daniel – good comment. On:
“show me a company (being the conservative/libertarian model so likes to base everything on the private sector) that has grown without debt, one that is carrying no loans.”
I would have said Amazon but it seems they too have borrowed $25 billion recently. I guess that was to pay for Whole Foods. Of course their market equity exceeds $700 billion. Irrational Exurberance?
I think Baker is talking about our current debt, not deficits down the road. You cannot figure out our debt service by applying the new, higher rates to debt that will be bought down due to the lowering of value of the debt at lower rates.
But then of course the new deficits from the time of the higher rates would be reflected in that debt service amount.
Good post & excellent example stats. I don’t want to rain on your parade, but…
Credit market debt other than Federal is presently about $50 Trillion. If interest rates rise from 3% to 4%, and that debt does not increase at all, the annual interest due on it goes from $1.5 Trillion to $2 Trillion. More than $2Trillion interest, if the debt increases. That’s a substantial burden on the private sector.
Also, if the interest rate on Federal debt goes up one percentage point, the rate on non-Federal debt will likely increase by more than one percent.
You have to figure out what part of that debt is at a fixed rate.
EMichael – even long-term fixed rate bonds eventually retire and have to be refinanced. They got it right in this scene from the 1989 movie of Batman:
Think About the Future!
(always loved this scene).
And no one is going to try and sell those long term bonds when current rates are higher?
This is an objection to a line of argument, not necessarily an objection to the main point:
“Suppose in that era the national debt runs up from $20 Trillion to $25 Trillion while at the same time interest rates rise from 3% to 4%. In that situation annual interest due on the debt goes from $600 Billion to $1 Trillion — an increase of $400 Billion a year. That’s $400 Billion that can’t be spent on infrastructure or social or insurance programs.”
What about the 5 Trillion you borrowed: is it written in the stars that none of that goes to infrastructure or social programs?
I don’t go into “Social or insurance programs” because you all know that Social Security is paid for directly by the workers who get the benefits and not out of “the budget,” don’t you.
In general I object to “mathematical” demonstrations of polititical “facts,” they always leave out the real world facts that at least potentially invalidate the mathematical conclusion.
Monetary regime change worked in 1930s and 1973.
Let the youngsters default, their parents and grandparents, including the author, were allowed to default on gold. We are really asking youngsters to cover past boomer bills and denying them default option.
I say to youngsters, you have the legal and moral right to default on long past due government debt. .
your thinking, if not your morals, appears to be something like this:
your parents borrowed money to build the house you grew up in. they die before the money (and interest) is fully paid back. you decide to default because it was it was those irresponsible boomers who borrowed the money.
i don’t suppose anyone is going to come and take away your house, but who do you suppose is not going to be paid the money their parents lent to your parents.
i wouldn’t ask you if you think you might have gotten some benefit from that house… mostly because i don’t think you’d understand the question.
i despise the expression “dead weight loss” because i first heard it applied to “taxes.” because, you see, no one gets any benefit out of taxes… or anyway, you don’t.
the same idea applies to those who call interest on the debt a dead weight loss. none of us children got any benefit, or get any benefit, out of money borrowed and spent, arguably, to make the country stronger or perhaps only better.
are there any grownups in the room?
(yes, there may be a level of borrowing that is dangerous or at least not wise, but that is a question that needs to be asked on its own merits and not “proved” with mathematics which ignores what the borrowing is for. and whether or not the young will truly suffer a crushing burden because of our (their? as in “them”?) borrowing.
for one thing, asking the real question might cause us to focus on the real spending.
or maybe, as i heard today on “radio for intelligent people” we could borrow from our social security to take time off for “paid family leave.”
and pay it back by delaying retirement.
after all, as i heard a young person say, delaying your retirement six months or a year won’t be a real burden.
at least not on the young.
Your statement is nicely and concisely put:
“If Federal spending/GDP in the future is say 20%, there is nothing wrong with raising Federal taxes/GDP to 21%?”
The entire basis of the national debt “problem” is
a) It serves the interests of “starve the beast” aniti-federalists by providing a “reason” to eliminate / privatize entitlements.
b).It is predicated on never raising taxes but rather demanding they be reduced.
Those two reasons have always been the basis for entire debt “problem” argument.
I agree with that. Trouble is we are talking to each other. The serious people and their newscasters believe gov’t spending can’t be more than 20%… or pick a number… of the economy as though it was handed down on Sinai.
