r<g
February 28 2021. Updated July 28 2021. r<g is an essay on the topic of debt and deficits. Sorry, debts must be repaid. It’s based on comments on Ricardo Reis’ r<g paper given at the spring 2021 NBER EFG, and comments on Neil Mehrotra and Dmitriy Sergeyev’s paper at the summer institute.
Abstract:
A situation that the rate of return on government bonds r is less than the economy's average growth rate g seems to promise that borrowing has no fiscal cost. r<g is irrelevant for the current US fiscal problems. r<g cannot begin to finance current and projected deficits. r<g does not resolve already exponentially-growing debt. r<g can finance small deficits, but large deficits still need to be repaid by subsequent surpluses. The appearance of explosive present values comes by using perfect-certainty discount formulas with returns drawn from an uncertain world. Present values can be well behaved despite r<g. The r<g opportunity is like the classic strategy of writing put options, which fails in the most painful state of the world.