Unlock the Editor’s Digest for free
Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The writer is a professor emeritus at the Stern School of Business at New York University and senior economic strategist at Hudson Bay Capital
The rise in long-term rates around the world is worrying finance ministries and Treasury departments. Higher rates not only make servicing the rising public and private debt burdens more costly, but also put economic growth at risk.
Independent central banks are reluctant to intervene by resuming past quantitative programmes of buying long-term bonds, or even cutting benchmark policy rates given above-target inflation in many leading economies. So backdoor quantitative easing via new forms of public debt management has become an option for financial ministries.
During Joe Biden’s administration, the US Treasury department started to change the composition of public debt issuance with more short-term offerings.
In a paper last year with my former colleague Stephen Miran — now chair of the Donald Trump administration’s Council of Economic Advisers — we labelled this strategy as Activist Treasury Issuance.
ATI was a variant of the so-called Operation Twist, where, after the financial crisis, the Federal Reserve pushed rates on longer-term bonds lower by purchasing them and selling shorter-term debt at the same time. Instead, however, the Treasury pushed down long-term debt by selling less of it.
We criticised ATI as a form of encroachment on monetary policy by fiscal authorities. And many Republicans — starting with the current Treasury secretary Scott Bessent — echoed similar concerns.
However, despite Miran and Bessent’s roles in Trump’s senior economic team, ATI is not being phased out. It is being continued for now, as phasing it out would sharply increase long rates.
Worse, Bessent is flagging the prospect of ATI with a far deeper form of Treasury-led QE: he has stated that if market conditions were to become disorderly, the Treasury could decide to do more outright buybacks of longer-term public debt as a way of preventing long rates from increasing too much.
And now ATI is becoming contagious across the world. In Japan, 10-year bond yields started to rise from negative before 2022 to close to 1.6 per cent now as the Bank of Japan started to normalise policy rates; long rates are rising also because public debt ratios are close to 250 per cent of GDP. Given the bar for the BoJ to resume QE is very high — probably another deflationary recession — the Japanese Ministry of Finance is reportedly considering its own ATI programme to issue less longer-term bonds and more short-term debt.
So, the prediction of my paper with Miran is becoming reality; once a government starts ATI, the risk is that its successors will become addicted to it or even double down on it like the Trump Treasury may do. And this encourages other countries, like Japan, to start their own ATI programmes.
Who else could go into ATI after the US and Japan? For now ATI in the Eurozone is unlikely as the European Central Bank has emergency facilities to resume QE if spreads on different sovereign debt widens excessively beyond what is justified by market fundamentals. Also, there is no central fiscal authority in the Eurozone that can issue significant amounts of debt, which is a joint liability of the union. The UK is a more likely candidate given its shaky fiscal position.
Economists have long discussed whether a game of chicken between a loose-budget government and a monetary authority committed to price stability leads to fiscal or monetary policy dominance. But with inflation still higher than target in the US, Japan and UK, and rising public debt more generally, we are now moving away from a world where central banks wimp out and support the financing of large deficits.
Over time it will be increasingly tempting for fiscal authorities to try to implement policies such as ATI that keep a lid on long-term bond yields. But this is a risky, slippery path that leads fiscal authorities to interfere de facto with monetary policy.
In turn, this can lead to inconsistencies between monetary and fiscal authorities that cause moral hazard by encouraging more risk-taking with leverage and inflaming inflation. Measures like ATI lead to looser financial conditions at times when monetary authorities are trying to achieve price stability and avoid the excessive overheating of their economies. This is dangerous stuff, opening the door for a more political business cycle.