Friday, March 16, 2012

Something to Pay Attention to In the Medium-Run

One of the goofed up parts of our government accounting system is that our announced deficits include interest payments to citizens. This is weird because we borrow most of the money from citizens, we repay most of it back to them, and we tax them in order to do so. It’s a wash, but counting makes the deficit seem bigger than it is.

So, I don’t think this is a huge deal, but because we count this way this could be a big deal when interest rates go up in a few years. It also is a big reason for policy pressure to keep interest rates abnormally low:

What we pay is the green line. We pay that for two reasons. One is the red line, and the other is the interest rate paid on each individual government bond.

The red line is going up because of Obama’s budget policies. The green line is holding steady because interest rates are abnormally low.

When interest rates go up in the future, and they probably must because we do believe there is mean reversion in interest rates, that green line is going to go through the roof.

When that happens, politicians will panic: everything will be on the chopping block, and they will be looking to increase every tax. It won’t be pretty.

Read the whole editorial, entitled “Uncle Sam’s Teaser Rate” in the March 12 issue of The Wall Street Journal.

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