Blanchard on public debt and interest rates; also: thanks, MMTers!

January 10th, 2019 at 12:58 pm

There’s a deservedly nice bit of buzz about a new paper by tony economist Olivier Blanchard. My WaPo piece today takes you through the argument, along with a heavy dose of my own interpretation, one familiar to OTE readers.

“The key points are disarmingly simple, and they’re ones I have written about before in this column. Part one is this: When a country’s growth rate is higher than the interest rate on its debt, the fiscal costs of sustaining its debt levels are somewhere between zero and low. The reason is that even if the government does not raise taxes to offset its higher debt, the ratio of debt to gross domestic product will decrease rather than explode over time. Part two: For most of the period covered by Blanchard’s research (1950-now in the United States), g>r, i.e., the GDP growth rate has exceeded the interest rate (same with the U.K., the euro area and Japan).”

I then discuss a nuanced aspect of the work. Because private capital accumulation is diminished in higher public debt scenarios, the return on capital investment must also be part of this cost/benefit analysis. In my interpretation, this leads to a conclusion that regardless of how low the interest rate on debt is, we still need to distinguish between the utility of borrowing what I call “good debt” and “bad debt.”

Here, I’d like to briefly discuss two thoughts I left out of the Post piece.

The first is in regard to the political economy implications of Blanchard’s findings. In a better world, these findings would lead fiscal policy makers to think more realistically about public debt. But in the real world, where every idea becomes a weapon in the arsenal of partisan politics, deficits are largely a political, not an economic tool.

R’s shout about them when they rise on the D’s watch and ignore them on their own watch. Because D’s have long been too sensitive to accusations of fiscal profligacy and R’s just don’t care about any of that, this has led to austerity in years when we needed the fiscal stimulus and visa versa now, or what I call “upside-down Keynesianism.” I go through the numbers/evidence here.

I don’t expect Blanchard’s evidence to change these dynamics because they’re not about fiscal costs, they’re about political posturing. But that doesn’t mean nothing will change!

A lot of the fear-mongering and deficit attention disorder is driven by deficit scolds outside of government. The pressure from MMT’ers (my next point), Blanchard’s analysis, similar historical work I cite from Kogan et al, and, most importantly, the lack of crowd-out or other predicted economic distortions from deficits, all make it harder for the austerians to be taken seriously by neutral observers. See, for example, David Leonhardt, a evidence-based columnist known for pitching it down the middle, in today’s NYT.

As I (and Blanchard) argue, this doesn’t mean deficits don’t matter. Again, see my GD/BD discussion. But this feels a bit like the minimum wage debate in the early 1990s when Card and Krueger came out with Myth and Measurement, their path-breaking work disproving the widely assumed connection between minimum wages and pervasive job losses. About 10 years later, the reality of their findings became broadly accept knowledge and the result has been much better policy in this space.

Thus, if progressive/empirical economists keep pushing on this more nuanced, realistic view of public debt, perhaps policy will be smarter in 10 years. Sorry if that’s a wait, but given the stickiness of lame ideas, you either play the long game or no game.

Next, I didn’t say anything about MMT but much of the discussion around the Blanchard buzz makes the correct point that the MMT’ers played an important, admirable role in elevating these issues. I’ve raised some questions about their model and Josh Barro’s new piece provides an excellent take on their perspective at this interesting moment in fiscal thought.

Much of the analysis shows that MMTers are advocating Keynesianism with a few wrinkles, like their argument that if fiscal stimulus does generate overheating, the Congress should reduce price pressures with a tax increase, which leads most of us to ask, “what’s plan B?”

But their relentless hammering against mindless deficit reduction has been a key force in the ongoing, salutary rethink of these relations, for which we should all thank them!

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2 comments in reply to "Blanchard on public debt and interest rates; also: thanks, MMTers!"

  1. Fred Donaldson says:

    Much of this debt talk comes after we see taxes lowered for the rich, causing more deficits. That seems calculated to me. Each time revenue is reduced, government programs are blamed for the shortfall. This is liking deciding to work fewer hours for a wage-hour job, and then complaining the wife is spending too much on groceries. It’s called making it nicer for yourself, and noisily blaming the victim. A good example is Medicare, which is a very expensive program for beneficiaries, and suffers many little cuts to benefits and higher prices for drugs.each year. The solution advocated by politicians is to privatize, not improve, and leave the healthcare to the whims of corporations – not the folks appointed by elected officials.


  2. Nick Estes says:

    Thanks for your shout-out to MMT; very gracious. Here is a related observation. I am only an amateur economics maven, but my understanding is that the following widely-believed statement (from your WaPo op-ed, and repeated here) is not correct: “One reason the extent of public debt matters is because it tends to lead to less private capital — machines, structures — than would otherwise accumulate.” This is the “crowding out” assumption. It assumes that the amount of “loanable funds” is limited, so if the government borrows more of it to finance its deficit, the competition with the private sector will increase interest rates and thus discourage private investment. But what if the amount of loanable funds is not limited? What if banks create the money they lend in the process of lending? Because that’s how commercial banks really work. The Bank of England issued a paper in 2014 that explained this, and there has been no academic rebuttal since. https://www.bankofengland.co.uk/quarterly-bulletin/2014/q1/money-creation-in-the-modern-economy Interest rates are essentially established by central banks; when they rise, it’s not because the government or anyone else is trying to borrow more money, but because the central bank has increased the target rate and/or because the markets think the central bank is going to do so. The Bank’s 2014 piece gently notes that their explanation is completely contrary most textbooks (no doubt including Dr. Blanchard’s). Banks do not lend out money people have deposited with them; they are not “intermediaries”; their deposits or reserves are not “multiplied up” to constitute the “money supply.” The level of budget deficits has nothing to do with the ability of the economy to accumulate capital. They can make all the loans they want to creditworthy borrowers who are willing to pay the going rate.


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