The need to issue long-dated gilts

Charles Goodhart, Duncan Needham 16 May 2020

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Until the recovery sets in, a combination of declining commodity prices, notably oil (Arezki and Nguyen 2020), and the dramatic rise in unemployment is likely to keep inflation down, though with such a massive change in the weighting of our consumption basket, it is quite hard to give much credence to any published figure for inflation (Miles and Scott 2020). Nobody knows quite when the pandemic will be over, nor the date and shape of any recovery. But when the recovery does come, the outlook for inflation is unusually hard to determine. The likelihood is that unemployment will remain higher than normal for some considerable period of time, and there are many who believe that the prior disinflationary trends will persist for a long time. On the other hand, the monetary increase has been huge, and, unlike QE previously, is piling up in the hands of the public and companies. Much of current savings is involuntary. Globalisation is in retreat, so the cheapest supply chains are being rejected in pursuit of self-sufficiency (Irwin 2020, Seric and Winkler 2020). The costs of businesses are rising, and profit margins badly need to be rebuilt. Moreover, the massive increase in debt, both in the public sector and with worsening fragility in the non-bank corporate sector, will cause central banks to hesitate before raising interest rates to rein back inflation, should it rise above target. 

Under these circumstances, it would be foolhardy to rule out the possibility of a resurgence of inflation in coming years. Currently, nominal interest rates are extraordinarily and exceptionally low. It would be a dereliction of our duty to future generations not to lock-in these rock-bottom interest rates for the longest possible period. That being said, of course, the current economic and health crisis requires our economies to be kept highly liquid. What this suggests is a barbell strategy of gilt issue, with a lot of short, a lot of very long issues, and very little in the middle. Anyhow, as Sir John Hicks used to argue, there is a congenital weakness in the middle of the yield curve.

Institutional investors, pension funds and insurance companies, like to hold assets of roughly equivalent tenor to their prospective liabilities. Hence, with a rapidly ageing population, such investors should have a large appetite for gilts with a maturity between 20 and 60 years.

But there is another possibility. This is that a perpetual undated ‘consol’ could be issued, aimed at retail individual investors. Covid-19 is often regarded as similar to war, and an undated consol could be presented as a way of encouraging people to respond financially to the crisis, with a campaign perhaps rather similar to the debt conversion in the inter-war period. After all, clapping one’s hands on a Thursday evening is but a gesture, however deeply felt, whereas a consol issue could be presented as ‘Funding the NHS for the Future: Let us be Better Prepared Next Time’. With infection by Covid-19 something of a lottery, attaching an additional lottery element to a gilt issue needed to counter its effects would have pleasing symmetry. Of course, while any debt issue cannot be hypothecated, the suggestion that this was ‘money for the NHS’ would be no more misleading than much else in the political arena. We would expect that Dominic Cummings could provide a catchy slogan for a gilt issue aimed at locking in low interest rates for as long as possible. A similar proposal was made by Giavazzi and Tabellini here on Vox on 24 March (Giavazzi and Tabellini 2020), and now by Soros on 9 May for Europe (Soros 2020).

It should also be noted that any attempt to reduce the slope of the yield curve, by yield curve control, would go in exactly the wrong direction. It would have the effect of reducing the average duration of debt, precisely when that needs to be increased. It would also have the effect of reducing the profitability of the commercial banks, just at a time when their non-performing loans are likely to increase dramatically. Given the present structure of rates, it should be possible to issue a consol attractive to retail investors at a rate which should help to protect the young and unborn generations from the threat that resurgent inflation would lead to a massive rise in their future debt service requirements. 

References

Arezki, R and H Nguyen (2020), “Coping with a dual shock: COVID-19 and oil prices”, VoxEU.org, 01 April. 

Giavazzi, F and G Tabellini (2020), “Covid Perpetual Eurobonds: Jointly guaranteed and supported by the ECB”, VoxEU.org. 

Irwin, D (2020), “The pandemic adds momentum to the deglobalisation trend”, VoxEU.org, 05 May.

Miles, D and A Scott (2020), “Will inflation make a comeback after the crisis ends?”, VoxEU.org, 04 April.

Seric, A and D Winkler (2020), “COVID-19 could spur automation and reverse globalisation – to some extent”, VoxEU.org, 28 April.

Soros, G (2020), “The EU should issue perpetual bonds”, Project Syndicate, 20 April.

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Topics:  Covid-19 Monetary policy

Tags:  COVID-19, debt, gilts, inflation, globalisation, unemployment

Emeritus Professor in the Financial Markets Group, London School of Economics

Dean and Senior Tutor, Darwin College and Director, Centre for Financial History, University of Cambridge

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