Analytical Corner: Macro Challenges—The Decline in Real Rates Despite Soaring Government Debt — Transcript

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1. 0:02In advanced economies and some emerging
2. 0:04markets, government spending
3. 0:06and borrowing have gone up for good reasons.
4. 0:09Now that's intensifying discussions
5. 0:12about what is the right level of
6. 0:14borrowing for governments.
7. 0:16Despite soaring debt, borrowing rates
8. 0:18are declining and staying low.
9. 0:21That leaves governments thinking
10. 0:23maybe the fiscal costs of expansion
11. 0:25is not that high;
12. 0:26maybe we can spend and do good things
13. 0:29with that money without worrying too much.
14. 0:32But are low borrowing rates good
15. 0:35for fiscal sustainability?
16. 0:37Should we expect low borrowing
17. 0:39costs to prevail in the future?
18. 0:43I am Ehsan Ebrahimy, and I am
19. 0:45studying the decline in real rates,
20. 0:47despite soaring government debt.
21. 1:00Debt is soaring in many advanced economies.
22. 1:03At the same time, you see the rate
23. 1:05at which governments borrow declining.
24. 1:08Normally, when a government borrows more,
25. 1:11investors ask for a higher interest
26. 1:13rate, as they are worried about
27. 1:15higher fiscal risk.
28. 1:17But when government default is very
29. 1:19costly, which is thought to be true
30. 1:22in many economies, what can
31. 1:24happen is that a government borrows more,
32. 1:27leading to lower rates rather than higher ones.
33. 1:31In this environment, we then see low
34. 1:33rates, but in fact, this might
35. 1:35mean that the fiscal risk is going
36. 1:37up, and not down.
37. 1:41Low rates may not always have a
38. 1:43benign interpretation.
39. 1:46When government default is not very
40. 1:48costly to the rest of the economy,
41. 1:50the demand for government bonds will be
42. 1:52as usual.
43. 1:54If a government sells more bonds,
44. 1:56it will borrow more, and interest rates
45. 1:59will be higher.
46. 2:00That's all shown in the red line you see here.
47. 2:05But when a government default is very
48. 2:06costly, things might be very different.
49. 2:10Take a look at this blue line.
50. 2:13What can happen for a range of
51. 2:15government borrowing is that
52. 2:17the demand curve for government bonds
53. 2:19is going to be different;
54. 2:21rates are going to go down
55. 2:23as a result.
56. 2:25So if we see low rates,
57. 2:27as you see in that blue line,
58. 2:30when the rates go down within the
59. 2:32intermediate range of borrowing,
60. 2:34it means that in fact, the risk of
61. 2:36default is going up.
62. 2:39Also, as you can see,
63. 2:41the borrowing rate starts going up
64. 2:43beyond an inflection point.
65. 2:47Whether the demand curve is going to be
66. 2:49sloping like that blue line,
67. 2:52The fact that government default is very
68. 2:54costly is going to compress
69. 2:56movements in government borrowing rates.
70. 3:00In the real world, when we are looking
71. 3:02at different country borrowing rates,
72. 3:05even if they are going up when
73. 3:07governments are borrowing more,
74. 3:09they are not going up enough
75. 3:11to raise the alarm.
76. 3:14There is quite a bit of risk
77. 3:16despite these little movements
78. 3:18in government yield.
79. 3:21In such cases, governments are
80. 3:23borrowing more,
81. 3:25but rates aren't going up as much,
82. 3:28or can be even going down in extreme cases.
83. 3:32They just don't seem to be responding
84. 3:34in the usual way to government borrowing.
85. 3:38And that can be misleading to
86. 3:40policy makers.
87. 3:42Not only low costs of borrowing may
88. 3:44hide underlying risks,
89. 3:46but these costs remain low
90. 3:49only up to a point.
91. 3:50And they will start rising again.
92. 3:54That leaves policy makers making
93. 3:56decisions based on an understanding
94. 3:59that may not be correct.
95. 4:01These effects are more likely to be
96. 4:03present if a government borrowing
97. 4:05from the market already has a lot
98. 4:08of outstanding debt.
99. 4:10Another factor is the riskiness
100. 4:12of other investments within the economy.
101. 4:15Also, the stronger the banks-sovereign nexus,
102. 4:19the more likely
103. 4:20we are to see these impacts.
104. 4:22All of these factors make government
105. 4:25default more costly.
106. 4:28But why is this happening?
107. 4:31When you have more government borrowing
108. 4:33while government default is very costly,
109. 4:35then we see two things happen.
110. 4:38First, because a government
111. 4:41is borrowing more, its economy
112. 4:43will be riskier.
113. 4:45Second, when government default
114. 4:47is very costly,
115. 4:49ironically, that makes government
116. 4:51bonds a safe asset.
117. 4:54The combination of these two leads
118. 4:57to a lower yield on government bonds.
119. 5:00The reason is that, given a riskier
120. 5:03environment, investors
121. 5:05are going to flock to bonds
122. 5:07looking for a safer investment.
123. 5:10That then lowers the rate on those
124. 5:12government bonds.
125. 5:14It might be counterintuitive,
126. 5:16but the key is that while government
127. 5:18bonds become riskier as a result
128. 5:21of more government borrowing,
129. 5:23they remain the safer asset.
130. 5:25All investment opportunities in this sort
131. 5:28of economy will be risky,
132. 5:30but among them, government bonds
133. 5:32remain the safest possible option.
134. 5:36What are the main takeaways?
135. 5:38First, policy makers need
136. 5:40to be aware that figures they are
137. 5:43seeing may actually be misleading
138. 5:45because the increase in the fiscal risk
139. 5:48may be larger than what borrowing rates
140. 5:50might suggest.
141. 5:52And second, these low borrowing
142. 5:54rates kind of start rising
143. 5:56beyond a certain level of debt.