The following graph (via Business Insider) shows the yield on the 10 Year Treasury (blue) relative to the Total Public Debt (red):
I point this out now as the calls for reigning in government spending are getting louder. It seems the primary reason why spending hawks do not want any more monetary stimulus is that it could move interest rates higher. However, as the graph shows, and as the article points out, there is no connection between spending and interest rates.
I have an idea of why this is happening – deleveraging (see here, here, and here). Basically as people begin to save more and pay off debt they spend less. The decrease in spending affects the whole economy as individuals, financial institutions, and companies begin to save and hold cash. Not wanting to take on risk, the cash is invested in Treasuries. Thus, lower yields.
I have advocated for more fiscal stimulus numerous times. While I do think longer-term – after the deleveraging cycle winds down – federal spending needs to be cut down, doing so now would make things worse. In the words of Richard Koo:
“The insistence that fiscal consolidation is necessary in the longer term is like the doctor who, faced with a patient who has just been admitted to the intensive care ward, repeatedly questions the patient about his ability to afford the treatment. This is both lacking in decency and irresponsible.
If the patient loses heart after learning the cost of the treatment, he may end up spending even longer in the hospital, leading to a larger final bill. Completely ignoring the policy duration effect of fiscal policy and constantly insisting on longer-term fiscal consolidation was what prolonged Japan’s recession.”
