The UK government can now borrow money over a ten-year period and pay just 0.71% interest a year, thanks to a fall in the yield on UK treasury bonds today. It can even borrow money over 30 years and pay just 1.61%.
Then again, in Germany, the cost of borrowing is even lower, minus 0.08% over ten years and a mere 0.37% over 30 years. In the world we live in today, for some governments credit is incredibly cheap, which does rather beg the question, why austerity, especially in Germany?
The price of government bonds changes all the time and is determined by the markets. And bond prices have an inverse relationship with their yield, the lower the yield the higher the price. The price of government bonds across much of the world is hovering around an all-time low.
Part of the explanation for the fall in yields on UK government bonds is easy to find. The Bank of England is widely expected to cut interest rates next week and some economists think they will be cut to a negative rate within a few months. In anticipation of this, the markets are bidding the price of government bonds upwards.
But when the yield on 30 year bonds fall that low, the markets seem to be saying that they expect interest rates to stay low for many years to come.
The UK government under the new chancellor Philip Hammond has been making noises about putting less emphasis on austerity and relaxing the targets for a fiscal surplus, saying that the UK could “reset fiscal policy.” the German government has been less willing to shift course, however, despite the IMF recently calling for more stimulus from the world’s major economies.
Germany has been similarly cautious about monetary policy and was one of the big critics of so called QE. Four years ago, Jens Weidmann, President of the Bundesbank (Germany’s central bank) likened QE to a Faustian pact with the devil, and told a story about the devil disguised as a fool advising a local ruler to print money to fund debt. The result, of course, was runaway inflation.
Yet since then, the European Central Bank has hit the QE peddle hard, but German inflation in July was just 0.4% and core inflation (with food and energy stripped out) is subdued.
Meanwhile in Japan, no less than 38% of government debt is held in bonds owned by the central bank. In other words, the Japanese government owes 38% of its debt to itself.
One option for using QE to fund government borrowing is for a central bank to pay the profits from QE to the government as dividends. So the Bank of England has spent £375 billion via QE on government bonds by creating money out of nothing, and receives interest on these bonds, yielding a profit. This could be paid to the government.
An argument made against using low interest rates, or printed money, to fund government borrowing and launching a big stimulus is that this may have the effect of crowding out the private sector.
But globally, there is clearly plenty of spare capacity, and right now this may be less of an issue.
There are dangers in a country carrying out a massive stimulus in isolation, however. Taking the UK as an example, its current account is already near a record high, if it was to hit the stimulus button, imports may come flooding in, and the deficit may become unmanageable.
That is why some kind of global collective action is required, especially among the bigger economies, but that means the world needs Germany to take part.