Russ Roberts pointed me to an essay from last year, by Edmund Phelps.

The bond market will see that, in the long run, the pile-up of government debt – and any pile-up of entitlements – will make things much worse than they would have been. As people try to sell off some of their government bonds and shares to each other to finance higher consumption, they will cause bond prices and share prices to be depressed.

Phelps wrote the essay as part of a Keynes-Hayek debate. According to Felix Salmon, the Keynesians won. Salmon complained that the Hayekians did not want to do anything. I guess the point that Keynesian policies could make matters worse did not impress him.

One point that Keynesians would make in response to Phelps is that we are not seeing the high interest rates that his analysis predicts. On the contrary, they would claim that there is a shortage of safe assets.

My reply would be to ask, if the markets love government debt and crave safe assets, then why does the Fed have to buy such a large share of what the Treasury issues? If the private sector really wants all this lovely “collateral,” then the Fed should be able to stay on the sidelines.

Instead, many private investors are scared of long-term Treasury bonds. We would rather earn nothing in money-market funds than take a chance on longer-term Treasuries.

For Keynesians, the low interest rates on U.S. securities are a sign from the markets that it would be a good idea to issue more debt. The rest of us doubt that the Fed could hold interest rates down forever. At some point, interest rates will double, and the holders of long-term Treasuries will take huge losses. Yet few of us are confident or aggressive enough to take big short positions in Treasuries. The result is a strange interlude.