Sunday, June 14, 2009

Krugman's Denial Of The Effects Of Deficits On Interest Rates

Though Treasury yields fell back somewhat during the last few days, they remain at a very elevated level. One of the factors (though not the only one) causing this is the increase in the budget deficit, as I explained a few days ago.

Now Paul Krugman tries to deny this by arguing that the decline in private borrowing more than offsets the increase in government borrowing. That is true in a purely empirical matter, at least if you look at the second derivative rather than the first derivative (or in simpler words, if you look at the change of the growth rate in debt, rather than the change in debt). It is however not true in the sense that total debt is falling, because it continues to increase.

And more importantly, it is not true in the sense that economists should be focusing on, namely the causal effect of a particular action, ceteris paribus. If the deficit had remained stable while private borrowing had collapsed, as opposed to what actually happened with a dramatic increase in the deficit, then this means that supply of Treasuries would have been a lot lower, which means that the price would have been a lot higher, which in turn means that yields would have been a lot lower.

There can in other words be no doubt that if the deficit had been lower, then so would Treasury yields. While Bush was president, Krugman recognized this casual relationship. But now that a Democrat is president, Krugman tries to make people believe it doesn't exist...


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