22 December 2011

Austerity Can Drive Up Interest Rates

Chancellor Osborne boasts continually that his austerity programme has reduced British interest rates compared to our European neighbours. (He means the rate at which government can borrow not the rate you pay on your mortgage but he doesn't always make that clear.)

Via Krugman, we have this from Olivier Blanchard, the Chief Economist at the IMF:
... it does not take large multipliers for the joint effects of fiscal consolidation and the implied lower growth to lead in the end to an increase, not a decrease, in risk spreads on government bonds
In other words austerity programmes can push up the interest rate on government borrowing as a result of the slower growth which they cause and which bond markets are beginning to price in.

To be clear Blanchard's claim is hedged with caveats. This is based on estimates which the IMF is still working on. We already know that austerity can fail to reduce the government debt ratio when it slows economic growth. Now it seems it it might increase the cost of government borrowing making reducing the deficit more difficult.

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