Contradicting Clarida.

• Author: Galle, William G.
• Position: Letters To The Editor

To the Editor:

The interview with Assistant U.S. Treasury Secretary Richard Clarida ("The Clarida View," Winter 2003) is an interesting study in contradictions. When discussing the international economy, Clarida is full of insight, subtlety, and nuance, in a wide-ranging discussion that covers the recent loosening of monetary policy, declining U.S. business investment, the flight to security in U.S. treasuries, sluggish global economic performance, and so on. When discussing the effects of budget deficits, though, he ignores all of those factors and focuses instead on two simplistic and meaningless graphs. One shows that interest rates are similar in six OECD countries, even though their current debt/GDP ratios differ. The other shows that the implied real return on Treasury inflation-indexed securities has fallen over the past few years even though projected budget deficits have increased.

Clarida's "evidence" proves only that factors other than deficits may affect interest rates. It says nothing about whether deficits affect rates. We venture that any good undergraduate macroeconomics student at Columbia University, where Clarida teaches, could tell him why his graphs are spurious. In particular, all of the issues that Clarida discusses so prominently in analyzing the world economy have served to reduce recent long-term interest rates, but his graphs control for none of them. (If we're going to play the game of ignoring other factors, does the reduction in investment that has occurred over the past few years, at the same time that long-term rates have declined, mean that interest rates don't affect investment?) Professor Clarida would surely not accept such naive arguments in the classroom, and they are no more acceptable in the policy arena.

Even the most recent Economic Report of the President disagrees with Clarida. In that report, the Council of Economic Advisers (CEA) accepts that a $200 billion increase in current deficits would raise interest rates by 3 basis points. By that measure, the $5.6 trillion decline in the 2002-2011 budget surplus that has occurred in the past two years (from $5.6 trillion in January 2001 to essentially zero in January 2003) would be projected eventually to raise long-term rates by about 84 basis points. The approach used by the CEA, developed in part by the new chair, Greg Mankiw, is a convenient role of thumb, but it probably understates the effects of sustained deficits on interest rates because it...