Duncan’s Economic Blog

Debt Maturity & Macroeconomic Trade-Offs

Posted in Uncategorized by duncanseconomicblog on April 13, 2011

Last week I commented on the importance of the debt maturity profile, something which I feel is often missing in the economic debate in the UK.

I noted (referring to recent Bank of America research) how crucially important this is when judging how sustainable a government’s fiscal position is.

There’s a tendency in the UK political debate around the government finances to concentrate on one number – the annual deficit (on which measure Britain is supposedly  at risk of a loss of market confidence) – and to ignore other measures such as the existing stock of debt to GDP, the interest rate charged on debt and the maturity profile of that debt, on all which Britain is in a strong relative position.

In this context, yesterday’s IMF Fiscal Monitor is well worth a look. (All the following data is from statistical table 9).

The average maturity of British government debt is 13.8 years, higher than any other developed economy. Indeed only Estonia comes even close with 11.5 years. The maturity profile of British government debt is more than twice as long as that of the US, Germany, Canada or Italy.

This matters. Osborne is often keen to point out that the UK deficit is higher than that of Greece, or Portugal, or whoever is in the news with debt problems in any given month. But this misses the point. Britain might have a higher deficit than those countries but it still needs to borrow less in any given year.

This may seem counterintuitive, but it’s actually quite straight-forward. Whilst Britain has to issue more debt to fund its deficit, it has to refinance much less existing debt. The long debt profile means that less of the old debt is due each year.  

The chart below shows the gross (as opposed to net) borrowing requirements for advanced economies in 2011.

As can be seen rather than being ‘the worst’ the UK is actually in the middle of the pack. To make this even clearer, the chart below shows the same data for the G7 group of leading economies.

 

The UK actually has the second lowest gross issuance in this group. The UK will be issuing less debt than Canada, Japan, France, the US or Italy next year – despite a higher deficit.

I’m not using this data to claim that a deficit of around 10% of GDP is ideal, but I do think that this issuance profile coupled with the very low interest rates this debt attracts (around 3.75%) makes it much more the government’s fiscal position much more sustainable than many would have us believe.

In the end macroeconomic policy rarely comes down to a right or a wrong answer. Instead it’s about trade-offs and risk. This gets lost in a polarised political debate as the UK is now experiencing.

The Government claim that cutting the debt will lead to ‘expansionary fiscal contraction’ and a ‘rebalancing of the economy towards net exports and investment’. This is unlikely to be correct, the evidence (see this post for example on recent IMF work) suggests that austerity policies lead to weaker growth – especially if interest rates are already low or cannot fall further. I’d have much more time for Osborne if he acknowledged that the cuts will hurt growth but argued that not cutting as fast and deep as he plans would risk a loss of market confidence and problems funding the debt. That’s a justifiable and reasonable position to hold.

We face a trade-off between cutting and hence harming the economy and not cutting and hence risking a loss of bond market confidence. The real debate, away from the shouty world of Westminster, is about the balance of risks.

Taken together I think the UK’s low stock of debt, the low interest rates it attracts and the debt profile outlined above more than offset the high deficit. I think the risk of cutting as fast and deep as the Government intends is far worse than the risk of a loss of confidence. I certainly don’t say that there is no chance the markets would lose faith in a British government that’s adopted a different approach, I just think the balance of risks points towards a less extreme and more growth friendly fiscal package.

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11 Responses

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  1. Liam Murray said, on April 13, 2011 at 12:49 pm

    As ever, ineresting & educational. A couple of quick thoughts:

    “I’d have much more time for Osborne if he acknowledged that the cuts will hurt growth but argued that not cutting as fast and deep as he plans would risk a loss of market confidence and problems funding the debt. That’s a justifiable and reasonable position to hold.”

    …and I suspect it IS the position he holds. It’s the politics of the issue – the “shouty world of Westminster” as you put it – which prevent him from being that forthright about those trade-offs, screams of ‘Osborne gives up on growth’ etc.

