From the TUC

Gilt yields & Optical Illusions

30 Jul 2012, by Guest in Economics

The Necker Cube is an optical illusion. Looking at the very same picture everyone can see a cube, but some people see a cube that faces inwards and some see a cube that points outwards.

What any individual sees can change with a blink.

The chart below, showing the yield on ten year gilts – the rate at which the government can borrow – is taking on some of those same characteristics.

Looking at this graph everyone can see that the cost of government borrowing has collapsed in the past two years, but some economists see this as a vindication of the government’s economic strategy and some see it as a consequence of collapsing growth.

To George Osborne this chart shows his ‘hard-won fiscal credibility’, the idea being that bond investors are so confident in his deficit-reduction strategy that they are prepared to lend at historically low rates.

But as Jonathan Portes has pointed out, the most recent IMF view on this is very different:

… the reason long-term gilt yields are low in the UK (and similarly in virtually every other “advanced economy with monetary independence”) is weak growth, not “confidence” or “credibility”. “Bond yields are driven more by growth expectations.” That is, yields are low not because of economic confidence but because of its exact opposite.

The very same picture can be taken as a sign of absolute success or a sign of almost total failure.

The debate about what is driving low yields for the UK is one of the most crucial in economic policy making. Are low yields the result of the markets rewarding austerity or are they (in the words of Citigroup’s Michael Saunders (as quoted by Larry Elliot today) “practically an invitation for the government to borrow more”? I.e. should the UK stick to ‘Plan A’ or move to ‘Plan B’?

For reasons I’ve explained at length, I fall into the second camp.

I am convinced of my interpretation because the chart above isn’t really like a Necker Cube at all. A Necker Cube is ambiguous purely because it is a simple line drawing, devoid of any context. Given the lack of contextualisation, the human brain is capable of perceiving it differently.

The chart of gilt yields on the other hand does not exist in isolation. By itself it may be hard to judge what it is telling us but when placed alongside GDP data and the experience of the longest slump in modern economic history it is very hard to read it as anything other than a sign of failure.

5 Responses to Gilt yields & Optical Illusions

  1. Frances Coppola
    Jul 30th 2012, 12:42 pm

    Placed alongside the fall in yields on USTs, bunds and other “safe” assets, it is possible to offer a third explanation – namely that although the UK may not be growing, it is at least not collapsing and it has control over its own destiny. I don’t think we can ignore the “flight to safety” effect, because it is so pervasive at the moment. Investors are running scared.

  2. Duncan Weldon

    Duncan Weldon
    Jul 30th 2012, 12:47 pm

    I agree there is a ‘safe haven’ issue at work here.

    Although chronic demand for safe assets does show global lack of confidence.

  3. Forgotten
    Jul 30th 2012, 1:06 pm

    There being a massive buyer in the market that will soon own 1/3rd of total supply + banks and insurance companies being forced to hold more of the stuff is probably the main factor.

    The “market” in gilts simply isnt a functional market anymore, so looking at prices/yields tells you little to nothing at all.

  4. Tom Freeman
    Jul 30th 2012, 2:07 pm

    I think it has to be an element of both explanations: poor investment prospects and economic fears are driving the flight to gilts (and other government bonds), but that flight requires that there be confidence in the safety of gilts.

    But of course the fall in gilt yields dates to late 2008, so even before the coalition’s austerity plans came in, the markets were convinced gilts were safe. Wherever the danger line is in terms of government debt credibility, we haven’t been anywhere near it.

  5. jonathan
    Aug 1st 2012, 3:50 pm

    The problem is in the cube: if you see from one eye, you see only one cube*.

    *If you close one eye and move your head nearer and farther, you get both but that’s the same point: you need to be able to change your own perspective to see and if you can’t you don’t.