Should We Worry About National Debt?

Governments have been borrowing for centuries. The figures for National Debt are staggering. In the US, National debt is $9.5trillion. From a personal perspective, we know debt is a bad thing. Therefore, it seems ridiculous that national debt can be so large. How much should we worry about these levels of national debt?

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.

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 up to 150% 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.

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.
However, although National Debt can be effectively managed, there are real concerns when debt grows faster than National Income.

Reasons to Be Concerned About Current Government Borrowing Levels

1. Government is not just borrowing for a short lived crisis. Government borrowing reflects a fundamental disequilibirum between spending and tax revenue. Borrowing as a % of GDP has been increasing in past few years, despite economic growth.

2. Present Government borrowing is not to finance investment in the economy. A large percentage of the debt is to finance transfer payments to an ageing population. If the government was borrowing to invest in infrastructure - new roads, communications. It might help to increase the growth rate in the long term. This in turn, would lead to higher tax revenues. However, paying pensions and health care to an ageing population, will do nothing to facilitate economic growth and higher tax revenues. It will get more and more difficult to finance the national debt.

3. Inflationary Pressure. There is a genuine 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 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.

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.
Perma Link | By: T Pettinger | Monday, October 6, 2008
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8 Comments:

Anonymous BASUDEB sEN said...

Well writen and lucid. Keep this record up. Cheers.

October 7, 2008 3:31 AM  
Anonymous Anonymous said...

What would a scenario be for a country without any national debt?

October 7, 2008 4:47 PM  
Blogger Tejvan Pettinger said...

A country would be pretty happy to have zero national debt. They would have no interest payments and could borrow money to invest

October 7, 2008 6:43 PM  
Anonymous Anonymous said...

Is there any country like that? Or likely to be?

October 7, 2008 8:34 PM  
Blogger Tejvan Pettinger said...

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.

October 7, 2008 9:59 PM  
Anonymous Anonymous said...

And what think ye of these proposals? Just found it when i found yours. http://www.prorev.com/sovreign.htm

November 29, 2008 9:28 PM  
Anonymous Anonymous said...

"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.

December 24, 2008 5:39 PM  
Anonymous Anonymous said...

bunch of grammatical errors. ms smith is a hoe

October 18, 2009 10:33 PM  

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