Deficits and interest rates

Could the Fed be keeping rates lower in order to reduce the federal cost of borrowing?

I have also been confused about the assertion that the federal government printing a lot of money to finance a deficit is necessarily inflationary. The way I look at it is that when the federal government prints and spends money it pumps up demand for goods and services. If you have more demand chasing the same amount of goods and sevrices you will have inflation; but, if you have more demand chasing more goods and services, you won’t necessarily have inflation.

In a period of substantial undrecapacity, such as now, the government could print and spend the money to hire and pay people for various public works jobs that would produce wealth. Then, the extra demand would be backed up by the extra wealth and not be inflationary.

For example, the federal government could build and run some factories that would produce some consumer goods, such as lithium ion batteries for electric vehicles, photovoltaic cells, some pharmaceutical compounds, etc., and sell them at somewhat of a loss in a period of weak demand, with the printed money covering the loss.

Dr Krugman, doesn’t this basically reflect the fact that right now, the “multiplier” for policy action is low, but just as the mutliplier contracted rapidly during 2008 (debt deflation), isn’t it capable of expanding rapidly (and maybe more rapidly than fiscal policy can be reversed)?

Put another way, in your heart of hearts, don’t you think your new apartment is a better store of value than cash or Treasury securities?

I think there is an old saying that things that are unsustainable probably won’t be sustained, and that seems especially true for excessive borrowing.

Professor Krugman-

You are performing an outstanding service in debunking the fatuous claims of the right. It seems that many economists, even respected ones, are willing to ignore or misconstrue evidence that threatens their ideological preconceptions.

You and Professor DeLong have been at the forefront of this intellectual battle. .

I am curious how this graph would look going back further, particularly during period stretching from the stagflation era into Reagan’s military build up deficits. Perhaps this speaks more about the nature of Fed policy and how it interacts with treasuries [duh], then deficit spending crowding out private investment.

In this post, it is stated that low demand for funds keeps interest rates low, an easily understandable idea. However, increased deficit spending is in fact an increase in demand for funds, being a public demand as opposed to private demand. What I am curious to understand is there any difference in the effect on interest rates, between an increase in public demand for funds and increase in private demand for funds?

Also, wouldn’t it be more precise to say that a weak economy drives up deficits because they lower revenues and not because they spur an increase in spending? So, it is somewhat of a leap to connect deficit spending with low interest rates? I would think that low interest rates are more connected with the lack of revenue side of a deficit than the increase public demand(deficit spending) side of a deficit.

PS – I’m a liberal too, so I’m merely attacking this out of academic curiosity, not because some conservative lobby scared me into it, lol

What you are saying is that it is hard to isolate tyhe effects of deficits on interest rates because other things – investment, consumption are also moving around a lot at the same time.

Of course, the idea that budget deficits don’t affect interest rates is perfectly consistent with Barro’s Ricardian equivalence, i.e., that if the Gov spends more, private individuals save more. But he’s “boneheaded,” right?

I am afraid that it is difficult to have a clear cut conclusion based upon such a short period ( app. a decade) , a testing of such theory should be done with a larger sample.

In addition, there are other factors that take place such as the coordinated expantionary fiscal and monetary policies ( as we have today) . Nevetheless, the main explanation for the apparent anomaly i.e. low interest rates with current account deficit and fiscal deficit during that period ,was the Chinese ( and other countries) mercantilist policies which helped to maintain US borrowing rates in a very low level ( denomitnated as Greenspan¨s “conudrum” or Bernanke´s “saving glut”) by recycling their surpluses into bond and other USD assets.

Did you consider that this correlation is because the federal reserve bank sets interest rates to reflect what the economy is going to do.

Back when President Bush was president Brad Delong would have said that deficits raise interest rates, according to the econometric models (he sent me an email saying so). Now I wonder if either Brad Delong or Paul Krugman would stake their professional reputation of the issue of if we in a liquidity trap today or not.

To the moderator: I’m not cursing, posting in all caps, or attacking another person making posts. So according to your own standards for posting how am I not being complient to the standards.

What about the role of foreign central banks and the Fed monetizing some of the debt? Until Aug 7, when the sense was that Chinese commodity buying would fuel inflation worldwide, the 10 year was headed higher. With American consumption down and the current account deficit down, China and other central banks might not want to buy so many treasuries. By cutting back on their commodity stockpiling, they’ve helped to put less pressure on treasuries. Since early August, when China announced its fine-tuning, the Shanghai Index, euro-dollar, crude prices, shipping rates, and 10 year treasuries have all declined together. We might see in the next couple months just how much leverage investors tied to the Chinese stimulus, if the Chinese really do take the pedal off the medal.

Paul, do you believe we have avoided the risk of a second Great Depression? I don’t.

Recent economic “strength,” a relative term, is due to data distortion and not authentic green-shoots.

First, the second quarter GDP report of minus 1% is based on a positive 1.38% contribution from net exports, despite the fact actual exports fell. Because imports fell faster than exports economists (alchemists) consider the improving trade gap a sign of growth.

Second, the recent improvement in the unemployment rate is because the government said 1 million workers were so discouraged they were removing them from the labor force.

Finally, the coup de grace is we are in a serious deflationary environment. The CPI is reported to be down by 2.1% over the last 12 months. Yet the cost of home ownership, almost 1/4 of the inflation calculation, claims owner equivalent rent dictates the cost of purchasing a new home is now 1 1/2% higher than it was a year ago. Yet the Case/Shiller index has median home prices down 17%. In the 1930’s home ownership costs were calculated by using the rise and fall of actual home prices. But we installed owners equivalent rent in 1983 to “improve” the accuracy of the calculation. It we used the same calculation they used in the 1930’s deflation would be running at 6% and 2%.

Hopefully your next column will be why we already need a fourth stimulus, since the first two weren’t enough and the next one will surely be inadequate too.

//escapethenewgreatdepression.com

weren’t interest rates high and deficits high also during the raygun years? aren’t those sorts of years the ones that the people who scream about the danger of inflation use to back up their arguments?