Without looking closer, it may seem cheap: Low interest rates and government borrowing

Are periods of low interest rates advantageous times for governments to increase expenditure by issuing debt? Because borrowing costs are lower, some economists have argued that the answer is yes. We argue that the logic used in reaching this conclusion may in fact be too simplistic. Whether or not it is a good time to issue debt depends not on whether interest rates are low, but rather on why interest rates are low. We show that if interest rates are low because of an increased preference for saving, then fiscal sustainability allows increasing debt in a period of low interest rates. In contrast, if interest rates are low because of a decline in trend output growth, then it is not sustainable to increase deficit financed spending. •We study the merits of debt financed fiscal expansion at low interest rates.•We demonstrate that why rates are low determines the desirability of expansion.•Environments with low rates caused by increased patience self-finance fiscal activism.•Environments with low rates caused by low growth require future budget surpluses.•The conclusions are robust to alternate modeling assumptions and transition dynamics.