Attempting to reduce debt after First World War

In the recent blog – Post-war economic boom and reduction in debt, we saw how the UK successfully reduced national debt as a % of GDP from 230% of GDP to 30% of GDP, over a period of 40 years.

However, the story after the First World War was very different. The UK finished the First World War with similar levels of debt. However, attempts to reduce the debt burden were largely unsuccessful.

UK debt 1920s

After the war, debt continued to rise to 180% of GDP in 1923. However, debt as a percentage of GDP barely fell to 160% in the late 1920s, before a slight rise at the start of the great depression.

However, this continued high level of national debt occurred despite years of austerity and attempting to balance the budget.

1913-38-UK budget-deficit

The primary budget deficit excludes interest payments on the debt. Even including interest payments (Public sector net lending) the UK ran a balanced budget  until the late 1930s.

Yet, this balanced budget did nothing to reduce the overall debt burden.

In the early 1920s, we see a sharp change in the budget. The government pursued a tightening of fiscal policy – spending cuts and tax rises to try and balance the budget.

A failed economy

real gdp 1920s

The UK economic performance of the 1920s was very poor. The post-war recession was very deep, and it took several years of slow growth to recapture the lost output.

The poor economic performance of the UK was due to several factors

1. Fiscal austerity and the highly contractionary budgets of the early 1990s

2. Relatively high real interest rates

real interest rates

With a period of deflation in early 1920s, the real interest rate become very high – good for savers but highly damaging for those with debt.

3. Return to gold standard and an overvalued exchange rate which led to expensive exports and a decline in competitiveness.

Conclusion and parallel with Europe

The 1920s were a lost decade for the UK economy. Despite the ‘Treasury view‘ dominating about the need to balance the budget, we never saw a reduction in the debt to GDP ratio from the very high level. The problem was that fiscal austerity was combined with:

  • Tight monetary policy – high interest rates
  • Deflation – falling prices causing lower aggregate demand
  • Overvalued exchange rate, leading to a fall in exports.

If you want to reduce the ratio of debt to GDP, the UK economy in the 1920s is a perfect model of how NOT to do it.

The problem is that the UK economy in the 1920s has many parallels to the current European economy.

  • Europe is pursing fiscal austerity but is seeing a fall in real GDP
  • Inflation is dangerously low and close to deflation
  • Many Eurozone countries are still facing an overvalued exchange rate
  • Monetary policy is relatively tight, with the ECB still reluctant to offer a significant loosening of monetary policy. (see: deflationary bias of the Eurozone)



National debt – mortgage comparison

Readers Question. You make the point that the debt to GDP fell in the post war period since the GDP rose faster than the debt but that still left the debt to be repaid and as such there was still the interest to be paid. I was expecting you to explain how the current debt could be eliminated. It is so large that I can’t see how it can be done. Talks of reducing the deficit pale into insignificance in the light of reducing the total debt.

The point is the debt burden was steadily reduced over a period of 40 years. It was becoming a smaller share of national income. That’s how we will pay off the current debt – steadily over the next 30 or 40 years. There is no necessity to completely pay off the debt.

National debt – mortgage comparison

People who struggle with the idea of government debt probably think nothing of taking out a mortgage of up to 400% of their annual income. With a mortgage you pay back your debt over a period of 40 years – and you could continue to roll the mortgage over for a longer period if you wanted.

Suppose you take out a mortgage for £100,000 and have a monthly repayment of £500.

If your income is £2,000 a month – 25% of your monthly pay goes on ‘servicing’ your mortgage debt.

If your income increases to £4,000 a month, then cost of servicing your debt falls to just 12.5% of your monthly income. Therefore rising income is making it relatively easier to pay for your mortgage.

You don’t have to worry about paying off your mortgage all at once. The crucial thing is can you afford the mortgage payments? If your income fell to £1,000, then your debt becomes a real problem because 50% of your income has to go on paying your debt.

