Monday, June 22, 2009

Government Borrowing and Output Gap

The Output Gap is the difference between actual Output and potential Output. With a fall in GDP, the UK has seen a rise in its output gap. This output gap is most easily visible with the rise in unemployment to over 2.25 million.

Public sector net borrowing is the annual amount the government has to borrow from the private sector to meet the shortfall between government spending and tax revenue.

As GDP falls, borrowing rises. Tax receipts fall and spending on unemployment benefits increases. The UK budget was particularly hammered because in the boom we increasingly relied on stamp duty from housing market and income tax from the city. With both the city and the housing market hit hard, the government has seen a dramatic rise in borrowing.

Interestingly in the 1981 recession, government borrowing actually fell. This is because of the different circumstances behind the recession.
In the 1970s, government borrowing rose to 8.1% of GDP in 1975 and 7.2% in 1976 (requiring a bailout from IMF). In 1979, the economy faced high borrowing and inflation of over 20%. The incoming Conservative government pursued strict monetarist policies of tight fiscal and monetary policies to reduce inflation. Taxes were increased. This reduced borrowing but caused a sharp slowdown in GDP and a steep recession. In other words the fall in borrowing caused the recession (though some economists would say it was necessary to reduce inflation. Others said the fiscal tightening went on too long to chase money supply targets which proved misleading. For more info see: 1981 recession)

The 1981 recession was different to the current recession because the motive was to remove inflation from the economy; there was no crisis in the banking system like we see now.

UK national debt

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