I have been getting ready to leave town, and so wrapping up other projects. The only thing that popped up in my internet browsing was the Return of the Bond Market Vigilantes, this time courtesy of a tweet on May 30th by the U.K. Green Party Leader, Zack Polanski. The short text was “We must stop being in hock only to the bond markets. No one voted for the bond markets.”
I am unsure about the exact context of his original tweet, and it appears to have been a one-off comment. I am not going to attempt to delve into Polanski’s full views on bond markets are (it is clear that they get the usual suspects mad, but the summaries I do not have great issues with), rather I just want to comment on the discussions online that were provoked by that statement.
No Point in Worrying About Bond Markets
My unsolicited advice to the centre-left (particularly in the U.K.) is to not reinforce the “Bond Vigilantes are more powerful than the government” narrative that characterised the post-1990 neoliberal consensus. If you are a Green Party supporter, you are likely correct that the average bond market denizen is not a fan of your favoured policies. Realistically speaking, there’s probably a lot of other people in the U.K. that also do not like your policies. For example, I doubt that the fox-hunting set are fans either. This does not matter because it seems implausible that fox hunters have a veto on government policies. The problem with the focus on bond market vigilantes is that they do not have a veto on government policy either — you need to look at the “independent” arms of government policy, like the Bank of England.
The bond markets do not exist solely because they benefit rich bond market investors. They exist because they reflect economic, accounting, and financial fundamentals, and you would need to do something about those fundamentals if you want to make anything other than a cosmetic change to the situation.
One of the unfortunate side effects of the explosion of Modern Monetary Theory (MMT) on the internet is that it picked up some bad habits, that then transitioned to related online economic communities. For my purposes here, there are two concerns. The first is that the “Mint the Coin” episode became too much of a role model. (The idea was to mint trillion dollar platinum coins in the United States to get around the debt limit.) Although ingenious, this was a cosmetic change that only worked because the Debt Limit is just a stupid cosmetic rule. The second is that the emphasis on operations led too much importance to being attached to minutiae of money market structure. Although details matter, we cannot lose sight of economic and financial forces. The rest of the article explains what I mean by the previous sentence.
Why Bond Markets?
If we make some simplifying assumptions about the accounting, the central government’s net deficit in a year equals its emission of financial liabilities. (The simplification is that the government is not doing anything that generates/consumes cash flow that is not affecting the deficit; most of the time, the deficit is close to financial liability emission.)
The government could theoretically issue equity, but most governments do not have profit-making enterprises that they can sell minority stakes of to the private sector. To the extent that this is happening, this is “privatisation” and “Public-Private Partnerships,” which are of course, neoliberal.
This only leaves us with the two categories of liabilities: cash, and debt. That breakdown is from the perspective of the owners of the liabilities. The government can call them whatever they want, but what matters is what the people who hold them think about them.
“Cash” as I use it fits the definition as used in portfolio management: short-maturity debt instruments. Central governments issue a variety of cash instruments:
banknotes and coins;
deposits at the central bank (“reserves” in Economics 101 textbook-speak);
short-dated debt securities (“Treasury bills”);
repurchase agreements (“repos”), typically with the central bank;
short-term loans to the government or central bank, including accounts receivables.
“Debt” is every other liability (excluding equity, which sometimes get lumped in with liabilities). Although governments could originate a variety of debts, they generally stick to bonds.
Given that there is a finite appetite to hold government-issued cash instruments (as discussed below), the bulk of deficit spending ends up expanding government debts, which are mainly bonds. Although one could theoretically issue other debt instruments than bonds, they would be economically equivalent to bonds from the perspective of the owners of that debt. Which means that you can either make a cosmetic change and relabel “bonds,” or you can run balanced budgets. Or you lock interest rates at zero, which is the only truly fundamental change you can make.
Why Not Just Issue Cash/Money?
