In response to a report by the UK Office of Budget Responsibility1 UK Journalist Robert Peston tweeted the following opinion:
So the obsession of Hunt and Sunak with defeating inflation is understandable - because in the absence of any significant fall in inflation, there is a risk that investors will shun UK government debt and interest rates for the government and for all of us would then rise to crippling levels. This parlous debt backdrop explains why the Bank of England and the Treasury are prepared to risk recession to bring down inflation.
Let’s look into this claim using the MMT lens.
Will investors shun UK government debt?
Banks hold deposits at the Bank of England called reserves. In aggregate, they can’t get rid of these deposits. Banks can only move them to other banks.
You can only buy UK government debt with reserves.2 Buying government debt is the only alternative for the financial system to holding reserve deposits.
The Bank of England pays interest on reserves at the Bank Rate. Banks forecast how the Bank Rate will fluctuate over time and how much money they will make. They will buy UK government debt if they believe it will make them more money.
Therefore, simple competition between the two alternatives determines the price of UK government debt.
If the Bank dropped interest rates to zero, stating it would stay there permanently, then the price of UK government debt would rapidly follow. We can see this in Japan where interest rates are near zero and the rates on Japanese Government Bonds remain very low. But perhaps more importantly there is no runaway inflation despite low interest rates.
There is no risk that interest rates on UK government debt will reach crippling levels. Interest rates are policy variables. Paying interest is a political choice.3
It is a fallacy of composition to state that investors will shun UK government debt. In aggregate, they have only one alternative: hold floating rate debt with the government sector in the form of bank reserves.
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Who at least have an excuse for their statements. They are required by law to produce ‘an analysis of the sustainability of the public finances’ - Budget Responsibility and National Audit Act 2011, s 4(b) ↩︎
An Accounting Model of the UK Exchequer, Berkeley et al., 2020, §6.5, p76-80 ↩︎
Alternative stabilisation policies that favour workers rather than bankers are available ↩︎