borrowing causes interest rates to rise" -- sounds
logical, but don't believe it.
a beautiful theory. The sound bite for it is 'Crowding Out' --
and hey, I like beautiful theories just as much as the next person.
Furthermore, I do not enjoy watching a beautiful theory get slaughtered
by ugly facts. Unfortunately, that's what has happened to the
'Crowding Out' theory; ugly facts have slaughtered it. It wasn't
pretty, but it happened.
in the bookcase of my mind, I've had to move the Crowding-Out
theory way over to that section in the corner I call "Bloopers
and Whoppers" -- the section where I also keep Flat-Earth,
Blue-Cheese-Moon, Geocentric-Universe, Toads-Cause-Warts, and
Clinton-Didn't-Inhale, to name just a few.
The Beautiful Theory
anti-deficit, pro-surplus argument is known to economists and
journalists as the 'Crowding Out' theory. Translated into plain
talk, it means that deficits cause higher interest rates, which
cause higher car payments and house payments for those of us in
the private sector. It's a beautiful, common-sense theory.
would-be borrower hates high interest rates - I do; don't you?
If the feds borrow money by running deficits, they are reducing
the supply of borrowable money, aren't they? Naturally, that would
lead to higher interest rates, wouldn't it? It's just plain common
sense. I hear it all the time from politicians, government officials,
debt-phobes, newspaper columnists, and talk-show hosts.
wonder our politicians are virtually unanimous that deficits cause
higher interest rates (and conversely that surpluses cause lower
interest rates). Too bad they're all wrong. AGAIN.
The Storm Clouds
first storm cloud to interrupt my blissfully ignorant acceptance
of the 'Crowding Out' theory appeared several years ago, in a
Wall Street Journal article (Feb. 25, 1993): "Deficits Have
Little Impact on Interest Rates," by Daniel J. Mitchell,
a fellow at the Heritage Foundation. Here are a few things he
had to say:
the past 20 years, interest rates and budget deficits have
traveled in opposite directions 76% of the time."
study by the Treasury Department
found no relationship
between budget deficits and interest rates."
evidence merely suggests that $30 billion, $40 billion, or
$50 billion shifts in the U.S. budget deficit are relatively
trivial in world capital markets totaling trillions of dollars."
The second storm cloud was an entire chapter in Francis X. Cavanaugh's
1996 book, The Truth about the National Debt. Chapter three ("Myth
Number Two: Crowding Out") had this to say:
studies have found no significant relationship between government
deficits and interest rates."
State University economist Paul Evans, a self-described Republican
conservative, has pored through data on budget deficits and
His conclusion? 'You can pick your period,
and you won't find any strong relationship
don't know exactly why,' he said in an interview."
when I started thinking, "Uh-oh. The 'Crowding Out' theory
looks like a building that's shaking, and beginning to lose pieces
of brick. Have those wacky politicians been masking the truth
The Ugly Facts
then, I wasn't sure whom to believe - the politicians, or the
economists? (To be honest, I was starting to lean in the direction
of the economists.) Consequently, I decided to run the numbers
it was not an extensive study by any means. It was a simple test:
Twenty-one years worth of deficits, compared to interest rates
for those same twenty-one years (1977-1997). For deficits, I picked
the change in public debt from year-to-year (sources: Treasury
page a and Treasury
page b.). For interest rates, I picked the two extremes: 30-year
T-Bonds, and 3-month T-Bills (source: Fed
I ran two correlation analyses, and observed the results. Here
Hmmm. If there was any causation at all, it was a negative
relationship. Hmmm. A negative relationship would mean that deficits
cause interest rates to drop, and that surpluses cause interest
rates to rise. THAT'S EXACTLY THE OPPOSITE OF WHAT THE POLITICIANS
HAVE BEEN TELLING US!
However, I refused
to go overboard on the basis of my simple study. I took a conservative
stance, and merely concluded that the economists are closer to
the truth than the politicians: There is little to no relationship
between budget deficits and interest rates.
Move over, Blue-Cheese-Moon theory; Crowding-Out needs some shelf
space in your section of the archives.