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.

TO BE NOTED: From Worthwhile Canadian Initiative:

"Failed" government bond sales?

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.

Posted by Nick Rowe on March 26, 2009"