A group of former top Democratic policymakers from the Obama and Clinton administrations are urging President-elect Biden to use upcoming COVID relief legislation to create new automatic fiscal stimulus programs to fight future downturns and to warn that the current era of low interest rates could end much sooner than many anticipate.
“The era of low interest rates is teaching many people the wrong lesson,” Peter Orszag, CEO of financial advisory at Lazard and former director of the Office of Management and Budget under President Obama said during a virtual event staged by the Peterson Institute for International Economics on Thursday.
“The lesson from the last five or ten years is more that we’re very bad at predicting the future and less that we should project an era of low interest rates without end,” he added.
Orszag was joined by Robert Rubin, former U.S. Treasury secretary and Goldman Sachs Group Inc.
co-chairman, and Joseph Stiglitz, the Nobel winning economist and former chairman of the Council for Economic Advisors.
While the three have different views on the urgency with which the U.S. should approach reducing the federal budget deficit once the economy recovers from the COVID crisis, they all agreed that “while low interest rates change the contours of the fiscal debate, they should not be assumed to persist forever,” according to an accompanying policy brief.
The yield on the benchmark 10-year U.S. Treasury note
has declined from roughly 14% to around 1% over the past forty years. Low interest rates have not only made it less costly for governments to maintain larger budget deficits, they have also increased the potential returns to government investment in things like infrastructure and education that may increase economic growth in the future.
But even a modest uptick in interest rates over time could vastly grow the budget deficit. Orszag, Stiglitz and Rubin show that if interest rates rise just 0.25 percentage points a year more than the Congressional Budget Office currently projects, the federal government outlays on interest payments could rise to $1.2 trillion annually in 2030, compared to the $664 billion currently projected and the roughly $338 billion spent in 2020.
A much sharper rise in interests rates, therefore, could be destabilizing to the U.S. economy and government programs, Rubin warned, and lead to high inflation fed by “excess demand, if you have unsound fiscal policy, or a decline in our currency.”
“There’s always the possibility of severe market distress,” he added. “These risks have not materialized, but all of financial history suggests that markets that get out of sync with reality always adjust and sometimes rapidly.”
Rubin, Stigliz and Orszag argue that policymakers should also include more so-called “automatic stabilizers” in future fiscal legislation that would automatically increase budget deficits in times of recession and raise revenues or reduce spending in times of full employment.
On the spending side, they argue that provisions like direct cash transfers, expanded food and unemployment assistance and infrastructure funding should be automatically triggered by an increase in the unemployment rate to a certain level.
The authors also suggest indexing fiscal programs like social security to metrics like life expectancy and economic inequality. As life expectancy rises, for instance, it could trigger slight increases in payroll taxes or an increase in the payroll tax cap to pay for larger expected outlays.
These automatic triggers would free policymakers from engaging in fractious debates during times of crisis and increase long-run economic performance, but still provide the ability to change course if needed, they argued.