Thursday, 30 November 2017

Increase public investments when interest rates are low?

A popular belief among the great and the good is that since governments can borrow at around a zero real rate of interest, governments should borrow more to fund public investments like infrastructure. E.g. this Oxford economics prof says “The obvious response is for the government to borrow to increase public investment, particularly when it is so cheap to do so.”

Unfortunately there’s a problem with that argument which is that the only reason governments can borrow at ultra-low rates of interest is that governments have coercive powers: they can confiscate money from taxpayers with which to repay their creditors even when their investment projects are a flop.

Thus the rate of interest that should be charged to public investments is the sort of rate that a private infrastructure provider would have to pay, and that is significantly more than the approximately zero real rate of interest that many governments pay.

The original funders of the English-French channel tunnel lost nearly all their money. So what rate of interest would you want for funding a similar project in the future?

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