One argument says that an increase in the national debt doesn't cause any problems. What happens is that by borrowing we merely enable the present taxpayer to enjoy a higher disposable income now rather than in the future. A cut in the national debt, would mean higher taxes now, rather than later. Therefore, national debt is just a way to spread national output amongst different generations. To understand national debt, it is important to remember how it is financed. Government debt is essentially a transfer from one part of the population to another. (Who owns national debt?)
Historical national debt
Furthermore, National Debt has been much higher in the past. During the second world war, the national debt of the UK and US, reached very high figures of over 150% of GDP. In the UK debt in the late 1940s reached over 200% of GDP. This is an example, of how a country can borrow during times of a national crisis and pay back the debt over a period of time. Therefore, national debt can be an effective way to deal with economic shocks such as recessions, financial crisis and world wars.
It is worth bearing in mind that in the 1940s, as well as paying for post war reconstruction we set up the NHS and welfare state. - There was no austerity panic in the 1940s!
Growth and Debt
Another factor is that economic growth usually makes it easier to pay back national debt. If GDP increases faster than national debt, then we need a smaller % of incomes to pay the debt interest payments. If GDP growth averages 2.5% a year, then increasing national debt by 2.5% means we will spend the same percentage of income on debt payments (assuming constant interest rates)
- An analogy. When I took out a mortgage loan of £140,000, I was left with mortgage payments of £800 a month. In 2004, this was nearly 40% of my income. However, if my income increases by 3% a year. In 20 years time, it will be much easier to pay that mortgage payment of £800, it will hopefully be 15% of my income. To buy a house, it makes sense to borrow a mortgage and pay back over 30-40 years.
Does Higher Borrowing cause higher bond yields?
In some cases (such as Eurozone economies) higher debt have pushed up bond yields. But, these are countries without their own currency and countries who have no ability to print money. Therefore, they are subject to liquidity fears.
Rise in net borrowing (annual budget deficit) didn't cause bond yields to rise.
The UK has seen a fall in bond yields during the recession of 2008-12. This is because, in a recession, private sector saving rises. Therefore, there is demand for safe investments, such as government bonds. In a recession, people don't want to take risks, therefore demand for shares and private investment tends to fall. In a recession, government borrowing doesn't tend to cause crowding out. Government borrowing is merely mopping up private sector saving.
From a Keynesian perspective, government borrowing can help to boost aggregate demand and offset the fall in AD. Borrowing can provide a boost to economic growth and therefore, help improve tax revenues.
Possible Reasons to Be Concerned About Government Borrowing
1. If the Government is not just borrowing for a short lived crisis. If government borrowing reflects a fundamental disequilibirum between spending and tax revenue then this may lead to unsustainable debt levels in the future.2. If borrowing is to finance welfare payments with an increased level of dependency. Paying pensions and health care to an ageing population, will do nothing to facilitate economic growth and higher tax revenues, and it will become more and more difficult to finance the national debt. Some are concerned that countries like Japan have a high debt (over 220% of GDP), but the real problem is the rapidly ageing population which will put even more pressure on Japanese debt levels.
3. Inflationary Pressure. There is a concern that higher levels of national debt can cause inflation. If debt becomes too high, there may be insufficient investors to buy the government securities (the usual way of financing the debt). Therefore, the government may be tempted (or forced) to fill the shortfall in revenue by printing money. Printing money and increasing the money supply, will lead to inflation. The problem with inflation, is that it devalues the value of bonds, people will sell bonds, leading to higher interest rates on bonds and higher debt interest payments. If investors see inflation is getting out of control, people will not want to hold bonds. Foreign investors will sell their securities and this will cause a devaluation in the currency. This is particularly a problem for the US, where foreign countries hold a high % of the national debt.
The hyperinflation of Germany in 1922-23 was caused by the government printing money to finance reparation payments to the allies. However, it should be pointed out, this is quite rare and only occurs if the government prints money recklessly without regard to the fundamental economic situation. Quantitative easing in 2009-12 didn't cause inflation in the UK and US. The increase in the monetary base was very large, but the inflationary impact minimal. - Inflation and quantitative easing.
4. Crowding Out. It is argued that if government borrowing increases, it will cause crowding out of the private sector. If the private sector buy bonds it means the private sector has less funds for private sector investment. Also, if borrowing increases, interest rates may rise. Higher interest rates also reduce private sector spending and investment.
5. As National Debt increases as a % of GDP, it means that the interest payments as a % of GDP increase. Therefore, higher levels of taxes have to be spent on just financing the national debt.
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11 comments:
Well writen and lucid. Keep this record up. Cheers.
What would a scenario be for a country without any national debt?
A country would be pretty happy to have zero national debt. They would have no interest payments and could borrow money to invest
Is there any country like that? Or likely to be?
Maybe the Vatican City (if that counts as a country).
Or some principality like Lichtenstein. - very small and very rich. Or maybe some rich oil producing country like Qatar.
I think it is unlikely, you don't gain popularity by abolishing the national debt, you gain popularity by cutting taxes and increasing spending.
And what think ye of these proposals? Just found it when i found yours. http://www.prorev.com/sovreign.htm
"If debt becomes too high, there may be insufficient investors to buy the government securities (the way of financing the debt). Therefore, the government may be tempted (or forced) to fill the shortfall in revenue by printing money."
I thought the government 'sells' the central bank buys and creates 'money' in the governments account anyway?
`the central bank then creates more 'reserves' to loan to commercial banks with a lower rate of interest.
bunch of grammatical errors. ms smith is a hoe
National Debt makes sense. If a government was £80 billion in the black they would be criticized for not spending that money on those who could really use it. And there is no sense in keeping national debt hovering at around zero; buy a new hospital ward one week, a tank the next, then maybe put the next few months spending into a new university. A government that develops and improves all services at the same time, and in meaningful measures, is going to build up national debt but it is the only way to do things.
Why does a rising public sector debt burden ( debt interest as a proportion of GDP) cause an intergenerational shift of disposable income to the present generation from future ones when gilts are held in the UK? The holders will benefit from interest payments just as the taxpayer has to pay them, so these payments offset. What proportion of gilts are held abroad?
Why does a rising public sector debt burden ( debt interest as a proportion of GDP) cause an intergenerational shift of disposable income to the present generation from future ones when gilts are held in the UK? The holders will benefit from interest payments just as the taxpayer has to pay them, so these payments offset. What proportion of gilts are held abroad?
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