The real cost of federal government deficits

Kevin Milligan had an interesting Twitter thread about the cost of federal deficits. Here it is, in full, with some analysis by me afterwards.

I totally agree with Kevin (and Lorin) — what we should be focusing on is the quality of federal spending. That said, I thought the “cost of deficit” question was interesting, and I wanted to be a bit more systematic about it.

I decided to look at the federal bonds that have been issued since 2016 (roughly speaking, since Trudeau was elected). The Bank of Canada has a fantastic resource for this data.

Turns out, there haven’t been all that many 30 year bonds issued in the last few years — just 11.4 billion worth. There’s been substantially more 10-year bonds, so that’s worth examining. Here’s a complete list.

There’s been $49.3 billion worth of these bonds issued since 2016. This isn’t quite the $71 billion “change in debt” figure that Kevin mentions, but it’s close. Let’s imagine a world where deficits over the last 4 years were, cumulatively, $49.3 billion lower than they were (so the change in debt was only $21.7 billion). In that world, the government wouldn’t have had to issue any of these bonds (they still might have, and instead not issued some other bonds, but just take this as a hypothetical example).

The weighted average coupon for these bonds was 1.6719, and the weighted average price was $98.66. What that means is if you bought a bond at issuance, you would have paid $98.66, you would receive $1.6719 a year in interest for the next 10 years, and you would get $100 back at the end of 10 years.

For simplification, instead of looking at each issuance separately, let’s assume all of them were issued at the same time, at a price of $98.66 and a coupon of 1.6719.

So the government sold $49.3 billion (face value) in bonds, received $48,639,731,000 (98.66% of $49.3 billion) and paid out $824,250,000 (1.6719% of $49.3 billion) in interest payments each year for 10 years.

Here’s what that looks like in nominal terms, and real (inflation-adjusted) terms, assuming 2% inflation each year (the Bank of Canada’s target).

Without adjusting for inflation, this 10 years of lending cost the government nearly $9 billion dollars. But, in real terms, financing this debt actually has a negative cost of nearly $1 billion. The actual real cost of this debt will depend on the actual yearly rate of inflation. So long as it is at or above 1.8% or so, this real cost will be negative.

In closing, it’s absolutely worth discussing whether or not this $49.3 billion in spending was money well spent, but obsessing over the financing costs makes little sense.