What Does The U.S. Manufacturing Recovery Mean For Commodities?

What are the risks?

But, warn fiscal conservatives, what would happen if interest rates rose? If we combined the high-interest rates of the 1980s with today’s higher debt ratios, debt service costs would soar. Can we take that chance? The response has several parts. 

First, the smart money says that is not going to happen. What pushed the interest rate so high in the 1980s was high expected inflation. Market-based data – not the estimates of some government economists but the real market bets of people who are putting their own money on the line – show that investors don’t expect inflation even to reach the Fed’s target rate of 2 percent over the next ten years. Wall Street is behaving as if 1980s-style interest rates are about as big a worry as an asteroid strike. 

Second, there are sound structural reasons to justify market expectations of low inflation and low-interest rates. Furman and Summers point to increased saving driven by lengthening life expectancy and rising inequality and also to decreased private-sector borrowing demand driven by changes in technology and corporate behavior. In fact, they consider a further decline in interest rates to be as likely as even a modest increase. 

Third, we need to consider economic growth. Just as your home mortgage becomes more manageable as your income grows over your career, growth of GDP makes government debt management easier. Without getting too technical about it, as long as the rate of growth of GDP is higher than the rate of interest (either adjusting both variables for inflation or adjusting neither), the debt is not going to explode. And, as Figure 3 shows, that has been the case for most of the past half-century. (See here for the detailed mathematics of deficits and debts.) 

Fiscal conservatives warn of inflation and a debt crisis, but the very measures they propose to avoid those risks – capping spending and balancing the budget -- have risks of their own. Economic policy, now as always, is a matter of balancing one set of risks against another. 

In the short run, the obvious risk is that of undertaking austerity prematurely, when aggregate demand is weak and the economy is still operating well below its potential. It is especially important to maintain an expansionary fiscal stance in periods when the Fed’s interest rate target is at its lower bound of 0 or close to it. Failure of fiscal policy to support aggregate demand at a time when zero interest rates render conventional monetary policy impotent virtually guarantees a slower recovery. A slow recovery, in turn, is more likely to widen than to narrow the budget deficit. 

That is just where we are, entering 2021. After its December 2020 meeting, the Federal Open Market Committee announced its intention “to keep the target range for the federal funds rate at 0 to 1/4 percent and expects it will be appropriate to maintain this target range until labor market conditions have reached levels consistent with the Committee's assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time.” A commentary from the Cleveland Fed notes that the FOMC expects inflation to remain at or below 2 percent at least through the end of 2021. A survey of private securities dealers in New York shows even lower inflation expectations, in the range of 1.7 to 1.8 percent, through 2022. 

Eventually, the economy will recover from the current pandemic-induced recession. At that point, the balance of risks will change. The biggest risk will then come not from inadequate fiscal stimulus, but from an inappropriate way of achieving the appropriate deficit target. 

That risk comes from another side to fiscal conservatism, one that often hides behind all the noise about the size of the deficit and the national debt. That is an insistence that the desired deficit target always be achieved through cuts on the spending side of the budget, not through adjustments to revenues. Such a one-sided view of budget balance risks undermining the state capacity that is essential to support healthy, long-run economic growth. My Niskanen colleagues Brink Lindsey and Samuel Hammond put it this way in a recent manifesto, “Faster Growth, Fairer Growth:”     

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