secular stagnation and solutions

Monetary and Fiscal Implications of Secular Stagnation by Krugman

The point is that the case against austerity is as strong as it ever was.

And maybe even stronger, once you think about debt dynamics.

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.

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.

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.

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.

So fear not: I’m still bitterly against austerity, and even less impressed by the fiscal scolds than before. Secular stagnation just adds to the reasons to believe that we’re doing things very, very wrong.