There’s an interesting mix of contrast and similarity between the policy debates in Britain and the United States right now. In both countries — as in every country that retains its own currency and has debts denominated in that national currency — interest rates are near record lows…
It’s very hard to come up with any reason why either the US or the UK might default, since they can simply print money if they need cash. And given the absence of real default risk, long-term interest rates should be more or less equal to an average of expected future short-term rates (not exactly, because of maturity risk, but that’s a fairly minor detail).
So if you expect the US and UK economies to be depressed for a long time, with the central bank keeping rates low, long rates will be low too — end of story.
But won’t that money printing cause inflation? Not as long as the economy remains depressed.
I vaguely recalled a debt and inflation crisis in Great Britain from the 1970s, so I googled to get the details. Try this summary from the UK national archives:
Sterling devalued and the IMF loan
Devaluation of the pound
The left wing of the Labour Party defeated the Public Expenditure White Paper in the Commons in March 1976. Subsequently, Harold Wilson resigned and James Callaghan took over as Prime Minister. Around this time, investors became convinced that the pound was overvalued and that the government might devalue. A large-scale sale of sterling began, which rapidly lost value against the dollar.
In spite of further efforts to reduce inflation, the pound continued to lose value, reaching a record low against the dollar in June 1976….
The 3.9 billion dollar loan
As pressure on the pound continued, the government approached the IMF for a loan of $3.9 billion in September 1976. This was the largest amount ever requested of the Fund, which needed to seek additional funds from the US and Germany. The IMF negotiators demanded heavy cuts in public expenditure and the budget deficit as a precondition for the loan. Healey’s proposals for a cut of around 20 per cent in the budget deficit were hotly debated in Cabinet, particularly by Anthony Crosland and Michael Foot. Eventually they acceded, as it seemed likely that the refusal of the loan would be followed by a disastrous run on the pound. Healey announced the forthcoming reductions in public expenditure to the House of Commons on 15 December 1976.
Following the agreement with the IMF, the overall economic and financial picture improved. Interest rates were soon reduced and the pound quickly appreciated in value. By the end of 1977, partly as a result of new oil revenues, there were improvements in the balance of trade. Britain did not need to draw the full loan from the IMF. Nevertheless, the IMF crisis reinforced a change in policy orientation away from full employment and social welfare towards the control of inflation and expenditure.
I know, I know: The only reason anything bad happened, was that the people in the UK government, the US government, and the IMF were all nuts. Had they just let the pound continue to sink, everything would have been fine. Krugman’s medicine just needed a larger dose and more time to prove its efficacy.
Also, in the 1970s there was disco fever. That isn’t the case today. Clearly the British experience in 1976 has no relevance for our current crisis. Only those ignorant of basic economics and world history could possibly think huge debts pose a problem for a government with a printing press.