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Trump Deficit: How it may push up interest rates
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It is a post-financial-crisis myth that austerity-minded conservative governments favor fiscal prudence, while redistribution-oriented progressives view large deficits as the world’s biggest free lunch. This simplistic perspective, while perhaps containing a grain of truth, badly misses the true underlying political economy of deficits.
The fact is that whenever one party has firm control of government, it has a powerful incentive to borrow to finance its priorities, knowing that it won’t necessarily be the one to foot the bill. So expect Donald Trump’s administration, conservative or not, to make aggressive use of budget deficits to fund its priorities for taxes and spending.
Back in the 1980s, conservative hero Ronald Reagan was willing to tolerate enormous deficits to fund his ambitious tax-cutting plans, and he did so in an era when borrowing wasn’t cheap. In the early 2000s, another Republican president, George W. Bush, essentially followed Reagan’s playbook, again slashing taxes and sending deficits soaring. In 2012, at the height of the standoff between the Republican-controlled Congress and Democratic President Barack Obama over deficits and the national debt, Republican presidential candidate Mitt Romney proffered an economic plan that featured eye-popping deficits to finance tax cuts and higher military spending.
On the other side of spectrum, Democratic President Bill Clinton, during what most academic economists consider to have been an extremely successful presidency, actually put the government into surplus. Indeed, at the end of the 1990s, some researchers actually wondered how international markets would function if the US government gradually retired all of its debt. Bush’s subsequent tax cuts and unfunded wars ensured that this never became a problem.
Different attitudes toward risk are a central factor in the perennial controversy over how much stimulus is optimal. Until recently, many left-leaning economic commentators have been arguing for massive fiscal stimulus in the US, though they seem to have changed their position overnight (the night Trump was elected, to be precise). No one quite knows what a reasonable middle ground between debt and stimulus would be.
The Nobel laureate economist Thomas Sargent and others recently argued that the optimal level of debt for the US is in fact very close to zero, though he does not recommend trying to get there anytime soon, given that US government debt is now over 100 percent of GDP. Sargent’s recommendation contradicts the view (espoused most recently in an Economist magazine leader) that instead of stabilizing debt, all advanced countries should be aiming to emulate Japan (where net debt is more than 140 percent of GDP, the highest ratio among the advanced economies).
What matters is not only the level of debt, but also how it is managed — a question I examined in a recent commentary focusing on the right mix of long-term and short-term government borrowing. Some, including Robert Skidelsky, seem to think that discussion of how the maturity structure of government debt should be managed is somehow a stalking horse for tight budgets and austerity. But if interest rates shoot up in the Trump era (as well they could), the US government will wish that it had opted for less short-term borrowing and more long-term borrowing.
If a Trump presidency does entail massive borrowing — along with faster growth and higher inflation — a sharp rise in global interest rates could easily follow, putting massive pressure on weak points around the world (for example, Italian public borrowing) and on corporate borrowing in emerging markets. Many countries will benefit from US growth (if Trump does not simultaneously erect trade barriers). But anyone counting on interest rates staying low because conservative governments are averse to deficits needs a history lesson.
Kenneth Rogoff is Professor of Economics and Public Policy at Harvard University. Copyright: Project Syndicate 1995–2017. Shanghai Daily condensed the article.
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