It is argued debt levels are too high and markets won't stomach this.
Yet, bond yields on UK, and US debt have barely risen since the recession started two years ago.
According to a simple Classical approach, higher government debt causes higher interest rates and crowding out and therefore is unsuccessful in reducing debt.
If governments in the UK and the US are borrowing too much, if the debt levels are unsustainable, why is the market (private pension funds, investment trusts e.t.c) still buying US and UK bonds at low interest rates?
It is important to bear in mind, they are not buying US and UK bonds out of charity. Far from it. They are buying government securities because they feel this is one of the best investments at the present time.
A strong argument for deficit reduction is based on the idea that the bond market has got it wrong, and actually bond yields should be higher (or are going to increase in the future).
I have now lost faith in the view that giving the markets what we think they may want in future – even though they show little sign of insisting on it now – should be the ruling idea in policySee: Comment by at FT
Of course, you could argue, we have low bond yields because markets have been working on the expectation that the government would tackle the deficit aggressively after the election. If this deficit reduction doesn't materialise, then the market will reassess the value of UK bonds and yields will rise.
However, amidst all this it is important to bear in mind.
- A double dip recession would be the worse scenario for the prospects for UK debt.
- National debt in the UK as a % of GDP is still only around 62% of GDP
- Greece / Spanish / Portugese debt became so unattractive because of forecasts for very low growth and the constraints of operating in the Eurozone