Lawrence H. Summers, the Charles W. Eliot university professor at Harvard, is a former treasury secretary and director of the National Economic Council in the White House. He is writing occasional posts, to be featured on Wonkblog, about issues of national and international economics and policymaking.
The Hutchins Center for Fiscal and Monetary Policy at Brookings is having a conference on Tuesday launching an important new volume on federal debt management policy. Just as in the Great War it became clear that war is too important to be left to generals, so too in the Great Recession it became clear that (government) debt management is too important to be left to the parochial world of debt managers. The composition of federal debt is itself often a useful tool for economic policy, particularly in the current low-rate environment in which the Federal Reserve will frequently be unable to cut rates as much as it would like and will instead be reliant on “unconventional” policies intended to effect the price of government debt.
Edited by David Wessel, the volume contains two chapters that I coauthored with Robin Greenwood, Sam Hanson, and Josh Rudolph as well as some separate comments of mine. There is also a provocative paper by John Cochrane, and a variety of perceptive commentaries by people with experience in debt management policy.
I think the volume makes a case for quite radical revisions in thinking about debt management policy. Here are my 10 main takeaways starting where I am most confident.
- Debt management is too important to leave to federal debt managers and certainly to leave to the dealer community. This is because, especially when interest rates are close to zero, it directly implicates monetary and fiscal policy and economic performance in the short-run -- and questions of financial stability in the medium-run.
- Whatever one’s view about desirable policy, it is fairly crazy for the Federal Reserve and Treasury, which are supposed to serve the national interest, to pursue diametrically opposed debt-management policies. This is what has happened in recent years with the Federal Reserve seeking to shorten outstanding maturities and the Treasury seeking to term them out.
- Standard discussions of quantitative easing -- which focus on the size of Fed purchases of long-term bonds and ignore the scale of Treasury sale of these instruments -- are intellectually incoherent. It is the total impact of government activities on the stock of debt that the public must hold that should impact financial markets.
- The preceding point is highly significant for the United States. Despite QE, the quantity of long-term debt that the markets had to absorb in recent years was well above, rather than below, normal. This suggests that if QE was important in reducing rates or raising asset values, it was because of signaling effects regarding future monetary policies -- not because of the direct effect of Fed purchases.
- The standard mantra that federal debt management policies should seek to minimize government borrowing costs is some combination of wrong and incomplete. It is wrong because it is risk-adjusted expected costs that should be considered. It is incomplete because it is hard to see why the effects of debt policies on levels of demand and on financial stability should be ignored.
- The tax smoothing aspect which is central to academic theories of debt policy is of trivial significance. Even far larger levels of tax variability than we observe or than could be offset by altered debt management policies have only trivial impacts on levels of income. It is much more important to understand debt management policy impacts on financial stability than on tax variability.
- The idea of rollover risk that is ever present in policy discussions is very confused. If there is the possibility that a period will come when the government’s borrowing rate will be very high this obviously needs to be considered in setting policy. But the problem is not one of rollover. To see this, think about long-term floating rate debt. Such debt does not offer insulation in the hypothetical circumstance where rollover would be difficult, because in such a situation floating rate debt yield will rise precipitously.
- Yield curves typically slope upward. The “carry trade” of borrowing short and lending long is a hedge fund staple. Rather than providing this opportunity, Treasury should reverse the trend toward terming out the debt. Issuing shorter term debt would also help meet private demands for liquid short term instruments without encouraging risky structures like banks engaged in maturity transformation.
- Institutional mechanisms should be found to ensure that in the future the Fed and Treasury are not pushing debt durations in opposite directions. The Treasury terming out the debt, which the Fed then buys in an effort to quantitatively ease, serves only to enrich the dealer community.
- Now that we are in a “secular stagnation” world of low interest rates, it is likely that debt management tools will be more important to stabilization policies in the future than in the past.