Grasping Reality on TypePad, by Brad DeLong

The argument that Google is making a mistake in borrowing now when the yield spread between short-term and long-term interest rates is high goes more-or-less like this:

1. The long-term interest rate is the average of expected future short-term interest rates, plus a (nearly constant) term premium.

2. When long-term interest rates are unusually far above short-term rates, it is a sign that investors are unusually and irrationally pessimistic about the likely course of short-term rates.

3. As time passes, investors will learn that they were irrationally pessimistic--and so long-term interest rates will fall.

4. Thus it is better to wait and borrow long in the future rather than to borrow long now.

5. Conversely, it is more profitable to lend long now than it will be in the future after investors have learned and so corrected their irrational pessimism.

I just don't see it. I just don't see the possible future in which investors conclude that they are--right now--unduly and irrationally pessimistic about the course of interest rates in the future.

This time, though, it looks as though it really is different...