This plan makes perfect sense from the taxpayer perspective - if the markets are prepared to lend us money for nothing (in real terms) we should be biting their hands off. As Martin Wolf has said, the markets are saying "borrow and spend, please". Borrowing more, long-term, at low interest rates, to finance the infrastructure spending the UK needs - while creating jobs and generating growth - is exactly what the economy needs right now.
But this opportunity - the current level of long term interest rates - does not reflect "market confidence." Both economic theory and the empirical evidence suggest that the current level of long-term interest rates is primarily the result of economic weakness, not strength.
When long-term interest rates do start to rise - as they will at some point - it will be good news; reflecting the fact that finally a sustained economic recovery is beginning to take hold. At that point, anyone who has bought an "Osborne bond" will see a large capital loss. I don't normally give investment advice; but unless you think that government policies really are condemning us to a Japan-style lost decade (or ten) - and I'm not that pessimistic - I'd give it a miss.
First, some theory. What determines the level of long term interest rates on government debt? The standard neo-classical view is that, as the Bank of England puts it in its handy beginners guide to monetary policy, "long-term interest rates are influenced by an average of current and expected future short-term rates".
"Against this background, and that of its most recent projections to be published in the February Inflation Report, the Committee judged that the weak near-term outlook for growth and the associated downward pressure from slack in the economy meant that, without further monetary stimulus, it was more likely than not that inflation would undershoot the 2% target in the medium term."So what underlies the Treasury's contention that low interest rates reflect "market confidence"? It is, of course, true that reduced default risk should lead to lower interest rates on government debt, just as it should on any other debt. But, as I have pointed out before, there is not and has never been any significant default risk on UK government debt. Nor is there any obvious evidence that movements in interest rates have been related to changes in market perceptions of default risk. As I predicted at the time, Moody's recent decision to put the UK's rating on negative watch had precisely no impact on market interest rates.
Obviously, if we believed the Chancellor, the main thing driving interest rates would be the deficit, and in particular market expectations of the deficit going forward. Conveniently, the Treasury publishes a summary of external forecasts of the economy. These forecasts change over time, and here is the average of external forecasts for the deficit in 2013-14, plotted against ten year gilt yields.
[ADDED 8AM MARCH 14]
Fraser Nelson (who has also blogged on this here) correctly points out that I should also have mentioned the impact of quantitative easing (QE) on gilt yields. Although the methodology is hardly robust, the Bank of England estimates that the immediate impact of the initial round of QE was a reduction of 1 percentage point in gilt yields. More broadly, as both the article and the MPC minutes make clear, QE, exactly like ultra-low short-term interest rates, is the Bank's policy response to economic weakness and the possibility that inflation may fall below the target. So, to the extent that low gilt yields are the result of QE, this is again about economic weakness much more than "market confidence".
Moreover, at some point - when the economic news is better - the Bank intends to sell the gilts it has bought under QE back into the market. It is very difficult indeed to say ex ante what impact this will have on gilt yields, but it would be surprising if it did not push them up somewhat; another reason why rising yields will eventually go hand in hand with economic recovery.