It’s fair to say that the American economy is hooked on low interest rates. If you need evidence, look at what the stock market and the bond market do when the Fed raises rates.
Rates have been extremely low since 2008. Some Democrats clearly view this as an immutable new normal and argue that blowing up the deficit with expensive new programs won’t damage the economy. Are they right? Not really.
Interest rates are the product of a number of factors, including the following:
- CONFIDENCE IN THE FUTURE: This cuts different ways. If you assume that the American government will always be predictable and competent (i.e., it will not create catastrophes or default on its bills) and that growth will remain slow but steady, you will bet on low rates. If you don’t believe in both of those things, you will demand higher returns on your money.
- INFLATION: The little-publicized up side to automation and globalization is low inflation. Given the state of American politics, can you safely assume that inexpensive Chinese products will continue to flood our markets and keep prices down?
- THE FED: The Fed wants additional ammunition to deal with future recessions. That, to a large extent, has driven the most recent interest rate increases. It also wants to maintain its credibility as an inflation-fighter with the markets, even in the face of criticism from Trump. Those motivations aren’t going away.
- FOREIGN INVESTMENT: Japan has a very high debt relative to GDP, but it also has high levels of domestic saving, so the debt is held by Japanese citizens. That is not true here. Foreigners could raise interest rates by refusing, for either economic or political reasons, to buy American debt.
The fact is that the investor class is likely to freak out if the 2020 election is won by a Democrat who promises lots of new expensive programs and doesn’t have a plausible way to pay for them. Investors prefer incompetent right-wing bozos who speak their language to left-wingers. That may be unfair, but it’s a fact of life. And so, while there is certainly some room to expand the deficit for overriding public purposes, I cannot agree that it does not matter; the possibility of significant increases in interest rates still exists.