Public debt: don’t target the quantity, target the price

As I’ve mentioned previously, when I started work on Economic Consequences of the Pandemic, I assumed I’d be writing a polemic against austerity, as I did in Zombie Economics. Based on the last crisis, it seemed likely that any stimulus measures would be wound back rapidly, leading to a sluggish and limited recovery. That’s pretty much what is happening in Australia, where I live, but not in the US, where the book will be published. On the contrary, Biden’s policies are pretty much what I would have advocated (certainly if you take into account the razor-thin majorities he is working with). And, with luck, the main elements will be in place by mid-year, long before my book can appear.

So I’m refocusing on the issue of debt and how it can be managed. This was the central issue after the Treaty of Versailles, and also in the return to the gold standard, which prompted The Economic Consequences of Mr Churchill. io o

My central conclusion is a simple one. Rather than aiming for a fixed ratio of public debt to GDP, governments should aim to control the long-term rate of interest on inflation-protected bonds, and set it at a rate of around 1 per cent, about equal to the long-term rate of productivity growth. Since rates are well below that now, there is plenty of room for more public investment.

More over the fold

Instead of targeting the quantity of public debt it is better to focus on the price, which is best measured by the real (inflation-adjusted) rate of interest on long-term government bonds. For the US, this is represented by the interest rates for Treasury Inflation-Protected Securities (TIPS), the principal of which is adjusted in line with inflation. Currently, the rate of return on 10-year TIPS is negative (about -0.5) while the rate on 30-year TIPS is just positive (about 0.1 per cent).

These rates have been declining slowly over recent years. However, the passage of the American Recovery Plan and the announcement of the Biden Infrastructure package, involving around $5 trillion in new expenditure led to an increase of around 0.5 percentage points.

get the right strategy on public debt, it’s worth considering why any limit might be imposed. The answer is that lenders might refuse to buy more bonds and demand the repayment of the existing debt as it falls due. If governments cannot raise the money required, as has happened on many occasions, a crisis will ensue. There are three main concerns here

  • If debt is denonominated in a foreign currency, and the domestic currency depreciates, the burden of repayment can increase rapidly
  • If bond buyers fear future inflation, they will demand higher rates of interest to compensate for this
  • If bond buyers fear that the government will default on its obligations, they will be unwilling to buy bonds and will demand an interest rate premium

The US does not face the first problem, since its debt is denominated in US dollars. The second is not as big a problem as it seems, since government revenue will rise broadly in line with inflation. Nevertheless, to clarify the issue it is best to focus on TIPS

If investors fear a default, the real rate of interest on inflation-protected securities will increase. Unlike exchange rates and expectations about inflation, which can change rapidly, real interest rates typically move very slowly.

As can be seen below, the rate of interest on 10-year TIPS has declined gradually since the turn of the century, falling from a little over 2 per cent to a range between 0 and 1 per cent in the years before the pandemic. Rates spiked briefly by 2 percentage points in the worst of the financial crisis, before returning to the previous trend.

There was also a brief uptick during 2012 and 2013. The rate fell to negative levels between 2011 and 2013, following large scale purchases of government bonds (quantitative easing), followed by a return to just under 1 percent. The reversal, occurring when investors expected a rapid reversal of ‘quantitative easing’ , is sometimes referred to as the ‘taper tantrum’, but what is more striking is how modest these fluctuations have been.

The key implication here is that, if long-term fiscal policy is focused on maintaining a low and stable real rate of interest on government debt, there is little likelihood that it can be derailed by a sudden change in investor sentiment. rate
The stability of rates can be enhanced by a shift to longer term financing. There is a strong case for relying more on 30-year bonds and encouraging retirement income systems that invest in these bonds to provide secure incomes.

The ultimate long term security is a perpetual bond, like the ‘consols’ on which the British government relied in the 19th century. The advantages of perpetual securities have been discussed by both conservative and liberal writers.

Where should the target rate be set? In a world of technological progress, we expect that there should be investment opportunities that yield a positive rate of return, roughly measured by the rate of multifactor productivity growth (the growth in output from a given input of labour and capital). This is about 1 per cent.
Even before the pandemic crisis, the TIPS rate was consistently below 1 per cent. This implies that, with a 1 per cent target, there is substantial room for public investment financed by long-term debt, even after the passage of the infrastructure bill.

