Six years ago I would have agreed with Greenlaw et al. that pushing U.S. net federal government debt up to more than 100% of a year's GDP would be very likely to be inconsistent with long-term Treasury yields in the range we have seen since 2000. Today I would change "inconsistent" to "consistent", and say that they are probably wrong.
Why? Because figure 3.14 of "Crunch Time: Fiscal Crises and the Role of Monetary Policy":
would appear to commit the authors to a currentcast that Japan's 10-year JGB interest rate is 25%/year rather than 1%/year. They escape this implication, of course, by allowing their regression to include "a country fixed effect that implies there is something very special about Japan".
Indeed.
When Paul Krugman and Matt O'Brien ask why the assumption is that there is "something special about Japan" rather than "something special about currencies that are not part of the eurozone", "Crunch Time" coauthor Jim Hamilton answers:
Econbrowser: Why I'm more worried than Paul Krugman about the U.S. debt burden: [Our] regressions use a panel of 20 different countries followed for a period of 12 years. Krugman and O'Brien note correctly that 13 of these 20 countries are in the European currency union, and suggest, appealing to De Grauwe's (2011) analysis of particular challenges facing the eurozone, that the experience of those 13 countries has no relevance for countries not in the eurozone….
[O]ur baseline assumption is that… every country could be different and every year could be different…. It is true that we allowed for differences across countries only through differences in the intercept…. [not in] the slope…. However much one might wish to [allow different slopes], this would have been quite a pointless exercise… if you chop the data set down to only a half-dozen countries, you're going to need a longer time series if you hope to estimate the relation with any kind of precision….
Ichiue and Shimuzu (2013)… found that a one-percentage-point increase in… external debt, was associated with a 3-basis-point increase in the 5-year-forward 10-year yield…. Laubach's (2009) analysis of the effects on yields of changes in CBO budget projections over 1976-2006. He found that a 1-percentage-point increase in U.S. debt-to-GDP was associated with a 3-to-4-basis-point increase in the 5-year-forward 10-year rate…
Hamilton says that his data set does not allow him to run what Krugman and O'Brien think is the sensible regression, but other people's data sets do. And, boom!, we are down from a 25%/year forecast Treasury rate come 2035 to an 11%/year forecast Treasury rate i their baseline.
But rather than concede what I took to be Krugman and O'Brien's point--that much of the rest of the literature sees the U.S. debt tipping point as considerably farther away than it is in "Crunch Time", Hamilton appears to double down:
There are many, many other studies confirming the basic relation that Krugman and O'Brien want to insist couldn't possibly apply to a country like the United States…. Are Krugman and O'Brien claiming that… U.S. debt could become an arbitrarily large multiple of GDP with no consequences for yields? If they acknowledge that there is a level of debt at which these effects would start to matter for the United States, what is their estimate of that level, and how did they arrive at it?… If Krugman, O'Brien, or anybody else thinks they have some other answer, let them articulate it clearly and cleanly.
Whether a country is able to borrow in its own currency is completely irrelevant…. [P]rinting money does not generate any magical resources with which to resolve a real fiscal shortfall…. Krugman and O'Brien seem to assert with great confidence that these tipping-point dynamics could never matter for a country like the United States. I find no basis in either economic theory or historical experience to warrant such a conclusion. Their argument ultimately seems to boil down to, "it can't happen, because it hasn't happened yet." Or rather, because it hasn't happened here yet…
Thus I award this one on points to Krugman and O'Brien. My view is that whenever you have to characterize your adversaries' position as "never" rather than "unlikely to happen soon", you have constructively conceded that the other guy is right…
