Tyler Cowen writes:
A wee bit more on spending, borrowing, and earthquakes: Regarding Brad’s response post. I view our disagreement as such. In my view, a low rate of interest on Treasury securities indicates a high chance that the investors will be paid back. That is all it means. It is not a market signal that the government output should be produced. Investment is a normal good and post-earthquake the world is poorer, and riskier, so optimal investment can either go up or down. The interest rate on debt is not a sufficient statistic summing up all of the conflicting “investment should go up” vs. “investment should go down” forces in our thought experiment. It is not summing up real consumption risk or output valuations, only whether the government will pay back investors (None of this, by the way, need deny that there might be other, non-earthquake reasons for expanding government spending).
If the price of something--in this case, government production--goes down, as it has in the aftermath of the earthquake-and-tsunami as U.S. Treasury interest rates have dropped by 10 basis points, shouldn't you buy more of it? Yes.
It is true that the world is poorer as a result of the earthquake--poorer by perhaps $100 billion as a result of all the destruction. And a poorer world should buy less of everything. But the U.S. is not poorer: we should not buy less of anything.
So it is very clear to me that the U.S. government should spend more.
How about the Japanese government? The world is still short of high-quality assets and the Japanese government can provide them on much the same terms and thus finance its spending on the same terms. Japan is poorer and should buy less of everything. But the return to rebuilding earthquake-and-tsunami damaged infrastructure is very high. The Japanese government should buy more as well.