Debt Maturity & Macroeconomic Trade-Offs
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.