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Less Debt Means Less Borrowing Cost

To illustrate the wisdom of supporting the Compact for a Balanced Budget, I wanted to share with you an email I received from one of our Educational Foundation’s Council of Scholars Members, Stephen Slivinski, who is a former Federal Reserve economist and is now Senior Research Fellow at the Center for the Study of Economic Liberty at Arizona State University. If you want to look at his mug, look to the left.

Anyway, Steve wrote me in response to a request for research on the impact of debt control measures on the costs of borrowing and advised me:

"One of the best state-level studies is a 1999 NBER study co-authored by James Poterba of MIT. Their main conclusion: '[T]ighter anti- deficit rules are associated with lower borrowing rates. A state with weak anti-deficit rules, all else equal, faces a borrowing rate 13 basis points higher than a state with tough antideficit rules.' They also summarize and cite a bunch of other studies too. One of them comes to this firm conclusion: 'The key finding is that the bond market’s reaction to a state deficit depends on whether or not the state has a balanced-budget requirement. States with balanced-budget rules experience smaller increases in their borrowing costs for a given deficit.' (see page 186 of the PDF of the link above). So, in other words, balanced budget requirements at the state level do have a clear effect on bond market behavior."

To paraphrase, our experience in the states shows that strong debt control measures tend to reduce interest rates significantly and tend to curb interest rate increases that would otherwise happen.

It is important to consider this evidence from the centuries-long experimentation in the states with debt control measures in light of the following infamous pie chart:

Focus on the little red slice above. That little red slice reflects historically low interest rates that are roughly half of the historically normal interest rate. Think about the political strength of the constituencies for the rest of the pie slices. Ask yourself who loses the most if the red slice doubles or triples in its portion size. Then consider the fact that our gross federal debt is still over 100% of GDP—where Greece was in 2007.

Then consider that our deficits are projected (conservatively-by the CBO) to return to $1 trillion levels in the next few years:

And then consider the fact that this projection does not contemplate another recession like 2008 happening--with which our resident Debt Doctor Dr. Sven Larson would strongly disagree if you've been reading his blogs.

I think you will see that from any vantage point, there is real reason to think that bond markets will balk at lending money at current historically low interest rates for much longer—especially with baby boomers retiring at a rate of 10,000 per day.

If we want to minimize the size of the red slice, and thereby avoid squeezing out the slices of the rest of federal spending pie, the states’ experience with strong debt control measures warrants your support for the Balanced Budget Amendment at the heart of the Compact for a Balanced Budget. The Amendment would give real confidence to bond markets that Washington is serious about fixing the national debt. It will minimize the interest rate bite that is otherwise inevitable.

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