US Government Debt Different - Finance Department - University of ...

Jim Millsteinon reserve balances will also decrease bank demand for short-termTreasury securities. And if inflation does in fact pick up or the dollardepreciates, investors will demand higher rates to protect real returnsand compensate for returns available elsewhere.157There is also a feedback loop that will constrain further Federal Reservemonetization of US debt. Woodford and Sims argue that priceswill naturally rise if fiscal authorities continue to run excessive deficitswhile the central bank restrains growth in the money supply. 7Unless policymakers begin to exercise fiscal discipline, we could entera vicious cycle of inflationary pressure and monetary tightening.The combination of an increasing sovereign debt burden, increasingbenchmark interest rates, and a falling dollar could drive FederalGovernment borrowing costs up significantly. It is entirely possiblethat we could return to Federal borrowing rates last seen in the 1990sand 1980s. If so, Federal Government interest costs would averagebetween seven and nine percent on new issues, compared with lessthan three percent at which the Government is borrowing on averagetoday. The threat of public debt service crowding out private capitalformation and government spending on productive activities wouldbe even more severe if the CBO’s alternative scenario projectioncame to pass, in which the ratio of debt held by the public wouldreach 82 percent by 2015 and the deficit still remain elevated at fivepercent of GDP. If markets forced Treasury borrowing costs to returnto the average of where they were during the stagflating 1980s—9.1percent—debt service would reach 70 percent of total governmentoutlays projected by the CBO in 2016.7 Woodford, M., Price-Level Determinancy Without Control of a Monetary Aggregate,Carnegie-Rochester Conference Series on Public Policy, 43, pp. 1-46, 1995; Sims,C.A., A Simple Model for Study of the Determination of the Price Level and Interactionof Monetary and Fiscal Policy, Economic Theory, 4, pp. 381-399, 1994.