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View Diary: Austerity - The Republican Path to Total Collapse (15 comments)

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  •  It is the debt service ratio and (0+ / 0-)

    its relationship to nominal GDP growth that is the most important factor in determining whether the debt and deficits are sustainable. If treasury interest is greater than GDP growth, only a budget surplus will prevent unbounded growth of debt service. If GDP growth is greater than treasury interest, persistent deficits lengthen the time to equilibrium and increase the upper bound, but are sustainable with debt service settling at a constant percentage of GDP. An examination of 1953-2012 data shows that interest was less than GDP growth from 1953 to q3-1979. We entered a high interest rate regime from q4-1979 thru 2000, with potentially unbounded growth in debt service until Clinton produced surpluses. Government sector surpluses are by definition private sector deficits - in Clinton's time financed by asset bubbles in real estate and equities. From 2001 on we went back to a low interest rate regime which except for q4-08 to q3-09 has been lower than GDP growth. Consequently, even with the current deficit and additional needed stimulus, we are on a complete sustainable path.

    The argument that interest rates are set in an open market and could go up on the whim of "bond vigilantes" is founded on a fundamental misunderstanding of the monetary system. The Fed sets interest rates in the overnight market. They control the rate because they control the reserves on which the rates are founded. The term structure of the bond market is anchored to the overnight rate, and the Fed announcements of future intentions which factor in inflation, unemployment and other parameters. So the interest rate on the debt is not a market rate, it is a policy decision.

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