In the UK and EU austerity programmes are rife. However, bond yields are also historically low, and have even been negative! At a time when debt is cheaper than ever, and below the accepted long term rate of inflation, why do governments not take this "free" money to maintain their states? Or, is it the austerity itself that is driving the rates?

  • 1
    $\begingroup$ Because the elected governments (at least for UK, DE) are ideologically for austerity and against an increase in debt. Why that is the case would make an interesting question over at politics $\endgroup$
    – user45891
    Jun 15, 2015 at 16:10
  • $\begingroup$ @user45891 Yes, I'm sure that is the case, but they seek to justify it in economic language. $\endgroup$
    – James
    Jun 21, 2015 at 8:47
  • $\begingroup$ @user45891 While I'm all in for calling politicians ideological straw men, your comment implies that doing what OP is observing cannot be a rational choice, which I strongly disagree with. See my answer. $\endgroup$
    – FooBar
    Jul 15, 2015 at 11:59

3 Answers 3


Debt being cheaper than ever doesn't mean that it is optimal to borrow. Unless you plan to invest the borrowed money into projects that yield higher returns with certainty (we would call this arbitrage), any debt implies a tradeoff between the welfare of current versus future generations.

  • Perhaps the borrowing before to higher rates was non-optimal under the current government's perspective. I.e. now we place a higher value onto future generations versus current generations
  • Perhaps now in the slump, the government doesn't see investment opportunities that yield a sufficiently high return.
  • Perhaps the current government has a different prior on how high returns to debt are. Different governments (or the same government over time) can have a different prior (guess) on how important/productive government spending onto infrastructure, education, health, military etc. is. This also includes a prior on how large the Keynesian multiplier is, and how effective demand stimuli are. Then, even presented with the same investment opportunities at a lower interest rate, a current government might chose differently than the previous government.

This was all without political economy consideration. There are arguments on optimal spending that take into account how your current budget will affect the budget of future (different) governments. Have a look at Persson and Svensson (1989) to get a feel for this kind of political economy reasoning.

Note that the argument in the cited paper would go the wrong way (i.e., too much spending of a conservative government), but it shows you how optimal policies under a permanent ruler can differ from optimal policies in a democracy.

  • $\begingroup$ FooBar, the intergenerational story is conventional, but not appealing. Government borrow from savers (via pension funds, banks, et al.) and lend money to borrowers (government agencies, sovereign investment vehicles). This debt is a part of the intermediation process. There's, of course, redistribution via debt as well, but it also happens within the current generation. $\endgroup$ Jul 15, 2015 at 12:31

I guess a very demagogic answer from one of such governments would be "if we take on more debt, we'll end up like Greece".

Now, a more serious government may try to justify the low level of debt in different ways:

  • The levels of unemployment in the UK 5.6% and in the EU 9.6%, are not far from their historical averages. One of the reasons to take on more government debt is usually to increase government spending which, in the Mundell-Fleming model, translates into higher output. This higher output translates into a shift of the aggregated demand (AD) curve to the right which implies an increase in inflation ceteris paribus (which implies fixed aggregated supply curve (AS)). The fixed AS curve can be thought of as a consequence of nominal wage rigidities in the short term. Anyway, the shift of the AD curve will imply higher inflation, as said before, as well as a decrease in the unemployment rate. The exact impact on inflation and unemployment will depend on how far the unemployment rate is from its natural level. All this is to say that one possible reason for governments to not increase their level of debt is that either the government is satisfied with the current unemployment level and wants to maintain a stable level of inflation or the government gives more priority to the level of inflation than the level of unemployment. The latter case is usually right for conservative governments.

  • Another possible justification is, and this might apply more to governments in the south of Europe were inflation is low and unemployment high (i.e. they could really use something that boosts up output like an increase in government spending), is that the low bond yields are subject to them following a fiscal policy aimed at austerity (low or no deficit and pay back the existing debt) due to their high levels of debt to GDP. This means that if those countries were to take on more debt, they'd probable be seen as irresponsible and fiscally undisciplined by the market and their yields would rise, causing some, if not all, of the benefits of taking on the new debt to disappear, for example all the gain in output goes to pay off the increased debt interest.

I'm sure there are more ways that I left out in which a government could justify not issuing more debt, but I hope these two give you a good idea.


Three key reasons:

  1. Public spending spillovers. The European Union isn't very united, and national governments still think locally. When they implement a stimulus, its effect on demand and employment spills over the neighboring countries. (That's one reason why the US is effective: the American states relied on the federal stimulus after 2008.)

  2. Business lobby. The public debt coupled with fiscal deficit are associated with higher taxation. And some European countries did raise taxes. Naturally, in this case, business and the rich prefer austerity over taxation. Leave alone the ideology of government intervention, which they also dislike.

  3. Government inefficiency versus demand. Some national governments in Europe score low at public governance. The logic is, if you give them more discretion, they'll spend money on hiring other inefficient public officials without much effect on the economy. See, for example, what the EU thinks about GIIPS. Ex-post, fiscal multipliers happened to be higher than the EU thought, but the time was wasted.

These are bad reasons, but they work for austerity.


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