On the other hand, there are good arguments for gradually unwinding the expansionary measures adopted specifically in relation to the pandemic emergency. This would provide more room to move in the event of a similar emergency arising as unpredictably as the pandemic and, before that, the GFC [these events weren’t, in fact, unpredictable and were in fact predicted, but even those who feared such events couldn’t say when they would hit]

15 thoughts on “Public debt: don’t target the quantity, target the price

  1. On the other hand, in a world of technological progress, but of ecological, climate and social regress, we might not expect that there would be investment opportunities that yield a positive rate of return. Such returns would, after all, be unrealistic relative to real trends. When I use the word “real” I refer to real systems (or sub-systems thereof) where quantities can be measured in scientific dimensions, in SI Units (International System of Units). Measuring in anything else is a ticket to fantasy land. In other words, I am saying if financial returns are positive (overall) while real systems, and real stuff measured in real systems, are declining (in quantity, quality and/or “serviceability” then the gap between the fictitious and the real (between finance and real stuff) is becoming ever more farcical and fantastical in character.

    Placing the emphasis on measuring, equating and managing fictitious “stuff” (quantities of the numéraire) at the expense of measuring and managing real stuff is the profound mistake at the heart of classical and neoclassical economics. The core attempt in finance and orthodox economics, utilising the numéraire, is to equate disparate real things by making the incommensurable commensurable in the fictitious (social-fictive) dimension of the numéraire. Ontologically, this procedure is fundamentally flawed and doomed to failure. The failure it is doomed to is precisely the crisis we see developing with ominous inevitvablity. We cannot sustainably manage real systems by this method. We destroy biosphere and climate but by jingo the numbers in the fictitious dimension look good, albeit for the rich only.

    A proviso must be placed on the above. The social-fictive dimension of money is real to people who obey its calculations, imperatives and dictates. It is operationally real at the formal level and socially real at the ideational and behavioral levels. The formal numbers are used to control possibilities and behaviors in a social world where people are educated and/or forced by various power realities to obey the dictates of te money-power system of our society.

    We are stuck with this system for the foreseeable future because most people believe in money and believe in the overall system and it does work practically in a certain way, to a certain extent and it suits a certain percentage of the population, for the time being at least. This is just as the medieval population (across all classes) believed in, or acquiesced under pain of excommunication or death to faith in God, the Divine Right of Kings and the general right of the people with gold to make the rules. Now, matters are simplified. We believe in Money, the divine invisible hand of commerce and the general right of the people with the most money and property to make the rules. This is despite our self-deluding pretensions to democracy.

    What is needed eventually is for faith in money, commerce, capitalism and wealth to be destroyed by real events. And this faith will be destroyed by real events, real soon. The biosphere will degrade, the climate run haywire and money will be exposed as incapable of measuring and managing the real no matter how its financial operations are finagled. In the meantime, we are tied to the faith system of capitalism. The reins of capitalism are still the only reins that work even if the horses now follow a fictitious rather than a real road. Thus, those that know money is ultimately tending to complete fictitiousness, also know that the money reins are still the only ones available to pull. With an eye to the actually real (real systems), they must pull the fictitious reins that are paradoxically given purchase by the mass-delusion faith in capitalism, and pull those reins to guide the deluded believers to a potentially more realistic road. This is what our best economists (like J.Q.) are trying to do. At least, that is the best spin I can put on it to maintain some shred of hope that we are not already totally lost.

  2. Niggle: “,,, a perpetual bond, like the ‘consols’ on which the British government relied in the 19th century.” During the long Victorian near-peace (99 years from 1815 to 1914) the British government barely borrowed at all. The debt had been run up before, in the long struggle with France, from about 1750 ( Even the spending in the 1850s (wars in the Crimea and India, sewers in London) barely makes a blip.

    Idle thought: if you are issuing consols, why bother with a face value? There’s the price you originally sold them for, a purely historical datum; and the current market price, of interest to investors but irrelevant to public finance. The change would annoy debt fusspots no end.

    Te US + Australian perspective is a bit narrow for the subject. I looked up the current bond rate for Nigeria, a large and pretty stable oil exporter. For 10-year government bonds, it’s 10.956% (Is that in dollars or naira?) For developing countries, debt crises are never far away.

  3. James’ contribution raises an interesting point. From the early 17502 to the 1840s consols were the preferred risk-free savings for the wealthy. You made your stash in India or cotton or privateering or industry and put it into land and consols, so gaining social status and security. As Britain retired debt, yet the economy grew, where did the wealth go? After 1870 land was out as a reliable investment. The novels of the time are full of setbacks due to unwise plunges into Peruvian mines, Ottoman bonds and such. Maybe Uber (25 billion in losses to date) is the equivalent in our times?

