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The Democratic Strategist

Political Strategy for a Permanent Democratic Majority

Signals from the Bond Market

At a time when it’s fashionable to draw analogies between 1994 and 2010, you hear some deficit hawks argue that Barack Obama needs to emulate Bill Clinton’s early emphasis on reducing the federal budget deficit instead of investing in job-producing activities on grounds that bond markets were sending a clear signal via higher interest rates that deficit reduction was imperative.
But as budget expert Stan Collender points out, bond markets today are sending exactly the opposite signal:

The economic situation today is the opposite of what existed at the start of the Clinton administration. In 1993, the bond market was worried about excess demand and soaring inflation, which would have eroded the value of bonds. Having the federal government spend less and tax more — that is, do things that would reduce the deficit — meant that the economy would cool rather than overheat, and therefore that the demand for goods, services, and workers would be reduced. This would keep inflation in check and allow federal bonds to maintain their value.
The big concern today is about deflation and slow growth rather than inflation and overheating. With unemployment high and capacity utilization low, the bond market not only isn’t worried about the excessive economic growth, it actually would welcome the additional activity that would be generated by higher spending and lower taxes.

Thus, concludes Collender, the pressure for deficit reduction right now is political, not economic, in nature. Markets aren’t reaching the conclusion that Herbert Hoover, not FDR, was right about how to deal with high unemploment and low consumer demand; politicians are, with self-fulfilling negative results as the federal government withdraws from efforts to stimulate the economy.

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