Gilt yields & Optical Illusions
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’?
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.