There is nothing ‘immoral’ about taking out a mortgage. Similarly there is nothing ‘immoral’ about government borrowing. Government borrowing can be beneficial, e.g. borrowing at 1% to finance public sector investment which gives a rate of return of 10% a year. – In that case society is benefiting from government borrowing.

Cost of servicing debt

A key issue is what % of GDP / % of tax revenues goes on servicing debt



UK post-war economic boom and reduction in debt

Readers Question: What caused the massive decrease in the debt to GDP ratio for the UK following World War II?



UK national debt peaked in the late 1940s at over 230% of GDP. From the early 1950s to early 1990s, we see a consistent decrease in the debt to GDP. Using the above measure of national debt, UK debt as a % of GDP reached a low of 25% in 1993. (1)  Since then UK public sector debt has increased to the present level of 77% of GDP.

The main reason UK debt to GDP fell in the post-war period was the sustained period of economic growth and near full employment until the late 1970s. This growth saw rising real incomes which in turn led to higher tax revenues and falling debt to GDP ratios.

Higher government spending

Firstly, debt to GDP was definitely not reduced through cutting government expenditure.

government spending real terms

UK government spending

Note – Debt to GDP fell, despite higher real government spending on the newly formed welfare state and national health service. In fact government spending as a % of GDP rose from around 35% of GDP in the early 1950s to the high 40%s in the 1970s. See: UK government spending

Why did UK debt to GDP fall?

Firstly, it is a very good question to ask. In the past few years, many European policy makers have felt that rising debt levels needed panic levels of austerity / spending cuts. But, that didn’t happen in the UK in the post war period.

The second thing is that total real debt increased in this period. But, GDP increased at a faster rate. Therefore, the debt to GDP ratio fell.

The third thing is a disclaimer – to fully answer the question, I would need to do more research on the period. Bear in mind, my answer may not be comprehensive. But, I will do the best I can.

Post war economic boom


This graph shows UK real GDP.  In 1955 it was less than £100,000 m (quarterly). By  the early 1970s, real GDP had doubled in a relatively short period of time.

economic growth

What caused economic growth?

The UK economy benefited from the period of rapid global economic growth, especially in Western Europe. In fact, in this period, UK growth lagged behind many of our Western European neighbours. But, overall the UK enjoyed a period of rapid growth in trade and economic growth. UK growth was so rapid, we experienced labour shortages – leading to the mass immigration of the 1950s and 60s to help feel labour market shortages.

Demand management and the absence of recessions

One of the cornerstones of William Beveridge’s Welfare proposals was the assumption that a comprehensive welfare state required considerable efforts to achieve near full employment. The UK experienced boom and bust cycles, but the downturns were relatively minor and there were no real recessions of any significance until 1973. It would be interesting to know why there why there were so few recessions in the post war economic period. Demand management may have played a role.

Continue Reading →


Saving rates in the UK

It is not a good time to be a saver in the UK. Interest rates are 0.5% and inflation has been above 2% for a high proportion of the previous five years. Because inflation is higher than nominal interest rates, we are seeing negative real interest rates. This means many savers are seeing a decline in the real value of their savings. Pensioners who are relying on interest payments as income, are seeing a decline in their income.

Inflation and interest rates


In most of the post-war period we have seen positive real interest rates – Base rates above the headline inflation. This means that savers are protected from the effects of inflation.

H0wever, 2008 marks a sharp contrast, with Bank of England base rates falling to 0.5% and inflation reaching above 5%.

In recent months, inflation has fallen to below 2%, but that is still higher than base rates of 0.5%

Effectively, you are getting 0.5% return on your saving, but prices are going up 2%, so the real value of your savings is falling by 1.5%.

Base rates and bank rates

The contrast between base rates and inflation looks very high. But, actually bank savings rates have not fallen as much as base rates. This is because banks were short of money in the credit crunch and were keener to attract deposits than lend money. Therefore, when the Bank of England cut interest rates to 0.5%, commercial banks were not so keen to reduce their own interest rates by as much. Usually commercial bank rates closely follow base rates, but after 2008 we see a break in this correlation.


