How Important are Credit Ratings?

Readers question: What will happen if the UK has its credit rating reduced from AAA to AA?

Do you remember all those sub-prime mortgage bundles which caused the credit crisis? These mortgage bundles which later proved to be almost worthless were, for a considerable period, given a AAA credit rating by rating agencies. Even Greece, now on the verge of insolvency, maintained an A credit rating until May 2009. (Bond yields at Datosmacro) What did a credit rating of A mean for Greece? It meant the credit rating agencies didn’t really know what was coming quite soon. (nor the rest of the market either)

Credit rating agencies have no greater ability to predict future defaults and financial flows than anyone else in the market. Someone once described fiscal policy like driving a car by looking out of the rear view mirror. (You can only look at past data.) To some extent, it’s the same with credit rating agencies. They are looking at data taken from the past.

If a credit rating agency moves a country from AAA to AA-, it doesn’t really add any extra data to investors and buyers of bonds.

Because credit ratings are a highly visible signal, they can perhaps gain more political importance than they perhaps deserve. A triple AAA credit rating sounds good. Plus, it’s much easier to explain to the public than the ‘merits of expansionary fiscal policy in a liquidity trap’.

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