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Thursday, November 18, 2010

Shiller: Shorting Fiscal Consolidation

A quick post between classes -- Robert Shiller can't figure out why we want to cut the deficit when the cost of new infrastructure is so low, and the benefits are so high:

Shorting Fiscal Consolidation, by Robert J. Shiller, Commentary, Project Syndicate: Real long-term interest rates – that is, interest rates on inflation-protected bonds – have fallen to historic lows in much of the world. This is an economic fact of fundamental significance, for the real long-term interest rate is a direct measure of the cost of borrowing... – and its levels now fly in the face of all the talk about the need to slash government deficits. ...
Long-term inflation-indexed bond yields have fallen to around 1% a year, or less, in the United States, Canada, the United Kingdom, and the eurozone. Elsewhere, yields have been a little higher – around 2% in Mexico, Australia, and New Zealand – but still very low by historical standards.
All these countries have shown roughly the same downward trend in real interest rates for many years, and notably since 2000. ... The low level of real interest rates does not appear to be due to the 2007-2009 financial crisis. In fact, there was a temporary upward spike in real long-term interest rates during the financial crisis in countries with indexed bonds. The rate has come down to low levels only during the period of recovery from the immediate crisis.
Instead, low long-term real interest rates appear to reflect a general failure by governments over the years to use the borrowing opportunities that the inflation-indexed markets present to them. This implies an arbitrage opportunity for governments: borrow massively at these low (or even negative) real interest rates, and invest the proceeds in positive-returning projects, such as infrastructure or education. ...
Surely, governments’ levels of long-term investment in infrastructure, education, and research should be much higher now than they were five or ten years ago, when long-term real interest rates were roughly twice as high. The payoffs of such investments are, if anything, higher than they were then, given that many countries still have relatively weak economies that need stimulating.
It is strange that so many governments are now emphasizing fiscal consolidation, when they should be increasing their borrowing to take advantage of rock-bottom real interest rates. This would be an opportune time for governments to issue more inflation-indexed debt, to begin issuing it, or to issue nominal GDP-linked debt, which is analogous to it.

    Posted by on Thursday, November 18, 2010 at 12:02 PM in Economics, Fiscal Policy | Permalink  Comments (6)


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