  4. Ikonoclast,
    You state: “On the other hand, in a world of technological progress, but of ecological, climate and social regress, we might not expect that there would be investment opportunities that yield a positive rate of return.”

    Well stated. For those that may have missed it, here are some ‘fact checks’ that I see on the existential threats of climate change:

    1. In 2020, per ERA5 data, global mean warming (relative to Holocene Epoch pre-industrial age) was already around +1.3 °C, land mean warming was almost +2.0 °C, and ocean mean warming was just over +1.0 °C.

    2. The Scripps Mauna Loa Observatory measuring atmospheric CO2 concentrations recorded hourly average levels spiking above 420 parts per million (ppm) on 20 Mar 2021 and above 421 ppm on 21 Mar 2021. I would not be at all surprised if we see daily, weekly, or even a monthly average reading crossing the 420 ppm threshold in the next few months. The last time planet Earth’s atmosphere was so rich in CO2 was millions of years ago, back before early predecessors to humans were likely wielding stone tools; the world was a few degrees hotter, and sea levels were tens of metres higher.

    3. Per the report “Climate Reality Check 2020”, page 11, the current Earth energy imbalance (EEI) – the radiative imbalance at the top of the atmosphere (between outgoing and incoming radiation), which is driving global warming – is in the range +0.6–0.75 °C for the level of greenhouse gases ALREADY in the atmosphere. So that means we are likely already ‘locked-in’ for a global mean warming in the range +1.9–2.05 °C at equilibrium, with no further human-induced GHG emissions.

    4.1. Regardless of any GHG emissions trajectory humanity chooses to take from now on, best modelling estimates indicate the +1.5 °C global mean temperature threshold is likely to be crossed sometime between years 2026 and 2029 inclusive – meaning, +1.5 °C is inevitable and likely before 2030. I’d suggest anyone who says we can still keep below +1.5 °C is either profoundly ignorant, or lying.
    DOI: 10.5194/esd-12-253-2021

    4.2. For crossing the +2.0 °C global mean temperature threshold, for higher GHG emissions scenarios (SSP2-4.5, SSP3-7.0 and SSP5-8.5) the best estimates are all before the year 2050 (i.e. 2046, 2043, and 2039, respectively). Only the lower GHG emissions scenarios (SSP1-1.9 and SSP1-2.6) best estimates are after 2050 (i.e. beyond 2100, and 2064, respectively). +2 °C warming would be extremely dangerous.

    4.3. For crossing the +3.0 °C global mean temperature threshold, for higher GHG emissions scenarios (SSP2-4.5, SSP3-7.0 and SSP5-8.5) the best estimates are all in the second half of this century (i.e. 2094, 2069, and 2060, respectively). +3 °C warming would be catastrophic.

    5. The “Hothouse Earth” scenario is one in which climate system feedbacks and their mutual interaction drive the Earth System climate to a point of no return, whereby further warming would become self-sustaining (that is, without further human perturbations). This planetary threshold could exist at a temperature rise as low as +2 °C, possibly even in the +1.5–2 °C range.
    DOI: 10.1073/pnas.1810141115

    6. If humanity cannot get its GHG emissions rapidly reduced, then its inevitable progressively more parts of the world will become uninhabitable.
    DOI: 10.1073/pnas.1910114117
    DOI: 10.1126/sciadv.aaw1838

    7. Risks of simultaneous crop failure increase disproportionately between 1.5 and 2 °C, so surpassing the 1.5 °C threshold will represent a threat to global food security.
    DOI: 10.1016/j.agsy.2019.05.010

    The Australian Academy of Science outlines what we may expect in its report titled “The risks to Australia of a 3 °C Warmer World”, published Mar 31.

    And yet it seems there are more fossil fuel projects being proposed and encouraged.

    An example of this IMO suicidal lunacy is highlighted in The Australia Institute’s (TAI’s) report titled “One Step Forward, Two Steps Back: New coal mines in the Hunter Valley”, published Mar 31, where scores of new and/or extensions of existing coal extraction projects equivalent in total to more than a dozen Adani-sized mines is documented. Unfortunately, Table 2 within the TAI report relies on apparently bad data from the Department of Industry, Science, Energy and Resources (2020) Resources and Energy Major Projects List, and the primary source data I see from the NSW DPIE major projects and IPCN websites indicates it contains serious errors that should have been corrected. The ones I know about, for example:

