You Call This 'Stimulating'? :The Democrats' ignorant plan.

Senate majority leader Tom Daschle recently indicated to the Washington Post that he would "oppose any stimulus plan that contained permanent tax cuts." According to the Post, he also "made it clear that he thought that several of Bush's proposals, such as speeding up parts of the tax cut passed last year or repealing the corporate minimum tax, were non-starters." Daschle started laying the groundwork for such obstructionism right after September 25, when the Senate Finance Committee met with former Treasury secretary Robert Rubin and Fed chairman Alan Greenspan. Shortly after that meeting, Daschle announced that economists had said "these tax provisions ought to be temporary," because permanent tax cuts would raise long-term interest rates and "cause the housing market to crash." Rubin and Greenspan, too, have been warning that any stimulus must be only temporary; otherwise, it would risk creating a budget deficit and thus jacking up mortgage interest rates.

But the notion that long-term interest rates rise because of budget deficits is one of the most persistent of Keynesian myths. The theory says that mortgage rates must fall when deficits fall, and rise when deficits rise-but the facts don't bear this out. The budget deficit shrank to a modest 1.6 percent of GDP in 1980, down from 4.3 percent in 1976-but mortgage rates were 13.8 percent in 1980, up from 8.9 percent in 1976. The real reason for 13.8 percent mortgage rates was careless monetary policy and accelerating inflation. The Fed subsequently put the screws to inflation in 1981-82, which increased both interest rates and the deficit. But-even though deficits remained large-mortgage rates were cut in half thereafter, as inflation declined. The deficit was 4.7 percent of GDP in 1993, and mortgage rates were 7.3 percent; last year, by contrast, the budget was in record surplus, but mortgage rates topped 8 percent. And very recently, the predicted surplus was rapidly eroded by recession, war, and talk of a pricey "stimulus package"; yet the rate on 30-year mortgages has dropped below 6.5 percent.

The supposed link between deficits and interest rates is impossible to find in U.S. history, and it's equally invisible in other countries. The budget deficit in Japan is 6.3 percent of GDP, yet corporate bond yields-which depend on high interest-are below 1.5 percent. Canada's surplus is 2.6 percent of GDP, yet Canadian corporate bonds fetch 7.2 percent. These numbers are clear refutations of the Rubin-Greenspan theory of deficits and long-term interest rates. There is, in fact, no connection between them.

Confronted with good facts, though, scoundrels seek refuge in bad theory. The prevailing theoretical confusion is to imagine that bonds and mortgages are like antiques, in the sense that investors would supposedly be willing to pay more for bonds simply because they have become scarcer. But this is nonsense, because investors care only about expected returns, after subtracting taxes and inflation. The expected real return has much to do with expected inflation and tax rates, but nothing to do with whether the Treasury is buying or selling a few more bonds. Besides, variations in the annual flow of Treasury bonds are tiny in comparison with the outstanding stock of bonds in general, including the bonds of corporations and foreign governments. It makes no more sense to say that a larger volume of Treasury bond sales raises bond yields than it would to say that the currently huge volume of new mortgages (mostly for refinancing) raises mortgage rates.

Real interest rates are largely explained by the real return on capital, which declines with recession. Nominal ...