Public Debt and Low Interest Rates

Blanchard develops four main arguments concerning the costs of public debt when safe interest rates are low. First, the current US situation of safe interest rates expected to remain below growth rates is more the historical norm than the exception. Debt rollovers—the issuance of debt without a subsequent increase in taxes—may therefore be feasible, lacking a fiscal cost. Second, even without fiscal costs, public debt reduces capital accumulation and may therefore have welfare costs, though these may be smaller than typically assumed. The reason is that the safe rate is the risk-adjusted rate of return on capital. A safe rate lower than the growth rate indicates that the risk-adjusted rate of return to capital is low. The average risky rate, i.e., the average marginal product of capital, also plays a role, however. Blanchard shows how both the average risky rate and the average safe rate determine welfare outcomes. Third, while the measured rate of earnings has been high, the evidence from asset markets suggests that the marginal product of capital may be lower, with the difference reflecting mismeasurement of either capital or rents. This matters because the lower the marginal product, the lower the welfare cost of debt. Finally, Blanchard discusses arguments opposing high public debt, in particular the existence of multiple equilibria where investors, believing debt to be risky, require a risk premium, which increases the fiscal burden and makes debt effectively more risky. This argument, while relevant, does not have straightforward implications for the appropriate level of debt. The paper seeks to foster a richer discussion of the costs of debt and fiscal policy and not to argue for more public debt, especially in the current political environment.