The crisis has brought important lessons about the benefits of possessing a freely floating currency. One benefit, UK experience suggests, is monetary and fiscal policy autonomy. But a substantial depreciation has contributed much less to the adjustment of the current account than most would have expected. These lessons have important policy implications.
As Belgian economist Paul De Grauwe of the London School of Economics has noted, the benefits of retaining a currency on one’s own are visible in the post-crisis interest rates paid on long-term public debt. The observation is simple: the International Monetary Fund forecasts for the ratio of net public debt to gross domestic product of the UK and Spain are essentially identical. In 2017, the ratio is 93 per cent for the UK and 95 per cent for Spain. Yet the yield on UK 10-year bonds is firmly under 2 per cent – among the lowest in UK history, and not much above Germany’s. The yield on Spanish 10-year bonds, meanwhile, is just under 5 per cent, far below the 7.5 per cent last July, but expensive for a country that is being forced towards deflation.
Why should countries with such similar fiscal positions face such different bond yields? One possible explanation is the UK’s long history of successful debt management. Also relevant is the fact that Spanish bonds may still be thought subject to the catastrophic risk of a eurozone break-up, despite the European Central Bank’s promise to intervene via its programme of outright monetary transactions. The ability and desire of the Bank of England to prevent outright default is more credible than that of an independent, supranational central bank. The BoE, as buyer of last resort, also promises market liquidity. If the market for public debt is subject to self-fulfilling prophecies of good or bad outcomes, this should guarantee stability at favourable rates.