The UK ‘Public sector Debt’ is now approximately £800 billion (July 2009 – )
Question: Who do we owe it to?
People and financial institutions who bought the UK bonds and gilts. These are mainly financial bodies such as pension funds, investment trusts. The irony is that many people in the UK who have private pensions indirectly have lent money to the government, though they are probably not aware of that.
Approx 20% of UK debt is owned by foreign investors (e.g. foreign pension funds and investment trusts)
Question: Where did they get all that money from?
The government raised the money through selling bonds and gilts. People buy the bonds because of the interest that is paid on the bonds.
Question: If the Bank of England belongs to us, why do we pay it interest?
The government pays interest to those who hold the bonds and gilts which make up the debt, we don’t pay interest to the Bank of England.
Question: And of course most importantly: Why don’t we print the money ourselves, at zero interest?
Typically, printing money creates inflation, and reduces the value of the Pound. (see: Printing money and inflation) Foreign investors would no longer want to hold UK debt. If inflation became a real problem no one would want to hold government bonds, instead they would switch to buying gold. The government are able to sell the debt at relatively low interest because there is an implicit expectation the debt will not be inflated. Countries who create inflation find it more difficult to sell debt.
Nevertheless because of the nature of the economic crisis, the fall in money supply and the deflationary pressures, some economists argue that at least part of the debt can be monetised because currently increasing the money supply is not causing inflationary pressures. But, this can only be done to a certain extent and when there is deflationary pressure in the economy.
See comment by Ralph Musgrave on this post