Reflecting on the latest budget projections from the Congressional Budget Office, which show relentlessly rising debt and interest costs over the next 30 years, Bloomberg’s Noah Smith says that one possible response to the problem involves a policy economists call “fiscal dominance.” Here’s how it would work:
“The government thus has a good reason not to let debt spiral out of control. And the easiest way to keep that from happening is for the Federal Reserve to cut interest rates to zero and keep them there. As the government replaces its old, higher-interest debt with new, lower-interest debt, its yearly interest payments would go down, until finally they dwindle to nothing at all. Doing this would stabilize the deficit, and even open up fiscal space for big new spending initiatives on issues like climate change.”
Japan has been using this approach for years, Smith says, as the country deals with a national debt more than twice as large as its economy. While the policy may not work the same way in the U.S. and necessarily creates its own set of risks, the Japanese case suggests that “fiscal dominance” may be an attractive and perhaps necessary option at some point over the next few decades.
Read Smith’s column here.