Investors would demand higher interest rates in compensation — and the government would be running just to stand still. Where governments have issued large chunks of foreign-currency debt or inflation-linked bonds, this escape route becomes even harder.
Workers would try to regain their real income by pushing up wages. If the experience of the s is anything to go by, that could lead to wage-price spirals and industrial strife. In a variation on the same theme, governments could instruct their central banks to keep interest rates permanently low — and when investors refused to buy their debt, print money to fund themselves.
But austerity caused no end of trouble. Quite apart from its unfairness, it helped create the virus of populism. This time round there will be little appetite to cut spending. In fact, there will be huge pressure to invest more in healthcare and increase the wages of key public sector workers. And that, by a process of elimination, is where many will end up. Those that do should keep two principles in mind.
First, it would be wise to impose the heaviest burdens on those with the broadest shoulders to avoid a further populist backlash. Second, they could increase taxes on carbon to prevent the planet frying. That way, they can at least make a virtue out of a necessity. Reuters Breakingviews is the world's leading source of agenda-setting financial insight. As the Reuters brand for financial commentary, we dissect the big business and economic stories as they break around the world every day.
Just how low are today's rates? The one-year rate is now 0. We have not seen rates this low in the post-war era. If an investor lends money at 0. Such low rates are therefore unlikely to last. Sooner or later, people will find better things to do with their money, and demand higher returns to hold Treasury debt. Low interest rates are partially a result of the Fed's deliberate efforts. But both the Fed's desire to keep rates this low and its ability to do so are surely temporary.
Low interest rates are also partly a reflection of investors' "flight to quality," as they have sought shelter in American debt amid the financial crisis and the emerging European debt crisis.
Short-term U. People are willing to hold it despite low interest rates for much the same reason they are willing to hold money despite no interest rate. But this special status, too, could change. It became clear during this past summer's debt-limit negotiations that the federal government is less committed to paying interest on its debt than many observers had thought.
For example, in a July breakfast with Bloomberg reporters, President Obama's chief political advisor, David Plouffe, said on the record that "the notion that we would just pay Wall Street bondholders and the Chinese government and not meet our Social Security and veterans' obligations is insanity, and is not going to happen. Missing interest payments would instantly mean a loss of liquidity of U.
A loss of the special safety and liquidity discount that American debt now enjoys could add two to three percentage points. A rising risk premium would imply higher rates still. And of course, if markets started to expect inflation or actual default, rates could rise even more. Low interest rates can climb quickly and unexpectedly, as Greece and Spain have learned. A rise in interest rates can lead to current inflation in the same way a change in investor views about long-term deficits can.
Every percentage point that interest rates rise means, roughly, that the U. And this number is cumulative, as larger deficits mean more and more outstanding debt. Again, present values can help clarify the point. The rate of return that investors demand in exchange for lending money to the government is just as important to the present value of future surpluses as is the amount of future surpluses that investors expect.
And since so much debt is short term, a fall in the real value of the debt must push the price level up. These two factors — expectations of future surpluses and deficits, and increases in interest rates — are likely to reinforce each other.
If bond investors decide that the government is likely to inflate or default on part of the debt, investors are likely to simultaneously demand a higher risk premium to hold the debt.
The two forces will combine to apply even greater pressure toward inflation. These dynamics essentially add up to a "run" on the dollar — just like a bank run — away from American government debt. Unlike a bank run, however, it would play out in slow motion. Before the financial crisis, Bear Stearns and Lehman Brothers rolled over debt every day in order to invest in mortgage-backed securities and other long-term illiquid assets.
Each day, they had to borrow new money to pay back the old money. When the market lost faith in the long-term value of their investments, the market refused to roll over the loans, and the two companies failed instantly. The United States rolls over its debt on a scale of a few years, not every day. So the "run on the dollar" would play out over a year or two rather than overnight. Furthermore, I have described for clarity a sudden one-time loss of confidence.
