Is it possible for a country to completely pay off its national debt?

Readers Question: Is it possible for a country to completely pay off its national debt?

Yes. A country with an easy source of tax (e.g. oil rich Middle-East countries) could easily run a budget surplus and buy back any previous government bonds.

It is possible people may not want to sell bonds to the government; they might like to keep the investment which promises to pay a guaranteed interest rate. In that case, the government would have to wait until the bonds expire at the end of their 10,20 or 30 year period.

According to CIA Factbook, the country with the lowest national debt as a % of GDP is Liberia [1] with 3.3% of GDP.

Is it desirable to pay off national debt?

A problem with paying off the national debt is that the country would effectively have no bond market. People with savings wouldn’t be able to choose the secure option of buying government bonds. It might encourage domestic savers to look abroad and buy bonds in other countries – causing an outflow of money.

Running a persistent budget surplus could also depress aggregate demand. The government is effectively withdrawing money from the circular flow of money.

If you look at countries with the lowest national debt as a % of GDP – they are not particularly countries with the best living standards.


Liberia, Libya, Oman, Kuwait, Takikstan, Estonia.

List of national debt by country


Money supply and the exchange rate

Readers Question: Does expansionary monetary policy, where money supply is increased, also cause a depreciation in the currency? since there is a surplus of the currency in the foreign exchange market.

Expansionary monetary policy means policies to increase demand in the economy. Expansionary monetary policy typically will involve:

  • Lower interest rates – to make it cheaper to borrow and encourage both consumption and investment.
  • Increasing the money supply, e.g. through quantitative easing – creating money electronically

In many circumstances an increase in the money supply could lead to a depreciation in the exchange rate. This is for two main reasons:

1. Inflation. Everything else being equal, an increase in the money supply is likely to cause inflation. (why increase money supply causes inflation) Alternatively, if expansionary monetary policy involves cutting interest rates – lower interest rates will tend to increase aggregate demand leading to possible inflationary pressure. (Effect of lower interest rates)

This domestic inflation will make your goods relatively less competitive and export demand will fall. Therefore, there will be less demand for the currency and its value will tend to fall on the exchange rate markets.

2. Lower interest rates. Also, if you increased the money supply, (through a Central Bank creating more money), then this reduces interest rates.


Higher money supply puts downward pressure on interest rates.

Lower interest rates will also tend to reduce the value of the currency. If UK interest rates fall relative to elsewhere, it becomes less attractive to save money in UK banks. We will see an outflow of ‘hot money’ as investors move to countries with higher interest rates. This will put downward pressure on the currency as people sell Pounds to buy other currency.

Why Expansionary monetary policy may not cause depreciation

The Pound fell rapidly in 2007 to early 2009 during the start of the credit crunch and great recession. But the Pound recovered in the period 2009-2012 – despite expansionary monetary policy and quantitative easing in this period.


In the great recession, we saw countries pursue expansionary monetary policy (Quantitative easing, zero interest rates) and at the same time, there wasn’t a depreciation in the currency). How could this occur?

1. Expansionary monetary policy may not actually increase the money supply

In the UK, quantitative easing created £375bn of new money to buy assets, however, this didn’t translate into higher money supply (M4). In the UK, M4 growth remained weak.


See: Quantitative easing and Money supply

There were a few reasons for this. But, one is that people preferred to hold the extra money. Banks didn’t lend the extra reserves they gained from selling assets to the Bank of England. Therefore, expansionary monetary policy didn’t lead to an excess supply of currency and depreciation in the Pound.

2. Liquidity trap

An increase in the money supply doesn’t always cause lower interest rates. In a liquidity trap, monetary policy can’t reduce interest rates because they are already at the ‘Lower zero bound rate’


If interest rates stay the same, we don’t get an outflow of hot money.

3. Expansionary monetary policy may not cause any inflation


The great recession is fairly unique in that the UK pursued expansionary monetary policy (zero interest rates, quantitative easing and even forward guidance to try an increase inflation expectations). But, UK inflation fell from mid 2011, even though monetary policy remained expansionary. Therefore, there has been less downward pressure on the currency than we might expect.

4. Other factors affecting currencies

e.g. Relative strength of currencies. In normal economic circumstances, we would expect zero UK interest rates to lead to a fall in the value of Sterling. But, in the great recession all currencies have been relatively weak. For example, investors have been put off the Euro due to the Euro debt crisis and austerity measures.