    1) “Airly Increase Production” in Table 2, or “Airly Mine MOD 3 – Production Rate, Workforce and Train Movement Increases” on the NSW DPIE website, was quietly withdrawn by Centennial Coal in Dec 2020;

    2) The ‘greenfield’ KEPCO Bylong Coal Project was refused by the Independent Planning Commission NSW (IPCN) on 18 Sep 2019. On 18 Dec 2020, the NSW Land and Environment Court rejected KEPCO’s appeal, upholding the IPCN’s findings that the mine was contrary to the principles of ecologically sustainable development and would have problematic climate impacts. KEPCO has recently lodged an appeal against the NSW Land and Environment Court’s decision to uphold the refusal;

    3) “Vickery” in Table 2, or “Vickery Extension Project” on the IPCN website, was approved by the IPCN on 12 Aug 2020, for a period of 25 years, proposed to extract a maximum 10 Mt/y ROM, NOT 8 Mt/y;

    4) Angus Place Mine is currently ‘mothballed’ and the current development consent expires in Aug 2024. “Angus Place Extension Underground” in Table 2, or “Angus Place Extension Project” on the NSW DPIE website, is currently at ‘Response to Submissions’ phase, with the proposal to extend the mine life to the end of 2053, increase the FTE workforce from 300 to 450 maximum, and increase the maximum extraction rate from current permissible 4.0 Mt/y to 4.5 Mt/y ROM, NOT 3 Mt/y.

    IMO, TAI should have done a better job at checking the data with primary sources. But I think fortunately, it doesn’t negate the overall conclusions in their report.

    Ikonoclast, I’d suggest: If you don’t have a habitable world to live on with adequate energy supplies, no amount of money will make it better.

  5. Peter Thomson: Your premise is wrong. The chart shows the debt/GDP ratio, not total debt. IIRC the debt total barely moved after 1815, with small sinking funds balanced by small wars. What steadily lowered the ratio was economic growth. The rich always had a safe low-yield asset to park their loot. But as you say, many had a high appetite for risk.

  6. James – happy to be corrected, but if the total debt stayed the same but wealth grew rapidly, then the rich must have had to find other assets?6 The more so as land yields dropped a lot after 1870 (David Cannadine’s book on the decline of the British aristocracy details just how hard many of the landed were hit, with fixed outlays and declining incomes – not that I bleed for them, more for the farm labour they screwed to the wall trying to make ends meet).

  7. @JamesW Thanks. My thought is that the emergency component of the debt, for example the cost of GFC and pandemic rescue packages, should be in consols. In normal times, they wouldn’t be issued, so the ratio to GDP would decline. The maturity of infrastructure debt would be matched to asset lives.

  8. How can individual governments set the real cost of debt? With moderate international capital mobility, this cost is determined internationally – it is not a fluke that interest rates are low everywhere now. If the US creates a bout of inflation, as it did during the Vietnam War years by refusing to raise taxes enough to cover its massive spending surge. then a small country like Australia will face higher interest rates irrespective of its monetary policies. It then makes sense to target the quantity of debt we raise.

  9. In the Australian context, could state governments issue ‘consols’ (or 30 year semis) – or would this have to be an entirely Commonwealth government policy?

  10. Harry, if interest rates rise in the US, the mechanism for how that raises Australian interest rates, at least according to second year macro (new Keynesian, I believe), is that there’s less demand for Australian bonds, since they have lower returns. This means there’s less demand for Australian dollars, since overseas investors won’t be trying to buy Australian bonds (and there will also be more Aussies buying US bonds and seeking AU$ to do so), and the Australian dollar will depreciate. This will make imports more expensive and exports more competitive, increasing GDP in Australia and thus raising interest rates until they are equivalent to the US (plus risk). So there’d be no need of aggressive fiscal policy, as GDP would be increasing and thus John’s proposal works.

    However, I don’t think that model is particularly relevant for 30 year bonds, which tend to take a longer view than the kind of cycles I outlined. I think it’s more Solos than Keynes.

    John, I’m slightly concerned about the implications of this sentence: “Rates spiked briefly by 2 percentage points in the worst of the financial crisis, before returning to the previous trend.” Does that mean we would have been unable to expand fiscal spending in our hour of greatest need?

  11. Seqaughur, If exchange rates are flexible the parity condition might also involve, in the short-run, exchange rate expectations but, yes, the long-run result will be that interest rate parity obtains. Large countries like the US can influence (not determine) world interest rates but small countries like Australia cannot. You cannot target what is not yours to determine – at least not in the longer term.

