Right now the real interest rate on US government borrowing is about 0.5 percent on 10-year securities, negative 0.4 percent on 5-year. Meanwhile, even pessimistic estimates of US potential growth put it in the 1.5-2 percent range. So r is less than g — the real interest rate on debt is less than the normal growth rate.
It’s the last sentence which is the real kicker; it’s about as relevant as saying that my heart rate is slower than traffic on the I-8 this morning. If he compared interest rates to inflation he would be making a meaningful point because both are about the value of money, but he compares it to economic growth only because he is getting ready to introduce another artificial and totally meaningless concept; the debt to GDP ratio.
This in turn means that the usual worry about a rising debt level — that it will require that we eventually run big non-interest surpluses to pay down the debt — is all wrong. As long as we run a primary (non-interest) balance, or in fact not too large a deficit, the debt/GDP ratio will tend to erode over time. What’s more, an increase in the primary deficit won’t cause a runaway debt spiral, it will lead to a gradual rise in debt to a higher level, but it will stabilize there.
Krugman claims to be a follower of Keynes, but the first part of that is about as non-Keynesian as one can be, because Keynes certainly never advocated that government should never repay the money it borrowed. He specifically said that it should do so, in fact, when economic times improved to the point that it was able to do so.
And this is where he brings in the debt/GDP ratio which will “erode over time.” This is what replaces the repayment of debt because the amount of debt is meaningless. The only meaningful measure of debt is its ratio to the GDP, and we can allow that ratio to shrink until the debt disappears altogether, at which point the government will no longer have to be paying any interest and we can quit worrying about interest rates going up.
His third point is that an increase in the deficit will not lead to “a runaway debt spiral” but rather cause a “gradual rise in debt to a higher level” at which it will stabilize. Really? Tell that to Japan, or Argentina. What, precisely, is going to be the factor which causes it to stabilize, other than eliminating the deficit?
Suppose, for example, that r is 0.5 and g is 1.5 — not too unrealistic. Suppose that you start with debt at 50 percent of GDP, and then begin running primary deficits of 1 percent of GDP. What will happen? Debt will rise to 100 percent of GDP, and stay there, even if nothing is done to address the deficit.
Our GDP is $15 trillion and deficits have been running $1.3 trillion, so our deficit is closer to 10% than 1% of GDP. Not to mention that our starting point is a lot closer to 100% of GDP than it is the 50% he posits. So how does starting at 100% of GDP and running deficits of 10% of GDP result in our debt “rising to 100 percent of GDP, and staying there, even if nothing is done to address the deficit” precisely?
Even assuming his more idealistic numbers, though, what causes the debt to stop rising when it hits 100% of GDP if the government has not and is not repaying debt and is still running a deficit? He doesn’t say what the mechanism is that causes that phenomenon, cites no examples illustrating it, and carefully omits mentioning multiple nations which have debts which exceed their GDPs by several orders. Whatever his limiting mechanism is, it clearly didn’t work for those nations.
I don’t want to push this too hard, but I just want to make it clear that if we really believe in low or even negative normal real interest rates, conventional views of fiscal prudence make even less sense than people like me have been saying.
The meaning of that is not entirely clear, but when he says that something "makes even less sense than what I’ve been saying” I’m inclined to go along with that.