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Budget deficit targets

Politicians are often keen on making targets to eliminate budget deficits by a certain year. There is a strong political motivation to be seen as strong and committed to reducing government debt. Politicians who are vague about the debt are often heavily criticised and it is seen as poor politics. An advantage of budget deficit targets is that it ensure politicians have a stronger commitment to make politically difficult choices – raising taxes or cutting spending.

However, from an economic perspective targets for reducing budget deficits are not always as helpful as they may seem.

Benefits of budget deficit targets

There can be many sound economic reasons for reducing government borrowing. Just because a government can borrow, doesn’t mean it is desirable to.

  • It can prevent politicians choosing politically popular policies, such as tax cuts and spending increases. A deficit target can help prevent politicians putting off making difficult choices.
  • Without deficit reduction targets, some economists fear that there is an incentive to keep increasing the size of government spending, which crowds out more efficient private sector spending.
  • It can reassure markets that the government have a ‘responsible attitude to debt’ and are less likely to rely on printing money to finance the deficit and rely on inflation to inflate away the debt – which can reduce the real value of government bonds.
  • In some cases reducing the budget deficit can help lower bond yields because – with lower debt available on the market there is downward pressure on bond yields.
  • Some argue that budget deficit reduction gives consumers more to spend and firms to invest because the private sector have more confidence when the government is reducing its debt and is acting in a ‘responsible manner’. Others criticise this as being wishful thinking (see: Confidence fairy)

Problems of a budget deficit target

  • To stick to a strict budget deficit target may require tax increases / spending cuts at a time which is not appropriate for the economy. e.g. the UK economy is recovering, but if we increase income tax rates to improve tax receipts it may lead to lower growth and be counter-productive. See: Austerity can be self-defeating
  • Experience of Eurozone economies trying to meet budget deficit targets has been a deep recession.
  • Achieving an overall budget deficit means government have to finance investment spending out of tax revenue. But, arguably there is a better case for allowing government to borrow to finance investment.
  • A zero budget deficit is of doubtful value compared to other macro-economic objectives such as full employment, sustainable economic growth and low inflation.

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UK National Debt

The UK national debt is the total amount of money the British government owes to the private sector and other purchasers of UK gilts.

  • Public sector net debt (PSND ex) was £1,432.3 billion in August 2014, an increase of £96.7 billion compared with August 2013. equivalent to 77.4% of gross domestic product.
  • Source: ONS [1. ONS public sector finances ] (page updated Sep 24th 2014)


Annual Borrowing / budget deficit

  • For the financial year 2013/14, Public Sector Net Borrowing PSNB ex was £93.7 billion  – (5.6% of GDP)
  • Public sector net borrowing (PSNB ex) from April to August 2014 was £45.4 billion, an increase of £2.6 billion compared with the same period in 2013/14. 
  • The central government net cash requirement (CGNCR) for the financial year 2013/14 was £75.4 billion, £29.6 billion lower than the same period in 2012/13 (£105.0 billion). This figure is lower than PSNB ex because it includes one off receipts, e.g. Royal Mail transfer.


Office for Budget Responsibility

As well as ONS, the Office for Budget Responsibility is a good source for data.

Latest statistics at OBR

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Economics and the environment

Readers Question: Is it possible to construct the economic system so that does not rely upon expanded growth which as we all know, is damaging the environment? causing pollution e.t.c.

Photo: Takver

Photo: Takver

Could we have a society without economic growth? or as economists might prefer to answer – Can we have environmentally sustainable economic growth?

To promote an economic system without economic growth isn’t necessary. It is possible to have economic growth (increased output and living standards) whilst at the same time improving the environment we live in. But, this requires a much more conscious decision to place the environment as a primary economic objective. If you leave economic growth to the free market, inevitably we will see economic growth leading to environmental problems.

One of the great challenges of modern economics is to protect the environment. Part of the motivation is a simple moral case for being good guardians of the earth. But (fortunately for economics) there is a strong case of intrinsic self-interest. Protecting the environment nearly always makes good economic sense – as long as we look at issues in the long-term and not just from a short term / selfish perspective.

