Reducing Government Debt Burdens Through Bond Buybacks

Policy makers in the U.S. and around the world continue to express concerns that high debt-to-GDP ratios will lead to slower growth. A threshold debt-to-GDP ratio of 90 percent in particular has been used as a justification for curtailing actions to stimulate growth here in the U.S. and the Eurozone, both still reeling in the aftermath of the Great Recession. A new issue brief from the Center for Economic and Policy Research (CEPR) demonstrates that buying back bonds when interest rates rise could easily reduce a government's debt burden.

"Interest rates on bonds currently issued are at historically low rates but are projected to rise in the future. If the United States were to buy back bonds at the market price in 2017, based on the interest rates projected by the Congressional Budget Office for that year, it would reduce the value of the outstanding debt by $458 billion dollars or 2.3 percent of projected GDP," said Dean Baker, a co-director of CEPR and an author of the report. "This measure is conservative since it assumes no savings on debt issued after March of 2103, yet it is still more than the projected reduction in defense or domestic spending for the years 2013-2021 resulting from the sequestration."

The issue brief, "Financial Engineering: The Simple Way to Reduce Government Debt Burdens," calculates the potential savings if the U.S. government were to buy back bonds issued at low interest rates during the downturn in the higher interest rate environment projected when the economy recovers. The calculations are based on Congressional Budget Office (CBO) projections of interest rates for 2017.

While this bond buyback would substantially lower the official value of outstanding debt, the interest burden on the U.S. Treasury would not change through these transactions. But if the argument is that growth will be impeded by a high ratio of debt-to-GDP with debt measured at its book value, then a debt exchange of this nature is an effective policy to address the problem.

"There is little obvious reason that the United States or other countries should continue to be concerned about as arbitrary a measure as debt-to-GDP ratios," continued Baker. "But since the idea of a high debt burden remains an obstacle to taking stronger steps to boost economies out of the downturn and spurring job growth, there is no less costly way to eliminate close to half a trillion in debt"

The issue brief can be found here on the CEPR website.