Rising borrowing costs will hit taxpayers sooner than you think
government debt seemed to matter less and less even as countries borrowed more and more. Falling interest rates made debts cheap to service even as they grew to levels that would have seemed dangerous a generation before. The pandemic put both trends into overdrive: the rich world borrowed 10.5% of itsin 2020 and another 7.3% in 2021, even as long-term bond yields plunged. Now central banks are raising interest rates to fight inflation and debt is becoming more burdensome.
The third factor is more complex: the maturity of the debt. When governments issue long-dated bonds, they lock in the prevailing interest rate. In 2020 America’s Treasury issued about $200bn-worth of 30-year debt at yields of less than 1.5%, for example. The more long-dated debt, the longer it takes for budgets to take a hit when rates rise. The most common measure of this protection, the weighted average maturity of debt, can be a source of comfort.
A full accounting of interest-rate sensitivity must thus adjust for the holdings of central banks, treating the associated debt as carrying a floating rate of interest. Refreshing thereduces Britain’s interest-rate half-life to just two years, meaning 50% of Britain’s government liabilities will roll on to new interest rates by late-2024. We have also replicated the exercise for bonds and bills issued by governments in America, France, Italy and Japan .
Using tiering to avoid paying banks interest while their funding costs went up would be a tax in disguise. Banks, considered together, have no choice but to hold the reserveshas force-fed into the system. Compelling them to do it for free would simply “transfer the costs [of] to the banking sector,” Sir Paul Tucker, a former Deputy Governor of the Bank of England, told a parliamentary inquiry in 2021. It would be a form of financial repression which may impair banks’ ability to lend.
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