  12. @Harry I’m writing for a US audience as I mentioned. For countries like Australia, scope is more limited, but there is enough home bias that it has some room to move, I think.

  13. John, Maybe you are right but I think some work needed here. If the US pegs the real cost of capital it is pegging a price and this can have serious consequences. With a fixed cost of borrowing the US has incentives to engage in an international Ponzi scheme – simply borrowing without limit until it hits its intertemporal budget constraint and the supply of foreign capital ceases. In fact, applying your pricing rule the US then looks like a small open economy. I assume you must be recognizing effects of increased borrowing on real interest rates that need to be offset with domestic policies to counteract their implied effect in increasing borrowing costs.

    But as I say you might be right – at least in the long run. If international capital is imperfectly mobile it might be that the Golden Rule f’=n holds in the long run for “optimal foreign borrowing” which is close to your suggestion where n is the rate of exogenous technical progress. This sort of rule crops up everywhere and it might crop up here. A complication is that if the US can influence international interest rates then, as a monopsonistic borrower in international markets, it has incentives to restrict borrowing somewhat via a kind of “optimal tariff” argument to reduce its steady-state borrowing costs and this might disturb this type of rule. Maybe it only determines the transition and not the steady-state. Yes, I am guessing/speculating here. Laziness.

    You could check this out by studying an infinite horizon economy optimizing the discounted utility of consumption but where the international cost of borrowing is an increasing function of the extent of borrowing. Do you get to a long-run equilibrium where the f’=n rule obtains? If so then your argument for pegging the real cost of borrowing to the rate of technical progress makes sense, at least in the long-run. I can’t believe that the rule holds in the transition since the demand for capital will depend on the initial state of the economy.

  14. Our current form of political economy is destroying the environment (entire biosphere) as a survivable place for much human, animal and plant life that adapted to the Holocene and the Pleistocene before that. It is an absurd idea to think that fiddling with amounts of the nominal Numéraire (money) which measures value in a social-fictive dimension (so-called economic value) will address, through free markets, the real problems of this economy interacting with the biosphere. The phrase “through markets” is key to that statement.

    Money will remain important but not through markets. Money measures nothing real so it is not the way to make efficient and sustainable allocations. That can only be done by moral philosophy (ethical and consequentialist) decisions being made, as informed by science, applied by science and done in in a social democratic administrative manner involving law and regulation. At the technical / administrative level this means, in a nutshell, science plus social democratic statism. Money should become entirely and purely an allocative tool as permssions to consume according to law and regulation, according in turn to full social democracy. As Steve Keen says:

    Realizing what Neoclassical economists have done on climate change has also turbocharged my original motivation for writing Debunking Economics. Their zealotry about their model of the economy has ended up not merely causing crises in the real economy, but jeopardizing the survival of human civilization, and causing the extinction of a substantial slab of life on Earth. If civilization does survive climate change, it certainly won’t be in the form of the mythical free market capitalism they believe they’re championing. In the struggle to survive, we could find ourselves in the equivalent of a War-based military command economy, with severe rationing, forced redistribution, and controlled production.” – Steve Keen.

    Keen is absolutely correct. It is now 100% certain that this will happen excepting the possibility of rapid collapse into catabolic barbarism. We are headed for an ecological-survival based command economy if we are to survive extinction. There will be severe rationing, forced requisitioning, forced redistribution, conscripted labor, and controlled production. The decision will be how we do it. China and Russia have opted for party oligarchic rule tending to one person dictatorship, riches for the oligarchs and some apparatchiks plus a controlled system which can rapidly switch the masses to severe rationing, forced requisitioning, forced redistribution, conscripted labor, and controlled production within statist totalitarianism. Their system is better place than ours to make the necessary transition.

    The command system is the only system with a hope of survival. Our only hope in the West is to switch to our own form of statism which must be developed from our social democratic tradition. A model different from Soviet and Chinese models is possible. But the decisions must be democratic and the sacrifices shared. Can this happen? Time will tell.

  15. Ikonoclasts political outlook and my political outlook have now almost completely merged. The only quibble that I would have with his last paragraph from 9:15 am is from his statement that the decisions must be democratic and sacrifices shared. My quibble with it is that it depends on how one thinks of the word democratic. If it is in the sense that decisions must be made for the benifit of the masses rather than the rich, or high ranking then I agreee. But if we think of it in allowing one person one vote, which allows allows for the possibility that the dumbest 51% of a population could prevent the a country from doing what needs to be done then I disagree. In fact in the future there will not even be time to ask the masses what they think should be done.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s