Source: Bank of England. Series IUMB6VJ | IUMWTFA

In 2008/09, base rates are cut from 5% to 0.5%, but fixed interest rates  (series IUMWTFA) only fall to 2.5 / 3%. Interestingly since mid 2012, fixed interest rates have continued to fall closer to 1%. This suggests the banks are less desperate to attract saving deposits and so can reduce interest rates.

It is a similar story with instant access saving rates (series IUMB6VJ) Since mid 2012, rates have fallen from 1.6% to 0.6%. This suggest the financial sector is in better health, but it means a poorer return for savers.


However, if you look around, you can still see higher fixed rates for those willing to ‘lock their money away’

It also depends how much money you can save. For example, according to ‘Money Saving Expert‘ you could get 3.25% if you can put £25,000 away for 5 years. – hardly a great deal, but you would just about get a positive real interest rate.

Should the Bank of England do more for savers?

In the past few years, many groups representing savers have felt they have been ignored – and the government / Bank of England should have done more to give a better rate of return for savers.

However, the past five years have seen declining living standards for most groups of people – real wages have fallen. Unemployment has been very high. The cost of renting has been very high. Given the general economic decline, savers have not been alone in seeing falling living standards. It is complicated by the fact that people with high levels of saving are more likely to be household owners. Homeowners have seen record low mortgage interest payments and rising house prices, which, to some extent, have offset the fall in the return on savings.

Young people without savings, but paying rent, have seen a bigger squeeze on their living standards.

However, someone who is relying on their savings to pay rent, is definitely in a bind.

Continue Reading →


Global currency

Readers Question:  Should The World Adopt A Unified Currency?


I haven’t given it much thought; given the great difficulties of the Euro single currency within parts of the European Union, the idea of extending this to include even more disparate countries seems a non-starter.

From a philosophic point of view, I think the world is heading towards greater integration, and perhaps in a thousands of years we will global governments, global fiscal transfers and we could move towards a global single currency. But, this would require a completely different mindset of selflessness, breaking down parochial self-interest and seeing the world as one world-family.

Alas, I can’t see this spiritual evolution happening quickly. Some issues to consider in a single currency.

What happens when countries have different inflation rates, but the same currency? In Europe, countries with higher inflation rates (e.g. Greece, Spain, Portugal) were left with large current account deficits, lower exports and lower growth. A global currency, would see even bigger disparities in relative costs and competitiveness.

Single monetary policy. For a single currency to be practical, the assumption would be that you need a single monetary policy. That would be highly impractical and could be devastating for some economies who have different rates of economic growth. For example, we might have very low interest rates, but countries with fast rates of growth could see inflation. It might be more practical to have a single currency, but have regional variations in interest rates. I’m not quite sure how this would work or what the consequences would be. But, with a single global currency you would see a lot of capital flows from less prosperous countries – especially with any variation in interest rate. Continue Reading →


Money Supply, M0, M3, M4 and Inflation

The money supply measures the total amount of money in the economy at a particular time. It includes actual notes and coins and also any deposits which can be quickly converted into cash.

Narrow Money e.g. M0 = This is the level of notes and coins in circulation + banks operational balances at the Bank of England.

Broad money e.g. M4 money supply is defined as a measure of notes and coins in circulation (M0) + bank accounts. It is a broader definition because it includes bank accounts, and not just notes and coins in circulation

(Technical definition of M4 includes private-sector retail bank and building society deposits + Private-sector wholesale bank and building society deposits and Certificate of Deposit.  [link])

M4 Money Supply


click to enlarge –  Source: Money databases LPMVQJU at Bank of England | see also (HM Treasury databank)

M4 is a key statistic because it can illustrate the underlying strength of economic activity. When the economy went into recession, we see a sharp fall in M4 growth from 15% a year to negative growth in mid 2008.