The fact is gov’t spending can be whatever portion of the economy makes sense. the economy changes over time in response to conditions. conditions now suggest a good deal more spending should be on government services than on plastic toys. But it isn’t going to happen.
maybe i saw part of the reason why the other day. i bought a car for my daughter, she couldn’t come to the dealer, the dealer couldn’t put the car in her name without a picture of her driver’s license… but she couldn’t be there, so i had them put it in my name. so now i have to pay the government an extra hundred bucks to “transfer” the registration from me to her.
this is only a tiny example of the kinds of ways the government finds to be obnoxious if not oppressive. and i guarantee this is what the people think about when they think about government and taxes. they do not think about global warming or the efficiency of government managed old age or health insurance.
Total Tax Revenue/GDP
EU-28 = 40%
US = 26.6% (includes all forms of tax revenues — federal, state, sales, propoerty, gasoline, etc.)
European nations chart of tax/GDP by country: https://commons.wikimedia.org/wiki/File:Total_tax_revenue_in_European_Union_as_%25_of_GDP.png#/media/File:Total_tax_revenue_in_European_Union_as_%25_of_GDP.png
in case you missed it
this greedy geezer (older than baby boomer) is buying a car for his daughter (younger than baby boomer). why is this? well, daughter belongs to a generation whose wages have not one up in forty years.
but send some guy famous for making a lot of money to tell the kids in a “good” (high end university) school that the greedy geezers are stealing their financial futures and the kids eat it up. as well as their high and low end news sources.
(nearly every geezer i know is supporting their adult kids. because we are rich? hardly. barely above poverty myself. but kids who don’t qualify for the meritrocity aren’t making enough to live.)
should have spelled it meretrocity.
If you want “guns” it costs you. If you want “butter” it costs you.
If you want “Guns AND Butter” you have to pay for them.
There’s no free lunch.
To make it easier to understand that Most Comparable Nations to the US pay far higher tax rates, while those considered 2nd world pay near US Tax rates,
2015 Tax Revenue/GDP
Total Tax Revenues, All Sources
Selected European Nations:
Germany 40%, Italy 43%, Finland, Sweden, & Austria 44%, Belgium, Denmark, & France 47%, Netherlands & Norway 38%, UK & Spain 35%
Cuba 44%, Canada 40%, Japan 36%, Australia & Brazil 34%, China 22.4% (2017 est)*
Nations Near US Rate:
South Africa, Kazakhstan, Tonga, Bolivia, Zimbabwe, & Jamaica 27%, Venezuela, Turkey, & Solomon Islands 25%, Mexico 24%
To be fair, the US has to spend for defense on two fronts, so we can’t ask more in taxes. Oh, and I forgot, we have to defend against incursions and being overrun by the masses from South of the Rlo Grande too, so that makes it even more imperative that we don’t add to the US tax burden.
Defense Spending, 2017, Billion
International Institute for Strategic Studies
US $603, China $151, Russia $61, UK $51, France $49, Japan $46, Germany $42, Australia $25
If you add up the US & it’s allies it’s $816, compared to Russia & China combined of $232 so in reality the US & it’s allies spend 3.5x their potential foes.
And that’s why we can’t charge more for taxes.
Do you get it now? Why the US can’t charge more for taxes?
I am kind of curios though why a nation that spends 25% or 10% of the US on defense would have any incentive to attack the US under any reasonable or even irrational scenario. Of course maybe the US and it’s allies defense spending is on stuff that’s far, far inferior to our potential foes stuff, huh?
On defense, don’t ever let anybody forget how a tiny 3rd world commie country whooped the US’s ass. So that’s another reason we can’t charge more for taxes.. I mean who knows, maybe Zimbabwe might be next to whoop our ass … you never know.
Come to think of it, the last war we fought in our defense was WWII I think, right? The Korean War was to defend the corrupt South Korean gov’t. The VN War was to defend the corrupt South Vietnamese gov’t,
Then there was the 1st Iraq war to defend against a tiny speck in the sand royal dictatorship.
The 2nd Iraq war was to take down a ME dictator because he had Weapons of Mass destruction he was going to use to take over Saudi Arabia, Egypt, and Israel. Oh… whoops. There were no Weapons of Mass destruction though.
