Of interest rates and budget deficits

June 1, 2009

Amidst all the talk about bond vigilantes and Obamanomics, JPMorgan economist Jim Glassman makes a good point about the murky relationship between interest rates and budget defiticts:

A quick review of history underscores the weak link between debt levels and interest rates. The US federal debt outstanding surged during World War II from 40% of GDP to 110% by the end of the war. That ratio came down to 25% by the early 1980s, amid a secular rise in interest rates. Then from that time through the mid-1990s, the debt-to-GDP ratio climbed steadily even as interest rates came down in what is now referred to as the Great Disinflation. Japan’s experience is even more striking, with its debt now 170% of GDP and yet Japan’s interest rates are the lowest of any industrial economy. Debt burdens are important, if they are a reflection of underlying mismanagement of fiscal policy. But clearly the interest rate story is more complex. Usually, cyclical swings in the economy, which undermine fiscal balance, are the main act for interest rates.


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I won’t quibble with Jim Glassman’s historical perspective but, his cool long view of interest rate/debt correlations in the excerpt you presented, misses an opportunity to forecast.

I took the recent rise in Treasury yields as a reality check & a welcome acknowledgment of sanity. Low interest rates, quantitative easing, declining USD should lead to some level of inflation and longer dated Treasury yields should reflect that — or even move if there is a real but nascent.

The Chinese are expecting that on this visit, Secretary Geithner will explain the “arithmetic” that will vet & endorse their current and prospective Treasury holdings. Suggestions have been made that they have been/ will shift into shorter dated debt and have been recycling towards increasing their commodity stockpiles.

Nice shout out from the bond market last week.

Posted by Siobhan Sack | Report as abusive

oops– forgot “recovery”after nascent.

Posted by Siobhan Sack | Report as abusive