With interest rates at record-lows, the U.S. government should borrow more to invest in infrastructure, not stop spending.

Commentaries on economics and technology.
Nov. 18 2010 2:45 PM

Governments Should Borrow More. Lots More.

With interest rates at record-lows, the U.S. government should borrow more to invest in infrastructure, not stop spending.

Road construction. Click image to expand.
Should the government be investing in infrastructure?

Real long-term interest rates—that is, interest rates on inflation-protected bonds —have fallen to historic lows in much of the world. This is an economic fact of fundamental significance, for the real long-term interest rate is a direct measure of the cost of borrowing to conduct business, launch new enterprises, or expand existing ones—and its levels now fly in the face of all the talk about the need to slash government deficits.

Nominal interest rates—quoted in terms of dollars, euros, renminbi, etc.—are difficult to interpret, since the real cost of borrowing at these rates depends on the future course of inflation, which is always unknown. If I borrow euros at 4 percent for 10 years, I know that I will have to pay back 4 percent of the principal owed as interest in euros every year, but I don't know what this amounts to. If inflation is also 4 percent per year, I can borrow for free—and for less than nothing if annual inflation turns out to be higher. But, if there is no inflation over the next 10 years, I will pay a hefty real price for borrowing. One just doesn't know.

Economists like to subtract the nominal government-bond yield from the inflation-indexed bond yield of the same maturity to get a market estimate of the inflation rate from now to that maturity date. But such forecasts of "implied inflation" can be wild, if not absurd. During the heat of the 2008 financial crisis, for example, the inflation-indexed yield in the United States rose so high for a brief period that implied annual inflation for the next seven years suddenly dropped to -1.5 percent.


The real reason inflation-indexed bond yields are an interesting economic variable is that they report on a market in which both investors and borrowers know exactly what is coming, in real terms. Notably, the issuer, that is the borrower, can rationally plan such borrowing to make real investments.

The supposed threat posed by government debt levels hasn't hurt these markets, at least in the relatively few countries that have inflation-indexed bonds. Long-term inflation-indexed bond yields have fallen to about 1 percent a year, or less, in the United States, Canada, the United Kingdom, and the Eurozone. Elsewhere, yields have been a little higher—about 2 percent in Mexico, Australia, and New Zealand—but still very low by historical standards.

All these countries have shown roughly the same downward trend in real interest rates for many years, and notably since 2000. If one were to extrapolate this trend, 10-year interest rates would move into negative territory in a few years or so for most of them. In the United States and the United Kingdom, yields on intermediate-term (five-year) inflation-indexed bonds are already actually negative this year.

One may ask: how can an interest rate be negative? Why would anyone lend (buy a bond) for less than nothing?

One can never have negative nominal interest rates (except through some oddity of taxes or regulations), since lenders would rather hold their cash than effectively pay borrowers. But there is nothing to stop negative real interest rates, since routine investors may have no alternative risk-free instrument that offers a positive real return.

The low level of real interest rates does not appear to be a result of the 2007-09 financial crisis. In fact, there was a temporary upward spike in real long-term interest rates during the financial crisis in countries with indexed bonds. The rate has come down to low levels only during the period of recovery from the immediate crisis.

Instead, low long-term real interest rates appear to reflect a general failure by governments over the years to use the borrowing opportunities that the inflation-indexed markets present to them. This implies an arbitrage opportunity for governments: borrow massively at these low (or even negative) real interest rates and invest the proceeds in positive-returning projects, such as infrastructure or education.

Opportunities for governments to do this exceed those of the private sector, which in many cases continue to be constrained by slow economic growth. Moreover, unlike private firms, governments can count as profits on their investments the benefits of positive externalities (benefits that accrue to everyone).

Surely, governments' levels of long-term investment in infrastructure, education, and research should be much higher now than they were five or 10 years ago, when long-term real interest rates were roughly twice as high. The payoffs of such investments are, if anything, higher than they were then, given that many countries still have relatively weak economies that need stimulating.

It is strange that so many governments are now emphasizing fiscal consolidation, when they should be increasing their borrowing to take advantage of rock-bottom real interest rates. This would be an opportune time for governments to issue more inflation-indexed debt, to begin issuing it, or to issue nominal GDP-linked debt, which is analogous to it.

This article comes from Project Syndicate.

Like Slate on  Facebook. Follow us on  Twitter.


Medical Examiner

The Most Terrifying Thing About Ebola 

The disease threatens humanity by preying on humanity.

I Bought the Huge iPhone. I’m Already Thinking of Returning It.

Scotland Is Just the Beginning. Expect More Political Earthquakes in Europe.

Students Aren’t Going to College Football Games as Much Anymore

And schools are getting worried.

Two Damn Good, Very Different Movies About Soldiers Returning From War

The XX Factor

Lifetime Didn’t Think the Steubenville Rape Case Was Dramatic Enough

So they added a little self-immolation.


Blacks Don’t Have a Corporal Punishment Problem

Americans do. But when blacks exhibit the same behaviors as others, it becomes part of a greater black pathology. 

Why a Sketch of Chelsea Manning Is Stirring Up Controversy

How Worried Should Poland, the Baltic States, and Georgia Be About a Russian Invasion?

Trending News Channel
Sept. 19 2014 1:11 PM Watch Flashes of Lightning Created in a Lab  
  News & Politics
Sept. 20 2014 11:13 AM -30-
Business Insider
Sept. 20 2014 6:30 AM The Man Making Bill Gates Richer
Sept. 20 2014 7:27 AM How Do Plants Grow Aboard the International Space Station?
  Double X
The XX Factor
Sept. 19 2014 11:33 AM Planned Parenthood Is About to Make It a Lot Easier to Get Birth Control
  Slate Plus
Slate Picks
Sept. 19 2014 12:00 PM What Happened at Slate This Week? The Slatest editor tells us to read well-informed skepticism, media criticism, and more.
Brow Beat
Sept. 20 2014 3:21 PM “The More You Know (About Black People)” Uses Very Funny PSAs to Condemn Black Stereotypes
Future Tense
Sept. 19 2014 5:03 PM White House Chief Information Officer Will Run U.S. Ebola Response
  Health & Science
Bad Astronomy
Sept. 20 2014 7:00 AM The Shaggy Sun
Sports Nut
Sept. 18 2014 11:42 AM Grandmaster Clash One of the most amazing feats in chess history just happened, and no one noticed.