Here’s Tyler Cowen:
Obviously lower interest rates — ceteris paribus — do indicate the government should borrow more, but as Scott Sumner frequently reminds us: “Never reason from a price change.”
Most of all, it seems that rates, including long rates, have declined because of a flight to safety. The price change itself is ambiguous, but if you buy that interpretation we should be spending more, and borrowing more, to invest in safety.
I mostly agree with Tyler’s post, but a few cautionary notes. Let’s start with the first paragraph, which I believe many people are likely to misinterpret. It does not imply that, “Normally lower rates would lead you to want to borrow more, but there may be weird cases where it does not, for “never reason from a price change”: reasons. Just the opposite is true. Consider the following slightly different claim:
Obviously lower interest rates do not indicate the government should borrow more, because as Scott Sumner frequently reminds us: “Never reason from a price change.”
Why does adding “ceteris paribus” matter? Because now we are moving along a demand curve for loanable funds, rather than contemplating a shift in the demand for loanable funds. But here’s the problem, interest rates never change, ceteris paribus. If other things are equal, the interest rate won’t change. Thus the fact that interest rates changed is an indication that ceteris is not paribus. Hence the first half of Tyler’s sentence is basically meaningless; it gives us precisely zero guidance as to whether we should borrow more. It’s like saying “other things equal we should consume more oil when prices are low.” True, but meaningless, as oil prices are usually low due to declining demand, as is the case right now
When interest rates fall because the supply schedule shifts right, then there is a presumption that society should borrow more. More often, rates fall because the investment schedule shifts left, in which case there is a presumption that society should borrow less. But even in that latter case, where society should borrow less, it’s possible that the government may want to borrow more, especially the federal government.
[State and local governments are more like private companies, responding to many of the same incentives. Thus borrowing by local governments in the Sunbelt to build schools and infrastructure for new housing developments probably fell in 2009, as the housing market crashed.]
The current crisis may be one of those unusual “savings shocks”, where there actually is a presumption that we should borrow more. More likely, it is both a positive saving shock and a negative investment shock, which is why rates have fallen unusually sharply.
Are low rates a time to borrow, because we want to lock in the low rates on 30-year bonds? Maybe. But a few years ago when 30-year yields had fallen to 3%, lots of pundits on the internet said something to the effect that “now’s the time to issue lots of 30-year bonds and lock in those low rates.” They were wrong. Ditto for when rates fell to 2%.
One argument for government borrowing more today is that it can boost aggregate demand. But monetary policy is a far more effective way to boost AD. In the unlikely case where the Fed is out of ammo you might want to allow the Fed to buy a wider range of assets. But let’s say the government decides that’s too risky. What then? In that case you could issue lots of 30-year Treasury bonds and have the Fed buy them with newly created money.
But even in that case there’s no obvious reason to do more fiscal stimulus. The government doesn’t have to increase spending or cut taxes to issue bonds, it can just create a giant sovereign wealth fund and buy up private stocks and bonds with borrowed money. Fiscal policy (deficit spending) should be based on traditional cost/benefit considerations, not a desire to “boost demand”.
Congress will certainly pass some sort of “fiscal stimulus”, and all indications are that it will be far too small to have much impact. What bothers me is not so much that fiscal stimulus would do great harm at the moment (it would not), rather that it leads us to take our eye off the ball. Why is Congress not using this occasion to give the Fed additional tools? Realistically, the Fed is the only institution in Washington that can have a meaningful impact on the future path of inflation and NGDP. Heck, it’s practically the only institution that is not dysfunctional. If you think that Congress is capable of targeting inflation at 2%, then I have a bridge I’d like to sell you.