Thursday, 6 December 2012

Robert Chote on the irrelevance of the credit rating agencies

I have frequently argued two, related, points.  First that, unlike countries in the eurozone, the UK's fiscal policy is not constrained by potential market fears of default; and second, that since the ratings of the credit rating agencies are in principle intended to reflect this non-existent default risk, the UK's AAA rating, and any possible downgrade, is meaningless and irrelevant. For these reasons, paying any attention to the ratings agencies when making policy is a serious mistake.  As I wrote here:

"In the event of nuclear war or an asteroid strike, it is possible the UK government might not pay its debts.   Then we'll have other things to worry about. Otherwise, it will, simply because it can -  and because the consequences of not doing so are dreadful...Saying that there is any meaningful probability that the UK will default on its debt - which is what downgrading the UK means - is not to take a particular view on the UK economic or fiscal outlook. It is simply not to understand what you are talking about...So how should the government, and the markets, respond to the rating agencies?  The former should, and the latter in my view will, simply ignore them."
I therefore watched with interest the characteristically combative exchange on this topic between Jeremy Paxman and Robert Chote, the head of the government's independent Office of Budget Responsibility, on Newsnight.  Here's my transcript (edited a little for clarity) or you can watch it here:
Paxman: Would you give this country a AAA rating?
Chote: That's not something that we have to reach a judgement on. I think the notion of a credit rating agency in terms of thinking about are the governments finances sustainable -the key difference is that we are in a position where we have our own currency and in that sense we have a greater degree of flexibility that means that the notion of the danger of insolvency is a much different question for us relative to for example countries in the eurozone..
Paxman: You mean we could just print more money
Chote: Well the government has been doing a deal of that. The Bank of England has been doing a deal of that to help keep demand going. So I think that people  take  a broad view on whether they think this government or any other government is going to deal with the difficulties in the public finances over an appropriate time horizon.
Paxman:  A lot of people say it would be a political disaster if we lost the AAA rating. From the point of view of a highly trained economist would it matter?
Chote: Well other countries have seen downgradings and have been in a similar sort of position and it's not made an enormous amount of difference to the reactions the markets have to them. As I say, often credit ratings agencies are looking at the same information that everybody else does and it's not clear what additional information a would-be investor in British government debt learns from that that they couldn't have learned from looking at our forecasts and other forecasts.
In other words, unlike countries in the eurozone, there is no possibility of the UK defaulting, so our fiscal policy is not constrained by markets in the same way; and we should ignore the credit rating agencies, because they're irrelevant.  Precisely. 

8 comments:

  1. Osbourne used the triple A credit rating and the retention of it as a justification to push through his oxymoronic "expansionary fiscal contraction". Telling any who would listen that the markets would crucify us if we lost it.
    Now it looks as though we might,well it's not such a big deal after all now,he says.
    What a imbecilic,useless chancellor he is.

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  2. If it is lost and the market response, measured by the change in UK borrowing costs, was "meh" (which it obviously would be) , then one of the primary justifications for current government policy would look a tad silly. As would the chancellor - so either it does matter and he's the man who lost our coveted AAA status or it doesnt and its a u-turn after inflicting avoidable pain.

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  4. And if further evidence of the ratings agencies being a lagging indicator were required:

    http://fivethirtyeight.blogs.nytimes.com/2011/08/08/why-s-p-s-ratings-are-substandard-and-porous/

    The 10yr UK Gilt yields about 1.73%... markets have already priced in a protracted period of low growth with no apparent fears of outright default (or implicit default through inflation)

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