Earthquakes and spending and deficits

Brad titles his post: “I Genuinely Do Not Understand Why There Is A Question Here…” and after quoting my post from yesterday writes:

If people thought that government debt was risky, its price would be falling as well. The fact that people are willing to pay more for government debt indicates that it is increasingly valuable–and so we should make more of it.

Ryan Avent comments as well.  A few points:

1. My post and question is about spending, but Brad has shifted the discussion to borrowing.  It’s easy enough to borrow more without increasing spending, if that is needed.  It’s still an open question whether spending should go up.

2. The countervailing forces which might favor lower government spending simply aren’t mentioned.  Those include lower wealth and higher tail risk.  If those can’t, at least possibly, imply lower government spending, what could?  The Japanese will need to spend on recovery, but must the U.S., normatively speaking, now feel compelled to spend more on its domestic programs?  A priori?  No way.

3. The earthquake and related events are a negative supply shock, so on Keynesian grounds they need not increase the case for activist fiscal policy.

4. Don’t forget that Mike Jensen answered Kenneth Arrow on risk in 1972.  Even if government spreads its pecuniary losses over many taxpayers, the relevant real risk is the covariance of the value of government output with private consumption.  Given that, an increase in risk still implies at least one force operating in favor of less government spending.

5.  It is an oddly non-Keynesian or perhaps even anti-Keynesian point.  In 1936 Keynes argued that the rate of interest did not allocate investment properly, or correctly signal the proper amount of investment, because interest rates also channeled liquidity preferences.  Today this is a claim which DeLong and Krugman are arguing against.

In other words, it’s an open question, as my original post implied.

Megan McArdle had some to-the-point words:

It’s hard to argue that we should become more willing to borrow because Japan had an earthquake that will cut into global GDP.

And:

And the bad signals aren’t just to the federal debt market–the flight to quality is ultimately going to push things like mortgage rates down too.  Would the people urging the government to take on as much debt as possible also urge our homeowners to once again leverage themselves as far as the banks will allow?

Update (12:25 pm) Reader abUWS has perhaps the best, most succinct metaphor I’ve ever seen for this argument:

“When the Titanic was sinking everyone eventually rushed to the stern of the ship. That didn’t mean that that part of the ship was actually safe.”

Addendum: Arnold Kling offers relevant comments.

Comments

Yes, why is there a question? You retire higher interest debt with lower interest debt.

"That didn’t mean that that part of the ship was actually safe.”
Compared to what?

"compared to what" is restating the point

I built a business and retired at 45 by taking advantage of the sweet spots where costs and opportunity lined up. The US is in a sweet spot now to take care of a backlog of infrastructure repair/improvement and instead we wring our hands and talk about the Titanic. Obama's proposed budget for 2011 was less than 25% of GDP. Titanic?! And I am buying real estate right now and would recommend anyone who thinks you grow wealth by buying low and selling high to consider doing the same (this obviously depends on your area).

"It’s hard to argue that we should become more willing to borrow because Japan had an earthquake that will cut into global GDP."

No, it's easy: the earthquake caused a market condition that lowered our cost of borrowing, and therefore we should be more willing to borrow. That's the point.

"Would the people urging the government to take on as much debt as possible also urge our homeowners to once again leverage themselves as far as the banks will allow?"

There are a lot of random superlatives here ("as much debt as possible," "as far as the banks will allow"), but if I were in the market to buy a house, and mortgage rates dropped but house prices didn't, I would certainly consider buying a bigger and more expensive house. It would be crazy not to. The problems with homeowner leverage in the recent housing bubble did not arise because people borrowed at interest rates that were too high.

"When the Titanic was sinking everyone eventually rushed to the stern of the ship. That didn’t mean that that part of the ship was actually safe."

In other words, maybe the market is wrong and has overvalued US government securities. Even if true, that doesn't answer the question of what the US government should do under those circumstances.

" I would certainly consider buying a bigger and more expensive house. It would be crazy not to."

Because you don't plan on taking out new debt once you pay off the mortgage. The government will not be paying down this debt when its term is up.

All the discussion (in this post and the predecessor) seems to treat government debt like a homeowner mortgage -- fixed rate for a fixed term, at the end of which the steady amortization of the loan results in no residual debt-forever. So if you borrow low, you can afford more house.

Ain't nuthin like that, is it? What happens to our economy ... to the world economy ... when the lenders get a little tighter and the interest on U.S. debt starts to go up? Suppose, for example, that the government of China makes a policy decision to invest more of their accumulated dollar surplus in infrastructure instead of U.S. Treasuries? What do we do then, just go ahead and pay it off?

