Risks of Debt?: Hoisted from Comments Tuesday DeLong Smackdown Weblogging
Brad: R&R, Hamilton, and many other serious, bright, empirical economists that are not part of your "faction" frequently argue "interest rates may be low now, but they could rise quickly." (Similarly, stock prices may be high now, but they could fall, particularly if long-term interest rates rise.) And in the next breath, they argue that because debt levels are slower and more costly to adjust than asset prices, the prudent course is to slow the growth of debt now.
What say you to this? In your title, you speak of "Risk". Theirs is (I think) a risk-management argument. Surely it deserves acknowledgement.
Indeed.
As Olivier Blanchard of the IMF/MIT said on April 17, 2013:
The true worries come not from the long-run higher-debt slower-growth correlation but rather from issues of multiple equilibria or equilibrium fragility…
Let me respond by noting a paragraph from Martin Feldstein:
I wouldn’t recommend [shorting bonds] to people even though I believe that bond values are ultimately heading lower. There is an opportunity, but it’s very risky, because you’re betting against the Fed, and you could win three months from now or you could win three years from now, and so you’d have the cost of carrying it for those three years. If I’m right about the potential magnitude of the fall, even if it took three years, that could be a winning bet. But, again, it’s a very risky bet right now… And one from Reinhart, Reinhart, and Rogoff (2012) on all the tools modern governments have to prevent spikes in interest rates when debt is denominated in a currency they control:
Directed lending to the government by captive domestic audiences (such as pension funds or domestic banks), explicit or implicit caps on interest rates, regulation of cross-border capital movements... public ownership of some of the banks or through heavy “moral suasion”... high reserve requirements (or liquidity requirements), securities transaction taxes, prohibition of gold... placement of significant amounts of government debt that is nonmarketable. In principle, “macroprudential regulation” need not be the same as financial repression, but in practice, one can often be a prelude to the other...
