BBC’s Economics Editor struggles with economics of public debt

In a blog post about George Osborne’s Autumn Statement and what the future holds for the interest rate the UK government must pay on its debt, the BBC’s Economics Editor Robert Peston drew on conversations with his mates in the financial sector to concoct a story about the possible differences between Tory and Labour governments. Economists Paul Krugman and Simon Wren-Lewis objected to some of Peston’s post, causing Peston to write a response today. It’s not very impressive! This is the contentious passage from Peston’s original blog:

“Mr Market matters because he decides what price the government pays to borrow, and whether the government will continue to benefit from the current record low interest rates.

The Tory view is that those interest rates can only be locked in if the government continues in remorseless fashion to shrink the state and net debt.

What Labour would point out is that countries in a bit of a fiscal and economic mess and currently refusing to wear the hair shirt that the European Commission thinks necessary, such as Italy and France, are also borrowing remarkably cheaply.

And here is where Mr Market may be capricious, according to my pals in the bond market.

They say the UK’s creditors would probably be forgiving and tolerant of George Osborne borrowing more than he currently says he wishes to do, in that his record of reducing Whitehall spending by £35bn since taking office in 2010 has earned him his austerity proficiency badge.

But Ed Balls has never been chancellor, although he was the power behind Gordon Brown when he ran the Treasury and much of the country, both in the lean years from 1997 to 2000 and the big spending Labour years thereafter.

So Mr Balls has yet to prove, investors say, that he can shrink as well as grow the apparatus of the state.”

In his follow-up blog, he goes on to write:

“But does that mean a plan to reduce the deficit has been irrelevant to the borrowing costs paid by the HM Treasury? That seems implausible.

The government inherited a deficit (a gap between what it spends and what it raises in taxes) of 10% of national income or GDP. Wren-Lewis and Krugman would presumably agree that a 10% deficit is unsustainably high – and if it recurred for years would prompt fears for the UK’s solvency.

So getting the deficit down from 10% – or perhaps promising to get it down – must have had some bearing on the so-called risk premium for lending to the UK government, or the interest rate that the UK had to pay to borrow.”

So he’s selling the idea that the interest rates on government debt are determined by the bond vigilantes who look at how serious governments are at dealing with their deficits, weighing up the risk of default and setting rates accordingly. The trouble is, this is a total fairy story. Simon Wren-Lewis points out in his blog that interest rates on debt are based in part on expectations about future short term rates, and those expectations are for short term rates to stay low because the economy is still weak.

This is true, but there is an even more fundamental reason why Peston’s theory is a fairy story. The UK has its own currency, so the concept of solvency risk just does not exist. Don’t believe me? Here’s Alan Greenspan and head of the OBR Robert Chote making the same point, and this chart from Paul Krugman makes drives the point home well by comparing the rates paid by countries of the Eurozone with major economies outside the Eurozone.

Peston is not alone in believing this fairy story. The 2010 election was basically fought on this basis (although we don’t hear much about credit rating any more), but as economics editor he should be offering his viewers and readers some more reality-based analysis. Fair play to him for highlighting the disagreement over his first post, but he only succeeded in compounding his error by raising the issue of solvency. Let’s hope this conversation continues.

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14 thoughts on “BBC’s Economics Editor struggles with economics of public debt

  1. The question Peston needs to answer is why the Bank of England would not step in with QE to lower bond rates, if it felt that government spending and therefore aggregate demand was to be withdrawn due to higher bond interest rates, given that the BoE’s mission is to maintain aggregate demand.

  2. I’m rapidly coming to the conclusion that a significant proportion of so called professional economists are clueless when it comes to deficits, the debt, etc. Bill Mitchell was drawing attention to incompetence at the IMF and OECD long ago on this subject. See respectively:

    http://bilbo.economicoutlook.net/blog/?p=24922

    and

    http://bilbo.economicoutlook.net/blog/?p=24113

    Plus I did a post on my own blog recently about a couple of incompetent articles in the Financial Times on the subject:

    http://ralphanomics.blogspot.co.uk/2014/12/deficit-unsustainability-clap-trap_11.html

    As for Kenneth Rogoff and the Harvard Department of Economics, they’ve caused me to reach for the puke bucket several times.

      1. If the UK Government now started down a fiscal stimulus route, choosing to be less concerned about the deficit, then yes there is a risk that at some point (probably a long way away) GBP would be significantly devalued which would have both negative and positive effects (it would probably help most exporters for example).

        But the key point is that there is also a big risk on the other side: by focussing on trying to reduce the deficit, austerity and slashing the public sector, there is a significant risk of reducing demand and damagaing the economy, leading to a lower GDP and deflationary risks with very negative effects for all.

        Many people believe the time is right for a looser fiscal policy.

        1. The post argues that there is no risk of default because the UK can print.

          Although theoretically true, this goes against the evidence and ignores defacto defaults through devaluation,

          Russia has defaulted on domestic debt, and is currently facing a massive devaluation. It is glib to pretend that fiscal costs do not matter simply because we have a printing press. Devaluations matter, they hurt the poorest and the elderly.

          I think you are misguided to argue that the UK needs to see a fiscal stimulus. We are currently running a large deficit already, unemployment has fallen and I don’t believe that there is that large an output gap, given that the economy is growing now, is there ever a period in which you would attempt to close the primary deficit?

          I think the best way to close the deficit now is further pay restraint in the public sector, reform of pensions, an increase in stamp duty, a lowering of the inheritance tax threshold and an increase in fuel duty.

  3. “And here is where Mr Market may be capricious, according to my pals in the bond market.

    They say the UK’s creditors would probably be forgiving and tolerant of George Osborne borrowing more than he currently says he wishes to do….”

    Invoking the authority of bond traders, is he??? They are the most gullible to mainstream mythology, and really don’t care anyway …they just want to take the spread and take home a bonus. But the very idea is capricious in itself. Bond traders and investors, by their very nature. prefer a higher rate, so why on earth would they “probably be forgiving and tolerant” out of the goodness of their hearts if it means giving up returns in order to do so? Wouldn’t happen, doesn’t happen. If they have influence of any kind, they will exert it. And if they don’t, well, they can’t. It’s really that simple.

  4. Be fair, it’s his job to be impartial. Being economics editor not the same as being an economist. Not least in an election year he has to find a way through the various arguments. You are setting up a straw man and missing the point of his role.

  5. Apostrophes! “The UK has it’s own currency.” ITS own currency…. (not “it is own currency”!) Otherwise, brilliant!!! Thanks.

  6. A couple of years back I read Peston’s book ‘Who Runs Britain?’, and before I even got to the end of the intro I was sneering. It was practically a non-stop panegyric on trickledown theory; he was even encouraging readers to ‘celebrate’ when *their bosses* awarded themselves enormous bonuses, because it would supposedly mean a slight improvement in the whole staff’s pension pot about twenty-seven years down the line. (Yeah, whoop-di-doo.)
    Peston did grumble that the preponderance of wealth at the top had been taken too far since the early-1980’s, but that’s not much of a concession. A little like a Russian Marxist admitting that The Purges were a case of ‘heavy-handed Government’.

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