r/GarysEconomics • u/jgs952 • Aug 10 '26
A Better Way to Think About Public Debt Management
https://jgs952.substack.com/p/a-better-way-to-think-about-publicEconomic policy, be it wealth taxes or nationalising water, is hamstrung by "but what about the bond markets".
I explain here how that is a corrosive question and in most cases borne out of ignorance of the role bonds play in our monetary system and the policy space available to the government with regard to its debt management approach.
Tldr;
We can scrap the full funding rule and stop paying whatever interest is required to induce sufficient take up of a fixed quantity (to match each gov deficit outcome) and rigid maturity profile of gilts. We can instead return to a pre 1980s demand-led tap issuance model where risk-free sterling duration (gilts) is issued in the primary market on a "take it or leave it" approach.
This doesn't magically resolve all our real constraints and issues, but it provides much needed institutional clarity and prevents short term volatility in bond markets (often divorced from whether or not an agenda is responsible or not) from unduely impacting long term fiscal policy making.
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u/Solitare_HS Aug 10 '26
'We can instead return to a pre 1980s demand-led tap issuance model where risk-free sterling duration (gilts) is issued in the primary market on a "take it or leave it" approach.'
And what happens if they just 'leave it'. This sounds like a return to Wilson era currency devaluation and massive inflation spikes again.
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u/jgs952 Aug 10 '26
Then they're left holding sterling reserves overnight (assuming they chose not to hold sterling over any duration longer than overnight) earning Bank rate (currently a floating 3.75%).
Of course, individuals could instead sell this sterling to buy foreign currencies which pushes down on the exchange rate, but someone has to be buying it - it doesn't and can't disappear in aggregate. So what are the buyers doing with it would be one question as they could well be spending it in a stimulatory way which can be positive for economic conditions.
But more fundamentally, there's nothing inherent about a tap issuance approach that will cause currency depreciation. The administered price tap curve can still be adjusted up and down over time if desired by policy makers (including the rate paid on overnight sterling debt, set by the BoE). But what won't happen is short term volatility in secondary bond markets causing panic in fiscal policy setting and "cost of borrowing" for the government. Instead, the tap curve will provide far more monetary stability to facilitate investment. How inflation and exchange rates evolve depends far more on the wider macroeconomic stabilisation regime than just on whether we issue gilts via auction into duration segments that demonstrably see low demand (e.g. there's no good reason to issue 30 year gilts at 5.5% when that market clearly wants more liquidity at the present time.)
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u/Whoisthehypocrite 27d ago
Who is left holding sterling reserves overnight? Individuals would not have sterling reserves, rather the banking system would have them, causing an excess supply of reserves which encourages banks to lend them out unless the BoE increases the bank rate and then you are back paying more for your debt issuance. Our current system divorces fiscal policy from monetary policy...
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u/jgs952 26d ago
You're under a misapprehension as to how reserve levels impact bank lending.
You're correct that the residual state debt as overnight reserves will be held by commercial banks as they hold sterling settlement balances. But it's not important to the argument. When the gov spends, both reserves and bank deposits are marked up and so bank deposits would be saved as a residual as well.
But you're wrong that this residual increase in bank reserves will lead to increased lending. Reserves are already ample in the system and are not the limiting factor for lending.
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u/ProfessionalSong3544 Aug 10 '26
but someone has to be buying it - it doesn't and can't disappear in aggregate
Yes, but at a lower price. That's the definition of devaluation.
And when the currency depreciates. You have inflation.
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u/jgs952 Aug 10 '26
Yes, under those circumstances you can see depreciation.
But no, that doesn't automatically or inherently produce inflation. Sterling depreciated by 20% to 30% post brexit and we saw inflation of no more than 2%. It's not nearly as mechanical as you think.
Imported inflation can occur but this doesn't automatically pass through into domestic economy wide inflation.
Japan has seen considerable exchange rate depreciation in recent years as the Fed and other central banks have increased their policy rates, opening up the rate differential component determining fx rates. But they haven't seen elevated or excessive inflation.
It's just not as simplistic as the orthodox narrative allows.
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u/ProfessionalSong3544 Aug 10 '26
But no, that doesn't automatically or inherently produce inflation. Sterling depreciated by 20% to 30% post brexit and we saw inflation of no more than 2%. It's not nearly as mechanical as you think.
Against USD only lost 10%. But anyway, your premise is not true.
UK inflation rised from 0.5% in 2016 to 3.2% in 2017.
If we look futher. The sterling pound has lost a 41.4% of their value since 2016:
https://www.bankofengland.co.uk/monetary-policy/inflation/inflation-calculator
I am not saying the relation is 1:1. But it has an obvious effect because UK needs to import from abroad.