The actual process of running from the dollar, however, is likely to take more time, much as the European debt crisis has trundled along for more than a year. In addition, because prices tend to change relatively slowly, measured inflation can take a year or two to build up after a debt crisis. Like all runs, this one would be unpredictable. After all, if people could predict that a run would happen tomorrow, then they would run today. Investors do not run when they see very bad news, but when they get the sense that everyone else is about to run.
That's why there is often so little news sparking a crisis, why policymakers are likely to blame "speculators" or "contagion," why academic commentators blame "irrational" markets and "animal spirits," and why the Fed is likely to bemoan a mysterious "loss of anchoring" of "inflation expectations. For that reason, I do not claim to predict that inflation will happen, or when. This scenario is a warning, not a forecast. Extraordinarily low interest rates on long-term U. If markets interpreted the CBO's projections as a forecast, not a warning, a run would have already happened.
And our debt and deficit problems are relatively easy to solve as a matter of economics if less so of politics. But we are primed for this sort of run. All sides in the current political debate describe our long-term fiscal trajectory as "unsustainable. Treasuries and even shorting them, as major players like Goldman Sachs famously shorted mortgage-backed securities before that crash.
As with all runs, once a run on the dollar began, it would be too late to stop it. Confidence lost is hard to regain. It is not enough to convince this year's borrowers that the long-term budget problem is solved; they have to be convinced that next year's borrowers will believe the same thing. It would be far better to find ways to avert such a crisis than to be left searching for ways to recover from it. The Fed is noticeably absent from this terrifying scenario.
We have come to think that central banks control inflation. In fact, the Fed's ability to control inflation is limited — and the bank would be especially impotent in the event of fiscal or "run on the dollar" inflation.
The Fed's main policy tool is an "open-market operation": It can buy government bonds in return for cash, or it can sell government bonds to soak up some money.
Thus, the Fed can change the composition of government debt, but not the overall quantity. Money, after all, is just a different kind of government debt, one that happens to come in small denominations and doesn't pay interest. Bank reserves, which now pay interest, are just very liquid, one-day maturity, floating-rate debt. So the Fed can affect financial affairs and ultimately the price level only when people care about the kind of government debt they hold — reserves or cash versus Treasury bills.
But in the "run from the dollar" scenario, people want to get rid of all forms of government debt, including money. In that situation, there is essentially nothing the Fed can do. When there is too much debt overall, changing its composition doesn't really matter. In this situation, money and short-term government debt are exactly the same thing. How can the Fed be powerless? Milton Friedman said that the government can always cause inflation by essentially dropping money from helicopters.
That seems sensible. But the Fed cannot, legally, drop money from helicopters. The Fed must always take back a dollar's worth of government debt for every dollar of cash it issues, and the Fed must give back a government bond for every dollar it removes from circulation.
There is a good reason why the Fed is not allowed this most effective tool of price-level control. Writing people checks our equivalent of dumping money from helicopters is a fiscal operation; it counts as government spending. The opposite is taxation. In a democracy, an independent institution like a central bank cannot write checks to voters and businesses, and it cannot impose taxes. Moreover, the Fed's ability to control inflation is always conditioned on the Treasury's ability and willingness to validate the Fed's actions.
If the Fed wants to slow down inflation by raising interest rates, the Treasury must raise the additional revenue needed to pay off the consequently larger payments on government debt. For instance, in the s, the lowering of inflation apparently induced by monetary tightening was successful while attempts to do the same in Latin America failed only because the U.
Monetary theories in which the Fed controls the price level, including the Keynesian and monetarist views sketched above, always assume this "monetary-fiscal policy coordination. The Treasury may simply not produce the needed revenue to validate monetary policy. In that case, the Federal Reserve would not be the central player. Standard theories fail because one of their central assumptions fails.
Again, events outpace ideas. One might imagine a resolute central bank trying to stop fiscal inflation by saying, "We will not monetize the debt, ever. Let the rest of the government slash spending, raise taxes, or default.
