The Bond Vigilantes Who Weren’t There

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Floyd Norris:

As 2010 began, there was nearly unanimous agreement in financial circles on at least one thing: Interest rates were sure to rise during the year. Quite to the contrary. As Labor Day approaches, interest rates have collapsed, plunging along with economic optimism. That turn of events, which has shocked savers and stunned investors, appears to indicate that financial markets’ worries are turning in a very different direction from those of many governments.

The governments are seeking ways to bring down budget deficits, fearing that without austerity they could go so far into debt that they would never be able to borrow again. Investors in the financial markets seem to be much more concerned by the possibility of renewed recession and a general deflation that could send asset values and prices down.

Macoreconomic stabilization policy isn’t easy, but it isn’t that hard either. When savers & investors all decide that the thing they want to invest in is United States government debt, then the United States government needs to find some useful projects to spend money on. Ideally, projects that can be undertaken at least to some extent by mobilizing the currently idle resources in an economy that’s full of idle resources. Finding useful projects and way to mobilize genuinely idle resources is a non-trivial undertaking, but congress isn’t even trying. Similarly, when the general level of demand for goods and services tumbles and the general level of demand for money increases, the central bank needs to create a lot more money until people decide they’ve got plenty of money and want to start trading it for goods and services.