Government Revenues from Low-Interest Rate Policies

by Andreas Hoffmann and Holger Zemanek*

Over the last two years Carmen Reinhart and Belen Sbrancia have published a series of papers on financial repression and its historical role in financing government debt. They show that throughout the Bretton Woods period governments in many advanced economies repressed financial markets to liquidate the high levels of debt that had been accumulated by the end of World War II.

During this period, low policy rates reduced debt servicing costs. Financial repression raised the attractiveness of government bonds relative to other investments. Inflation liquidated government debt. The authors report an annual debt liquidation effect for, e.g., the US and UK government debt of about 3 – 4 percent of GDP (Reinhart and Sbrancia 2011).

Today government debt levels in many countries are comparable to those after the Second World War II! After all, good politicians do not need a World War. There are plenty of other ways to spend. But in the light of the European debt crisis, governments are feeling the need to correct the spending-revenue misalignments in order to make debt-service sustainable.

Because economic growth remains sluggish and there is opposition to austerity, central banks are again urged to take on special roles! Low interest rates and central bank interventions reduce debt-servicing costs.

In the US, the Federal Reserve purchases government bonds to drive down bond yields. As a consequence, long-term interest rates for US-Treasury securities have significantly declined. Compared to the effective debt-service interest rate from 2008 (after the initial crisis reactions), the fall in yields reduced US debt service by 3 to 4 percent of total government revenues – about one percent of GDP in 2011 and 2012 (Hoffmann and Zemanek 2012).

The European Central Bank purchased government bonds of struggling countries on the secondary market (by the end of 2011: 210.5 Billion Euro) to bring down bond yields. The interventions by the ECB led to significant reductions in sovereign bond premia of euro area crisis countries (Link). Recently, the ECB even announced an unlimited government bond purchasing scheme, which might even imply government yield caps (Reuters 2012).

The German government is an – perhaps unintended – beneficiary of the crisis measures. At least in the short run, the ECB prevented a collapse of the financial system. Recapitalization costs are – let us say – foregone.

Second, the capital flight from South to North caused a steady decline in German government bond yields. Consequently, the 10-year yield has declined below 1.5 percent by September 2012. The 1-year yield turned negative! Compared to the effective debt-servicing rate in 2008, the government saved about 2 percent of government revenues p. a. on debt service in 2011 and 2012 – almost one percent of GDP (Hoffmann and Zemanek 2012).

Given that central banks help cut government spending, balancing the budget should have become easier in both the US and Germany. Obviously, such policies have other consequences as well. William White (2012) summarizes them with a focus on the US. But (to many) that is another story. Why worry now? One problem at a time! In the long run, and so on..

*University of Leipzig, Germany, the views are those of the authors

8 thoughts on “Government Revenues from Low-Interest Rate Policies

  1. This is important. I do not know what projections the budgetary authorities are making in the US about the course of interest rates over the next decade. Clearly, these will affect the projected amount of revenue available
    for government spending. But in which direction? If interest rates rise because the economy improves then there will be more revenue. If interest rates rise because of inflation only the revenue may be the same in real terms. In the mixed case, it is not clear.

  2. Bernanke suggested in recent speeches that the Fed’s focus has shifted from inflation to unemployment. I believe nominal interest rates will be held low, even if inflation picks up slightly. This could reduce the debt level.

  3. I doubt the Fed will raise interest rates until inflation is high enough to cause substantial political blowback. “Financial repression” is a euphanism for confiscating savings.

  4. Nice post, Andreas. I agree, this is really important.

    For the U.S., back of the envelope calculations tell us that the “average interest rate” (see paid on marketable public debt has fallen since 2005 by 2.3 percentage points (more than 50%). This is principally the effect of ultra-easy and deliberate Fed policy. Without that decrease, U.S. interest cost on public debt, estimated to be about $360 billion FY 12, would instead be about $560 billion. The public debt has roughly doubled since 2005, yet the interest cost as reported by the U.S. Treasury is roughly the same.

    In 2007, the average interest rate on marketable public debt was 4.9%. The Fed’s easing since 2008 has pushed rates down to 2.6% in 2009, 2.37% in 2010, 2.28 in 2011, and 2.05% in 2012. The Fed claims that its simply pursuing counter-cyclical policy, yet it has also been the principal enabler disguising the costs of the growth of government.

  5. Dear Bill,

    in our policy paper we base the “calculation” on a 2008-benchmark. We believe it is possible to argue that the initial reactions were counter-cyclical and purely crisis related. Since the Bernanke-Twist, however, real yields have fallen sharply again. And the objectives of these actions have been less clear.

    But no matter what, the Fed certainly helps the Treasury. From the latest talks, it seems it does so intentionally. Bernanke said in a somewhat similar way more than once, -that the Fed does what it can and that now fiscal policy should have some leeway and it is up to them to act.(not literal)- So there is some intention.

  6. Let me just expand a bit on a couple of points. I chose 2005 to establish a “guessmark” for interest rates prior to the onset of serious debt/GDP ratios but without biasing the decline in rates from earier periods, when rates were very much higher.
    (See: There is no doubt the recession prompted the Fed to force raters lower and its announcements have made that plain. And rates in the U.S. may also reflect developments elsewhere.

    I do not “know” if the Fed’s easy money policies may have been partially motivated by fiscal considerations. Calling the Fed an “enabler” does not imply a specific intention on the Fed’s part – and while I think that argument can be made made in this case, it was not the argument I was making. The lure of low long rates the Treasury has to pay for selling debt does in fact reduce the current (and future) cost of trillion-plus deficits in the U.S. The Fed’s policies, intentional or not, have been complicit in keeping those costs artifically low.

  7. Higgs has two interesting blogs on money and deleveraging at Both seem to predict low growth and inflation for years ahead. We seem bent on imitating Japan.

    So the best thing investors can do if imitate the Japanese by borrowing as much as possible while rates are low and investing overseas where rates are higher.

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