Over at the Coordination Problem blog Pete Boettke points to a new working paper by economists Carmen Reinhart and Kenneth Rogoff called “A Decade of Debt.” They write:
The combination of high and climbing public debts (a rising share of which is held by major central banks) and the protracted process of private deleveraging makes it likely that the ten years from 2008 to 2017 will be aptly described as a decade of debt. As such, the issues we raise in this paper will weigh heavily on the public policy agenda of numerous advanced economies and global financial markets for some time to come.
You may remember their much cited 2010 empirical research study about the consequences of public debt for economic growth. In that work, they used a historical data set spanning forty-four countries and two hundred years. They found that, across wealthy and poor countries, the median growth rates for countries with publicly held debt exceeding 90 percent of gross domestic product are roughly one percent lower than they would be otherwise. They find slightly different results for emerging markets.
In their new paper, they reiterate the conclusions of their previous work and add to it. One key aspect of their work is to show the impact of debt on interest rates, and, among other things, they stress that interest rates will rise with levels of debt, and that “interest rates can turn far faster than debt levels, so if deleveraging does not occur, debt will be a continuing vulnerability.” Reinhart and Rogoff go on to explain that it is possible that interest rates stay low for a while even in a time of high debt, for a variety of reasons, but at some point they turn, and when they do it generally happens fast.
That point is important in the context of the current debt-ceiling debate. Note how Reinhart and Rogoff talk about interest rates rising with debt. They are not talking about rates rising because of a lack of borrowing. Yet, many people these days argue that we must raise the debt ceiling in order to prevent an increase in interest rates. The idea is that failure to increase borrowing will lead to a failure to pay our bills. That, they argue, may signal to investors that Treasury debt is risky and lenders may ask for higher interest rates.
This argument overlooks an important aspect of the situation we are in. If rates go up after failing to raise the ceiling, it won’t be because we don’t pay our bills per se, or because Treasury prioritizes its payments. Rather, it will be because we have reached a level of debt that puts Treasury in the position of being unable to pay bills without more debt. The “not paying” is just a symptom of our debt levels and spending habits. It will also be a symptom of Washington’s unwillingness to signal to our investors that things will change. Allowing Washington to increase its borrowing by raising the debt ceiling might alleviate the symptom of higher rates in the very short turn, but it makes the disease (high debt and rampant spending) worse. It is unbelievable to think that this won’t have serious consequences. Moreover, as Reinhart and Rogoff explain, when interest rates turn they turn fast — so fast, it’s too late.
This point shouldn’t be overlooked by lawmakers who are struggling today with the decision of whether to raise the debt ceiling or not. Raising the debt ceiling without a serious commitment to changing the fiscal path the country is on will send a signal to investors that Treasury debt is risky. In fact, it will send a clear signal that Treasury debt is more risky than it was before the debt ceiling was raised. This is an important decision. It will have consequences.
The great news is that Treasury doesn’t even have to stop paying its bills. In fact, Treasury has much more legroom than it claims, as evidenced by how the debt-ceiling deadline has been pushed back by months. This piece by my colleague Jason Fichtner and me lists the assets that Treasury could potentially use to continue paying its bills if the debt ceiling wasn’t raised. Obviously, at some point, after exhausting all of the financial options available and selling off all of the government’s assets, Treasury will then run out of options and a debt ceiling increase will be necessary — the question is when. However, we think with all measures at Treasury’s disposal they should be able to go through the end of the fiscal year.
By the way, we are not saying that selling government assets at fire-sale prices is a responsible way to budget. However, there is time for the Congress and the administration to work out a deal to raise the debt limit along with spending reductions that will reduce the deficit and get the nation’s spending and debt under control — for the real issue that threatens the financial security of the U.S. is the nation’s uncontrollable spending and borrowing. Congress shouldn’t just pass a debt ceiling increase under false pretenses or misleading information. Continuing to pass debt-ceiling increases without proper spending reforms would be just as irresponsible as getting to the point where Treasury would have to stop paying the government’s bills.
I will conclude by quoting Pete Boettke:
Perhaps it is time to take the gloves off in the fight of the century. Economic science, as well as the history of political economy, tells us something valuable and enduring about all of this and we ignore it at our own peril.