Interest rates and Budget Deficits

In the weeks surrounding the UK budget you will hear a great deal about the link between the UK budget deficit and interest rates on UK government debt. [1] Most discussion will be predicated on a simple idea: the way to get interest rates on government debt down is to run smaller budget deficits. There is a bit of truth in this, but not for the reason that many journalists suggest. This post is about this relationship. The first and most important point to note is that the continuing increase in interest rates on government debt is a global phenomenon. That means that the impact any UK specific action on longer term UK interest rates will be small relative to recent increases. I discussed possible reasons for this global trend in this recent post, although as Chris Giles notes the range of explanations indicates how little we really know. One possible influence is the AI boom. Another is inflationary pressure caused by the US attack on Iran, coupled with belief that this will keep…