How robust are Blanchard’s results?
In this paper Richard Evans attempts to replicate the stated approach of the Blanchard (2019) paper and explores the robustness of Blanchard’s main conclusion, namely, that in a persistent low-interest rate environment fiscal policy should be used to sustain demand. He finds that:
- His attempt to replicate the modeling and calibration approaches of Blanchard (2019) leads him to contrasting results i.e. that there are no long-run average welfare gains from increased government debt;
- Blanchard makes a strong assumption that forces the risk from public debt to be low. When more realistic increases in risk are introduced, welfare losses are exacerbated.
Public Debt, Interest Rates, and Negative Shocks
Author: Richard W. Evans
From: University of Chicago
r-g<0: in reality households face far higher marginal rates
B[lanchard] points out that real growth rates routinely exceed real safe (1-year to 10-year U.S. bond) rates, with current differentials running between 100 and 200 basis points. But close to 90 percent of Americans are in debt and their safe real rates – the real rates they can earn for sure by pre-paying their mortgages, credit card balances, student debt, etc. – equal or exceed the real growth rate. Such debt-ridden Americans would be worse off if forced to participate in a Ponzi scheme paying the growth rate rather than their higher borrowing rate. If the scheme is implemented by borrowing from savers with subsequent debt rollovers, borrowers won’t be forced to earn what is, for them, a below-market return. But they will be forced, due to capital’s induced crowing out, to pay even higher borrowing rates. And along paths in which the scheme fails, borrowers, like lenders, will have to pay higher lifetime net taxes.
Leveraging Posterity’s Prosperity?
Authors: Johannes Brumm, Laurence Kotlikoff, Felix Kubler
From: Karlsruhe Institute of Technology, Boston University, University of Zurich
When r-g<0 is not a guarantee against default
Mario and Zhou conduct an empirical analysis of interest-growth differentials, using a large historical database on average effective government borrowing costs for 55 countries for a period of 200 years. They find that negative differentials have occurred rather often and have persisted for long periods of time. Most importantly, they demonstrate that low interest-growth differentials are not associated with lower frequency of sovereign defaults.
Based on the findings reported in this paper, our answer is: not really. Sovereign default histories demonstrate that after prolonged periods of low differentials, marginal rates can rise suddenly and sharply, shutting countries out of financial markets at short notice.
r − g < 0: Can We Sleep More Soundly?
Authors: Paolo Mauro, Jing Zhou