What about the safe liability? The question is about a safe liability for governments (people often misleadingly call it a “safe asset”), which in the eurozone arose because of the struggle of peripheral member states to refinance their bonds during the 2010-12 sovereign debt crisis. With borrowing needs soaring because of large deficits, the high interest rates demanded by bond investors and the prospect of no buyers at all turning up at debt auctions drove governments into an aggressive consolidation of their public finances, causing downturns that made their debt burdens worse than they would otherwise have been.
What about the safe liability? The question is about a safe liability for governments (people often misleadingly call it a “safe asset”), which in the eurozone arose because of the struggle of peripheral member states to refinance their bonds during the 2010-12 sovereign debt crisis. With borrowing needs soaring because of large deficits, the high interest rates demanded by bond investors and the prospect of no buyers at all turning up at debt auctions drove governments into an aggressive consolidation of their public finances, causing downturns that made their debt burdens worse than they would otherwise have been.
A reasonable definition is that “safe” here means a government can be confident that it will not be prevented from running budget deficits to combat recessions simply because it cannot find anyone willing to lend it money. But note that it cannot mean that the government can borrow any amount for as little in borrowing costs as it likes. No government has that ability.
Even governments that force banks to buy their bonds and require their central banks to keep official rates low would eventually come to a point where private sector or foreign lenders demand higher real interest rates to compensate for greater inflation risk and worsening creditworthiness.
That already shows that the notion of safety is not binary. The question therefore becomes one of how safe government liabilities must be to allow sensible countercyclical fiscal policy. If it is just a matter of somewhat higher interest rates, after all, a government can just bite the bullet and accept higher interest spending in later years for the sake of putting a brake on the downturn today. But in the eurozone crisis, one number took on a magical quality: 7 per cent was frequently seen as the sovereign bond yield above which a government would have to seek a rescue loan or some other intervention.
It was never clear why. A hard stop to deficit spending would only come if bonds could not be sold at all. But both Italy and Spain, after all, retained market demand for their bonds, even if yields hovered around 7 percent. The ultimate budgetary cost would depend on how long yields remained that high, since it only applied to new bonds issued to fund deficits or refinance old debts falling due. What mattered, in other words, was the average maturity of government debt — how fast new borrowing was needed (at high rates) to replace old debt (paying lower rates).
Both concerns — ensuring market access in the first place and limiting the cost of higher yields — point to the same solution. The less an indebted government needs to refinance debts falling due in the short term, the less vulnerable it will be to temporarily high market interest rates. In other words, sovereign bonds are a safer liability for governments the more stretched out the redemption schedule is, or the longer the average term to maturity of government debt is.
The latest OECD data on sovereign debt show two things. First, governments have been moving in precisely the right direction since the financial crisis. Longer maturities now make up a greater portion of the outstanding debt stock; the average term to maturity across OECD sovereign borrowers has increased from about six to almost eight years in the past decade.
But second, the vulnerability to short-term refinancing risk remains high. Even the eurozone, which was badly burned by sovereign refinancing risk, needs to roll over outstanding debt worth nearly 15 per cent of its gross domestic product in the coming 12 months. This is at a time when deficits average only 1 per cent of GDP. With much more stretched-out debt maturities, refinancing needs could clearly be brought down to single-digit per cent of GDP, and perhaps low single digits in good times. Again, it is not the deficits but the refinancing of old debt that matters.
It is easy to see that a government which needs to find, say, 25 per cent worth of GDP of borrowing, as some eurozone states had to in the crisis, is highly vulnerable to market sentiment. A government that only needs to find, say, 5 to 6 per cent each year is much less vulnerable. But going from one situation to the other is in a government’s own hands; it can do this by issuing much longer-term debt and retiring shorter-term bonds. In other words, a government can unilaterally make its liabilities safe for itself; even the eurozone has no strong need for a common safe liability.
