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Public Debt and Low Interest Rates

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  • Olivier J Blanchard

    (Peterson Institute for International Economics)

Abstract

Blanchard develops four main arguments concerning the costs of public debt when safe interest rates are low. First, the current US situation in which safe interest rates are expected to remain below growth rates for a long time is more the historical norm than the exception. If the future is like the past, this implies that debt rollovers—that is, the issuance of debt without a subsequent increase in taxes—may well be feasible. Put bluntly, public debt may have no fiscal cost. Second, even without fiscal costs, public debt reduces capital accumulation and may therefore have welfare costs. However, welfare costs may be smaller than typically assumed. The reason is that the safe rate is the risk-adjusted rate of return on capital. A safe rate that is lower than the growth rate indicates that the risk-adjusted rate of return to capital is in fact low. The average risky rate, i.e. the average marginal product of capital, also plays a role, however. Blanchard shows how both the average risky rate and the average safe rate determine welfare outcomes. Third, while the measured rate of earnings has been and is still quite high, the evidence from asset markets suggests that the marginal product of capital may be lower, with the difference reflecting either mismeasurement of capital or rents. This matters for debt: The lower the marginal product, the lower the welfare cost of debt. Fourth, Blanchard discusses a number of arguments against high public debt, and in particular the existence of multiple equilibria where investors, believing debt to be risky, require a risk premium, which increases the fiscal burden and makes debt effectively more risky. This argument, while relevant, does not have straightforward implications for the appropriate level of debt. Some of these conclusions will be controversial. But the aim of the paper is to foster a richer discussion of the costs of debt and fiscal policy than is currently the case, not to argue for more public debt, especially in the current political environment. The appendices and data underlying this analysis and appendices are available https://piie.com/system/files/documents/wp19-4_0.zip

Suggested Citation

  • Olivier J Blanchard, 2019. "Public Debt and Low Interest Rates," Working Paper Series WP19-4, Peterson Institute for International Economics.
  • Handle: RePEc:iie:wpaper:wp19-4
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    More about this item

    Keywords

    Unemployment; Debt; deficits; interest rate; safe rate; risky rate; marginal product of capital; growth rate; risk premium; secular stagnation; overlapping generation; welfare; transfers;
    All these keywords.

    JEL classification:

    • H3 - Public Economics - - Fiscal Policies and Behavior of Economic Agents
    • H6 - Public Economics - - National Budget, Deficit, and Debt
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy

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