Let me chew on that… you’re right that I was assuming that the monetary authority does nothing in response to debt levels, and that the coordination between monetary and fiscal authorities matters.
Dwight Wrote: ------------------------------------------------------- > bchadwick Wrote: > -------------------------------------------------- > ----- > > There’s another issue though, If your tax take > is > > 15%, and your Debt/GDP ratio is 90%, then a 1% > > increase in your interest rate translates to a > > 0.90/0.15 = 6x or 6% increase in your interest > > payments as a proportion of your revenue. > > > > If debt goes to 150% of GDP, a 1% increase in > the > > interest rate turns into a 10% increase in your > > interest rates as a proprtion of your revenue. > > > > Yes, you can run the printing presses, and I’ve > > more or less advocated versions of doing that, > but > > the more extreme the Debt/GDP ratio is the more > > damaging it will be to do this in terms of the > > “and what comes next” issues. > > > > This also highlights a problem with cutting > taxes > > too low, particularly if you are financing > stuff > > with deficit increases. You become more and > more > > sensitive to interest rate changes as you do > it. > > > Ahhhh but for a fiat currency interest rates go > down as debt/GDP goes up. Not the other way > around. > > Fiscal deficit spending creates more deposits in > the private sector. Those deposits naturally tend > to seek out yield. This drives down interest > rates unless the central bank decides to issue > more bonds to soak up the liquidity. Then it > becomes a central bank decision on where interest > rates should be - but expansionary monetary policy > is to keep rates low. > > Japan is a good modern day example of this > phenomenon. The US is making a stab at going down > the liquidity trap path too, though the bubble > here was not as large and the policy response has > been faster and more effective. @dwight Could you clarify this please Fiscal deficit spending creates more deposits in > the private sector. Those deposits naturally tend > to seek out yield. This drives down interest > rates unless the central bank decides to issue > more bonds to soak up the liquidity. Then it > becomes a central bank decision on where interest > rates should be - but expansionary monetary policy > is to keep rates low. >
Ok, debt/GDP is completely meaningless because it doesn’t make sense. It’s like if you work at ExxonMobil and you compare your debt to the entire market cap of ExxonMobil because, while improbable, it’s possible that you could one day potentially earn that much. debt/tax revenue makes more sense when calculating a country’s ability to repay with the assumption that the country wants to avoid hyperinflation and doesn’t want to completely destroy its economy by running the printers all night. Debt/GDP just seems to be a very worthless measure and I see a lot of policy being based on it.
bchadwick Wrote: ------------------------------------------------------- > Let me chew on that… you’re right that I was > assuming that the monetary authority does nothing > in response to debt levels, and that the > coordination between monetary and fiscal > authorities matters. My basic point is that for a fiat currency country, taxes and interest rates both drain liquidity by either taking cash directly out of peoples pockets or by encouraging savings. Deficit spending and (theoretically) expansionary monetary policy inject liquidity by either putting cash directly into people’s pockets or encouraging “dis-savings”. Since the flows of each variable are dependent on growth and the demand for liquidity in the private sector, the stock of “debt” is essentially irrelevant since it is just a bookkeeping entry illustrating the private sector’s desire to accumulate claims against the government (dollars or treasuries). The “bond vigilantes” are also a myth - people decide how much they can save and want to save and the central bank provides the interest rate that it thinks is appropriate to them given where the economy is. Yesterday Bernanke sent a message to savers that the economy is not growing and that they will unequivocally lose money over the next two years to inflation by hoarding. He is trying to encourage spending since without it the economy grinds to a halt and the value of savings disappears anyway. There are limits to what he can do though since in aggregate people are not rational like they are assumed to be in the Princeton textbooks. Some banks are actually charging for deposits now, since they cannot lend them out because they know they will be short-term. There is a bubble in “safe” assets like cash/treasuries and also in “perceived safe” assets like gold. Saving is all well and good for individuals and individual companies, but everyone cannot do so at the same time mathematically.
C3Po Wrote: ------------------------------------------------------- > @dwight > > Could you clarify this please Sure which part? I think you can sum it up by saying that interest rates for a fiat currency are determined by inflation and growth expectations (not credit risk) with the caveat the the central bank can set interest rates anywhere they want. Makes you realize why we went off the gold standard. The central bank is a powerful entity. “Don’t fight the fed”.
Thanks Dwight, I’ll digest this and respond when markets get a bit calmer.
bchadwick Wrote: ------------------------------------------------------- > Thanks Dwight, I’ll digest this and respond when > markets get a bit calmer. Sounds good very interested to hear your thoughts.