With this lever I can rule the world Bwaaaaahhhaaah! The single interest rate lever is supposed to be Pavlovian in its stimulus/response. When the rate goes down that means “spend”. When it goes up it means “don’t spend”. That’s the belief, which fiscal policy is supposed to follow along behind like a faithful hound.

What’s amusing is that this response process doesn’t appear to take into account expectations.

Here’s Rishi Sunak:

the chancellor pointed out that the UK is now “sensitive” to interest rate changes

it doesn’t take a lot for suddenly ‘yikes’ – we have to come up with x billion a year to pay for higher interest rates

Similar threats come from opinion pieces:

This will take decades to work off, and threatens to eat deep into government expenditure on other things in the event of any appreciable rise in interest rates.

there is also the potential for debt service costs to rise alarmingly when interest rates go up

There is clearly an expectation that interest rates will go up in the future, and that will increase the amount of interest that needs to be paid on spending.

But that doesn’t fit with the Pavlovian response designed into the One Lever To Rule Them All belief system. Interest rates are low which means “spend now”. When the central bank puts interest rates up that means “stop spending”. Since spending has to be stopped when interest rates go up, there won’t be any increased debt service costs on that spending - since it won’t be happening at that point.

Similarly it cannot be a concern with accumulation of the interest over time, since that would require the Ricardian imposition of austerity measures and tax rises now, and that isn’t happening either.

Therefore the concern must be about the spending happening today becoming more expensive in the future. But since we are selling Gilts and Bills which have a fixed interest rate that can’t be the case either. They can’t pay more interest. The Interest Rate is fixed at the time of sale: a 0.25% £100 nominal Gilt sold this month will still pay 25p interest per annum in ten years time no matter what happens in the meantime.

So what is the problem? The problem is that the Debt Management Office is trying to reduce the interest cost of government funding and it does that by issuing Gilts for a fixed amount of time as well as a fixed rate. And it does this because the financial markets said that is what they want. The DMO colludes with the market to produce the financial instruments the market says it wants, rather than ostensibly what is needed - in an attempt to keep the price down and hit its KPIs. The financial markets get to decide what welfare payments it gets from the government.

To be consistent with the Pavlovian lever belief, arguably governments should only issue perpetual bonds - since that fixes interest rate costs at the market price today with no consideration required for tomorrow. By chasing lower prices and introducing terms, expectations creep into the Lever belief system which puts a brake on the spending the interest rate signal is allegedly trying to achieve.

If you want to swap floating rate for fixed rate, do it properly. Or perhaps it would be better not to bother at all and replace the whole One Lever belief system with a superior functional stabilisation system - the Job Guarantee.

A concept so terrifying to central bankers they dare not mention its name.