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Us Lurching Towards 'debt Explosion' With Long-term Interest Rates On Course To Double

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http://www.telegraph.co.uk/finance/finance...-to-double.html

In a 2003 paper, Thomas Laubach, the US Federal Reserve’s senior economist, calculated the impact on long-term interest rates of rising fiscal deficits and soaring national debt. Applying his assumptions to the recent spike in the US fiscal deficit and national debt, long-term interests rates will double from their current 3.5pc.

The impact would be devastating by making it punitively expensive to finance national borrowings and leading to what Tim Congdon, founder of Lombard Street Research, called a “debt explosionâ€. Mr Laubach’s study has implications for the UK, too, as public debt is soaring. A US crisis would have implications for the rest of the world, in any case.

Using historical examples for his paper, New Evidence on the Interest Rate Effects of Budget Deficits and Debt, Mr Laubach came to the conclusion that “a percentage point increase in the projected deficit-to-GDP ratio raises the 10-year bond rate expected to prevail five years into the future by 20 to 40 basis points, a typical estimate is about 25 basis pointsâ€.

The US deficit has blown out from 3pc to 13.5pc in the past year but long-term rates are largely unchanged. Assuming Mr Laubach’s “typical estimateâ€, long-term rates have to climb 2.5 percentage points.

He added: “Similarly, a percentage point increase in the projected debt-to-GDP ratio raises future interest rates by about 4 to 5 basis points.†Economists are predicting a wide range of ratios but Mr Congdon said it was “not unreasonable†to assume debt doubling to 140pc. At that level, Mr Laubach’s calculations would see long-term rates rise by 3.5 percentage points.

The study is damning because Mr Laubach was the Fed’s economist at the time, going on to become its senior economist between 2005 and 2008, when he stepped down. As a result, the doubling in rates is the US central bank’s own prediction.

Mr Congdon said the study illustrated the “horrifying†consequences for leading western economies of bailing out their banks and attempting to stimulate markets by cutting taxes and boosting public spending. He said the markets had failed to digest fully the scale of fiscal largesse and said “current gilt yields [public debt] are extraordinary low given the size of deficitsâ€.

Should the cost of raising or refinancing public debt in the markets double, “the debt could just explodeâ€, he said, adding that it would come to a head in “five to 10 yearsâ€.

Interest rates it seems will destroy everything.

No wonder base rates are at 0% national govts are screwed.

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http://www.federalreserve.gov/Pubs/feds/20...2/200312pap.pdf

Abstract

Estimating the eects of government debt and decits on Treasury yields is compli-

cated by the need to isolate the eects of scal policy from other influences. To abstract

from the eects of the business cycle, and associated monetary policy actions, on debt,

decits, and interest rates, this paper studies the relationship between long-horizon

expected government debt and decits, measured by CBO and OMB projections, and

expected future long-term interest rates. The estimated eects of government debt and

decits on interest rates are statistically and economically signicant: a one percent-

age point increase in the projected decit-to-GDP ratio is estimated to raise long-term

interest rates by roughly 25 basis points. Under plausible assumptions these estimates

are shown to be consistent with predictions of the neoclassical growth model.

1 Introduction

Much controversy surrounds the quantitative eects of government debt and decits on long-

term real interest rates. Economic theory provides dierent answers depending on issues

such as whether decits reflect changes in government expenditures or shifts in the timing of

taxes, and on the planning horizon of households who hold government debt and pay taxes.

One might hope that empirical evidence could be brought to bear on this question, but here

the results are just as ambiguous. One major obstacle in obtaining empirical estimates is

the need to isolate the eects of scal policy from the many other factors aecting interest

rates. The most obvious of these factors is the state of the business cycle. If automatic

scal stabilizers raise decits during recessions, while at the same time long-term interest

rates fall due to monetary easing, decits and interest rates may be negatively correlated

even if the partial eect of decits on interest rates { controlling for all other influences {

is positive.

This paper proposes to address this identication problem by focusing on the relationship

between long-horizon forecasts of both interest rates and scal variables. Decits and

interest rates expected to prevail several years in the future are presumably little aected

by the current state of the business cycle, thus greatly reducing the reverse-causality eects

induced by countercyclical monetary policy and automatic scal stabilizers. Of course, there

are many conceivable factors that jointly determine scal variables and interest rates, and it

is unlikely that a reduced-form regression would ever completely overcome this endogeneity

problem, but focusing on long-horizon forecasts is an important step in the right direction.

Moreover, decits projected several years into the future may be informative about the

longer-run scal position, and may therefore approximate investors' expectations about the

eventual level of government debt relative to GDP. Such measures of expectations thus hold

out the prospect of uncovering any causal relationship from fiscal variables to interest rates.

http://www.federalreserve.gov/Pubs/feds/2003/

2003-12 (April)

New Evidence on the Interest Rate Effects of Budget Deficits and Debt

Thomas Laubach

This is a revised version of this paper; previous paper was dated March 2003.

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This kind of analysis usually assumes the yield curve is sensitive to the fiscal health of the Government but the bond market is blind to their insolvency. It is only when they realise they won't get their money back and the State will default that yields will drop, precipitously. Only they would be able to tell you, but I have no idea where bond investors believe the money is going to come from to pay off the debt.

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"The US deficit has blown out from 3pc to 13.5pc in the past year but long-term rates are largely unchanged. Assuming Mr Laubach’s “typical estimateâ€, long-term rates have to climb 2.5 percentage points.

He added: “Similarly, a percentage point increase in the projected debt-to-GDP ratio raises future interest rates by about 4 to 5 basis points.†Economists are predicting a wide range of ratios but Mr Congdon said it was “not unreasonable†to assume debt doubling to 140pc. At that level, Mr Laubach’s calculations would see long-term rates rise by 3.5 percentage points."

something wrong with his arithmetic - says 1% change on the debt to gdp gives 0.25% change in IRs ,

and his example of 3->13.5% , is ~10pc -> 10 * 0.25 -> 2.5 , which is what he says.

however doubling to 140pc implies 70-->140 ie delta of 70pc -> 70 * 0.25 = 17.5% which doesnt look like 3.5% to me .

what's wrong with my calc ?

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Guest KingCharles1st

So - if loan interest rates to some degree reflect risk, then with no rates, there is no risk, there is not much to shout about. except of course that they WONT LEND

And that means what exactly-- :rolleyes:

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So - if loan interest rates to some degree reflect risk, then with no rates, there is no risk, there is not much to shout about. except of course that they WONT LEND

And that means what exactly-- :rolleyes:

There lying?

The system is full of liar loans?

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