If the interest rates on long-term Treasury bonds were high, such a policy would be sound. But the rate on the oft-quoted 10-year Treasury today is substantially below the Fed’s targeted inflation rate for that period, which implies that people around the world are effectively paying for the privilege of handing their money to the U.S. government for the next 10 years.
Under these circumstances, as Lawrence H. Summers recently argued in the Washington Post, the right policy is to “term out” public debt—locking in the very low rates for as long as possible—not to “term in” the debt as the Fed is doing with QE. Here, a government is like a family looking to take out a mortgage: the lower long-term rates are, the more sense it makes to borrow long.
The homebuyer’s analogy also illuminates the other risk introduced by short maturities: exposure to future interest-rate hikes. In the U.S., where 30-year fixed-rate mortgages are common, a new homeowner need not worry about what the Fed will do with interest rates next year—or even in the next couple of decades. But in the United Kingdom, where floating-rate mortgages are the norm, homeowners are always fretting over what the Bank of England will do next.
In managing its debt, the U.S. federal government has gone the way of British homeowners. Though interest rates will not rise tomorrow, they certainly will someday, and when that happens, rolling over huge stocks of debt at higher yields will have a non-trivial fiscal cost.
One can also imagine nasty financial dynamics at work: a rising interest burden causes more debt to be issued, and this increase in supply reduces the liquidity premium on the new bonds, further raising interest rates and requiring ever-larger bond issues.
Moreover, unsavory political dynamics could emerge. When the central bank’s decisions have a big impact on the public purse, politicians will be more tempted to cajole central bankers to keep rates low. Skeptics will counter that this kind of thing doesn’t happen in the US. But America’s previous president was not above browbeating the Fed via Twitter, which was not supposed to happen. (Presidents like Donald Trump were not supposed to happen, either.)
These are not arguments for a more contractionary monetary policy; the Fed can keep the short-term interest rate as low as needed. Nor are they arguments in favor of a more contractionary fiscal policy; if the Biden administration wants to spend more, it can issue long-term bonds or raise taxes. Printing money to pay for the deficit used to be the progressive thing to do. Not anymore.
Andrés Velasco, a former presidential candidate and finance minister of Chile, is Dean of the School of Public Policy at the London School of Economics and Political Science. He is the author of numerous books and papers on international economics and development, and has served on the faculty at Harvard, Columbia and New York Universities.