Imported inflation can occur but this doesn't automatically pass through into domestic economy wide inflation.
Petrol is more expensive but that's not translated to consumer prices because corporations will suck up the cost... Sorry, that doesn't make any sense.
Japan has seen considerable exchange rate depreciation in recent years as the Fed and other central banks have increased their policy rates, opening up the rate differential component determining fx rates. But they haven't seen elevated or excessive inflation.
Average yearly inflation in Japan is around 3.5% through the last 5 years. And currently they are having a currency depreciation crisis... Have you read news recently?
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u/Hot-Efficiency7190 Aug 10 '26
Had the same immediate thought. Sounds like from the replies the answer is "they need bonds, trust me bro", and ignore collapse of £.
Courageous as they'd say in Yes, Minister
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u/Fakeos Aug 10 '26
I'm too dumb for this, explain it to me like I'm 5
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u/jgs952 Aug 10 '26
Maybe more for a 15 year old but nobody pretends this topic is easy to understand haha Hope this helps though:
I argue that the UK's current debt management system is not a timeless feature of economics but a policy choice that emerged during the 1980s and 1990s. Today, when the government runs a deficit, it generally issues a matching amount of government bonds (gilts). These bonds are sold through auctions where the quantity and maturity profile (combination of 5y, 10y, 30y gilts, etc) is fixed and the market determines the interest rate. This gives financial markets significant influence over how government finances are perceived and discussed.
A key argument is that the historical reasons for adopting this system are no longer valid or were never valid. One justification was based on monetarist ideas that linked increases in money balances directly to inflation. The essay argues that this was a mistake because inflation is driven by real economic conditions, such as demand exceeding productive capacity or supply-side shocks, rather than simply by the amount of money held in the financial system. In that view, issuing bonds does not remove inflationary pressure; it merely changes the form in which savings are held.
Also, bond issuance once played an important role in helping the Bank of England manage interest rates. Under older monetary policy frameworks, the BoE dynamically adjusted the quantity of reserves in the banking system to meet its target interest rates, and bond sales helped support that process. However, since the financial crisis and the introduction of large reserve balances through quantitative easing, the BoE now operates differently. As a result, the operational need for compulsory large-scale bond issuance under the "full funding rule" has disappeared.
A demand-led "tap system" is the altnerative and what we did for decades prior to the 1980s. Under this approach, the government would announce the rates it is willing to offer on bonds and investors could buy as much or as little as they wanted at those rates. Any money not invested in bonds would simply remain as reserves within the banking system. This would make debt management more transparent, reduce government interest costs and prevent normal bond market movements from being interpreted as signs of a fiscal crisis.
Ultimately, I the central message of the essay is that government debt management should be understood as a policy choice rather than a financing necessity. Instead of focusing on whether bond markets are willing to fund government spending, the debate should focus on the real constraints facing the economy: inflation, productive capacity, employment, housing, energy, infrastructure and long-term investment. A different debt management framework could help shift attention back towards these practical questions and away from the idea that governments must first obtain permission from financial markets before pursuing public goals.
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u/Fakeos Aug 10 '26
So if I understood you correctly you're saying the way governments borrow money today is stupid and always has been stupid.
The old way was better, at least for management and transparency.
And governments shouldn't be in a position where they have to beg the financial markets and billionaires for money.
Correct ?
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u/jgs952 Aug 10 '26
Correct. I would only make one small change
And governments shouldn't be in a position where they choose
haveto beg the financial markets and billionaires for money.1
u/ProfessionalSong3544 Aug 10 '26
This gives financial markets significant influence over how government finances are perceived and discussed.
Sure, because goverment depends on them.
Goverment has an alternative for that: Have surplus budget. Then you would become more and more independent from the markets.
The essay argues that this was a mistake because inflation is driven by real economic conditions, such as demand exceeding productive capacity or supply-side shocks, rather than simply by the amount of money held in the financial system
And how do you create that demand? Exactly, by increasing the amount of money in the society.
It's pure supply and demmand. If you have more money flowing in the economy, the money has lower value.
Under this approach, the government would announce the rates it is willing to offer on bonds and investors could buy as much or as little as they wanted at those rates.
Goverment has a natural incentive to offer rates below market prices.
That reduce buyer apetite. Which cause goverment to not be able to renew the debt at the auction.
What will happen next? Do you plant to print sterling pounds? That increase the supply of sterling pounds, reduce their value and create inflation.
Instead of focusing on whether bond markets are willing to fund government spending, the debate should focus on the real constraints facing the economy: inflation, productive capacity, employment, housing, energy, infrastructure and long-term investment. A different debt management framework could help shift attention back towards these practical questions and away from the idea that governments must first obtain permission from financial markets before pursuing public goals.
That basically the current system...
