It's the Interest Rates...Stupid!!

[Donnachaidh]

http://smirkingchimp.com/thread/yellow/36271/its-the-interest-rates-stupid

James Galbraith, an economist at the LBJ School of Public Affairs in Austin, Texas and son of the late John Kenneth Galbraith, America's first "celebrity economist" has pointed out yet another reason that the current hysteria over the debt and deficits is a red herring; interest rates remain at all time lows!! Galbraith asserts in a study paper for the Levy Economics Institute that, "So long as interest rates exceed growth rates, any primary deficit is “unsustainable.” But as Galbraith points out, real interest rates in the US have been at historic lows and sometimes negative. This allows the government to borrow cheaply in order to stimulate the economy to create jobs and allow business to increase output to capacity thus increasing returns on their capital investment and encouraging more. This of course, further strengthens the case for fiscal stimulus as Keynes would have argued. Interest rates are also low due to the unchallenged role of the US dollar as a global currency allowing the US to run both trade and budgetary deficits while absorbing greater and greater levels of investment in its relatively low yielding Treasury Bonds; both the US dollar and the federal government's risk free, highly liquid bond market has been providing a long term financial investment safe haven to recycle foreign trade surpluses for years.

While the US is not Greece and it is easy for us to wait as long as two decades to stabilize the debt to GDP ratio by growing the economy instead of cutting spending and paying down the debt, it is imperative that real interest rates remain as low as possible in order to achieve this. A modestly negative interest rate is best but the banks would never allow it. But, as Galbraith points out, following the CBO's model in a recent study to raise the real interest rates on bonds to attract borrowers will create the very "unsustainability" of publicly held debt levels that low interest rates would prevent! Economists Alan Auerbach and William Gale make this assessment in a 2009 report on CBO baseline projections for debt and deficits from 2009 to 2019;

"It is worth noting that the 2009 deficit and debt would be even higher were it not for the extremely low interest rates on government debt that have recently prevailed. Whereas debt service accounted for $253 billion – 1.8 percent of GDP – in fiscal year 2008, it is projected to drop to $177 billion – about 1.2 percent – in 2009, despite the increase in debt relative to GDP. Some see low interest rates as a silver lining that will reduce the crowding out effects of deficits and make it easier to meet long-term fiscal obligations."

Although it has been clear since Obama took office that federal budget deficits would average over a trillion a year until 2019, economic growth, employment levels and per capita income would rise making these deficits a smaller and smaller share of GDP over the very long term (though some fluctuating of this ratio is predicted by the CBO authors). Thus, growing the economy is key to long term financial stability!! But for this, low interest rates are absolutely a requirement. I wonder if House Majority Leader, Eric Cantor thought about this issue during the recent debt ceiling debate when he brazenly announced his willingness and that of the Republican Party to allow the US federal government to default on its outstanding debt.

[Turbineguy]

1. And if you default at 1.2 percent......

which is what the GOP wants to do, good luck borrowing at 12 percent in the future. The GOP wants to destroy America and Bush gave them the tools to do it.