Source of safety.

Photographer: Karen Bleier/AFP/Getty Images

The World Needs More U.S. Government Debt

Narayana Kocherlakota is a Bloomberg View columnist. He is a professor of economics at the University of Rochester and was president of the Federal Reserve Bank of Minneapolis from 2009 to 2015.
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Are government-imposed restrictions holding back the U.S. economy? In a way, yes: The federal government is causing great harm by failing to issue enough debt.

The U.S. generates more income than any other country, and will keep doing so for many years to come. The federal government can generate a lot of revenue by taxing this income -- a power that puts it in a unique position to issue the kind of extremely safe bonds that are in great demand among the world's investors.

How is the U.S. government wielding its power? Not well. The yield on a 20-year inflation-protected Treasury bond, at just over 0.5 percent, is nearly two full percentage points lower than it was 10 years ago. This means that the price is near record highs, suggesting that the U.S. government's supply of such safe investments is falling far short of demand. In other words, we're starving the world of desperately needed financial safety.

To some, the idea that the U.S. government isn't issuing enough debt may seem counterintuitive -- after all, federal debt outstanding has more than doubled over the past 10 years. But scarcity is not about supply alone. In the wake of the financial crisis, households and businesses are demanding more safe assets to protect themselves against sudden downturns. Similarly, regulators are requiring banks to hold more safe assets. Market prices tell us that the government needs to produce more safety in order to meet this increased demand.

The scarcity of safety creates hardships for people and businesses. Retirees can’t get adequate returns on their nest eggs. Banks can't earn enough on safe, long-term investments to cover the costs of attracting deposits (interest rates on which can’t fall much below zero).

The broader economy suffers, too. The lack of safe investments leaves many households and businesses uncertain about their future prospects, and hence unwilling to spend. As a result, the Fed and other central banks must keep short-term interest rates very low in order to generate enough demand to achieve their inflation and employment goals. Here, the central bankers face another government-generated constraint: They can't take interest rates too far into negative territory, lest people pull their money out of banks to get the zero interest rate paid by government-issued currency.

The inadequate provision of safe assets also has profound implications for financial stability. Without enough Treasury bonds to go around, investors “reach for yield” by buying apparently safe securities from the private sector (remember all those triple-A-rated subprime-mortgage investments of the 2000s?). If such behavior becomes widespread, it can create systemic risks that tip the financial system into crisis.

From a purely economic point of view, the government’s policy seems entirely artificial. No private entity would behave like this. Imagine a corporation with such a safe cash flow and such low borrowing costs. It would issue debt to fund expansions or payouts to its shareholders.

Analogously, the U.S. government should issue more debt, using the proceeds to invest in infrastructure, cut taxes or both. Instead, political forces have imposed artificial constraints on debt -- constraints that punish savers, choke off economic growth and could sow the seeds of the next financial crisis.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Narayana Kocherlakota at nkocherlako1@bloomberg.net

To contact the editor responsible for this story:
Mark Whitehouse at mwhitehouse1@bloomberg.net