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As the world’s big central banks are due to make announcements over the next couple of days, you’re likely to hear a lot of chatter about what they’re up to, and why. And a lot of that chatter will be nonsense.Yesterday we wrote about a particularly annoying meme that’s going around, which is that governments are no longer able to stimulate the economy by taking on more debt, and that there’s really not much more the central banks can do either.
Another thing you often here is that the reason the Fed engages in actions like QE (which has mostly taken the form of buying government Treasuries) is to reduce public sector debt burdens.
The arguing goes: With governments issuing record levels of debt, they’ve now turned to their central banks for their funding and to reduce interest rates. The Fed happily complies and engages in ‘financial oppression’, lowering the rates on government debt to below where the market would otherwise set them.
This is a VERY mainstream idea.
Anti-debt politicians are always talking about how the Fed is somehow enabling fiscal recklessness via ultra low rates and bond purchases.
And in his latest US Macro Dashboard note, Morgan Stanley’s Vincent Reinhart discussed this idea as part of a broader point about why large public sector debts are associated with lower economic growth (a thesis that his economist wife Carmen Reinhart has become quite famous for).
High levels of public debt relative to the scale of an economy are costly. That is a message from work done recently with my wife Carmen and Ken Rogoff, both of Harvard University.1 One reason we think so is that governments resort to forms of financial repression to lower their borrowing costs. Limiting investor choice, forcing financial intermediaries to hold more government debt, and keeping policy interest rates low makes the fiscal burden of the debt more sustainable. But there is a cost, as this crowds out private borrowers and slows economic growth.
The problem is: This really doesn’t make much sense.
First of all, private borrowers are FAR from being crowded out these days. Yesterday, Unilever and Texas Instruments just borrowed money at the cheapest rate in corporate history. If anything, QE “works” because it forces money out of government securities and into private sector securities, like corporate bonds or home mortgages.
But beyond that, it just isn’t the case that the Fed, when deciding what policies to take, is looking much at US government debt.
For one thing, Uncle Sam, despite record levels of debt issuance over the last few years, has needed no assistance whatsoever in paying its debt bills.
Thanks to the secular decline in interest rates (which started well before the Fed got into the QE game of the last couple of years), Federal expenditures on interest payments are lower than they were in the 90s.
Here’s an even more stunning chart. It shows how much the government is spending on interest payments divided by total government expenditures. Basically, the cost of servicing the national debt has never been such a minuscule line item for Washington DC.
You can make equivalent charts showing that the same thing different ways. Interest payments as a share of total tax revenues or GDP are also quite modest by historical standards.
The fact of the matter is that we know what the Fed looks at when it decides when and how to act.
It looks at inflation, unemployment, and probably even the stock market. When things are getting bad, it pumps the accelerator. When things are heating up it lays off the accelerator. Recent history is pretty clear on this. There is nothing anywhere (not in Bernanke’s discussions, not in Fed minutes, and not in actual examples of how the Fed acts) that suggests that a motivation for the Fed is to help Uncle Sam reduce debt payments. It’s purely a popular fiction.
If the Fed WERE trying to lower government borrowing costs, it’s doing a horrible job.
As you can see on this chart from Doug Short, yields on the 10-Year Treasury (the green line) rose during both QE1 and QE2 (shaded areas).
In fact, if the Fed were primarily concerned with government borrowing costs, it’s obvious that the easiest course of action would be to do nothing, let everything collapse into deflation, and watch the world pile into US Treasuries, sending yields even lower than where they are now.
They haven’t done this. The Fed is trying to inflate the economy and that means higher rates. The myth that the Fed is motivated by public sector debts is nonsense.
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