As to the open question of whether spending should go up when unemployment is 9% and real interest rates hover around 1%, realizing these gains of $200 billion per year (http://newamerica.net/publications/policy/costs_of_the_infrastructure_deficit) probably will require the government to chip in a few dollars. And it might even help mitigate that pernicious structural unemployment problem that plagues us.

Who knows? There might even be some other types of profitable public investments. If only we would decide to look for them!

Its kind of like when Best Buy offers me 0% APR and no payments for two years on a flat screen TV. Yes, the lower financing costs makes me more likely to buy the TV. But in two years all I've got is a depreciated consumer asset and a bunch of bills.

The federal governmentatany point in time must have some investment projects that make sense at one borrowing rate that do not make sense at a higher borrowing rate. Ditto if there are a lot of unemployed resources. Keynesian government spending seems to flow naturally out of conventional cost benefit analysis.

Alkali--as another commenter points out, this isn't like borrowing on a fixed-rate 30-year self-amortizing mortgage. It's like borrowing on a balloon ARM.

The US can sell 30 year fixed rate treasuries if it wants. Google finance says they are trading at about 4 1/2 % today.

Would you advise my city to borrow money to fix our leaky water system so that we have enough water to continue our normal growth rate? We are losing a fairly large percentage of water and now face shortages.

It seems the answer to your question has nothing to do with seismic activity in Japan, which is the point.

Just to expand a bit - if the cost of your town's repairs is $10MM, and you were going to borrow at 4% for 10 years, but post-quake, rates fall to 3%, DeLong is saying you should borrow $13MM and find some other use for the 3. No one on either side of the debate is saying do or don't borrow the 10. And if you had some other use for the 3 that will generate more than 3 in 10 years time, that may make sense, but if you didn't, then it doesn't make sense to take it down and spend it because that is negative NPV. Right? And one option is simply to borrow the 10 at 3% and have $90,000 a year less in interest expense. So the point is a drop in interest rates does not rationally imply that a prudent person borrows as much as the market will lend. A speculator might but a prudent person managing taxpayer money should still do only NPV positive projects and this is just a change in one input to the NPV analysis.

Since the Reagan revolution, bankers and realtors were telling telling individuals that low interest rates and low down payments were telling the home buyer to buy a bigger liability that ever before. Before Reagan helped bankers innovate, bankers kept questioning whether I should be borrowing so much because a house was a major liability, and they didn't want to be stuck with mine.

So, it seems to me DeLong is saying what the bankers liberated from liberal debt ideology by the conservatives told borrowers. And Wall Street has richly rewarded the firms with high capital worth who borrowed heavily and reduced net worth, carving out a special niche business of leveraged buyouts. Seems to me DeLong is talking conservative debt theory.

"No one on either side of the debate is saying do or don’t borrow the 10" We must live in separate realities because in mine, "don't borrow the 10" is exactly what people are saying. We are not borrowing the 10 and have no intention of borrowing the 10. We just send out crews to plaster on another patch. I am saying that is crazy and there are multitudes of examples just like that around the entire country.

My point is that there are way more positive NPV projects than we are currently funding, many of them projects we will have to fund in the near future when costs are much less advantageous. I think DeLong's point is that when investors want to park their money in low interest treasuries, this money leaves circulation leading to slower growth and investments. I took Cowan's question to be whether lower borrowing costs should lead us to fund more of these projects than we currently fund. My answer is, of course.

I think we are definitely identifying the fundamental difference - whether you believe govt has many unfunded NPV positive projects (and implicitly that all its existing projects are non negative NPV and therefore cannot be cannibalized to fund the positive NPV ones). I don't believe that at all. I think a lot of government activities are not positive NPV. I think there is massive waste..I think private citizen identification and determination of the NPV of expenditures is at least as good as government's on average. If you are Keynesian and believe that paying people to dig ditches and fill them back up again is a net positive NPV activity, then like DeLong you will say, go borrow more money in addition to the money you are already borrowing. and pay more people to dig ditches and fill them back up Now, I think that is a really bad idea because there is no way the tax revenue garnered by that activity ever pays the government back. But that is the nub of the difference on this issue.

mark,
What if the town has a repair project that was not viable at 4.5% but is now viable at 4%.

It's easy to create stories. This is a MACRO issue. Stories about town repairs, house leveraging, what someone is having for dinner are nice, but don't inform. At least you didn't throw in a bunch of asanine superlatives like McM did.

I think your first sentence is simply consistent with the final sentence of my comment so thank you.

I have no idea what you mean by the phrase "this is a macro issue" and the all caps did not enlighten me. NPv analysis is inherently not a macroeconomic issue. If you mean something Keynesian, I understand your point of view although disagree.

The patient has the security right? Everyone will say: of course! But, the hospital praying for patients is, many of these patients to the hospital, apparently hopeless, hospital or do one's duty to was treated, delaying the about life, finally back in the weak. The patient's family whether can say no guarantee the safety of power and hospital complained? Obviously, security right at patients, there will beat discount. In addition, patients have right to know? Yes, of course.

