What will happen to interest rates in the short run is a question that divides economists.

On one hand, you have people who think that interest rates won’t go up because the U.S. is still a safe place (or the only safe place) to invest — relative to other countries — and hence the government can continue to spend more and to grow more. The evidence, according to this side, is how low interest rates are now, which leads to the conclusion that the probability of them increasing quickly is low. If you think this sounds like what Paul Krugman would say, you are correct.

On the other hand, you have people who think that we are so much in debt that we may run the risk that our lenders — domestic or foreigners — may soon need much higher interest rates to buy or hold U.S. assets. The prescription, then, is austerity, if only to send a sign to investors that the U.S. is serious about its debt problem. I have made that case, even though I have to say that I’m not sure what our investors are thinking and hence what the probability is that interest rates will go up quickly. It seems like a possibility in the current situation (even though the U.S. is benefiting from the fact that European countries are doing so poorly and remains a relatively safe harbor). That being said, I am mainly arguing for serious reductions in government spending because I think America would be a better place if the government were much smaller.

So who is right? What’s the probability that interests will go up quickly? Does a low interest rate now signal that it won’t go up? In that context, I find these comments in The Economist by George Mason University’s Tyler Cowen really interesting:

More often than not, market prices are right and probably interest rates will not soar anytime soon, just as they did not soar in 2004. Still, there is some risk that market interest rates are wrong.
What are the main risks in particular? One risk is that China crashes, or undergoes a “lost decade”, and no longer buys up so much US government debt.
If you, as an investor, are worried about those sorts of risks, what will you do today? Probably you’ll buy up a lot of Treasury securities—where else can you hide? Low interest rates therefore may be cloaking some of the future possible danger.
Note, by the way, that our debt structure is especially slanted toward short-term debt. That means a spike in interest rates would be especially damaging to our long-run fiscal position. It also means we should be especially cautious. It’s no accident that the Treasury has chosen so much short-term debt—there is a fear the market won’t absorb so much of the long-term issues and that is why the Treasury is not doing more locking in of the relatively low long rates.
If we engage in a bit of worst-case thinking, we should be prudent on the fiscal side, even in light of low interest rates. That said, it is foolish to dismiss the data expressed in market prices or to think that the second-guessers see through to the real problem. Market prices still reflect the best available forecast. If we are making decisions about fiscal policy, it may boil down to how much risk we are willing to take.

Read more on the issue here.