Is Robert Rubin right?
Answer:
There is a market for debt, just as there is a market for anything else. If there are more people (or entities) trying borrow than there are lenders, rates will rise until people with marginal projects are pushed out (since the returns of these projects will be insufficient to repay the loan) as well as drawing more lenders in. If there are fewer borrowers out there, lenders will choose to either lower their rates or to exit the market, and a new equilibrium will be reached at lower interest rates. Lenders cannot loan more, or at higher interest rates, than borrowers are willing to accept, so if there are more lenders than borrowers, the interest rate must fall to draw in additional borrowers and squeeze out more lenders.
Since the government generally borrows in long term capital markets, the impact of a drop in government borrowing would be more muted in short term rates than in long term ones. Short term rates are more influenced by current economic shifts than by the movement of long term rates.
When the government enters the credit market, it increases demand and causes rates to rise. Some private investments will not be profitable at these higher rates, and will therefore not be funded. This is called “crowding out”, and refers to the displacement of private debt by government debt.
Implicit in Rubin’s analysis is that private debt is better than public debt. There are a couple of assumptions necessary for this to actually be true.
The biggest one is that the investments the private sector makes, as opposed to the government, are more geared towards capital investment, not current consumption.
If the government were to use the money to invest in things that had long term economic effects, like improving the power grid or transportation system, while private industry returns the borrowed money to investors in the form of dividends, then a shift towards the private sector could actually have a negative effect on growth.
The other condition necessary for there to be a stimulative effect on the economy is that TOTAL borrowing from all government sources needs to decline. If the federal government balances its budget by pushing costs down to the states or municipalities, there is no net effect, since government is still borrowing the same amount.
Lenders are usually banks. The interest rates charged by them are very much subject to overnight inter-bank interest rate in the country, e.g. in UK, it is based on LIBOR. (Remember, banks most of the time also borrow monies to lend monies)
E.g. The UK government through its central bank will decide on the LIBOR (rates). If the government sees the necessity to curb inflation or tighten the economy, they will try to reduce monies in circulation by;
1. increase the LIBOR rates.
2. increase the minimum required bank's deposit.(to all banks)
3. increase the statutory deposit (banks required to put statutory deposit in the Central Banks)
It will make the interbank lending cost higher.
Back to your question: Should the govt balances its budget, the lack of borrowing will cause long term intetrest rates to go down?
Should the Govt balance its budget, meaning that the govt need no requirement to finance its expenditure by borrowings. In the local scene , the Govt need no urgency to issue bonds (bonds have dividend cost) to raise money, Therefore, they do not subject to the interest charges costs from the local or overseas borrowings.
Answer:
In the long run, the economy activities runs well without major borrowings by the govt. Lack of borrowing indicates sufficient or over-supplied of circulation of money in the economy, and yes it may cause the interest rates to go down.
Oversupplied of money in the economy may make lenders lent at lower interest rates.
your question: Or does the lack of borrowing require lenders to raise interest rates to sustain their profits?
No, interest rates up/downs depends on demand/supply of money. No, lenders cannot simply raise interest rates, as his loan facility would be more expensive than others and no one will take the loan from this particular bank.
The bank may sustain their profits as the borrowing cost (overnight money rates) is cheaper.
Profits = Lending rates - Lending cost
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