Another few graphs to look at the impact of the UK budget deficit on bond yields and interest payments.
Government net borrowing for 2012-12 excluding Royal Mail pension fund transfer and Asset Finance Programme (AFP – the proceeds from Q.E)
Government borrowing vs debt interest payments
The very large deficits have had little impact on changing the cost of net interest payments as a % of GDP. This is because, despite higher borrowing, bond yields have fallen to record lows. The amount of national income devoted to servicing debt interest payments is lower than in the 1990s.
You might be tempted to say, that because of government borrowing, we have to increase taxes just to pay the interest rate cost. But, this hasn’t happened yet.
Low bond yields are not guaranteed – just look at the Eurozone. But, despite the size of UK government borrowing, we still retain that very useful ability to print money and get the Central Bank to intervene in the bond market, if necessary. Interest payment costs are forecast to stay low into 2016-17.
Government borrowing v bond yields
more on debt interest payments here
If you teach budget deficits to students, you would typically say – Higher government borrowing is likely to push up interest rates. The logic is that if the government borrows more, they will have to compete for funds from the private sector. Therefore, the more the government borrow, the higher the interest rate they have to offer.
In the case of the Eurozone, increased budget deficits did cause rising bond yields. This was because markets feared illiquidity and demanded higher yield to compensate for the perceived higher risk.
However, if we look at the UK since 2007, a sharp increase in government borrowing has led to a significant fall in bond yields. The fall in the bond yields is mainly because in the recession, savings have increased and the private sector are keener to buy bonds. The Asset Finance programme has also helped keep bond yields low.