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Worrying about the wrong spending will keep us from doing the right spending


In a post titled "the invisible bond market vigilantes continue their invisible attack," Paul Krugman notes that the interest rate on 10-year treasuries is 3.05 percent, which is so low that you almost feel bad for the people purchasing treasuries. "Clearly," snarks Krugman, "we must slash spending immediately to satisfy the market’s demands!"

To be fair to the other side's argument here, they'd say that our low rates are an artifact of the market being more worried about Europe right now. But eventually, that'll end, and the market, as we know, can turn on a dime. An ounce of deficit reduction is worth a pound of market panic and all that.

The problem with that perspective is that it's not falsifiable. The best evidence we have as to whether the market is worried about our ability to pay back our long-term debt is the market's willingness to buy our long-term debt. And right now, the market is begging for it. It's true, of course, that the market could be irrational and could turn on a dime. But it could do that even if we don't spend more on stimulus. And in any case, our serious debt problems are only amenable to major policy changes, and those changes are not going to happen without market pressure, so why not take advantage of this interregnum to borrow money at cheap rates and stimulate the economy and make necessary investments? Heads, we don't need to worry about the deficit right now; tails, short-term stimulus spending isn't what's behind our deficit and isn't what worries the market about our deficit.

The unknown here (when does the market get worried about our long-term deficit problems?) does not actually appear to depend, or even relate, to the policy we're talking about (short-term stimulus spending). But the discussion is pretending the two are virtually the same. I think this is because, as I wrote in my column this weekend, people aren't clear enough on what time table they're talking about when they're talking about the deficit, but in any case, it's mainly serving to confuse everyone.

By Ezra Klein  |  June 28, 2010; 1:49 PM ET
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If the markets could turn on a dime in an irrational way, why should policy-makers take rational market hypotheses seriously? Another way of putting it: if the markets can act irrationally, can we do anything to stop them from doing so?

Posted by: ctown_woody | June 28, 2010 2:16 PM | Report abuse

"Worrying about the wrong spending will keep us from doing the right spending."

I hate to have to keep bringing it up, but isn't this precisely the point? The Peterson people and the deficit peacocks and the GOPers don't really care about the deficit as such; they care about stopping spending on the kind of people and activities they don't approve of. The proof was in the Bush Admin--the tax cuts and Medicare Part D, plus the off-bedget wars. And Dick "deficits don't matter" Cheney, who would weigh in on all this if he were in better health.

Posted by: Mimikatz | June 28, 2010 2:24 PM | Report abuse

Been away for awhile. Got to thinking this morning "hmmmm, I wonder what short-sighted, uninformed, history-skewing, fantastical economic theorists are thinking this week". Of course, when that question enters my mind, my first stop is Ezra Klein's column.

Is Ezra serious? Just keep spending borrowed money (on liberals pet projects, of course) until the lender wakes up and realizes you can't pay it back? Isn't this what liberals have been decrying as the root of the mortgage crisis?

Granted, liberals like to blame the 'greedy' lenders, not the irrational and irresponsible borrowers who kept borrowing money they could never pay back because....well, lenders kept lending to them!

Liberals are incredibly shallow thinkers. They almost invariably propose as the 'fix' the very thing(s) that led to the mess that was created. You know, because they are smarter than everybody else, and the previously failed policy will work if THEY implement it.

Ezra, let me make it simple for you. You can spend more money than you make for a year...or two...maybe three. But you can't do it every year for 10-20 years, use the excuse "well, it's cheap to borrow money", and expect to find yourself in a financially healthy situation.

Posted by: dbw1 | June 28, 2010 2:50 PM | Report abuse

There is no 'rational market hypothesis', only an 'efficient market hypothesis', most basic form simply states that prices reflect publicly known information.

By the way, turning on a dime doesn't necessarily signal irrationality. You can rationally believe that holding 10 year government bonds at 3.05% today is a good trade. Suppose you expect the U.S. to fall into a deflation because you don't think the central bank will prevent it. At the same time, you also expect the federal government to continually and futilely keep trying to reflate via fiscal policy (see Japan). Eventually, the U.S. debt burden becomes high enough that interest expense becomes burdensome even at low interest rates, at which point rates then shoot through the roof and you have either default or monetization left as options.

