Wednesday, 28 December 2011

There, but for austerity, go us?

In his New Year message to his party, Nick Clegg said “We have had to make some very difficult decisions, but they've been the right ones for the long-term good of our country. A country that was at risk of falling prey to the international markets has been pulled back from the brink.” He added “We only need to look at what is happening in countries on our European doorstep to see what we could have ended up dealing with in 2011.”


This line, which has been (and will be) repeated over and over again, has power – until we take a look at the evidence. 
Interest rates on Government debt
This chart compares the UK to the US and Japan. I’ve chosen those countries because they dispel two common myths about interest rates on government debt. One is that UK rates have been falling because the UK has undertaken clear action to rapidly control debt. Compare with the US, where political stalemate and uncertainty is endemic, and attempts at fiscal stimulus are being made. Yet it is not the case that UK rates have been falling and US rates rising. The second is that debt in the UK was reaching critical levels: we were ‘on the brink’ to quote Clegg. Government debt is twice the size of GDP in Japan, whereas debt in the UK is well below annual GDP, yet interest rates on Japanese debt are lower and have also been falling.
Of course we could always argue that the US and Japan had special characteristics, until we note that interest rates have been falling pretty well everywhere except the Euro area: Australia, New Zealand, Canada, the Czech Republic, Iceland, Japan, South Korea, Norway, Sweden, Switzerland, the U.K. and the U.S. The one area that clearly is special is the Eurozone. It is special because the ECB has not (Greece) and may not print money to avoid default in individual Eurozone countries.
What is noticeable about this chart is how correlated these interest rates are. In part this is because interest rates have been responding to the same thing: perceptions about future growth in the global economy. The deterioration in the prospects for global growth during 2011 implies central banks will keep short term rates near zero for longer, which in turn implies lower rates on longer term assets like government debt. What lower growth prospects do not imply in the US, UK or most other countries with their own currency is an increase in the risk of default. The opposite is the case in the Euro area, which is why it is the exception.
So next time this line is trotted out, please will someone say: but the Eurozone economies are different, because they do not have their own central banks.

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