Pethokoukis, Economics, U.S. Economy

Does the Fed really have a ‘hidden agenda’ to hide the cost of US debt?


The Drudge Report links to a piece entitled “The Fed’s ‘hidden agenda’ behind money-printing.” The article’s claim: Although the Fed justifies its bond buying program — also known as quantitative easing — as a way to boost economic growth, there’s more to the story. The Fed’s “hidden agenda,” apparently, is the suppression of interest rates so Uncle Sam can more easily finance and afford its growing national debt:

I believe that one of the most important reasons the Fed is determined to keep interest rates low is one that is rarely talked about, and which comprises a dark economic foreboding that should frighten us all. … Thanks to the Fed, the interest rate paid on our national debt is at an historic low of 2.4 percent, according to the Congressional Budget Office. Given the U.S.’s huge accumulated deficit, this low interest rate is important to keep debt servicing costs down.

The piece  goes to explore a scenario where US interest rates return to their 20 year average of 5.7%. If the federal government were to pay an average interest rate of 5.7% on its debt versus the 2.4% we pay today, debt service cost in 2020 would be about $930 billion. Here is the kicker: 85% of all personal income taxes collected would go to servicing the debt. And who knows, maybe rates will go even higher “as a  result of the massive QE exercise of printing money at an unprecedented rate. We just don’t know what the effect of all this will be but many economists warn that it can only result in inflation down the road.”

Sounds awful. But I find this analysis problematic. While the 20-year average for long rates might be 5.7%, the six-decade average is about 3.0%. But the most recent Congressional Budget Office forecast already assumes 10-year rates rise to 5.2% in 2017, close to the rates specified in the article. And CBO forecasts that in 2020, debt service will nearly triple to $644 billion. But guess what? Net interest only doubles as a share of GDP to 2.8% from 1.4%. Total debt as a share of GDP actually declines to 71.5% from 75.1%. And the annual budget deficit falls to 3.2%  from 4.0%.

What explains bigger debt but a smaller debt burden? An economy growing faster than the debt. Slow or falling nominal GDP growth is what creates debt problems. As Scott Sumner wrote about the euro crisis:

Lots of news articles on the eurocrisis focus on the sky-high interest rates now being paid by the Spanish and Italian governments, roughly 6%.  But I rarely see people pointing out that until a few years ago 6% interest rates on government bonds were completely normal.  As was the 70% ratio of public debt to GDP that you see in Spain.  So why is this interest rate now such a crushing burden?  Simple, in the old days 6% interest rates were accompanied by much more robust NGDP growth rates.  The problem today in the periphery is that NGDP growth has collapsed.

You can’t assume all else equal and just forecast debt and interest rates rise. Maybe rising rates reflect faster economic growth. Indeed, as as economist David Beckworth explains, “The proximate reason for today’s low-interest-rate environment is that the ongoing weak economy has stirred investors’ appetite for safe and liquid assets.”

The article also makes the mistake of equating low interest rates with the Fed running an easy monetary policy. As Milton Friedman put it: “After the U.S. experience during the Great Depression, and after inflation and rising interest rates in the 1970s and disinflation and falling interest rates in the 1980s, I thought the fallacy of identifying tight money with high interest rates and easy money with low interest rates was dead.”

There is also a scenario worth exploring where interest rates never “normalize.” Maybe the Great Recession and Financial crisis have created long-term risk aversion and a desire for AAA US government debt. Economist Brad DeLong:

We may well find ourselves in a situation in which the U.S; government can simply borrow and borrow and never have to pay it back because the economy grows faster than interest accrues. In which case the U.S. government looks much more like the Renaissance Medici Bank–an organization you are happy to pay to keep your money safe, rather than a debtor from whom you demand a healthy return.


2 thoughts on “Does the Fed really have a ‘hidden agenda’ to hide the cost of US debt?

  1. There are many things I could pick apart in this opinion piece, but let me concentrate on the last 2 paragraphs.

    Yes, the Great REcession and financial crisis have inspired many investors to be more cautious with their money. I believe it is mostly by default that investor seek US government debt, as first, they believe the likelihood of being completely wiped out is fairly low. The government will always pay its debts, even if it has to get the FED to print more money to borrow so that they can continue to pay. BUt this scenario is not without consequences, not without risks. This constant injection of money into the system IS inflation, that is an expansion of the money supply. Even IF higher prices do not result, there is still the problem of shifting power and wealth to those who are allowed to counterfeit the money into existence, namely the FED and its member banks.

    But let me also point out that the reason the government borrows is because of the huge predilection of politicians to spend more money than they have. THe feedback mechanism is positive in the sense that the more they borrow the more they spend the more they have to borrow. All this debt-caused inflation may not immediately manifest itself in higher prices, but long term it is certainly highly probable. And given that long term the dollar HAS depreciated, prices HAVE risen, to a great extent the “prosperity” is funded by stealing the wealth of those who save, which DEFINITELY drives down interest rates paid savers, Uncle Milty notwithstanding. ANother episode of the great one not being quite so great.

    Now that we have a preponderance of politicians dedicated to increasing spending, and even more, now that we have had several generations brainwashed into thinking that government handouts and government “stimulus” programs are a good thing, it is all the more problematic that the fedgov will live within its means. Price inflation is already here in capital markets, capital goods and housing, and believe it or not, among many consumer goods. For CPI, like the unemployment rate, the numbers are cooked.

    Please note also that despite or as I believe, BECAUSE of the high level of government spending and government interference in the market place, the market place has been both less stable and less certain that at any time since the Great Depression. Times may be marginally better now, but we have not repealed the law of supply and demand, nor have we repealed other time-proven economic verities.

    The market monetarists are just as wrong as the outright Keynesians. In fact, they are kissing cousins.

  2. CNBC as economic retards.

    When the Fed does QE, it is increasing the supply of money. That should lead to more demand and then higher inflation and interest rates.

    Aside from that, no one is forced to sell or buy a 10-year Treasury note. Those rates are pretty much set by the market.

    We may see low interest rates for a long, long time. See Japan.

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