But such behavior by our Federal Reserve seems unlikely. Imagine how the "run on the dollar" or "debt crisis" would feel to central-bank officials. They would see interest rates spiking, and Treasury auctions failing. They would see "illiquidity," "market dislocations," "market segmentation," "speculation," and "panic" in the air — all terms used to describe the crisis as it happened. The Fed doubled its balance sheet in that financial crisis, issuing money to buy assets. It would be amazing if the Fed did not "provide liquidity" and "stabilize markets" with massive purchases in a government-debt crisis.
We may get a preview of this scenario courtesy of Europe, where the European Central Bank — responding to similar pressures — is already buying Greek, Portuguese, and Irish debt. The ECB is also lending vast amounts to banks whose main investments and collateral consist of these countries' debts. If a large sovereign-debt default were to happen, the ECB would not have assets left to buy back euros.
As in the scenario described above in the context of the dollar, a "run" on the euro could thus lead to unstoppable inflation. Neither the cause of nor the solution to a run on the dollar, and its consequent inflation, would therefore be a matter of monetary policy that the Fed could do much about.
Our problem is a fiscal problem — the challenge of out-of-control deficits and ballooning debt. Today's debate about inflation largely misses that problem, and therefore fails to contend with the greatest inflation danger we face. An American debt crisis and consequent stagflation do not have to happen.
The solution is simple as a matter of economics. This is why all of the various fiscal and budget commissions of the past few years, regardless of which party has appointed them, have come up with the same basic answers.
Our largest long-term spending problem is uncontrolled entitlements. Our entitlement programs require fundamental structural reforms, not simply promises to someday spend less money under the current system. Congressman Paul Ryan's plan to essentially turn Medicare into a system of vouchers for the purchase of private insurance is an example of the former. The annually postponed "doc fix" promise to slash Medicare reimbursement rates is an example of the latter.
Ryan and the Obama administration actually project spending about the same amount of money on Medicare in the long run; the difference is that the bond markets are much more likely to be convinced by a structural change than a spreadsheet of promises. Above all, we need to return to long-term growth. Tax revenue is equal to the tax rate multiplied by income, so there is nothing like more income to raise government revenues.
And small changes in growth rates imply dramatic changes in income when they compound over a few decades. Conversely, a consensus that we are entering a lost decade of no or low growth could be the disastrous budget news that pushes us to a crisis.
Much of the current policy debate focuses on boosting GDP for just a year or two — the sort of thing that might perhaps be influenced by "stimulus" or other short-term programs. But not even in the wildest Keynesian imagination do such policies produce growth over decades. Over decades, growth comes only from more people and more productivity — more output per person. Productivity growth fundamentally comes from new ideas and their implementation in new products, businesses, and processes.
This fact ought to give us comfort: We are still developing and applying computer and internet technology like mad, and biotechnology and other innovative fields have only begun to bear fruit. We are still an innovative country in an innovative global economy. We have not run out of ideas. But governments have a great capacity to stop or slow down growth. Witness Greece. Witness Cuba. Our tax rates are too high and revenues are too low. And decades of weakened unions and rising industrial concentration have weakened worker power.
The big overhang of unemployed workers in the coming depression will weaken it even further. The situation now is very different from the postwar period when strong unions and full employment made sure that wages kept pace. So an elevated inflation target needs to be paired with higher minimum wages, policies to strengthen unions and other measures to encourage employers to raise pay.
The government could even use wage-matching policies to raise pay across the board rather than just for essential workers, as some now are proposing. The Bank of Japan has been trying mightily to raise inflation for years with only modest success.
A higher inflation target should be part of the policy menu for getting the economy back on its feet. This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Noah Smith is a Bloomberg Opinion columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion. Are you looking for a stock? Try one of these. News Video. News Video Berman's Call.
0コメント