It would be entirely rational given that view to be long 10yr USTs at 3.05%, wait for yields to rally to the 2.25%-2.50% context, take your capital gains and then reinvest in gold, German bunds, whatever. At the start of the deterioration in the U.S., perhaps the next trade would be to buy shares in ultra short treasury funds.

Or it could be that the U.S. is the tallest Midget, and once the situation is resolved in Europe attention will turn our way. Or it could be that market participants expect austerity and so they are okay with 3% yields on 10yr bonds. Or it could be because investors don't like near-term volatility seem in risk assets but need better yield than short term US treasuries or bank accounts, but plan to reevaluate their positions next year.

Ezra, I think you're correct that the long term problem has nothing to do with short term stimulus. An extra $100 billion isn't going to make things now materially worse. The problem is that we've got a 5% of GDP structural deficit (that's the average CBO deficit for 2016-2020, when the CBO is expecting full employment). Under the CBO projections, the deficit never improves to the point where it is only as bad as the worse Bush deficit. Even at full employment. So yes, we're going off of a cliff either way, I just don't want to be pushing on the gas - I want to start hitting the brake. Only one pedal has a chance of preventing us from going cliff diving.

Posted by: justin84 | June 28, 2010 3:05 PM | Report abuse

Ezra's argument: "because I can borrow money cheaply, I should borrow more money." This works for businesses where the return exceeds the interest rate, but even there there are diminishing returns. However, let's not ignore the principal!

Even with a generous Keynesian multiplier- that money is not all coming back as taxes, even if we could borrow money for free.

If the US would invest in assets that might have a true long term return in building capabilities, stimulus could make sense. Instead, we have idiotic programs like cash for clunkers and attempted hand outs to Union monopolies.

Posted by: staticvars | June 28, 2010 3:20 PM | Report abuse

So in 10-15 years, which party will be the 21st Century version of the Party of Hoover.

Posted by: tuber | June 28, 2010 4:45 PM | Report abuse

I fear much of the money will be wasted (again) but, more than that, I fear new stimulus money will be spent on programs and government jobs that will be nigh impossible to pare back once the economy rebounds and we have to cut the deficit. Government jobs programs create their own constituencies that lobby the government to pertuate them long after their reason for being has expired.

Posted by: tbass1 | June 28, 2010 4:55 PM | Report abuse

"When does the market get worried about our long-term deficit problems?"

The more important question is: Why should we care? Because interest rates will spike? Well, the Fed can keep them low if it wishes. There is no question that it has the capacity to do this.

You say the Fed will not so wish. Fine, then what we are actually talking about is not "when will the market get worried?" but rather "when will the Fed start punishing the real economy because it decides that this is what the market wants?"

How about not waiting to find out? How about announcing now that if the Fed chooses to allow interest rates to rise before full employment is achieved, and before there is any sign that inflation is actually rising, we will simply stop issuing public debt to "cover" spending in excess of tax receipts?

Our main problem right now is not that "people aren't clear enough on what time table they're talking about when they're talking about the deficit." Our main problem is the way the poverty of the liberal/progressive imagination keeps locking us into wholly unnecessary rhetorical and argumentative traps.

Posted by: amileoj | June 28, 2010 6:49 PM | Report abuse

Ezra has become a market man. Just change a couple of words.....The best evidence we have as to whether the market is worried about the high price of housing is the market's willingness to buy houses at high prices. And right now, the market is begging for it.....and everything is just great until it isn't.

Posted by: bobopapal | June 28, 2010 9:04 PM | Report abuse

Agree with your overall point, especially this: "It's true, of course, that the market could be irrational and could turn on a dime."

So, then, I don't understand why this is an argument for taking actions intended to please the market. If the market is irrational, it's irrational. We should stop making policy choices to try and manipulate it, and we should simply do what we think is the best macroeconomic policy, and leave the market to sort itself out.

Posted by: theorajones1 | June 28, 2010 9:41 PM | Report abuse

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