Eric M. Engen

Federal Government Debt and Interest Rates

Does government debt affect interest rates? Despite a substantial body of empirical analysis, the answer based on the past two decades of research is mixed. While many studies suggest, at most, a single-digit rise in the interest rate when government debt increases by 1% of gross domestic product (GDP), others estimate either much larger effects or find no effect. Comparing results across studies is complicated by differences in economic models, definitions of government debt and interest rates, econometric approaches, and sources of data. Using a standard set of data and a simple analytical framework, we reconsider and add to empirical evidence about the effect of federal government debt and interest rates. We begin by deriving analytically the effect of government debt on the real interest rate and find that an increase in government debt equivalent to 1% of GDP would be predicted to increase the real interest rate by about two to three basis points. While some existing studies estimate effects in this range, others find larger effects. In almost all cases, these larger estimates come from specifications relating federal deficits (as opposed to debt) and the level of interest rates or from specifications not controlling adequately for macroeconomic influences on interest rates that might be correlated with deficits. We present our own empirical analysis in two parts. First, we examine a variety of conventional reduced-form specifications linking interest rates and government debt and other variables. In particular, we provide estimates for three types of specifications to permit comparisons among different approaches taken in previous research; we estimate the effect of an expected, or projected, measure of federal government debt on a forward-looking measure of the real interest rate; an expected, or projected, measure of federal government debt on a current measure of the real interest rate; and a current measure of federal government debt on a current measure of the real interest rate. Most of the statistically significant estimated effects are consistent with the prediction of the simple analytical calculation. Second, we provide evidence using vector autoregression analysis. In general, these results are similar to those found in our reduced-form econometric analysis and are consistent with the analytical calculations. Taken together, the bulk of our empirical results suggests that an increase in federal government debt equivalent to 1% of GDP, all else being equal, would be expected to increase the long-term real rate of interest by about three basis points (though one specification suggests a larger impact), while some estimates are not statistically significantly different from zero. By presenting a range of results with the same data, we illustrate the dependence of estimation on specification and definition differences.

Do Saving Incentives Work

American Saving Rates have recently fallen to their lowest levels since 1950. After averaging roughly 8 percent in the 1950s, 1960s, and 1970s, the net national saving rate fell to about 4.5 percent in the 1980s and has fallen below 2 percent since 1990. The personal saving rate has also declined, from an average of 7 percent between 1950 and 1980 to an average of 4.6 percent since 1990. These declines have raised concerns that the economy may be unable to finance investment and sustain growth over the long run and that a significant fraction of the baby-boom generation may not be saving adequately for retirement.

The Macroeconomic Effects of the Federal Reserve's Unconventional Monetary Policies

After reaching the effective lower bound for the federal funds rate in late 2008, the Federal Reserve turned to two unconventional policy tools--quantitative easing and increasingly explicit and forward-leaning guidance for the future path of the federal funds rate--in order to provide additional monetary policy accommodation. We use survey data from the Blue Chip Economic Indicators to infer changes in private-sector perceptions of the implicit interest rate rule that the Federal Reserve would use following liftoff from the effective lower bound. Using our estimates of the changes over time in private expectations for the implicit policy rule, and estimates of the effects of the Federal Reserves quantitative easing programs on term premiums derived from other studies, we simulate the FRB/US model to assess the actual economic stimulus provided by unconventional policy since early 2009. Our analysis suggests that the net stimulus to real activity and inflation was limited by the gradual nature of the changes in policy expectations and term premium effects, as well as by a persistent belief on the part of the public that the pace of recovery would be much faster than proved to be the case. Our analysis implies that the peak unemployment effect--subtracting 1-1/4 percentage points from the unemployment rate relative to what would have occurred in the absence of the unconventional policy actions--does not occur until early 2015, while the peak inflation effect--adding 1/2 percentage point to the inflation rate--is not anticipated until early 2016.

Lifetime Earnings, Social Security Benefits, and the Adequacy of Retirement Wealth Accumulation

This paper provides new evidence on the adequacy of household retirement saving. We depart from much previous research on the adequacy of saving in two key ways. First, our underlying simulation model of optimal wealth accumulation allows for precautionary saving against uncertain future earnings. Second, we employ data on lifetime earnings. Using data from the 1992 Health and Retirement Study, we find that households at the median of the empirical wealth-lifetime earnings distribution are saving as much or more as the underlying model suggests is optimal, and households at the high end of the wealth distribution are saving significantly more than the model indicates. But we also find significant undersaving among the lowest 25 percent of the population. We show that reductions in Social Security benefits could have significant deleterious effects on the adequacy of saving, especially among low-income households. We also show that, controlling for lifetime earnings, households with high current earnings tend to save far more adequately than other households.