The environmental costs of economic growth

Rapid economic growth combined with a rapid population growth has placed great stress on the environment. If we are not careful – damage to the environment will threaten future living standards. For example:

  • Air / land / water pollution causes health problems and can damage the productivity of land and seas.
  • Global warming leads to rising sea levels,  volatile weather patterns and could cause significant economic costs
  • Deforestation damages soil and makes areas more prone to draught.
  • Economic growth leads to resource depletion and loss of biodiversity
  • Creation of waste and toxins.

What economic system could help promote environment?

The first essential aspect is for society and governments to recognise all the external costs and external benefits of the environment.

If we leave it to a free market, consumers and firms will ignore the external costs of their actions and we will get overconsumption, environmental costs – and a decline in economic welfare.

We need to put a monetary value on the cost of pollution / environmental damage and make sure that is reflected in the price people pay (e.g. tax on negative externalities). This will mean the cost of burning fossil fuels will increase – reducing demand. The biggest problem is making sure that we actually include all environmental costs in the price of goods and services we use.

For example, if burning fossil fuels is causing global warming and sea levels to rise. The effect could be devastating to future generations. In this situation, we are underestimating the external cost of this pollution. We are not paying the full social cost, and in the long-term we are failing to correctly price goods.

The long term view

A difficulty is that we are used to pricing the cost of a good in terms of present value. Many environmental problems are cumulative and the costs are to future generations and people elsewhere in the world. Because we ignore these future costs, we are underestimating the potential social cost of current actions.

Another difficulty in calculating future costs is that we don’t know for certain. There is an element of uncertainty. This means we have to deal with probabilities. However, if we are dealing with the environment, there is a good case for being risk averse and not gambling on the hope that global warming will be less damaging than some scientists predict. Reducing CO2 emissions can be done with only marginal cost to current consumers. But, damaging the environment in the long-term could lead to a devastating high cost to future consumers.

Positive technology

On the other hand, we need to encourage the production and consumption of technologies which don’t damage the environment.

To give a simplistic example – we could increase tax on petrol (which causes pollution). Then use this tax revenue to subsidise solar powered/electric cars which don’t pollute.

This will ensure that our society seeks to reduce the consumption of goods which are damaging to the environment. We can enjoy the same level of transport, but it will be supported by a different energy source which doesn’t damage environment.

People often ask how economic growth can help the environment. Technology is the key. If we develop technology which creates a more efficient source of energy, but without pollution – this would enable higher output, and reduce pollution levels.

e.g. a steam train caused high pollution levels. An electric train powered by solar powered energy plants can go much faster and doesn’t create pollution – that is economic growth and less pollution.

Limits of tax and subsidy

However, the use of tax and subsidy is not enough to deal with all environmental problems. For example, if we take the problem of deforestation of land in South America / Africa, a different response is needed.

For example, it may require governments to actually ban the process. It also requires a strong degree of international co-operation. Developing countries may feel a strong economic need to cut down forests or mine precious metals. However, it would be in the interest of the whole world to protect forests. Therefore, there may be a need for transfers to very poor countries in return for adopting less environmental damaging operations. Alternatively, it may just be a case of the need to educate about long-term sustainable practices.

As well as government action, there needs to be a change in consumer behaviour. A willingness to shift consumption patterns and be willing to pay higher prices and / or avoid consumption of certain products. e.g. only buy in season fruit, adopt a vegetarian diet. People want to protect the environment, but are we willing to pay an extra 10% increase in fuel bills?

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Economic system to improve income distribution

Readers Question 1) Can an economy that factors in the need for government funded public services and to offer people a living wage, and other more distributive economic strategies such as taxing the rich more, etc. Can it work in purely economic terms?

Essentially the question is

  • Can we have economic growth and greater income redistribution to ensure everyone benefits from the proceeds of growth?


Economic growth (rising real GDP) makes it easier for the government to spend money on public services and welfare payments. With economic growth, tax revenues rise, as the government will collect more VAT and income tax. This can help reduce absolute poverty. If you compare UK society – 50 or 100 years ago, there have been great strides made in reducing the worst forms of poverty.

However, to reduce relative poverty and inequality may require different policies, such as a more progressive tax system and more generous means tested benefits.

Welfare payments can help economic growth

Unemployment benefit enables people to survive economic turbulence. It helps support them in finding a new job suited to their qualifications. Removing benefits would reduce income and could cause serious social problems as people feel totally excluded from society.

Government funded public services like education and health care play a major role in improving a nations productive capacity and helping long-term economic growth.

A living wage / minimum wage can help prevent monopsonistic exploitation. By increasing workers wages also creates more demand in society for goods.

