High government debt doesn’t lead to high interest rates

At some point I seem to have got myself on the email distribution list for Tory Party spam, so I regularly get updates from the likes of Michael Green (Grant Shapps) and Mr Egg (Sajid Javed) about how wonderfully the current government are doing. A phrase they often include is “tackling the deficit to keep interest rates low”. This repeats the widely held belief that once government debt gets too high, the interest rate ‘the markets” demand to lend more money to the government will start to rise, at which point debt interest payments will get out of control and BAD THINGS WILL HAPPEN. Thank god for the coalition eh?

Today I came across these helpful charts presented by Paul Krugman in a recent conference paper which help us examine this assertion more closely (I found them in this post, which makes the same points I make here).

51062179debt-interest-rates-krugman-fig.1-2013-nov

In this chart, each dot is a country. The debt-GDP ratio is on the bottom access, and the interest they pay on 10-year debt is on the left-hand axis. Broadly speaking, there seems to be a clear positive relationship between higher debt and higher interest rates. The dot on the far right is Japan, which doesn’t fit the pattern, but they must be a special case right? Maybe Green/Shapps and Mr Egg are right then?

6981316debt-interest-rates-krugman-fig.2-2013-nov

Hang on though. This chart is the same, but Krugman has distinguished between Euro and Noneuro countries. The relationship between high debt and high interest rates for the Noneuro countries (like the UK) has disappeared. So what can we conclude:

1. High government debt does not lead to high interest rates if you have your own currency. Tories and Lib Dems are talking rubbish when they say “tackling the deficit to keep interest rates low”.

2. If we don’t need to fear high government debt, austerity is an even more horrendous policy

2. Don’t join the Euro. Ever. That means you too Scotland.

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