The immediate response I would expect to the previous statements is that the government can just issue “money” (deposits at the central bank, presumably). Of course, they already do. The problem is that the private sector is already at the limit of the amount of 0% interest rate money it is willing to voluntarily hold. One of the wackier theories that you can run into online is that there is “an infinite demand for money,” which is not true. There is perhaps an infinite demand for wealth, but the consensus of every serious attempt to model economies is that money holdings are determined by a portfolio balance argument (including transaction demand, including the underground economy).
Since the whole point of money is that it is easily exchanged for other goods and services, it is difficult to get the private sector to hold it involuntarily. The only scheme that worked in practice is forcing banks to hold required reserves against deposits. However, this is a tax on the regulated part of the financial system — tilting the playing field towards non-traditional bank finance (“shadow banks”). (Note that real-world banks in practice are generally holding companies that include traditional banking and shadow banking subsidiaries. Favouring “non-bank finance” just means which subsidiaries are favoured within the “bank.”)
Any attempt to extend who gets stuffed with 0% money has the effect that the stuffees “sell their money” to buy government bonds — driving bond yields to 0% as well. Which means that the policy is economically equivalent to saying “let us lock the risk-free yield curve at 0%.”
You could try to escape this by paying interest on “money” — which is what central banks did in the aftermath of the ZIRP (“Zero Interest Rate Policy”) era. They had bought too many bonds, and banks were stuffed with deposits at the central bank. This was not an issue when the policy rate was at 0%. However, to raise interest rates, they needed to pay interest on central bank balances. Which means that we have just made a somewhat cosmetic change: interest-bearing bonds were replaced by interest-bearing deposits at the central bank. People can generate pretty much the exact same “markets will punish the government” story, since these stories already have a loose grip on reality even with a conventional bond market.
So Why Not Lock Interest Rates at 0%?
Locking the government yield curve at 0% is a MMT policy proposal. But if you look at online discussions and critiques of MMT, it is nearly impossible to find anyone who actually tackles the subject. All you will find are arguments about “printing money.” And it is not even necessary to “print money” to get to the 0% state: Warren Mosler floated a proposal was to issue Treasury bills at an extremely low fixed interest rate (for example, 0.25%) to soak up money creation (which is the role of bonds and bills). Although 0.25% is not exactly 0%, it is close enough for government work — and that rate could be fixed by statute, so there’s no “Treasury bill vigilante raising rates” story to spin.
From my perspective, there are three good political reasons to not waste political capital on the project of locking rates at 0%.
The vast majority of economists are against the policy. This even includes Post-Keynesian economists who theoretically should be politically aligned with progressive MMT economists. The idea is so far out of the world view of conventional economists that they barely can wrap arguments around it when “critiquing MMT.” You would also be taking on central bankers, who have a very large political presence in financial media.
Locking the government benchmark curve at 0% blows huge holes in the economic position of the pension and insurance industries. This is not just an issue for fat cats: insurance and pensions are critical components of the broad middle class.
Given that nobody else supports the policy, you are always one election away from the policy being reversed.
Realistically, if you wanted to go for a “permanent 0% rate policy” in a democracy, you would need to build a supporting bloc of at least more than a half dozen economists who show up in financial media in the country. Furthermore, to build such a supporting bloc, you would need to convince people that interest rates are not critical to the regulation of the economy. Running around telling people that bond market vigilantes secretly run everything in the economy is exactly 180 degrees out of phase with that objective.
Concluding Remarks
The demise of incumbent governments after the pandemic inflation spike is yet another major set of data points confirming that voters hate inflation. Containing inflation puts constraints on fiscal policy (although some progressives are coming up with regulatory schemes to fight inflation). But the political solution for progressives is straightforward: taxes are the price you pay for a civilised society, so they need to go up. The fight is to avoid listening to the worriers who would set them too high and strangle growth.
The worst political strategy for progressives is to emulate the brain trust of the Starmer Labour Party and embrace the bond vigilante story line, as that story line will always be invoked in a way that almost only constrains the left — right-wing parties have to do something extremely stupid (e.g., Liz Truss) to end up facing revolting bond markets.
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