Matt Yglesias today:
Normally you face a tradeoff. Taxes impose costs on the present-day population that might impair wealth creation over the long-term, but to avoid taxes by borrowing you need to pay interest to creditors. But the real interest rate we’re being asked for is low. Less than zero. So what’s the tradeoff? Why not sell as many negative-yield ten-year bonds as the market will buy (sell enough bonds and presumably interest rates will rise) and let that auction revenue “crowd out” taxes as a way of financing government activities? Now in an ideal world we’d use that money to finance valuable public sector investments, but that all gets very politically controversial and you can see why it’s impossible to agree on this given our dysfunctional politics. But what’s the constituency for taxes in a negative interest rate environment?
Okay, suppose we completely eliminated taxes. Just borrowed 100% of what we needed to finance government’s operations. In fact, suppose we just had the Fed print all the money we need to do this, and don’t even bother with borrowing from the market – that way we don’t have to worry about rising interest costs either. That reductio ad absurdum is pretty much what Yglesias is advocating, right?
Don’t be silly, he’d say. I’m not really calling for the elimination of all taxes, or the monetization of all debt. But clearly sometimes you should run a deficit; clearly sometimes you should expand the money supply (clearly, that is, if you aren’t afflicted with an Austrian conviction that money has some intrinsic value rather than always having merely a conventional value as a medium of exchange). And I’m just making the point that right now, with the deficits we are currently running, the market is telling us that we can borrow for free – that is to say, at a negative real interest rate. We probably couldn’t borrow 100% of our budget for free, but shouldn’t we keep borrowing until we find the point at which the market says, “stop; you’re borrowing too much”? Why stop before that?
These sorts of arguments are all of a piece. We should continue to cut taxes and increase spending, increasing the deficit so as to increase demand, until we get self-sustaining growth that doesn’t require government to prod it along. The Fed needs to “drop money from helicopters” and thereby signal its irresponsibility, because that perception of irresponsibility will cause investors to flee cash for other assets and/or higher current consumption, which will raise nominal growth. The common assumption behind all of these arguments is real growth expectations will not be affected, or will even be positively affected, by this kind of activity.
I would like to see some evidence for this assumption. I can think of lots of good reasons to think that the sign goes the other way – that real growth would be hurt by the perception that the American political system had given up on trying to control its budget or was committed to debt monetization as a growth strategy. And if real growth rates drop, then you won’t get as big a nominal growth bang for your borrowed buck as you might expect – indeed, depending on how much real growth is hurt, you can’t be sure that nominal growth would increase even if inflation picked up. In fact, if real growth took a big enough hit, and inflation picked up sharply, you could see a rise in nominal rates without negative real rates budging much. Which would mean, by Yglesias’s argument, that we should borrow even more even as borrowing got progressively more expensive.
Within the normal range of plausible policy stances, I wouldn’t expect that to happen. I would expect nominal growth expectations to increase, but I would expect real growth expectations to move as well, and to move with a direction and magnitude dictated by the market’s perceptions of how well-structured the stimulus is – that is to say, the degree to which it was perceived to be promoting self-sustaining growth. But for a wildly irresponsible policy course, I’d expect the effect on real growth expectations to be sharply negative.
I could present other arguments. I could say that tax cuts are difficult to reverse (particularly in our dysfunctional political system) and therefore should be understood as more likely to increase the structural deficit than to smooth out the business cycle. I could point out that the maturity structure of Treasury debt is still pretty short-term, and that while the Treasury has been extending it out since 2009, it’s been a delicate process, and we still basically don’t issue anything beyond ten-year paper. We could discover that turbo-charging debt issuance would send interest rates higher very very quickly. And then what do we do? Say, “sorry – just kidding?” But these are really specific examples to illustrate my general question: how does Yglesias know that real growth rates won’t be negatively affected by a strategy that appears, to the ordinary observer, to constitute defiant fiscal irresponsibility?
I’m not an Austrian. I don’t think the government has no role to play in promoting growth. I don’t confuse an individual’s budgeting, where you might save money as a store of value in order to spend it later, with the role of money in an economy as a whole, where if every country saved more than it could productively invest you’d just have a depression. I happen to think we need more stimulus – but stimulus of real growth, coupled with structural reforms to reduce the inflationary impact of that stimulus, and ensure that more of the nominal growth we get is real. And I am flat-out baffled trying to figure who folks like Yglesias think they convincing with these sorts of reductio arguments that amount to saying: all government really needs to do to dig us out of our economic hole is stop behaving responsibly.
I am really getting tired of repeating myself. Maybe I should just do a bloggingheads with Yglesias so I can finally hear his answer?