What Should Government do about its debt?

At the moment, an important economic and political question is when and how to tackle the government’s public sector debt. It is currently over £800bn (56%) but growing very rapidly.

D.Cameron has been making a case that the government debt poses a threat to recovery and it should be tackled with a high priority. He makes the following points.

High levels of government debt could cause the UK to lose its triple A rating status. A downgrade in  status would make it more difficult for the UK to borrow. It would increase the cost of borrowing and possibly force interest rates up. This would hamper a recovery.

Gordon Brown is making a case that the most important thing is an economic recovery. Tackling the budget deficit too early, could stamp out a recovery and push the UK back into recession.

Both are making valid points. It is a concern that UK debt is forecast to grow to 100% of GDP. When debt gets so large it could create problems of financial crowding out (higher interest rates) and possibly inflation, and depereciation of sterling.

However, in a fragile recovery, the last thing you want to do it is to be increasing taxes and cutting government spending, as this will reduce aggregate demand and push the economy back into recession.

Conclusion – So What Should We do?

Personally, I feel that:

The Dangers of borrowing in the short / medium term are often exaggerated. The bond market is not panicking at the level of government debt. Interest rates are bonds are still quite low (true, this has been helped by quantitative easing and purchase of gilts by Bank of England). But, this level of government borrowing is not unprecedented. Other countries have similar or worse, levels of debt. The UK has had much higher levels of debt in the past.

This does not mean borrowing is a good thing and it should not be tackled. Clearly this kind of debt level has to be reduced in the long term. Markets will need assurance that the debt is temporary.

But, I feel the immediate priority is an economy recovery. It is only through economic recovery that we will see a recovery in tax receipts and fall in unemployment (which will of course help reduce budget deficit).

I see little threat of inflation. But, if the economy does recover strongly, it makes sense to tighten fiscal policy (higher taxes) first before monetary policy (higher interest rates)

Related

2 thoughts on “What Should Government do about its debt?

  1. Generally good. I just want to take you up on one point
    “When debt gets so large it could create problems of financial crowding out (higher interest rates) and possibly inflation, and depereciation of sterling.”
    The major problem with this argument is that the government does not ‘compete’ with the people for loans. What the government loans is spent on the people, and possibly loaned to them. The government does not consume any of the money, simply rearranges it.

Leave a Reply

Your email address will not be published. Required fields are marked *