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DeLong vs Cowen

Brad DeLong and Tyler Cowen are having an argument.

Brad argues that because interest rates are low in the US, the government should borrow more money:

Otherwise, the purpose of a market is to tell you what things are valuable so that you can make more of them. Right now with the decline in interest rates on government debt the market is telling us that government debt is more valuable than it was last week. So we should make more government debt–pull spending forward from the future into the present and push taxes back from the present into the future.

Tyler responds:

In my view, a low rate of interest on Treasury securities indicates a high chance that the investors will be paid back. That is all it means. It is not a market signal that the government output should be produced.

Brad answers and says yes, it is a signal that the government should produce more:

If the price of something–in this case, government production–goes down, as it has in the aftermath of the earthquake-and-tsunami as U.S. Treasury interest rates have dropped by 10 basis points, shouldn’t you buy more of it? Yes.

It is true that the world is poorer as a result of the earthquake–poorer by perhaps $100 billion as a result of all the destruction. And a poorer world should buy less of everything. But the U.S. is not poorer: we should not buy less of anything.

So it is very clear to me that the U.S. government should spend more.

Another Keynesian mystery for me. A lower interest rate doesn’t mean that government production is less expensive. It means government borrowing is less expensive. The cost of government spending is foregone private spending. Maybe the government should be bigger. Maybe we don’t have enough interstate highways or Mars manned space missions while everything else is at just the right level. So government should be bigger. The only way this makes sense is the Keynesian idea that when there is excess capacity, government spending is a free lunch–there is no foregone private output or if there is, the lower interest rate says there’s less foregone private output.

Think about it at the personal level. Does a lower price of debt mean I should borrow more? Live further beyond my means? It does not. It might mean I should make a lower down payment and borrow more for my car or house. But even that doesn’t automatically follow.

Brad disagrees:

Yes, to the extent that mortgage rates drop, people can afford to buy bigger and more expensive houses.

And they should do so.

To argue that people should not respond to falling mortgage rates by buying bigger houses is simply silly, like arguing that people should respond to falling computer prices by buying fewer and simpler computers or should respond to falling clothes prices by making more of their own garments.

It’s true it would be silly to respond to lower clothes prices by making more of your own garments. But it would be equally silly always to buy more shirts when they get cheaper. It’s nice to have more shirts than fewer shirts. I like choice. But it would be a mistake to keep expanding my stock of shirts just because the price of shirts goes down. At some point, even though shirts are cheaper and more choice costs me less than it did before, the benefits of additional choice is offset by the cost of the other things I give up when I acquire another shirt.

When interest rates are lower, borrowing to finance public spending is cheaper. So what? It’s also cheaper to finance future private consumption. Brad is implicitly arguing that another bridge or road or bigger payments to farmers or expanding the US military doesn’t mean less of something else. He also seems to forget that the world is an uncertain place. Buy the bigger house  or spend another trillion and you may find yourself in an unexpected situation that is not pleasant.

by Russ Roberts



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