When bond yields are negative in real terms (as they are in Germany, the US and the UK) it leads to weird economic incentives.
Jonathan Portes has previously written about how interest rates this low mean that the government could embark on a £30bn infrastructure investment package for just the income raised each year by the now-defunct pasty tax. Portes, who is the director of the National Institute for Economic and Social Research, argued that:
If the government were, as I suggest, to fund a £30bn (2 per cent of GDP) investment programme, and fund it by borrowing through issuing long-term index-linked gilts, the cost to taxpayers – the interest on those gilts – would be something like £150m a year. . .
Twenty, or fifty, years from now, economic historians will look back at the decisions we are taking now. I cannot imagine that they will be anything but incredulous and horrified that – presented with these charts and figures – policymakers did nothing, international organisations staffed with professional economists encouraged them in their inaction, and commentators and academic economists (thankfully, few in the UK) came up with ever more tortuous justifications.
Today, Tyler Cowen argues that there is a dangerously underexamined hidden assumption in Portes’ argument:
Keep in mind that the interest rates on quality government debt are down, in part, because the risk premium is up. Non-governmental investments are perceived as riskier. . .
You might think the government investments are “low hanging fruit” in terms of quality. Maybe yes, maybe no, but the low real interest rate doesn’t signal that, rather it signals merely that people expect to be repaid.
In this argument for more government investment, the notion of government investments as low hanging fruit is doing a lot of the work.
Cowen doesn’t seem to be taking a fair approach to the situtation. Government investments aren’t low hanging fruit so much as all other investments are unfeasibly risky. The long-term usefulness of transport, energy or education infrastructure, for instance, is little changed due to the current economic climate, so the multiplier for investment in them remains the same as it ever was.
But if investment in infrastructure is too risky, Matt Yglesias suggests another use for negative real interest rates: Stop collecting taxes. Yes, all of them:
Normally you face a tradeoff. Taxes impose costs on the present-day population that might impair wealth creation over the long-term, but to avoid taxes by borrowing you need to pay interest to creditors.
But the real interest rate we’re being asked for is low. Less than zero. So what’s the tradeoff?
Why not sell as many negative-yield ten-year bonds as the market will buy (sell enough bonds and presumably interest rates will rise) and let that auction revenue “crowd out” taxes as a way of financing government activities?
The really interesting thing about such a plan would be seeing the political fallout. In so many economic arguments, taxation, spending and size of government are used interchangably; lefties like big government, high taxes, and high spending, and right-wingers the opposite. But put a massive disconnect between the taxing and spending sides of government, and who knows which side of the line people will fall? Are the Taxpayers Alliance in favour of low taxes or small government? What about David Cameron?
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