Minneapolis Federal Reserve Bank President Narayana Kocherlakota went to Korea to talk about an obscure treasury bond and managed to make news as an apparent advocate for even higher government debt.
He didn’t actually say that more government debt is good, though. He said it has benefits along with costs, and that’s quite a different thing.
It’s interesting, though, to think about how such a surge in government debt would have benefits.
His talk focused on what’s called the neutral real rate of interest, one of those economic terms that needs to be unpacked.
A real rate of interest is an interest rate that’s been adjusted for inflation. If inflation is running at 2 percent and the bonds pay 4 percent, the “real” rate of return is 2 percent.
The term neutral means an interest rate that prevails in the market when the economy is at full employment, and the rate of inflation is about at the central bank target rate. In the United States, the inflation target currently is 2 percent.
Government debt, as he pointed out in his talk, has an impact on that interest rate. Having more government bonds outstanding would increase the supply and presumably drive up the neutral real rate of interest to attract enough investors to own them all.
So why would anybody making monetary policy care about that?
Well, we remain in a very low interest rate environment. The main thing central bankers do during a slowdown, of course, is try to lower interest rates. That makes it easier to borrow, both for businesses and consumers, which should stimulate and economic activity. It also reduces yields on investments and thus the incentive to save money rather than spend it.
But in the period we’ve just come through, once the Fed drove short-term interest rates to near zero, there weren’t that many easy options left. You can’t lower an interest rate further if it’s already on the floor.
If these conditions continue, with a very low neutral real rate, that doesn’t give the central bankers much of a policy lever when we go back into a recession. It will be much harder to stimulate the economy and get the unemployed back to work.
A second problem he mentioned by having interest rates stay too low was greater “financial instability.” Really low interest rates drive up the value of financial assets to a very high price, and then lead to much more market volatility. The fixed income crowd in New York will create more financial mischief.
Kocherlakota told the audience that he frequently hears from older people when out in public, savers who have seen their incomes decline due to very low interest rates. Issuing a bunch more public debt would raise rates and benefit those people.
There are costs, of course, that fall on other people.
Taxpayers will have to service that additional debt, paying the interest and principal when the bonds come due.
“Balancing these gains versus losses is clearly a job for the fiscal authority,” he said, “not for monetary policymakers like me.”