Confessions of a Supply-Side Liberal: My Thoughts about What Brad Says in the Quote Just Above: As I noted above, my reaction is to what we Yichuan and I found is similar to Brad’s. There must be a negative effective of debt on growth through the bond vigilante channel [when it is active vis higher interest rates], as Yichuan and I emphasize in our interpretation. For example, in our final paragraph, Yichuan and I write:
…other than the danger from bond market vigilantes, we find no persuasive evidence from Reinhart and Rogoff’s data set to worry about anything but the higher future taxes or lower future spending needed to pay for that long-term debt.
The surprise is the pattern that when countries around the world shifted toward higher debt than would be predicted by past growth, that later growth turned out to be somewhat higher than after countries around the world shifted to lower debt. It may be possible to explain why that evidence from trends in the average level of debt around the world over time should be dismissed, but if not, we should try to understand those time series patterns. It is hard to get definitive answers from the relatively small amount of evidence in macroeconomic time series, or even macroeconomic panels across countries, but given the importance of the issues, I think it is worth pondering the meaning of what limited evidence there is from trends in the average level of debt around the world over time. That is particularly true since in the current crisis, many people have, recommended precisely the kind of worldwide increase deficit spending—and therefore debt levels—that this limited evidence speaks to.
I am perfectly comfortable with the idea that the evidence from trends in the average level of debt around the world over time is limited enough so theoretical reasoning that shifts our priors could overwhelm the signal from the data. But I want to see that theoretical reasoning. And I would like to get reactions to my theoretical speculations above, about (1) supply-side benefits of lower taxes that reverse in sign in the future when the debt is paid for and (2) liquidity effects of government debt (which may also have a price later because of financial cycle dynamics).