Home Economics What The Hell Has The Observer Misunderstood Here?

What The Hell Has The Observer Misunderstood Here?



Within a newspaper the editorials are written by the bright young things who really know their chips. This is the starting ground for those with Oxbridge firsts to find out whether they’ve got it in that climb up the greasy pole to the editorship of a national and the inevitable knighthood. Of course, there are counter-examples like Ollie Kamm but then every compass has its butt end.

Given this it’s remarkable quite how wrong such editorials can be:

The answer to the last question is the Bank of England’s purchase of government debt through its quantitative easing programme. With more than a third of government debt on its books, the central bank has become a major mortgage lender to the UK government, and that debt is no longer on fixed-rate terms for 10 or 20 years, but refinanced overnight on the international money markets.

At the moment that means a better deal for the government, reducing a 2% charge in the debt markets down to the Bank’s more favourable 0.1% base rate. The flip side of this benefit comes when the Bank, faced with spiralling inflation, increases the base rate and sends the UK’s debt servicing costs higher.

You what?

QE works by the government issuing gilts. The Bank of England buys them with money it has just printed down in the basement. This increases the money supply. But those gilts are on whatever terms the government has issued them – the BoE has been buying, largely, medium term bonds. So, the interest coupon the government must pay is fixed in that medium term.

That is, QE is entirely the opposite of being refinanced overnight on the international money markets. The interest cost to government is fixed in the medium term – here meaning 10 years and so on.

Having the deficit – or the national debt if you prefer – financed by bills (a few year maturity) and notes (months) would indeed leave the coupon to be paid at the mercy of those markets. But that’s not what is being done therefore we actually have a government with greater than usual certainty about its future payments, not less as The Observer is claiming.

Sigh. It does, in fact, get worse too:

Is inflation likely to rise? Would central banks react by raising interest rates? And why, after all the lessons learned during the 2008 financial crash, has the UK left itself so vulnerable to an increase in rates?

The worry is not that the central banks will increase interest rates. Although, obviously, they might if inflation takes off – the only alternative would be to significantly increase the tax burden to kill inflation that way – but that the markets will raise nominal interest rates if inflation takes off. Fewer people would be willing to buy that portion of the gilts issuance which is not QE financed. Which makes that portion of the non-QE financed debt/deficit carry higher interest rates.

Which the central banks could cure by buying more bonds financed by QE but this would increase the money supply and thereby inflation. Bit of a bind there really.

That is, it’s not that central banks would want to raise interest rates it’s that markets might force them to. The only response possible to prevent this being the very thing which will increase nominal interest rates again.

If the pupae of the Great and the Good in the newspaper editorial departments get this sorta stuff wrong then what hope the rest of us?

Update- Ahh, here’s what the Observer’s brightest have managed to mangle:

Yet all is not as it seems. Buried in a document published on Budget day by the Office for Budget Responsibility, there was a wake-up call. Because of quantitative easing, about a third of the stock of government bonds is held by the Bank of England.

On the other side of the Bank’s balance sheet, financing these holdings of gilts, there are huge deposit liabilities owed to the commercial banks. Although these liabilities cannot be redeemed under current arrangements, they earn interest at Bank Rate. As rates go up, so do these interest payments.

These liabilities accordingly should be regarded as extremely short – effectively overnight.

When you adjust for this factor, then the mean maturity of government bonds falls to 11 years. But the median is probably a better guide to short-term pressures. The median gilt is of 11 years maturity and when you adjust for the gilts held by the Bank it is only four.

Moreover, once you take account of other forms of government debt – principally treasury bills and national savings, which are both of short maturity – then the median maturity of all government debt is set to be less than one year by March 2022.

They have, entirely and wholly, managed to mangle it, haven’t they?



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