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Stress test the government?

Summary:
During the 1920s, real interest rates were fairly high. Then during the period from 1933 to the 1950s, both nominal and real rates were fairly low. Then nominal rates rose in the 1960s, and somewhat later the real interest rate also increased. Since 2000, both nominal and real interest rates have fallen to very low levels. What lesson can we learn from this historical pattern of ups and downs? If you believe most of the pundits that I read, the proper lesson is something like the following: “No need to worry about the unprecedented budget deficits that are pushing the debt to GDP ratio steadily higher, because interest rates will never go back to the levels seen in the 20th century. The debt will never become a burden, because it is not a burden at the moment.”

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During the 1920s, real interest rates were fairly high. Then during the period from 1933 to the 1950s, both nominal and real rates were fairly low. Then nominal rates rose in the 1960s, and somewhat later the real interest rate also increased. Since 2000, both nominal and real interest rates have fallen to very low levels.

What lesson can we learn from this historical pattern of ups and downs? If you believe most of the pundits that I read, the proper lesson is something like the following:

“No need to worry about the unprecedented budget deficits that are pushing the debt to GDP ratio steadily higher, because interest rates will never go back to the levels seen in the 20th century. The debt will never become a burden, because it is not a burden at the moment.”

Maybe. I also expect rates to stay low for a substantial period of time. But don’t these same pundits insist that the lesson of 2008 is that we need tougher “regulation” of big banks? That we need to worry about “black swans”? That we need to have annual “stress tests” to make sure that banks can survive an unexpected bad shock?

So why doesn’t this sort of precautionary principle apply to government financing? Suppose the national debt were to eventually hit 200% of GDP, and then interest rates rose back up to 5%?

PS. Until 2016, the budget deficit got bigger during recessions and then recovered somewhat during long expansions:

Stress test the government?

It feels good when the government gives the voters lots of goodies, while at the same time cutting their taxes.  Perhaps too good to be true?

PPS.  Here’s a recent headline from The Hill:

What could go wrong?

Scott Sumner
Scott B. Sumner is Research Fellow at the Independent Institute, the Director of the Program on Monetary Policy at the Mercatus Center at George Mason University and an economist who teaches at Bentley University in Waltham, Massachusetts. His economics blog, The Money Illusion, popularized the idea of nominal GDP targeting, which says that the Fed should target nominal GDP—i.e., real GDP growth plus the rate of inflation—to better "induce the correct level of business investment". In May 2012, Chicago Fed President Charles L. Evans became the first sitting member of the Federal Open Market Committee (FOMC) to endorse the idea.

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