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Why Not Lock In Low Interest Rates?

The federal government has failed to take up an historic opportunity to lock in ultra low interest rates on long term Government of Canada bonds.

Normally – as outlined in annual debt management reports – the government follows a strategy which is intended to achieve two main goals -  low overall debt servicing costs, and stable and predictable bond markets.  Since the yield curve is normally upward sloping – ie long term bonds carry higher rates of interest – the government issues a mix of treasury bills (t bills) and shorter and longer term bonds to balance the trade-off between cost and risk,  and the projected mix for the coming year is announced in the debt management strategy section of the annual federal budget. Borrowing needs for the coming year essentially consist of financing most of the annual deficit, plus refinancing current debt as earlier bond issues mature.

The latest debt management report (for 2010-11) tells us that the term structure of federal market debt has remained broadly stable since early 2008, before the financial crisis.  The share of treasury bills rose in 2009 as the government used this source to fund much of the sharp increase in the deficit, and it has since been run down by shifting from t bills to shorter term bonds.

But the share of long term bonds has remained quite steady at about 40% – 20% for ten year bonds, and 20% for very long term bonds (30 year bonds and real return bonds.) (See Chart 2.) The average term to maturity is just under 6 years.

The debt management strategy in the last Budget tells us that the government intends to continue reducing the overall share of t bills over the coming year,  but will maintain the share of long term bonds over the next ten years at about 40%.

As one would expect as a result of very low interest rates in the wake of the financial crisis, the average cost of servicing federal market debt has fallen to a low of 2.8% in 2010-11. But there would seem to be a strong case for shifting the term structure to long term bonds.

As of today, interest rates on long-term federal government bonds are just above record lows – 1.94% for ten year bonds, 2.5% for 30 year bonds, and 0.5% on real return bonds (ie 2.5% if inflation is 2%.)

Obviously the government and the Bank of Canada should not cease issuing t bills which are required to conduct monetary policy and to to maintain a stable bond market, but there is surely an opportunity to lock in ultra low interest rates for a very long period of time.  Why are we not taking advantage of it?


Comment from Roy McPhail
Time: December 31, 2011, 7:16 am

I would be interested in thoughts as to whether Mark Carney ever finds himself conflicted acting as both the Governor of the Bank of Canada and as Chairman of the Financial Stability Board of the G20.

Comment from Larry Kazdan
Time: January 1, 2012, 7:27 pm

Also, should government at all levels not be borrowing more from the Bank of Canada and less from private institutions?

Letter sent to Toronto Sun:

Re: Fiscal prudence for new year, Editorial, December 30, 2011

Your editorial equates fiscal prudence with smaller government and less stimulus spending on infrastructure. But although Canada’s national debt stood at about 120% of Gross Domestic Product (GDP) at the end of WWII, a period of great economic expansion followed, including the introduction of many government social programs. Much of the war and post-war funding was financed by the Bank of Canada at near-zero interest rates. So don’t confuse fiscal prudence with conservative ideology. Austerity programs that shrink the economy and cause even more suffering could well be fiscally imprudent.

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