    In terms of the wider point re: debt profile, again I think tribal politics are obscuring sensible economics (at least sensible discussion of economics). Most serious people accept the household / credit card methaphor is wrong for discussing public finances but can you imagine what it’s proponents would make of your explanation above?! Lot’s of ‘head in sand’ type comments, Labour ‘in denial’ or ‘putting the final notice from the credit card company behind the clock’ etc. etc. Unfair of course but a lay person reading your explanation could easily be convinced that that’s what your saying.

    • duncanseconomicblog said, on April 13, 2011 at 4:26 pm

      I suspect it’s his position too. I can see why politics means he can’t be more open.

      And neither can Labour – imagine if a Shadow Minister said ‘the risk of our policy is that it causes a bond market sell-off but we don’t worry about that because of xyz…’

  2. Peter Kunzmann said, on April 13, 2011 at 12:55 pm

    Very interesting post.

    It’s perhaps worth noting too that negative growth (or perhaps even just very low growth) could itself risk ‘market confidence’. This too could be factored into the risk equation.

    • duncanseconomicblog said, on April 13, 2011 at 4:24 pm

      Thanks Pete. Indeed it could be (and should be).

  3. Andreas Paterson said, on April 13, 2011 at 1:17 pm

    “I’m using this data to claim that a deficit of around 10% of GDP is ideal..”

    Surely..I’m not using…

    • duncanseconomicblog said, on April 13, 2011 at 1:19 pm

      Thanks! Amended.

  4. Dave Holden said, on April 13, 2011 at 10:04 pm

    “I’d have much more time for Osborne if he acknowledged that the cuts will hurt growth but argued that not cutting as fast and deep as he plans would risk a loss of market confidence and problems funding the debt. That’s a justifiable and reasonable position to hold.”

    I suspect this is the way Osborne see things, politics being the reason he doesn’t present his position this way.

    I recall reading Chris Huhne’s position on the economy last year and couldn’t believe how optimistic he was – again I put this down to politics.

    I would say it was probably the position I held but I’m now leaning toward the proposal by by Adam Lent and Tony Dolphin http://www.guardian.co.uk/commentisfree/2011/mar/18/deficit-reduction-averaging-george-osborne that you pointed out in a previous piece. But then unlike a politician I’m free to change my mind ;)

    On the debt maturity I’m glad to read something positive, I’ve just finished reading Denninger’s piece on the US and debt in general

    http://market-ticker.org/akcs-www?singlepost=2506151

    It’s not pretty.

  5. Paul Newman said, on April 14, 2011 at 12:50 pm

    That only means our upward curve of debt financing will be steeper and as our deficits include less interest this only shows our real problems s are even worse than we thought. Nonetheless no doubt this sort of thing which will be used by Unite to befuddle their members into believing anyone thinks pensions can go on as they are, a lie as you know .Do please retract it , its a sort of academic version of smashing windows and I expect better of you.

    The debate is not polarised the debate is over .Only the Labour Party are still debating and thats between truth and political opportunism .You have no”Plan for growth” except to borrow more money and inflate demand which is not a ‘plan’ its just an excuse to keep flinging money at the Public Sector ( for which there is no possible justification.)
    Any time you want to come down to our Company and tell us how to grow you are very welcome Duncan

    (Retired Newmania , sick of that silly bloggy thing and too old for it by the way , my name is Paul Newman )

  6. BenM said, on April 16, 2011 at 4:08 am

    Paul Newman – debt inflates demand then that demand pays off debt.

    Austerity kneecaps demand and begets more borrowing.

    The debate is not over.

  7. Greek default risk said, on April 17, 2011 at 7:36 am

    [...] one more part to this. As Duncan has pointed out, it isn’t just the interest rate that causes problems. It’s the maturity profile of the [...]

  8. [...] rather than arguing that the cuts will be painful but are needed to appease the bond markets they instead embrace the new theory (actually the very old theory) of ‘Expansionary Fiscal [...]


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