Deficits, the National Debt, and Economic Growth: What many politicians don't want you to know.
Debt is the wrong enemy.  Growth is our forgotten friend.
  Speak Out
  You and I
  Site Map

"Son, we'd like to keep you around this season, but we're gonna try to win a pennant."
--Casey Stengel

Interest Rates & Blue Cheese Moon
  Next section >>>

"Government borrowing causes interest rates to rise" -- sounds logical, but don't believe it.

It's 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.

Consequently, 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

The 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.

Every 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.

No 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

The 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:

"Over the past 20 years, interest rates and budget deficits have traveled in opposite directions 76% of the time."

"A 1984 study by the Treasury Department… found no relationship between budget deficits and interest rates."

"…the 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:

"…economic studies have found no significant relationship between government deficits and interest rates."

"Ohio State University economist Paul Evans, a self-described Republican conservative, has pored through data on budget deficits and interest rates… His conclusion? 'You can pick your period, and you won't find any strong relationship… I really don't know exactly why,' he said in an interview."

That's 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… AGAIN?"

The Ugly Facts

By 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 myself.

Admittedly, 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 release data).

Then I ran two correlation analyses, and observed the results. Here they are:

Correlation of T-Bond interest rates to deficits: negative .343
Correlation of T-Bill interest rates to deficits: negative .557

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.

End of this article
Last update of this page: June 24, 2001
prev: My Checkbook