The UK government "failed" to sell all the bonds it wanted to sell to finance its deficit spending. The story is here. And here.
There are many aspects of this story I find puzzling.
1. What does "failure" mean? Does it mean that nobody would buy all the bonds at any price, or does it just mean that the price would need to be lower (and the yield higher) than the government was prepared to accept? Is 4.55% unacceptable? That's a low yield, historically. Or should I think of the government, like a monopolist, picking a point on a downward-sloping demand curve for its bonds? If so, how should I think of its MC curve?
2. Why is the government selling bonds while the Bank of England is buying bonds? Why doesn't the government just sell to the Bank of England? I recognise that the government is selling 40-year bonds while the Bank of England is buying 10 year, but why is this? Why don't they both choose the same term to maturity? The only reason I can think of is that they both want to lengthen the average term to maturity of the national debt. Why would they want to do this? Is it to reduce the risk of being unable to rollover maturing debt?
3. This explanation for the failure doesn't make sense to me:
Robert Stheeman, head of the U.K.’s Debt Management Office, which runs the bond auctions, says it wasn’t able to attract enough bids partly because of the Bank of England’s efforts to lower yields through debt purchases.
“Yields at these levels are not at all attractive,” Stheeman, chief executive officer of the Debt Management Office, said yesterday in an interview in London. “Yields have shifted downward. Why have they shifted down? It’s partly because of the Bank of England’s announcement about quantitative easing.”
Why should the Bank of England's increased demand for bonds make it harder for the government to sell bonds? Lower yields mean higher prices, which should make it easier for the government to sell bonds at any given price. Now maybe 10-year and 40-year bonds are not perfect substitutes, but are they complements?
4. Why is it bad news? One of the main features of the financial crisis is a rush to buy only the safest and most liquid assets — money and government bonds — and not to buy anything else, like commercial bonds and stocks, and newly produced goods. Prices of government bonds are high, prices of commercial bonds and shares are low, and there is an excess supply of goods and labour at sticky prices. News that people are unwilling to buy more bonds suggests to me that they are willing to buy more of something else instead, which is exactly what we want them to do. Or if the news is not that the demand for bonds is low, but that the elasticity of demand for bonds is low, that's goods news too. It means that monetary policy can be more effective, because we are not in a liquidity trap. An open market purchase of 40-year bonds by the Bank of England could lower interest rates.
The case for fiscal policy is that people want to buy bonds, not money or goods, so the government has to sell them the bonds they want to buy and use the proceeds to buy the goods people don't want to buy. If people change their minds, and decide they don't want to buy bonds, then what do they want to buy instead? If it's money, that's OK; the Bank of England just sells them all the money they want to buy. If they want to buy goods, that's OK too, because then the government doesn't need to, and so doesn't need to sell bonds.
Worthwhile Canadian Initiative 
I would guess that “failure” is mostly an institutional issue, where somebody in the government (or an agent thereof) made a wrong estimate of the price at which the bonds would sell — which means that the demand was lower than the government expected and therefore probably lower than what most people expected.
I share your puzzlement with respect to the other issues (and have expressed similar puzzlement regarding the US).
Andy: I’m glad to hear I’m not the only one puzzled by this stuff! I think your interpretation of “failure” makes sense, but then it’s not such a big deal, really. If bond issues didn’t sometimes “fail” in this sense, and were always over-subscribed, it would mean they were pricing them too low.
just to revisit Patrick’s comment from yesterday:
“Excess reserves are starting to drain out of the Fed.
http://research.stlouisfed.org/fred2/fredgraph?chart_type=line&s%5B1%5D%5Bid%5D=EXCRESNS&s%5B1%5D%5Brange%5D=5yrs“
here’s a story on that from some of Canada’s best and brightest:
“Excess reserves of US depository institutions are total reserves less required reserves. Latest figures show that they have fallen on a non seasonally adjusted basis by just over 25% since Jan 14 or $222bn (from $844bn to $622bn). Rather than being an encouraging sign it is in fact the opposite. It largely reflects the fact that swap lines have been cut back in response to government gteed bank debt.”
bill yields slightly negative this morning seem to confirm that this was not due to a sudden demand for credit…
Hi Nick,
In answer to question #1, the answer is that the government determines, in advance, the rate at which they expect the auction to clear. Since rate is the same as price, the two are obviously interchangeable.
Failure simply means that not enough bids could be attracted at a high enough price (low enough yield) to clear the volume. A similar thing happened yesterday in the US. The auction cleared but at a higher rate (lower price) than was expected.
In answer to #4, this is “bad news” because it means that there may not be enough demand for the bonds for the government to fund itself. Sure, it can just print money, but they would surely prefer that the new “on the run issues” go to private investors while the BoE takes older “off the run” issues off the market.
Andrew, but what we don’t know is whether this was a case of investors not putting in enough bids, at any price, or of the DMO refusing to fill some bids because they weren’t high enough.