Factors other than government policy

Also, fairness in society doesn’t just depend on government policy. It depends on the attitudes of firms, workers and society. If people in society value an element of redistribution it is more likely to happen. For example, do firms make workers shareholders in the company or is society dominated by powerful monopolists who want to maximise profits?

In the Nineteenth Century, the Dickensian idea of firms was that they were happy to pay as low wages as they could. The proceeds of economic growth did little to ‘trickle down’ to the poorest workers.

Post Second World War, economic growth was more consistent with reduced inequality; this was partly due to government welfare policies – e.g. unemployment benefit, but also firms were perhaps more likely to see it in their ‘enlightened self-interest’ to pay workers well and look after their welfare. Success in society became a little less judged by monetary gain, but also how you treated other people. Continue Reading →


Effect of minimum wage on AD/AS

Readers Question I realise that at the maximum wage, (minimum wage) for labour – Qty supplied would exceed quantity demanded. Therefore, from the labour market diagram there is an obvious fall in Qty of labour, given that there would be an unwillingness to supply labour at the lower wage rate.

Diagram showing minimum wage above the equilibrium


I think you mean minimum wage. It is a minimum wage that causes excess supply of labour and lower demand.

If labour markets are perfectly competitive and if there is a national minimum wage (NMW) above the equilibrium wage, you would expect a fall in demand for labour (Q1 to Q2) and therefore, there would be excess supply of labour (Q3-Q1) (Known as real wage unemployment)

My question is how would I show this impact on an Aggregate demand and Aggregate supply (AD AS) diagram?

If we assume labour markets are competitive and if we assume that a minimum wage does cause lower employment, the most likely scenario is a negative impact on aggregate demand. People who become unemployed would spend less, leading to lower aggregate demand. To some extent, this would be counter-balanced by some workers having higher wages, leading to more consumer spending. But, I think the unemployment effect would be greater than the higher wages effect.

From the firms perspective, they would have higher costs, which could be passed onto consumers, higher wage costs could see SRAS shift to the left, leading to higher prices and slightly lower real GDP.

That is most likely analysis of AD/AS


Real World Analysis

In the real world, I think a minimum wage would have only a marginal impact on AD/AS analysis.

Firstly, a minimum wage may not cause any unemployment. Labour markets may not be competitive, but monopsonistic.

Demand for labour may be wage inelastic. Firms just pay higher wages and there is little fall in demand.

Only a small percentage of workers are affected by a minimum wage.

If anything, I would expect a minimum wage to increase AD. I’m doubtful UK Minimum wage causes any significant levels of unemployment. But, with a higher NMW some workers would receive higher real income and spending would rise. (Low income workers tend to have higher marginal propensity to consume / low propensity to save)

It is possible a rise in minimum wags could cause inflation due to two factors

  1. - higher spending by workers (demand pull inflation)
  2. - higher costs for firms, leading to wage push inflation.

But, overall, the effect on inflation would be fairly limited because a minimum wage would only alter AD by a small amount.

Essentially a minimum wage has little macro-economic effects (unless, it was a really big increase in the minimum wage)


Maximum wage

If you did mean a maximum wage, the analysis for maximum wage is entirely different, I will do a post on maximum wages next.

But, demand for labour may fall. Firms may have lower costs, but some workers would have lower wages.

Maximum wages are rarely talked about. I can only think of professional footballers having a maximum wage until 1960s.



Scotland post referendum

An independent Scotland would have made an interesting economics case study. How would Sterlingisation  or a Currency Union have affected the Scottish economy? Now we may never find out. There were undoubted risks involved, though I’m not sure how much the issue affected the outcome. The Eurozone is also an interesting economics case study, but it has been a disaster for those who are at the receiving end of austerity and mass unemployment. I’m glad we don’t have a situation where five years down the road Scotland is marooned by English monetary policy and a lack of a Central Bank. Perhaps the SNP lacked the confidence to go all out for independence which means their own currency and Central Bank.

Last week, I made a rare foray away from economics in writing about why I emotionally I hoped Scotland would stay part of the UK

However, I watched an interview of Alex Salmond a few days later and was surprised at how much I agreed with him. I agreed with his views about nuclear weapons, the Iraq War, vague notions of social justice and what constitutes a good nation. I was reassured by his homilies  about Scottish independence would mean England losing a surly neighbour and gaining a good friend. He is a talented politician – probably very skilled in knowing what his audience would like to hear. I suppose he’s not always been so forthcoming in promoting English / Scottish oneness. But, as the campaign went on I was impressed by the optimism of  the Scottish independence movement – even if I was glad Scotland voted no.

