Public Debt and Low Interest Rates

By Olivier J. Blanchard. The American Economic Review, 2019

719 citations recorded by the source corpus.

This lecture focuses on the costs of public debt when safe interest rates are low. I develop four main arguments. First, I show that 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 later increase in taxes, may well be feasible. Put bluntly, public debt may have no fiscal cost. Second, even in the absence of fiscal costs, public debt reduces capital accumulation, and may therefore have welfare costs. I show that welfare costs may be smaller than typically assumed. The reason is that the safe rate is the risk-adjusted rate of return to capital. If it is lower than the growth rate, it indicates that the risk-adjusted rate of return to capital is in fact low. The average risky rate however also plays a role. I show how both the average risky rate and the average safe rate determine welfare outcomes. Third, I look at the evidence on the average risky rate, i.e., the average marginal product of capital. 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, I discuss a number of arguments against high public debt, and in particular the existence of multiple equilibria where investors believe debt to be risky and, by requiring a risk premium, increase the fiscal burden and make debt effectively more risky. This is a very relevant argument, but it does not have straightforward implications for the appropriate level of debt. My purpose in the lecture is not to argue for more public debt, especially in the current political environment. It is to have a richer discussion of the costs of debt and of fiscal policy than is currently the case. (JEL E22, E23, E43, E62, H63)

Subfields: Economics and Econometrics

View Paper: https://www.semanticscholar.org/paper/ecf4cec0867dd1fbd2a0f85181eaac51ddd83929

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Citations in the corpus

Can the Covid Bailouts Save the Economy? (2020, neutral): “While some are sanguine about the government’s ability to spend trillions more (Blanchard, 2019), Jiang, Lustig, Van Nieuwerburgh, and Xiaolan (2020b) warn of higher yields on government debt.”
Fiscal Space and the Aftermath of Financial Crises: How It Matters and Why (2019, neutral): “I made a first pass at it in my 2019 address to the American Economic Association (Blanchard 2019), and, based on that address, you can predict my answers: In an environment where interest rates are low, indeed lower than growth rates, the fiscal costs of debt are small, and so are the welfare costs”
Redesigning EU fiscal rules: from rules to standards (2021, background): “In the past, periods of negative r − g have alternated with periods of positive r − g (Blanchard 2019).”
In sickness and in debt: The COVID-19 impact on sovereign credit risk (2020, positive): “Blanchard (2019) argues that high levels of public debt bear little social cost as long as safe interest rates are below long-run expected growth rates.”
On Secular Stagnation in the Industrialized World (2019, background): “Blanchard (2019) makes the argument that traditional views about fiscal policy likely reflect excessive concern about debt when real interest rates are very low and are likely to remain low for a long time to come.”