[Robert Peston, the BBC’s economics editor, is] 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, according to Alex at alittleecon.
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 it’s 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.
There’s more on alittleecon – give it a visit.
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