July 12, 2004
OPPOSITE:
Deficits, Interest Rates and the Fed (Alan Reynolds, July 11, 2004, Cato Institute)
As the Federal Reserve finally begins to raise interest rates, those who have been patiently waiting to find some connection between budget deficits and interest rates naturally seized this opportunity to suggest it is the budget deficit rather than the Fed that is really to blame.Stanley Collender, a longtime professional budget worrier, told CBS "Market Watch" if voters could be persuaded shrinking the deficit might help curtail Fed tightening, "it might focus attention on the budget in a way that hasn't happened in the last couple years."
Conservative columnist Bruce Bartlett wrote that because the Fed will be raising interest rates, "this will begin to change the terms of debate on fiscal policy, increasing the likelihood of a budget deal next year that will involve tax increases."
Never mind that the Fed also raised interest rates when the budget was in surplus, in 1999 and 1969, and the effect was the same. A stubborn fiscal fixation nonetheless causes some people to insist the budget deficit, not the Fed, is somehow responsible for raising the interest rate at which the Fed stands willing to buy Treasury bills with new money.
In the late '90s, as the federal budget went into surplus, the Fed raised rates. After 9-11, as the budget went back into debt, they lowered them. Now we're in the middle of a boom that is lowering the deficit every day and they're raising rates again. Wouldn't any reasonable person have to conclude that increased debt lowers rates and reduced debt raises them? Posted by Orrin Judd at July 12, 2004 11:57 AM
You've got your carts and horses all mixed up. Rates don't go down because people borrow more, people borrow more because rates are lower. The lowering of rates is part of a stimulus policy by the fed, the increased borrowing is it's desired effect.
Posted by: Robert Duquette at July 12, 2004 1:39 PMThe Left will never let go of this canard, because it is their only weapon against tax cuts. It was quite amusing during Clinton's 2nd term to watch the liberal Democrats shout hosannas to a balanced budget. Would they do so today? Never.
Posted by: jim hamlen at July 12, 2004 1:40 PMThe argument is very convincing, theoretically, that, all things being equal, deficits increase real interest rates.
The problem is that all things are never equal. Hence, the empirical data really doesn't support the (quite convincing) claim. There really is almost no historical correlation between interest rates and deficits (one might also note how Reagan is associated with larger deficits, lower interest rates and lower inflation), but most economists believe that it's because other factors cancel out the effect.
Posted by: John Thacker at July 12, 2004 3:42 PM