A number to paste in your hat

William Gale and Peter Orszag at Brookings estimate that adding 1% of GDP — roughly $100 billion at current rates — to the long-run annual Federal budget deficit will add between half a percentage point and one percentage point (50 to 100 “basis points” to long-term interest rates. So if the Bush tax cuts, once fully in place in 2010, will reduce Federal revenues by about $300 billion per year, that would add about 200 basis points to long-term interest rates (remembering that the GDP will be bigger by then).

That helps explain why, even with inflation, inflation expectations, and short-term interest rates all very low, long-term interest rates have stayed up: since January 2001, the interest rate on three-month Treasury bills is down from from 5.5% to 1.25% — a drop of 425 basis points — but 30-year fixed-rate mortgage rates are down only 110 basis points, from 7.25% to 6.15%. Long-term rates are naturally less volatile than short-term rates, so one wouldn’t expect anything like a point-for-point drop, but the stickiness of long rates has been remarkable.

Brad DeLong provides a link, and a quick explanation of why — contrary to the protestations coming from the vicinity of 1600 Pennsylvania Avenue — expected deficits increase interest rates and thus depress long-run economic growth.

Author: Mark Kleiman

Professor of Public Policy at the NYU Marron Institute for Urban Management and editor of the Journal of Drug Policy Analysis. Teaches about the methods of policy analysis about drug abuse control and crime control policy, working out the implications of two principles: that swift and certain sanctions don't have to be severe to be effective, and that well-designed threats usually don't have to be carried out. Books: Drugs and Drug Policy: What Everyone Needs to Know (with Jonathan Caulkins and Angela Hawken) When Brute Force Fails: How to Have Less Crime and Less Punishment (Princeton, 2009; named one of the "books of the year" by The Economist Against Excess: Drug Policy for Results (Basic, 1993) Marijuana: Costs of Abuse, Costs of Control (Greenwood, 1989) UCLA Homepage Curriculum Vitae Contact: Markarkleiman-at-gmail.com