The negative M4 growth during 2011 and 2012 was a sign that economic activity was falling and unsurprisingly the economy went into a double dip recession.

The past governor of the Bank of England, Mervyn King has said that M4 remains an important variable for influencing monetary policy. Negative M4 growth is a key factor in the justification for more quantitative easing, keeping interest rates low and attempts to bolster bank lending.

Quantitative easing

Quantitative easing involves the creation of electronic money by the Bank of England to purchase gilts from the financial sector. In theory, this should increase the money supply.


See also: Quantitative easing and inflation

At the start of quantitative easing, M.King said:

“the unprecedented actions of the Monetary Policy Committee to inject £200bn directly into the economy…have averted a potentially disastrous monetary squeeze” Bank of England pdf)

Therefore, without quantitative easing, we may have seen a bigger fall in the money supply and a deeper recession.

However, the relatively weak money supply growth figures also suggest that quantitative easing was limited in its ability to stimulate bank lending and get money to the real economy.

Money Supply and inflation

Monetarists believe there is a link between money supply and inflation – basically an increase in the money supply can cause inflation. However, in practise, this link is often weak and inflation can be determined by several factors other than inflation.


Still M4 money supply growth can give a guide to underlying inflation and economic activity. For example, in 2011, 2012, the UK experienced cost push inflation. But, the Bank of England didn’t increase interest rates, they felt the economy was still weak. Later CPI inflation fell, and in late 2014 is 1.5% – below the government’s target.

A resurgence in M4 will be a key factor in ending quantitative easing and increasing interest rates.

Continue Reading →

Price regulation / restrictions

Readers question: Please tell me some products for which equilibrium price is not favourable for some producers and consumers which invite the state to impose price restriction.

The equilibrium price is the price determined in a free market; the price determined by the interaction of supply and demand.


Under what conditions could this market price be unfavourable?

Volatile prices. Some agricultural markets could see very volatile prices due to changes in the weather and inelastic demand. The government could attempt to maintain an average / target price, which avoids these short term fluctuations.


For example, a very good harvest could reduce the price of a food item. This low price (p2) would reduce incomes of farmers and could leave them with insufficient money for that year. In this case, the government could use a minimum price (perhaps buying some of the surplus and storing, e.g. see Buffer Stock)

In this case of a minimum price, consumers don’t lose out too much. If price of potatoes falls or rises 20%, it doesn’t make much difference to our living standards, but a fall in income of 20% for farmers could.

On the other hand, if prices rose too much because of a shortage, the government may be concerned that prices were too high and low income consumers might not be able to afford. In this case the government may use a maximum price to prevent prices going too high. The motivation for this is to ensure that all consumers can still afford the good. In developing economies, we may see maximum prices for food, in the developed world perhaps maximum prices for renting or transport. However the problem is that a maximum price may lead to shortages, queues and a black market.


Maximum price of Max P leads to shortage D (Q2) greater than Supply (Q1)

Very inelastic supply

If we have a good with a very inelastic supply, it gives firms / owners the potential to increase price significantly. But if the good is very important, the government may again use maximum prices. One example is rents. Supply of rented accommodation is inelastic, at least in short term. Landlords could use this shortage of accommodation to increase the price of rents and make more profit. In the First World War, the UK government introduced it’s first rent controls to prevent landlords increasing rents above a certain amount. The 1915 rent act restricted how much rents could rise during a period of zero house building during the war.

Continue Reading →


Economic growth with falling real wages

The UK recovery paints an unusual situation. We have both positive economic growth and falling real wages. How can we have economic growth with falling real wages?

Real wages are not the only source of economic growth. We can see growth from other components of AD –

I (Investment), G (Government spending) plus net exports (X-M)

Also, it is possible for consumer spending to rise despite falling real wages (at least in the short term). For example, if spending is financed by borrowing or declining savings ratio. Consumer spending could also be financed through re mortgaging houses (equity withdrawal) against the backdrop of rising house prices.

