Arnold Kling and Niklas Blanchard discuss the past and future of US debt.
Niklas concludes
if borrowing pushes up the nominal interest rate on bonds above the productivity growth (which is highly correlated with GDP growth), then the trend in public spending becomes very unsustainable very quickly. Why is this a problem for the US and not countries in Europe? Because of their lower levels of growth, there is a lot of low-hanging fruit for those countries to pick off in order to increase their productivity growth rates. The US, seemingly (from the above graphs), not so much.
If I am remembering my growth models correctly then its not possible for the risk free real interest rate to exceed the GDP growth rate for an extended period of time. Which leads me to two possibilities:
- The US debt becomes a problem because it is no longer risk free. This is a theoretical possibility but requires a lot of systemic change. The devastating nature of a US default makes US debt risk free both because no other asset would be immune to such a failure and because it is unlikely that the US political structure would allow such an event. Both of these factors could change but I tend to think we would see that coming
- Somehow the economy adjust to produce rapid expected GDP growth. Now, the easiest way to do that is through a massive consumer driven recession. This seems the likeliest possibility to me. Rapidly rising government interest rates begin to crush consumer spending which leads to a massive recession and skyrocketing savings. Something similar to what we just experienced but likely much larger. The rapid increase in savings would push down government yields and the decrease in output would push up expected growth.
3 comments
Comments feed for this article
Monday ~ April 26th, 2010 at 11:14 am
jazzbumpa
I wonder about the correlation of productivity growth to GDP growth. The trend in Yr over Yr GDP growth has been irregular, but clearly down since the early ’80′s. For ’09, it was negative. Meanwhile, especially on the most recent years, American productivity has been increasing at a rate that is probably unsustainable.
Re your point 2) I’ve never seen anyone suggest that a recession is the way to achieve rapid growth. Yes, GDP grows rapidly immediately after a recession, but that is because the economy is climbing out of a trough. The Ln GDP trend is very close to a straight line, gong back to at least 1800. Recovery might overshoot the trend line, but it never stays above very long, in the absence of world war.
Now we have had increasing productivity leading into the recession, and are up against the 0 interest rate bound. I expect the trend on long bond rates to be down.
Cheers!
JzB
Monday ~ April 26th, 2010 at 10:27 pm
…and You Though I was Grim « It Don't Mean Much, These Seats are Cheap.
[...] : "http%3A%2F%2Fcheapseatsecon.wordpress.com%2F%3Fp%3D1809" } Karl Smith at Modeled Behavior took the time to make a comment about my post on the US fiscal situation, in which he comes to two differing [...]
Monday ~ April 26th, 2010 at 10:28 pm
…and You Though I was Grim « It Don't Mean Much, These Seats are Cheap.
[...] } Karl Smith at Modeled Behavior took the time to make a comment about my post on the US fiscal situation, in which he comes to two differing [...]