The earthquake, presumably, did not reduce the U.S. government's "credit score," if you will. So it is a better deal to borrow today than it was last week.
But the argument has always been over the size of the borrowing, not its terms. No one was arguing last week that the U.S. should curtail borrowing because the cost of the debt was too high.

I have a new policy. I don't read or listen to anything Brad DeLong says. So far, the early results are that I'm smarter, happier, and less jaded about the world.

I credit Bainbridge as the inspiration for this policy. He cites George Bernard Shaw - "I learned long ago, never to wrestle with a pig. You get dirty, and besides, the pig likes it."

Isn't the simplest refuation to ask Brad DeLoud to specify how he would repay the incremental debt? I am sure he doesn't have a clue. And then the answer would seem to be that to borrow without any idea of how to repay it is not a sustainable strategy..

DeLong's argument is clever and hard to refute. One approach would be to say that bond investors aren't responding rationally to the Japan situation, but that is likely a dead end in these quarters. Another idea is that when the cost of borrowing is decreased, one should borrow more, but only if they were previously borrowing at the optimal amount from whatever is the relevant public policy perspective. Since the USA is hurtling towards default in the medium term, it seems that what commentators on here really want to say is that: (1) we were wildly over-borrowing to begin with; (2) the Japan-based interest rate shock makes the over-borrowing slightly less bad, but we are still over-borrowing and therefore should not respond to these events by accumulating debt at an even faster pace.

If the US is hurtling to default, it is merely because the Congress, especially the House, is failing to honor and use their first and second enumerated powers.

Of course, I think the Tea Party and others consider the first and second enumerated powers of Congress to be unconstitutional.

All those Tea Party folk seem to have forgotten the reason why we have a Federal government, and why the first and second enumerated powers of Congress and number one and two. But it probably is related to the home schooler Bachmann teaching American history to her fellow Congress members, and getting it as correct as the location of Concord and Lexington.

There is a tendency to elide the difference between economically rational arguments and moralistic ones. When Obama was elected, lots of people on the Right panicked and started buying guns and ammunition. Under those conditions, manufacturers should produce more (if they have capacity). It isn't necessarily _morally_ preferable to flood the market with cheap, lethal, firearms, but it is the economically rational thing to do.

Those arguing on the side of "less borrowing" now are most often (but not always) those who adopt arguments on the "economically rational" side on other topics. Possibly, Prof. DeLong is merely chiding them on their inconsistency.

Some would disagree with your assertion that it is "economically rational" to borrow more. See dave or James Lynch above

I believe they confuse strict economic rationality with other kinds of behavior which certainly can be described as "rational" when non-economic factors are taken into account. Strict economic rationality dictates that if preferences do not change, when prices in a product fall then agents who prefer to own the product should buy more. Since money can be viewed as a product and the interest rate its "price," as interest rates fall the economically rational action is to "buy" more of it.

Certainly, if the price of chewing gum falls, then toothless people should not buy more of it. That would not be rational in the broader sense. But they didn't have a preference for that good to begin with.

The question here, and which "dave," "James Lynch," and also McCardle and Cowen ask implicitly is whether an earthquake/tsunami/nuclear meltdown in Japan should have any influence on the _preferences_ of the US Treasury, US homeowners, or other economic actors for borrowed funds. The answer to that question is probably "No." However, if potential borrowers in the US actually have a preference for _more_ borrowing but were dissuaded by the prevailing interest rates ("priced out of the market", so to speak), then it would be natural (and rational) for them to increase their borrowing if the interest rates (price) fall.

I think an open debate among members of a polity on their collective preference for borrowing is a good thing. However, when the debate becomes a moralistic screed about the virtues of thrift and the vice of debt, I think it can actually be harmful.

A better question is why the US doesn't just convert it's debt to these historically low 30Y rates. When you can answer that, then you will know why DeLong is best ignored.

I don't think this bit is right:

3. The earthquake and related events are a negative supply shock, so on Keynesian grounds they need not increase the case for activist fiscal policy.

The earthquake is a negative supply shock in Japan, but from the US perspective our productive capacity is undiminished (at least mostly) while the earthquake has (probably) reduced demand for our output of goods and services. So on the US policy side, from a Keynesian POV, this would be a negative shock to demand on warrant more supportive fiscal policy.

I like aBUWS' metaphor as well. It puts me in mind of the old adage about the prettiest horse at the glue factory.

the bad signals aren’t just to the federal debt market–the flight to quality is ultimately going to push things like mortgage rates down too. Would the people urging the government to take on as much debt as possible also urge our homeowners to once again leverage themselves as far as the banks will allow?

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