There are times when you feel a bit small minded for always thinking of economic risks, pension funds and optimal currency areas.  There are more important things than economics and financial stability, but whether Scottish independence is, I’m still not entirely sure.

Referendum Question

If the question had been:

Do you want to remain part of the UK?

The campaign and outcome may have been quite different. It would have been easier for the Better Together campaign. The Better Together Campaign were criticised (with a degree of fairness) for being ‘negative’ – but when you campaign for a “No” vote – it does lend itself to a certain negative slant.

If the Scottish Independence movement were campaigning for a no, they would have found it much harder. In some senses it was quite a generous question that the UK government agreed to put on the ballot paper.


Looking through human history, it is remarkable to have an independence debate which is wholly democratic and – despite rising tempers towards the end, remarkably good natured and peaceful. It is a powerful example of democracy in action; it is something that both Scotland and the UK can be proud of.

There are many regions looking in envy on both Scotland and the UK

Post referendum Squabbles

There will be inevitable post-referendum squabbles, especially revolving around the last minute vow of the three main parties. But, however difficult and problematic – they are nothing compared to the bitter divisions which would have been created by independence. The SNP had already put on the table walking away from their share of the national debt. Osborne had already ruled out Currency Union (without making much effort to explain why it wouldn’t be good for Scotland). A split in the union would have been a messy divorce. This is probably best outcome of the result – at least it’s clear and we can move on.

I haven’t read so many political articles since I was 18 and actively involved in politics. It certainly has touched something deep in Scotland and Great Britain. A very interesting experience.



Does inflation cause unemployment?

Readers Question: Does inflation causes unemployment?

There are a few different scenarios where inflation can cause unemployment. However, there is not a direct link. Often we will notice a trade off between inflation and unemployment – e.g. in a period of strong economic growth and falling unemployment, we see a rise in inflation – see Phillips Curve.

Also it is important to bear in mind, (especially in the current climate) If the economy has deflation or very low inflation and the monetary authorities target a modest rate of inflation, then this may help boost growth and reduce unemployment.

Inflation can cause unemployment when:

  1. The uncertainty of inflation leads to lower investment and lower economic growth in the long term.
  2. Inflationary growth is unsustainable leading to a boom and bust economic cycle.
  3. Inflation leads to decline in competitiveness and lower export demand, causing unemployment in the export sector (especially in a fixed exchange rate).


Inflation creates uncertainty and lower investment

One argument is that a period of high and volatile inflation discourages firms from investing. Because inflation is high, firms are less certain investment will be profitable. It is argued that countries with higher inflation rates tend to have lower investment and therefore lower economic growth. Therefore, if there are poor levels of investment this could lead to higher unemployment in the long term.

It is argued that countries with low inflation rates, such as Germany have enabled a long period of economic stability which helps to attain a long term low unemployment rate. Low inflation in a country like Germany also helps them to become more competitive within the Eurozone, which also helps create employment and reduce unemployment.

See also: costs of inflation

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Unemployment Stats and Graphs

A selection of graphs and statistics on UK measures of unemployment. Also, looking at factors that explain UK unemployment and why unemployment has fallen in recent years.

UK unemployment-rate

Current UK Unemployment rate

  • Unemployment rate of  6.2%, (July 2014) –  the lowest since late 2008. (page updated Sept 18th, 2014)
  • 2.02 million – (ONS)  (a fall of 468,000 since 12 months ago – biggest fall since 1988)
  • (Scottish unemployment of 6%)
  • Average Eurozone unemployment – 11.5%

Recent Unemployment Trends


Raw data:  Labour market data  | ILO unemployment % rate at ONS

UK Employment Rate

  • 73.0% of people aged from 16 to 64 were in work (May to July 2014) up from 71.6% for a year earlier.
  • There were 30.61 million people in work.

Participation Rate

  • 22.1% per cent inactivity rate for those aged from 16 to 64. 8.95 million economically inactive people aged from 16 to 64. In activity means that people are either not working or not seeking employment (e.g. students, parents bringing up children, early retirement, long term sickness) See also: Participation rates

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