The Corner

Do Low Interest Rates Mean the Government Should Borrow More?

Interest rates are low. For some, that means that the U.S. government should borrow more money. Larry Summers, for instance, made that case in the Washington Post yesterday. According to the former Obama adviser, there are ways the government could improve its fiscal balance through more borrowing, as long as the money is well-used (for instance, it is used to buy space that is currently being leased). He writes:

Rather than focusing on lowering already epically low rates, governments that enjoy such low borrowing costs can improve their creditworthiness by borrowing more, not less, and investing in improving their future fiscal position, even assuming no positive demand stimulus effects of a kind likely to materialize with negative real rates. They should accelerate any necessary maintenance projects — issuing debt leaves the state richer not poorer, assuming that maintenance costs rise at or above the general inflation rate. . . .

This is a view that should be shared by those most alarmed about looming debt crises, because the greater your concern about the ability to borrow in the future, the stronger the case for borrowing for the long term today.

I don’t buy it. The U.S. should repay its debt rather than increase it. But it isn’t be so much because I worry about the future cost of borrowing as Summer suggests. Rather it is because I doubt the government’s long-term ability to repay its already gigantic and growing debt (I also want smaller government.) Who truly believes that the explosion in spending due to Medicare, Medicaid, and Social Security liabilities will be matched by the necessary economic growth and/or tax revenue under realistic scenarios? Not me. And who believes that lawmakers will engage in fundamental spending cuts when the economy recovers? Not me either.

#more#That means, even with the current low interest rate, debt will grow and will continue to grow independently of our ability to repay, so adding to the debt today seems very unwise (for a lack of a better word). Just look at the new CBO Long Term Budget Outlook. As Peter Suderman of Reason wrote in reaction to the debt projections: Budgepocalypse Now, Budgepocalypse Forever.

Moreover, as Tyler Cowen points out, the idea that there are many investments out there just waiting for the government to cash in is likely wishful thinking, and if it is, then more borrowing is not a good idea.

You might think the government investments are “low hanging fruit” in terms of quality.  Maybe yes, maybe no, but the low real interest rate doesn’t signal that, rather it signals merely that people expect to be repaid.

In this argument for more government investment, the notion of government investments as low hanging fruit is doing a lot of the work.

Finally, calls for more borrowing are ignoring the consequences of public debt on economic growth. Yes, debt is the symptom of spending, but there comes a point when debt is so big that it becomes the disease. The work of economists Carmen Reinhart and Kenneth Rogoff, for instance, shows that across wealthy and poor countries, the median growth rates for countries with publicly held debt exceeding 90 percent of GDP are roughly 1 percent lower than they would be otherwise. One percent may not seem like a lot, but over time it makes a big difference to our standard of living (a loss of 30 percent if the U.S. had reached this point in 1975).

Now, the reason I worry slightly less today than I used to about increases in interest rates in the United States is because the data shows that in some countries (others than Japan) very high levels of debt haven’t systematically led to a large increase in interest rates. In a new paper called “Debt Overhang: Past and Present,” Carment Reinhart, Vincent Reinhart, and Ken Rogoff show that in 11 of the 26 cases in their sample, countries that were in what they call “debt overhang” (at least five years during which debt exceeds 90 percent of GDP) didn’t experience an increase in interest rates.

But that’s no reason to rejoice or borrow more. Even if rates didn’t go up, these countries’ economy shrank all the same. Economic growth, in the 26 cases, is 1.2 percentage points lower than in other periods and “the average duration of debt-overhang episodes is 23 years, and it produces a ‘massive’ shortfall in output that is almost one-quarter less, on average, than in low-debt periods.”

In other words, the fact that bond markets in high debt countries like the US may still be perceived as safe shouldn’t be mistaken for a signal that the government can borrow more without risk. They write: “Those waiting for financial markets to send the warning signal through higher interest rates that government policy will be detrimental to economic performance may be waiting a long time.”

This paper turns on its face the theory that, as long as investors are willing to put their money in the U.S. and keep rates low, we have nothing to worry about or that we should borrow more money. As it turns out, the U.S. is close to joining the debt-overhang club, since it broke the 90 percent threshold in 2008.

Of course, as Reinhart and Rogoff have also shown that government officials and the economists who rationalize their financial follies will continue to claim, this time is different.

Veronique de Rugy is a senior research fellow at the Mercatus Center at George Mason University.

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