Higher Debt-To-Gdp Agency … Lower Bond Yields?

This article addresses ane number regarding Fed “Tapering” (reduction of bond purchases, or Quantitative Easing (QE)) that I had non previously discussed: the touching of Fed purchases on bond yields. To recap my before article, I argued that QE had no touching on the economic scheme equally a outcome of the alter of size of the Fed’s residue sheet. But did QE lower bond yields equally a outcome of the increased demand for bonds? In this article, I laid out to outline why I scream back provide as well as demand factors accept express touching on the grade of bond yields.

Update: The analysis inside this article has been adapted to appear inside the mass Understanding Government Finance, which was published inwards 2015. The mass is an introduction to the operations of authorities finance, as well as has a tidings of what determines bond yields.

If provide as well as demand factors affair inwards the instance of QE, they ask to affair to a greater extent than generally. The nautical chart below shows the annual average of Treasury 10-year bond yields, as well as the Federal gross debt-to-GDP ratio. (Before 1962, “long-term” Treasury yields are used instead of the constant-maturity 10 years.)

When nosotros aspect at a scatter diagram of bond yields versus the debt/GDP ratio, the human relationship does non run across intuitive expectations. Influenza A virus subtype H5N1 basic plumbing equipment of the data* shows that increased debt/GDP ratios are associated amongst lower bond yields.

It seems somewhat surprising that this fairly potent human relationship regarding debt/GDP ratios as well as bond yields is non heavily publicised. I would propose that this is because it does non run across heuristic views close authorities finance – nosotros consider that increased provide increases the price! I accept seen dozens of sophisticated attempts to supervene upon the downward-sloping tendency inwards the higher upwards nautical chart amongst an upward-sloping relationship; soundless at that spot is no way I could encompass them all inside this ane article. To locomote fair, ane needs to proceed inwards hear the "financial repression" that capped bond yields during the 1940's as well as 1950's. But inwards whatsoever event, fifty-fifty if ane could bring out or as well as therefore agency past times which rising debt implies higher bond yields, the outcome has to locomote really modest to locomote consistent amongst the observed data. 

 Although this analysis is non applied to QE inwards particular, it is the kickoff of an declaration that provide as well as demand factors are of secondary importance for the conclusion of bond yields.

To locomote really clear, the plumbing equipment I demonstrate higher upwards is non a model; it an indication that the dynamics which generate high debt/GDP ratios too Pb to depression bond yields. It is possible to model the dynamics, as well as generate a model-predicted human relationship betwixt these variables. Influenza A virus subtype H5N1 quick suggested explanation of why higher debt/GDP ratios are associated amongst lower yields:

• When a modern Welfare State experiences slower nominal gross domestic product growth, the debt/GDP ratio rises rapidly. This tin locomote seen past times modelling the financial flows in a Stock-Flow Consistent Model.
• The park Central Bank reaction to slower nominal gross domestic product growth is to lower the policy rate, leading to lower bond yields via the charge per unit of measurement expectations persuasion of bond yield formation.

This explanation has been good covered past times Modern Monetary Theory (MMT) writers, amid others. (For example, Warren Mosler as well as Bill Mitchell.) Over time, I volition aspect at the number of provide as well as demand inwards to a greater extent than detail, given the importance of this theme to many bond marketplace position participants.

* If you lot wishing to reproduce these results, I regressed the logarithm of the yield on the logarithm of the debt/GDP ratio. This is the easiest way to larn a plumbing equipment of the apparently nonlinear human relationship inwards the scatter diagram. Influenza A virus subtype H5N1 linear regression volition accept problems plumbing equipment the data.

See Also:

• Understanding Government Finance, past times Brian Romanchuk

(c) Brian Romanchuk 2013