The question is not whether the current policy path is acceptable. The question is what should be done? To come up with a viable solution, consider the remarkable level of interest rates in much of the industrialised economies. The US government can borrow in nominal terms at about 0.5 per cent for five years, 1.5 per cent for 10 years and 2.5 per cent for 30 years. Rates are considerably lower in Germany and still lower in Japan.
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These low rates even on long maturities mean that markets are offering the opportunity to lock in low long-term borrowing costs. In the US, for example, the government could commit to borrowing five-year money in five years at a nominal cost of about 2.5 per cent and at a real cost very close to zero. What does all this say about macroeconomic policy? Many in both the US and Europe are arguing for further quantitative easing to bring down longer-term interest rates. This may be appropriate given that there is a much greater danger from policy underreacting to current economic weakness than from it overreacting.
However, one has to wonder how much investment businesses are unwilling to undertake at extraordinarily low interest rates that they would be willing to with rates reduced by yet another 25 or 50 basis points. It is also worth querying the quality of projects that businesses judge unprofitable at a -60 basis point real interest rate but choose to undertake at a still more negative real interest rate. There is also the question of whether extremely low safe real interest rates promote bubbles of various kinds.
Right now, the markets are essentially asking the US government to borrow. And yet, we're still discussing the idea ofausterity.....
