How Can We Know How Much Government Debt Is too Much? By Looking at Prices as Well as Quantities
The highly intelligent and thoughtful Ken Rogoff writes another column where I simply cannot grasp the force of his argument:
World is right to worry about US debt: The idea that one should just ignore all these problems and apply crude Keynesian stimulus is a dangerous one. It matters a great deal how the government taxes and spends, not just how much. The US debt level is a constraint. A growing number of empirical studies, including my own joint work with Carmen Reinhart, suggest that the US has already reached a debt level that has been associated with slower growth in advanced countries. The fact interest rates are low today does not necessarily mean the US is an exception to this rule – take one look at stagnant Japan’s rates. The dollar’s reserve currency status buys America more room, but how much and for how long? A high debt burden is a problem precisely because it reduces a country’s capacity to deal with future shocks…
Three points:
At current interest rates, if there is any hysteresis shadow at all cast by low employment and low private and public investment on the future level of potential output--and it is highly, highly likely that there is, with the Oulton and Sebastiá-Barriel (2013) paper finding results consistent with η=0.2 just the latest piece of evidence--"crude Keynesian stimulus" does not ignore debt-financing problems but reduces them. To be opposed to "crude Keynesian stimulus" right now because one worries about the burden of the debt on the economy in the future simply gets things backward.
Economists do not look at quantities only but at prices. That is the very point of being an economist: to not simply be some operations-research material-balance accountant of product flows but to look deeper and take market prices as indicators of Lagrangian multipliers associated with the appropriate social-welfare maximization problem. Whether the amount of any commodity is "excessive" depends on what supply is relative to demand. And prices tell you what supply is relative to demand. When the price of a commodity like U.S. Treasury debt is sky-high, that tells you that supply is not excessive relative to demand. And to point out that the quantity of U.S. Treasury debt right now is high and analogize our situation to others in which the supply of government debt was high and the price of government debt low is to forget that the economics that the parrot who says "Price and quantity! Supply and demand!' knows.
The right response to the claim that you care not just about the market price of the debt now but the market price in ten, twenty, and thirty years when the debt has to be refinanced is not to say "we shouldn't sell debt now because we fear we will have to refinance it on unfavorable terms"; the right response is either to (a) sell consols now, or (b) develop a backup financing plan to adjust in order to limit the extent to which a hypothetical fall-off in future demand for U.S. Treasurys would affect their price.
We have real problems. We don't need to stop ourselves from dealing with our real problems out of fear of the invisible bond market vigilantes.