Economic growth in the UK


Since 2013 Q1, we have seen a decent rate of economic recovery. In the past 12 months – between Q2 2013 and Q2 2014, GDP in volume terms increased by 3.2%

Real wages


Real wages have been falling since the start of the great recession in mid 2008. In a recessing falling real wages are to be expected, but since the recovery, we might have expected real wages to match the growth in real GDP.

Why are real wages falling despite economic growth?

1. Flexible labour markets creating low paid employment. In this recovery, unemployment has fallen more rapidly than previous recessions. Evidence suggests the economy has been successful in creating new employment (often temporary / part-time/ self-employment). These new jobs are not particularly well paid. The recovery is good for job-seekers, but less good for those already in work. The relatively elastic supply of labour willing to take low paid jobs is keeping any wage growth low. Continue Reading →


UK wage growth

Wage growth is a key factor in determining living standards, aggregate demand and inflation. Since the great recession of 2008, nominal wage growth has fallen behind the headline inflation rate causing a significant drop in real wages.

Research from the ONS, stated that in 2012 real wages have fallen back to 2003 levels. (real wages fall) Between 2010-12, there has been an annual average drop in real pay of nearly 3%. Unfortunately, this trend looks to be continuing in 2014.

Recent wage growth in UK


Source: wages KAC3 – ONS (average weekly earnings) – | CPI inflation (D7G7) ONS

Until May 2008, wage growth was above inflation, causing positive real wage growth. But, since 2008, the UK has seen negative real wage growth.

Wage growth since 2000


During the great moderation, we saw a steady period of rising real wages. This has been reversed since the prolonged recession of 2008 onwards.

Real wage growth


Economic implications of recent wage trends

1. Muted inflationary potential. Some economists have worried that there is a risk of inflation from ultra low interest rates. During the great depression, we saw cost push inflation, but this has evaporated because they were just temporary factors, such as rising oil prices, higher taxes e.t.c.

This shows the importance of wage growth for determining underlying inflationary trends. Whilst wage growth remains low, there is muted potential for any inflation.

Continue Reading →

Economic Growth UK

  • Economic growth measures the change in real GDP (national income adjusted for inflation; ONS call it chained volume measure of GDP)
  • In 2013 – annual GDP in volume terms increased by 1.7% in 2013.
  • In the past 12 months – between Q2 2013 and Q2 2014, GDP in volume terms increased by 3.2%
  • The peak to trough fall of the economic downturn in 2008/2009 is now estimated to be 6.0%
  • In 2013, GDP at market prices was £1,713,302 million (£1.7 trillion)
  • Updated October 6th, 2014

Recent UK Economic Growth


Source: ONS IHYQ

Raw data:  National income accounts | real GDP | % change quarterly

Recent history of economic growth

  • Since the recession of 1992 ended, the UK experienced a long period of economic growth – it was the longest period of economic growth on expansion. Also, the growth avoided the inflationary booms of the previous decades. However, the credit crunch of 2007-08 hit the UK economy hard and caused a steeper drop in real GDP than even the great depression of the 1930s. Helped by a loosening of monetary and fiscal policy, the UK experienced a partial recovery in 2010 and 2011. But, by Q1 2012, the UK was back in recession.
  • The second double dip recession was caused by a variety of factors including European recession, lower confidence caused by austerity measures, continued weakness of bank lending and falling real incomes.
  • Since the start of 2013, the UK economy has experienced positive economic growth – one of the relatively best performances in Europe. However, real GDP is still fractionally below it’s pre-crisis peak of 2007.
  • The recovery has been stronger in the service sector than manufacturing and industrial output. There are fears the UK recovery is still unbalanced – relying on government spending, service sector and ultra-loose monetary policy.

It is worth bearing in mind that sometimes economic growth statistics get revised at a later stage.

Continue Reading →

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