Revisiting Furman-Summers: Fiscal Policy in the Era of Low Interest Rates

A little over 5 years ago, Harvard economists Jason Furman and Larry Summers (FS) published a paper that became influential in the fiscal policy space—a paper that was meaningful in the moment. The paper broadly emphasized that historical arguments for responsible fiscal budgeting were no longer relevant for an era in which interest rates had been falling.

The first claim by FS comes in their opening sentence:

“The last generation has witnessed an epochal decline in real interest rates in the United States and around the world despite large buildups of government debt.”

The authors then demonstrate this in a table, noting that “table 1 illustrates U.S. ten-year indexed bond yields declined by more than 4 percentage points”. Below you can see the table that they refer to.

Now that we have a little over 5 years of additional data, we can add 2026 data to table 1. Below is the updated table 1, which shows that real interest rates have re-escalated in recent years, back to 2.4% as of July. The generational “epochal” decline in interest rates doesn’t seem to have persisted as most economists had forecasted it would. Perhaps the near zero interest rates in 2020 were not reflective of a broader trend but were instead the result of the broader COVID pandemic effects of the time combined with zero interest rates policy (ZIRP) and quantitative easing by the Federal Reserve.

Following their claim that low interest rates were the new normal, FS then went on to make a second claim:

“countries may be less constrained by fiscal space because fiscal expansions themselves can improve fiscal sustainability by raising GDP more than they raise debt and interest payments.”

Given that we just lived through a natural experiment with the COVID downturn and subsequent fiscal response, we can test this theory. Did the $5 trillion fiscal expansion of the early 2020’s “improve fiscal sustainability by raising GDP more than they raise debt and interest payments”?

Evidently not. The debt ratio is more than 20 percentage points higher today than pre-stimulus, while the cost of servicing the debt as a share of GDP is double what it was pre-stimulus. In fact, the only reason the debt was relatively stable in the 2021-23 period was due to the fact that a large portion of the debt stock was inflated away as excessive stimulus triggered the highest levels of inflation in four decades.

While on the topic of soaring inflation, this brings me a third claim made by FS:

“A clear downward trend in longer term real rates antedates the 2008 financial crisis and has continued since it was substantially resolved. The observations that the trend has been equally pronounced in long- and short-term real rates, has lasted over 30 years and has coincided with constant or slightly declining rather than increasing inflation and inflation expectations suggest that it is a real rather than a monetary phenomenon.”

This claim is largely true. Inflation and interest rates had both broadly fallen between the 1980’s and 2020. However, this doesn’t mean that the future will be like the past. But also, the historical decline in interest rates narrative typically cherry picks a starting date somewhere between 1980 and 1985. The chart below shows a longer-term view of long-terms rates using the Jordà-Schularick-Taylor database, which tracks back to 1870.

The period between 1965 and 1990 was dominated by high levels of inflation. This period is the anomaly of the 156 years observed in the above chart. During the 95 years up until 1965, interest rates averaged about 3.5 percent, and since the turn of the 21^st century, they’ve also average about 3.5 percent. Economists that use the anomalous period of high inflation as a starting point to argue that interest rates have been falling for decades just need to take a step back and review the longer-term data.

FS also noted that since the Great Financia Crisis (GFC), the federal funds rate had been at the lower zero lower (ZLB) bound 59 percent of the time. They then note:

“As we write, options markets suggest that five years out there is a 72 percent chance that nominal rates will be at their current level of effectively zero or even negative.”

In actual fact, 5 years after FS wrote this paper, the federal funds rate was around 3.9 percent—not effectively zero and not negative. Since the GFC, the federal funds rate has now been at the ZLB about 48 percent of the time.

Why does all of this matter?

Well, it matters because these predictions about low interest rates and where interest rates were heading based on past trends led FS to make three bold conclusions, that inspired fiscal policy decisions in the 2020-2021 era. These three conclusions were that (1) fiscal policy must play a critical role, (2) fiscal sustainability cannot be assessed by traditional debt-to-GDP ratios, and (3) public investments pay for themselves.

This was the economic consensus of the moment, corroborated by other academics such as Olivier Blanchard, and carried forward in policy decisions by public figures such as Treasury Janet Yellen and the Biden Administration more broadly. These ideas grounded in the belief that low interest rates were here to stay were the fuel that fired up the great inflation of 2021 and 2022 through massive unfunded stimulus including the 2021 American Rescue Plan Act.

At her confirmation hearing before the U.S. Senate Committee on Finance in January 2021, then Treasury Secretary nominee, Janet Yellen, noted that: “with interest rates at historic lows, the smartest thing we can do is act big”.

The lesson here isn’t that FS were reckless, it’s that a specific, historically contingent window got mistaken for a permanent structural shift. Three decades of falling rates looks a lot less like an “epochal” law of economics once you set it against a century and a half of data showing rates gravitating back toward historical norms.

That distinction mattered enormously, because the moment economists declared debt-to-GDP obsolete, the argument stopped being academic and became the intellectual permission slip for trillions of dollars in unfunded stimulus. The bill for that miscalculation didn’t arrive as a debt crisis, it arrived as the highest inflation in forty years, paid disproportionately by the households the stimulus was supposed to help.

It’s worth remembering this now that many of those same voices are rediscovering their concern for the debt. The framework didn’t fail because the math changed, it failed because the math was wrong, and the people now sounding the alarm are often the ones who spent it into existence.