Does the Prime Minister agree that the United Kingdom’s retention of its triple A status, when France lost its triple A rating this week, shows that the UK retains the confidence of international markets because of the difficult but necessary decisions that we are taking?
I say it's a daft question because as Jonathan has repeatedly pointed out, low gilt yields owe more to fears about the weakness of the global economy than they do to "the confidence of international markets".
But let's look at this a different way. What is an AAA rating worth? Perhaps the cleanest simple measure comes from the US municipal bond market. Here, AAA-rated 10 year bonds yield 1.5%, whilst AA-rated ones yield 1.61% and A-raters yield 2.32%. This implies that a one-notch downgrade from AAA status would raise yields by only 0.11 percentage points; small wonder, then, that reaction to France's downgrade was so puny. However, a two-notch downgrade would add around 0.8 percentage points to gilt yields.
How much damage would this do to the economy? If we take the Bank's estimate (pdf) of the impact of QE as a guide, a 0.8 percentage point rise in gilt yields would reduce GDP by 1.6%; I suspect this is a maximum estimate. This is equivalent to 470,000 jobs, which is not much more than the fall in public sector employment since late 2009.
However, such an impact is easily avoided. The Bank of England estimates that its first £200bn of QE reduced gilt yields by around one percentage point. This implies (with caveats) that the adverse effect on yields of a two-notch downgrade could be offset by another £160bn of QE.
On balance, I suspect that our AAA rating is worth something, but not very much, and it's benefit is probably not as great as the cost of securing it.
Put it this way. By 2014-15 the coalition will have tightened fiscal policy by 2.1% of GDP more than under Labour's plan (table 3.1 of this pdf). There are three conditions which, jointly, would justify this:
1. This is the minimum tightening necessary to prevent a two-notch downgrade, or worse.
2. The fiscal multiplier is low. If we assume a 0.8 per cent rise in yields would take 1.6% off GDP, then a multiplier of less than 0.76 (1.6 divided by 2.1) would mean that the tightening does less harm than the downgrade.
3. QE is for some reason infeasible or less effective in reducing yields than the Bank's estimate.
Personally, I suspect these conditions don't hold.Instead, there's a danger that our AAA rating today serves the same function as sterling did in the 50s, 60s, and 70s - as a national virility symbol, to which the economy is sacrificed.