Curiouser and curiouser.
The U.S. government is borrowing bucketloads of money, with budget deficits on track to hit $1 trillion a year and rising. Yet the deluge of debt isn’t pushing interest rates up from their paltry levels –- or stoking inflation, which remains stubbornly below the Federal Reserve’s 2 percent target.
“This is an Alice in Wonderland world,’’ said former International Monetary Fund chief economist Olivier Blanchard.
It’s one that Japan has long been familiar with, and Europe may be getting used to. In the U.S., it’s prompting policy makers to reconsider how public finances and interest rates should be managed. Possible results include even bigger government deficits and debt, and faster inflation -- all anathema to Econ 101.
Voodoo Economics?
In Congress, there’s a brewing fight over fiscal policy. Progressive Democrats have seized on the growing tolerance of red ink to propose expensive new programs like the Green New Deal championed by New York congresswoman Alexandria Ocasio-Cortez. The political calculus goes something like this: If President Donald Trump can drive up the deficit by cutting taxes for corporations and the wealthy without spooking the bond market, why can’t the Democrats do the same with the spending packages they prefer?
At the Fed, Chairman Jerome Powell and his colleagues are conducting a formal review of how they make policy -- and putting a renewed focus on fanning the inflation they complain is “muted.” After raising interest rates four times in 2018, the central bank surprised markets in January by calling a time-out. Investors are now betting the Fed will stay on hold for the rest of this year, and that its next rate move is more likely to be a cut than a hike.
In academia, meanwhile, a debate on the efficacy of government debt is playing out among left-leaning economists. At its heart is something called Modern Monetary Theory -– a heterodox economic school that argues the U.S. can run bigger budget shortfalls without worrying about going broke, because it prints its own money.
Mainstream Democrat economists have lambasted the theory. Former Treasury Secretary and now Harvard University professor Larry Summers has said it’s akin to voodoo economics, with its promise of a proverbial free lunch.
‘Assuming We’re Alive...’
But such blowback obscures an important point. Even among establishment figures like Summers, there’s a growing tolerance for deficits. In a keynote address to the American Economic Association in January, Blanchard argued that with interest rates low and likely to stay that way, government debt needn’t be a bogeyman.
The Peterson Institute for International Economics senior fellow returned to the theme last week, sketching out this hypothetical scenario to reporters: “It’s 2050, global temperature has increased by 5 percent, the world is coming to an end. And we turn to the kids at that point, assuming we’re still alive, and we say, ‘Look guys, yes, it’s not good, but there is no debt’.”