If nobody will lend me money at a price I can afford, how is that not a failure?
it is a failure and definitely bad news.
“…don’t want to buy bonds, then what do they want to buy instead? If it’s money, that’s OK; the Bank of England just sells them all the money they want to buy.”
How does that work? They trade in their old wrinkled bills for new ones?
But seriously, how and why would anyone pay cash for cash? Or trade some numbers in a bank account for the same numbers in the same order from the central bank?
asp: maybe it was because I had recently arrived in Canada, or maybe it was because I had been thinking too much about macro/money, but I once went into the Bank of Montreal and told the teller I wanted to buy some Canadian dollars. She gave me a weird look, so I explained again what I wanted to do. “Oh, she replied, you want to sell some foreign exchange!”. Same with the Bank of Canada above. If the Bank of Canada buys something, anything, it sells Canadian dollars. The thing the Bank of Canada normally buys (apart from economists, computers, and stuff like that) is IOUs, either from the banking system, or from the government (i.e. bonds).
Adam P: I still don’t get why it’s bad news. My guess is that it’s a symbol of the same increasing confidence (or increased expected inflation, or whatever) that caused stock prices to rally. I just hope it lasts.
Adam P: Do I have it right that a swap line is when the Fed and a foreign central bank agree to swap dollars for foreign currency for a fixed period of time at a fixed exchange rate? Supposing that’s more or less how it works, how would that directly affect excess reserves of US depository institutions?
I don’t have any proof, but I’m inclined to think that the banks are starting to believe that nationalization is off the table and the US Gov’t will rescue them no matter what. As a consequence, they’re draining down their reserves they accumulated. My fear is that Simon Johnson is right, and they’re using the money to take big risks to try to win back their losses; something that almost never works.
I hope I’m wrong …
Nick, it implies potential bond buyers think long term government debt is riskier than cash (maybe they are waiting for the opportune time to invest in debt of another more credit-worthy country, or an inflation hedge, or an interest rate that the government can’t afford). How could that be interpreted as anything other than bad?
Nick, in my view it’s bad because it interferes with the BoE getting yields lower. I agree, it likely reflects higher inflationary expectations which is a good thing. However, what we need is a lower/negative real rate and higher expected inflation that is compensated for in higher nominal yields gives you a real rate that hasn’t changed. This get’s us nowhere.
Patrick, what I understood from the story about swap lines (the story isn’t mine, I just repeated it), is that it referred to swap lines between the banks. That is, the banks are substituting gov’t guaranteed debt issuance for interbank borrowing (cheaper to issue gov backed paper to the market then borrow from another bank). This is bad because inter-bank lending (along with effective credit intermediation) is necessary for the magic of fractional reserve banking to work. Now that I think about it I’m actually less sure, but that was my understanding.
http://www.bloomberg.com/apps/news?pid=20601085&sid=a4a00k8exdVU&refer=europe
Hurray! 3.2% increase in consumer prices in the UK. Does that mean quantitative easing worked, the economy has recovered and they can raise interest rates?
…but the economy hasn’t recovered yet. What happens if we get 6% increases in a few months and still no recovery? Do you keep printing forever or do you have a cutoff point at which you admit quantitative easing failed?
pointbite 12.41, Adam P: The central bank is trying to lower interest rates relative to the natural/equilibrium/neutral level of interest rates. I would interpret difficulty in selling bonds as evidence of an increase in that natural/equilibrium/neutral rate. Put it another way: the government is trying to borrow and spend only because people aren’t willing to borrow and spend, and are too willing to lend and not spend. Difficulty in the government borrowing means that people are less willing to lend and more willing to spend.
pointbite 3:35: The object of monetary (including QE) and fiscal policy is to increase aggregate demand to prevent deflation. If it succeeds in preventing deflation (and keeps inflation going), that’s all we can ask it to do.
pointbite, seriously. Why be deliberately obtuse? That number refers to inflation for the past 12 months. Consumption is determined by expectations of future inflation and everyone who’s saying anything publicly (including those quoted in the article you linked to) still expect it to be lower. Also, RPI was zero and wages basically flat. We want inflation but not a falling real wage rate, we hope the real wage will be determined by productivity as usual. Finally though, to the extent this actually means the UK is a bit farther from deflation then it is good news.
Nick: “Difficulty in the government borrowing means that people are less willing to lend and more willing to spend.”
In this case though it seems likely they just bought bonds from other governments or waited for a later auction. Moreover, this failure was probably a blip due to some (probably misunderstood) things that King said this week that drove yields higher. Stock rally aside, I don’t see much evidence that this really represented a rush to buy real assets. Of course you could be right but I’m still bearish the real economy.
Adam P: well, you really got me thinking, and thinking a lot to try to get my head clear and my reasoning straight, so I did a whole post on that issue! That’s why I like blogging!