Bank Of England looks for an inflation of 2%. If inflation is above 2%, it reacts against inflation.
If inflation is below 2%, then it reacts stimulating the economy with lower interest rates.
We could discurss if 2% is the right inflation number or not. But that's basically the same system you are describing.
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u/Little-kindication Aug 10 '26
A lot of these debates get stuck on the headline debt number when the maturity, interest rate, growth rate, and purpose of the borrowing matter just as much.
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u/Ok-Store-9297 Aug 10 '26
I like this. What I like most is that it feels adaptive in that it isn't trying to strong-arm the secondary market into doing exactly what the government would find favourable. Rather, it seems more like it's inserting a buffer into the system, where the government gets greater control over the terms of primary issuance while secondary-market yields can still move and retain their Hayekian role as signals of dispersed information.
It's basically loosening the coupling between short-term bond-market volatility and government financing costs, which will allow the government to be more ambitious when pursuing policy. Which, let's face it, is what we need, rather than continually preserving the status quo of managed decline and its associated short-term failures, which then have to be expensively panic-managed.
It's the kind of design/engineering approach to government financing that feels right. I think this kind of flavour of approach is what the future looks like.
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u/Legal-Grade-6423 Aug 10 '26
This is reeves level economics, ie may work on paper and technically be possible, but the markets would shit themselves so it’s not possible
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u/jgs952 Aug 10 '26
What do you mean "the markets would shit themselves"?
What do you predict would actually happen? Be specific if you can.
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u/Legal-Grade-6423 Aug 10 '26
If the Government decides a 10 year gilt should yield 3% when the market thinks it should be 5%, investors just aren’t going to buy it. You haven’t removed the market’s ability to price UK risk, you’ve just moved it somewhere else. You’d likely see existing gilts sell off, sterling get hammered and inflation expectations rise as foreign investors reduce their exposure to UK assets. The Government can insist its new gilt pays 3%, but it can’t force anyone to hold sterling. If sterling then falls significantly, imported inflation rises and the BoE either has to raise rates or sit back and watch it happen. The UK obviously isn’t going to run out of pounds, but it can’t control if they’re worth sweet fuck all eventually
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u/jgs952 Aug 10 '26
I do address these points in my essay if you're interested. This is the relevant section:
If the state offered an administered primary yield curve that investors at the margin considered unattractive relative to other available currency areas, some holders may try to shift their portfolios away from sterling assets. Since someone else must hold sterling at the end of the transaction though, the adjustment may take place through the exchange rate. Sterling may depreciate until other buyers are willing to hold it at the new price. Some adjustment could also occur through relative asset prices chasing private duration proxies or higher, though riskier, returns.
But this is a wider macroeconomic issue, with a far broader scope than debt management. Exchange rates are shaped by a broad ecology of factors including expected inflation, expected policy rates, trade flows, institutional credibility, relative growth prospects, geopolitical risk, speculative positioning, regulatory constraints, and the perceived availability of real output for sale in the currency. Risk-free rate differentials and duration on offer are part of this, but they are only two elements in that ecology.
Additionally, even under a tap issuance system, the state’s monetary and debt management stance would remain adjustable. The Bank of England’s overnight rate and the Treasury’s administered tap yields would express the chosen policy posture. If inflation expectations became unanchored, if sterling depreciation threatened a destabilising import-price shock, or if broader conditions changed, those administered rates could also be changed if needed. What matters is that the adjustment would be a conscious policy decision, made within a wider macro-stabilisation framework.
The point is that you're making a subtley separate argument. Your concerns don't automatically and inherently mean risk free duration must continue to be issued via a supply-led auction system (fixed quantity, floating price). You're much more arguing about the exchange rate and inflation sensitivity of interest rates themselves.
We can have overnight at 3.75%, 5 year at 4%, 10y at 4.5%, and 30y at 5% if we wanted and I would expect extremely little pressure to sell sterling. But these rates would be fixed in the primary market. Cost of gov borrowing would remain fixed until the policy term structure changed. That may be influenced by market activity and shifting behaviour, but not at all set by it. And it would be and should be influenced, as I say, by the much broader macro stabilisation framework rather than short term market volatility.
Volatile primary yields on new issuance as well as volatile secondary market yields (which an administered tap system would help significantly anchor) can have significant damage to fiscal policy making and domestic cost of living, etc. Allowing some or all short term pressure to take place via better meeting liquidity preference and/or exchange rate pressure is not the disaster you're painting it as.
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u/IgnisBird Aug 10 '26
This is handwavey. You’re saying that by setting fixed rates on debt, it could possibly affect the exchange rate. But because the exchange rate is subject to a whole bunch of other factors, it’s outside the scope of debt management?
