Low interest rates vs. high risk premium

It is often claimed that the governments of the United States, the UK, and Germany should spend more money because they can borrow at low rates, thus raising the present expected return on the investment considered as a whole.

Maybe, but keep in mind that the interest rates on quality government debt are down, in part, because the risk premium is up.  Non-governmental investments are perceived as riskier.  It is also possible that governmental outputs are perceived as riskier, as those outputs will be evaluated by consumers.  Note that Kenneth Arrow’s “the government can spread around the financial risk” point does not eliminate this more fundamental risk, namely the risk associated with the quality of government output, just as there is a risk associated with the quality of private sector output.  Michael Jensen made this point in 1972.

You might think the government investments are “low hanging fruit” in terms of quality.  Maybe yes, maybe no, but the low real interest rate doesn’t signal that, rather it signals merely that people expect to be repaid.

In this argument for more government investment, the notion of government investments as low hanging fruit is doing a lot of the work.


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