How nutty is the CBO?

Krugman points to this passage in the CBO report: So we turn to Table A-1 on page 104 of the CBO report, and we learn that for the next 25 years CBO projects an average interest rate on federal debt of 4.1 percent and an average growth rate of nominal GDP of 4.3 percent. 

I did not read the CBO report on long term projections. But I know of no economic model that predicts much beyond a few years.

I did make this graph from Fred. It has two wiggles, the red wiggle is the ten year constant maturity treasury rate. The blue wiggle it the effective interest rate Congress pays for its current debt.  The blue wiggle is total interest payments yearly divided by total debt.

So Congress effectively  pays the ten year rate, and that rate has dropped continuously since 1980.

That ten year rate, and the effective interest rate Congress pays will either stay where it is, or the Treasury curve will go flat line.  There is no way Congress can return to any 4.1% interest rate regime. On what basis does the CBO think interest rates are suddenly going to explode to the high side? OK, I will look it up. OK, he thinks inflation will start to be reflected in the ten year rate. But take a look at those grey bars. Whenever inflation works into the treasury rates we get a grey bar which signals a reduction in rates. That is not going to change, if Congress had to pay for inflation, it would rather disband the union, its job would be hopeless! Further more, if Congress paid the real rate, the Fed would have no business to earn its own salary. They will not do that either.

Let's look at the numbers.

How much of the federal budget are interest payments?

About 11%.  The CBO think that will jump to something like 20% including rate rise, and extra borrowing. Where in the frig is Congress going to cut 10% of the budget? They are not going to.  So how does the private sector operate and how does the government avoid paying the real rate? Simple, more poor people who consume less with less money and the inflation rate will reflect the consumption of a thinner, smaller middle class.   The basket of goods does not and will not reflect the broad consumption of the population, most poor people will be off the books.

How long can we survive as a third world nation?

For as long as any other third world nation. The only catch is we need at least 1.5% growth, which is the nominal cost of maintaining the fraud. But I think one of the software geeks will simply produce the smart cart supporting an array of digital currency and pass them around to the poor.  There is nothing DC can do, they will not be able to afford the enforcement costs of monopoly money.

Mathematics

The CBO estimates scalars assuming first moment noise. DSGE estimates trends assuming second moment noise. We are starting to see some research estimate quadratics assuming third moment error.