I guess if we don’t need to fight a defensive war we just go out and make up any ol’ excuse to defend another corrupt gov’t or take down another dictator in some third world nation to justify our humongous defense spending. Makes us proud though, huh? Now if we can just get the corrupt gov’t to take solid power in Afghanistan we’d be set for taking out Iran next..
While I’m on the subject and to be pedantic, in my entire lifetime to date the US has fought one defensive war on two fronts simultaneously with allied help. I was born 1 month after VE day and 2 months before Hiroshima and Nagasaki. That war was 76 years ago now. .
The last defensive war before that was against the southern defector states (82 years prior), and the one before that was the War of 1812 (48 years prior to the Civil War).
So since the Revolutionary War we’ve fought 3 wars for defense… one of which was a Civil War, or 2 foreign defense wars. The Spanish-American War and the Mexican war were not among them being created to take over foreign territory .. so wars of aggression to expand U.S. power and territory rather than defense.
3 Wars for defense in 240 or so years… roughly every 80 years on average.. all the rest were wars for some 3rd world corrupt gov’t or dictator or for territorial expansion or rights to rule by use of force.
I don’t count WWI since we were both very late to that war and not decisive in it’s outcome… or you can count it simply as the basis for WWII occurring so WWI and II were actually just one war with a form of temporary truce between them..
” I was born 1 month after VE day…”
Thus, long in the tooth. I get it now.
“Total Tax Revenue/GDP
EU-28 = 40%
US = 26.6% (includes all forms of tax revenues — federal, state, sales, propoerty, gasoline, etc.)”
Longtooth looks at total taxes which is indeed the right metric. Of course total government spending is higher than 26.6% of GDP so yes Houston, we do have a problem. Progressives would raise the Federal income tax. Right wingers prefer to have the states do more so the burden of taxation falls on the little guy. The latter is part of Paul Ryan’s agenda but shhhh – they do not want this mentioned.
perhaps if i knew more i would be less confused.
Longtooth says total taxes in US are 266% of GDP. You say they are higher.
I “know” (Bureau of Statistics) that Effective federal income tax rate on highest earners is about 17%. My own effective tax rate is about half the published marginal rate. and my State income tax is actually larger than my federal tax. my small house and smaller property pay about 10% of my income to the county. the city takes another 600 dollars a year or so tax disguised as my “water bill.”
Fact is, i don’t really care about what percent or even how much my taxes are as long as they contribute to a higher standard of living… which i think they do. certainly my “payroll tax” (Social Security Insurance) contributed enormously to my present standard of living (the difference between living under a bridge and having a house and property tax today).
And i do think that we need to keep our eyes on that prize: are we getting value for our (“our”) money? I think we are, arguably.
The thing is, no one really likes to pay any tax, but the rich are in a position to pay less than they probably should and simultaneously rig the laws so ordinary people can be cheated out of their wages, or by their banks, or by their government… currently destroying the country or waging counter productive wars all over the world.
no doubt we still need to talk about taxes and national debt and the effect of rising interest rates, but it gets far too easy to make decisions (or have opinions that enable those who actually can make decisions) based on numbers that have nothing to do with the real issues.
it does not matter whether the tax rate is 1% or 99% as long as the money is used to make us “richer” in ways that count. those who argue that at some point the tax rate inhibits the power of the “natural” economy to provide “wealth” have a point. but we don’t know where that point is, or whether meaningful wealth is the same as “more money” or higher gdp, as opposed to living in a decent society.
Coberly – re: your problem with that car for your daughter
The Wright Brothers invented the airplane so we’d have airlines to make dealing with the government look good.
BTW Coberly – I think you’re being very sensible here. Absolute percentages or numbers are meaningless if the end result is a higher standard of living. I’d pay a 99% tax rate if I got the right bennies. If I eat well, sleep well, have fun with my friends and get just about everything I want at the market, why should I care if I make a billion dollars a year and pay 99.999% of it in income taxes?
you are just being sane.
i really didn’t get your point about the airplane, but the last time i dealt with the airlines was in 1980. I wouldn’t go near one today.
but back in 1970 or so, when terrorism meant you might get an unscheduled stop over in Cuba, I went up to the ticket counter and they asked to see my driver’s license. I told them I didn’t want to drive the damn thing; i just wanted to sit in back.
They refused to sell me a ticket.
If I had the sense god gave a small dog i’d have just gone back to the end of the line and tried again.
on second reading I do get the point.