Sometimes, even abject policy failure doesn't make much material difference. This is the paradox of the UK government's loss of its AAA credit rating.
Economically speaking, this won't make much difference. As I wrote recently:
Markets are relaxed about the possibility that rating agencies might soon cut the government's credit rating from its present AAA grade. Such a prospect, says Sam Hill at RBC Capital Markets, "is priced in".
And Reuters reports:
Charles Diebel, a fixed income strategist at Lloyds, was sanguine about the impact of the downgrade on gilts, as U.S. and French debt was not badly affected when these countries lost their triple-A ratings.
"This has been speculated as inevitable and is most likely largely in the market. I would expect only very limited damage to the gilt curve and to sterling. Historically, losing your AAA is actually a bond bullish event," he said.
There's a simple reason for this. Ratings agencies don't usually tell investors anything they don't know already, and on the odd occasions when they do, they are often wrong. There's no new news about the public finances in Moody's statement.
The truth is, of course, that the government's creditworthiness is impeccable, simply because - even if the worst comes to the worst - the Bank of England can print as much money as is necessary to buy gilts. There is, therefore, no chance of the government ever having to default on its obligations to borrowers, unless it chooses to do so.
However, even if you think all the above is wrong and that credit ratings matter, they still don't matter much.
The best measure of what an AAA rating is worth comes from the US municipal bond market. Here, a one-notch rating cut adds 0.23 percentage points to five-year yields.
But this is puny. If we use the Bank of England's estimate (pdf) of the effect of the first £200bn of QE as a guide - it estimates that this reduced gilt yields by a percentage point - an extra £50bn of QE would offset the impact of the downgrade.
However you look at it, then, the economic effect of Moody's move is insignificant.
Instead, it matters only for party political purposes. "We will maintain Britain's AAA credit rating" said Osborne in his Mais lecture in February 2010. "We will safeguard Britain’s credit rating" promised the Tory manifesto (pdf). In this sense, Moody's move represents a failure of policy.
Sometimes, though, policies can be so silly that their failure doesn't much matter.
Hi Chris,
Would we be able to cross-post this at Left Foot Forward by any chance? Will link back of course.
Many thanks,
James Bloodworth
Posted by: James Bloodworth | February 23, 2013 at 01:15 PM
You make an excellent point. In general, I agree that the markets will have seen this coming, though I would qualify things a bit when it comes to this part:
The truth is, of course, that the government's creditworthiness is impeccable, simply because - even if the worst comes to the worst - the Bank of England can print as much money as is necessary to buy gilts. There is, therefore, no chance of the government ever having to default on its obligations to borrowers, unless it chooses to do so.
You haven't mentioned the risk of inflation and the possibility of a currency crisis. There is never no chance of a default, otherwise countries with independent monetary policies would never default on their obligations to borrowers.
Posted by: Liberal Europe | February 23, 2013 at 01:47 PM
@ James - yup, cross-post away.
Posted by: chris | February 23, 2013 at 02:52 PM
Thanks, Chris. Here we go: http://www.leftfootforward.org/2013/02/why-have-moodys-downgraded-britains-credit-rating/
Posted by: James Bloodworth | February 23, 2013 at 03:06 PM
Liberal Europe, there may or may not be inflation/currency risk. But that is not what rating agencies purport to measure. They just say "if you lend £x, will you get £x back when you're meant to?" What you can buy with £x doesn't come into it.
Posted by: Luke | February 23, 2013 at 08:18 PM
Further to Liberal Europe, the unsaid here is that while the pundits are talking about the markets have already "priced it in", the actually market shift has been practically zero - the 10yr rate is up half a percent in the last six months, and no higher than a year ago.
Posted by: gastro george | February 24, 2013 at 05:20 PM
@Luke
At some point, if there is a sustained increase in the money supply, the effects of inflation are arguably worse than the effects of a default. When that happens, a country is very likely to restructure its debts and / or seek assistance from the IMF.
Yes, we're currently unlikely to reach that point in the UK, but it's worth reminding ourselves that Britain has in the past suffered severe inflation + currency crises (including an IMF bail-out).
Ultimately, the chances of Britain defaulting on its debts have a lot more to do with the shape of the global economy than whether or not Britain has an independent monetary policy.
Posted by: Liberal Europe | February 24, 2013 at 10:36 PM