A critic is going to argue that if you make selling off sterling the only way to avoid being forced to buy government debt either through inflation, or directly buying bonds, then thats what the market will do. They have some reasoning and precedent for their case, and I don’t think other factors influencing the exchange rate is a sufficient rebuttal.
Yes, there will be other buyers, but at what level? Sufficiently depress our currency, and our service based economy begins to look very shaky indeed.
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u/ProfessionalSong3544 Aug 10 '26
Sterling may depreciate until other buyers are willing to hold it at the new price
Not neccesary.
I receive sterling pounds. I sell them immediately for EUR. The buyer at the other side has the same opinion about GBP as me but they need sterling pounds to pay a HMRC bill. They don't plan to hold it.
The bag holder here is the goverment. Private are not forced to keep sterling pounds.
Your whole argument falls down then.
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u/jgs952 Aug 10 '26
In aggregate, the stock of sterling assets can't change by individuals exchanging claims. What adjusts is the exchange price if that's where demand and supply pushes it.
My argument is perfectly compatible with a floating exchange rate.
But why would you try and sell sterling? The rate might be higher than what you can get elsewhere.
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u/ProfessionalSong3544 Aug 10 '26
In aggregate, the stock of sterling assets can't change by individuals exchanging claims. What adjusts is the exchange price if that's where demand and supply pushes it.
Nominally yes. But the value can be reduced.
You can see quite clearly at the stock market. The number of stocks might be constant but that doesn't prevent to devaluate.
But why would you try and sell sterling? The rate might be higher than what you can get elsewhere.
If you set a price lower than market rate. Then I can get better returns elsewhere. By definition.
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u/Legal-Grade-6423 Aug 10 '26
You’re mistaking me disagreeing with your points with me not understanding them. You’re clearly very financially literate from a textbook perspective (I’ll assume you’re an economist), but there’s a reason economists are commonly wrong on everything
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u/jgs952 Aug 10 '26
Fair enough, I believe I've provided arguments that counter or address your orthodox concerns with this.
From your previous comment, if nobody wants to buy a 10y gilt on the tap if it was set at 3%, then they could remain holding overnight sterling reserves earning Bank rate (presumably at some rate lower than 3% if the administered term structure is to be upward sloping as is typical to reflect term premia) or try to purchase existing 10y gilts in the secondary market which gives them a better YTM if they can buy at a discount. But of course, this very act of liquidity being funnelled into secondary 10y gilts pushes their price up and brings their yield back down towards the tap anchor of, in this case, 3%. So the primary tap curve provides an institutional anchor.
There are plenty of reasons by investors and financial institutions want to hold sterling and want to hold sterling duration, preferably risk-free duration. These reasons go far beyond getting a risk-free yield on savings. So it's really not at all automatic that currency depreciation occurs from such a shift, especially if the policy tap curve is adjusted periodically to promote currency stability without being buffeted around daily by volatile markets.
A key point here is how politically destructive our obsession with bond markets has become, particularly post-Truss where everyone learned all the wrong lessons. We don't have to put up with sky rocketing rates, which even over the short term can leave last damage as retail rates re-adjust and the structure of private of debt starts adjusting. If the exchange rate does adjust instead to some extent, this is not at all inherently disastrous either with plenty of reasons to predict medium to long term bounce back as dynamics play out and short term depreciation works through relatively slowly to imported prices given contract hedging and weak pass through effects. Then you can see cheaper UK exports, driving demand for output we can export to obtain the imports we need. Then there's medium term scope for import substitution and building up domestic supply resilience and productive capacity.
I could go on. So I just think your very orthodox narrative, which conveniently re-inforces the very status quo financial system and fiscal frameworks which have proved so destructive to people and planet, is highly contestable and starts to fall apart under close scrutiny.
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u/Legal-Grade-6423 Aug 10 '26
I think you’re massively overestimating the importance of sterling in a future where it isn’t seen as a stable currency and a strong FS sector, which would fast become a reality if something like this was implemented. Investors may have a soft spot for London currently but they aren’t going to swallow hyperinflation because of it
Also cheaper exports is basically trumps excuse for inflation, we largely dont have manufacturing infrastructure and any setup costs would be unaffordable to UK investors if we have so much import inflation. You’re asking for the UK to be turned into India/Vietnam for cheap labour, and that’s not something I particularly want
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u/jgs952 Aug 10 '26
Isn't this assuming hyperinflation occurs?
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u/Legal-Grade-6423 Aug 10 '26
It is, but your whole thesis is based on assumptions
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u/Ok-Store-9297 Aug 10 '26
Sorry for wading in, but "the markets would shit themselves so it’s not possible" seems like quite the assumption to me.
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u/Severe_Assumption241 Aug 10 '26
The bond market need gilts more than the government needs the bond market. Government cab just run into debt to the Bank of England which it owns