Thursday, November 1, 2018

FRED Blog — How expensive is it to service the national debt? : A battle between interest rates and growth rates

Not that affordability is relevant from the MMT POV, but it's worth looking at anyway. "They" view it conventionally in terms of the interest rate "r," that is, the policy rate, and the growth rate "g" measured as change in GDP.

This is the ratio of r to g, or "r : g". As long as r is greater than g, "they" consider the increasing interest affordable. In fact, "r > g" has become a meme and entered the jargon since the publication of Thomas Piketty's Capital in the Twenty–First Century.

While MMT regards this ratio is irrelevant to affordability for a currency sovereign, MMT economists also point out that that it is under the control of the central bank as the monetary policy authority that sets "r" as the policy rate. The central bank can set the policy rate where it chooses relative to its mandate of growth, employment and price stability ("inflation"), although price stability usually predominate, since central banks tend to target an inflation rate and use employment rate as a tool under NAIRU.

There are no bond vigilantes that control interest rates in a currency zone where the government is sovereign in its currency and does not undertake obligations in terms where it is not sovereign and therefore could get squeezed.

So from the MMT perspective, concern over the affordability of the national debt is a canard that distracts from the issues that are actually important for policy. Neither fiscal payments by the Treasury nor monetary payments like interest on excess reserves are constraints on the government to spend. According to MMT, the real constraint is availability of real resources and the nominal constraint is inflation. "Affordability" is not an issue for a currency sovereign as the monopoly issuer of its currency as the unit of account in the currency zone.

The classic MMT paper on this issue is "Interest Rates and Fiscal Sustainability" by Scott T. Fullwiler (2006).

How expensive is it to service the national debt? : A battle between interest rates and growth rates

1 comment:

Ralph Musgrave said...

I agree with Tom that having g greater than r is irrelevant. Obviously if g actually is greater than r, that means the debt can be afforded in the long term, but by the same token I can afford to buy one pint of beer a day and throw it down the drain. That does not prove (you’ll be amazed to learn) that throwing beer down the drain makes sense….:-)

Tom also says that a monetarily sovereign government can choose any rate of interest it likes on its debt. That’s true, but it doesn’t answer the question as to what the best or “GDP maximising” rate is. Well the question as to what the “best” rate is was given by Warren Mosler: the best rate is zero. Put another way, there is no point in government borrowing anything.

I find Warren’s reasons a bit convoluted. I set out MY reasons at the link below. They are briefly and first that none of the motley collection of reasons put for government borrowing actually make sense. For example one popular argument is that government borrowing should fund infrastructure investment. Well one glaring flaw in that argument is that education is one huge investment, but no one ever suggests the entire state education budget for children should be funded by borrowing. Second, the REAL reason for most government borrowing is the desire by politicians to fund public spending by borrowing rather than by tax so as to ingratiate themselves with taxpayer / voters (something Trump is doing big time at the moment). David Hume pointed to that temptation facing politicians almost 300 years ago.