Readers Question: After the insightful post on ‘Italian Economic Decline’, I was particularly captured by the % debt to GDP line graph of the different developed countries. The one thing that really caught my eye was Japan’s huge % debt to GDP and yet their government bond yields are consistently declining. Aren’t the markets worried that Japan may default on their debt someday or is the fact that they have a lender of last resort (no fear of liquidity problems) unlike Italy and their 0% interest rates shielding them from augmenting yields?
It is true that Japanese public sector debt is over 239% of GDP, yet bond yields in Japan remain low. It seems the markets have no current concerns over Japanese repayment. Spain might feel aggrieved that they face rapidly rising bond yields – even though their public sector debt (70% of GDP in 2011) is considerably lower.
Japan debt 229.1% of GDP on a gross basis, and 127.8% of GDP on a net basis
Why Can Japan Government Debt be So High at Low-Interest rates?
High levels of savings in Japan. Japan’s saving ratio has fallen in recent years (partly due to an ageing population) but although it may sound a paradox, there are still high levels of domestic saving. Up to now, this large pool of savings has been used to buy Japanese government debt. (Japan Saving ratio)
A reader on twitter asked – How has government borrowing helped me recently?
I’m tempted to paraphrase as – What has borrowing ever done for me? – just so that I can make a reference to Monty Python and the Life of Brian? – And what have the Romans ever done for us? – apart from education, sewers, wine, roads, peace, law and order … (youtube)
But, I frequently get asked it, so here’s a few more ideas.
Why do we need to be in debt at all? Surely all the money in interest (some £50bn pa?) would be better spent on ourselves as a country?
It is true that the government spends around £50bn a year on interest payments. (and forecast to rise) But, those interest payments enable higher government spending now.
We could reduce the amount of interest payments by raising taxes / cutting spending. But, it wouldn’t make us better off. It would just change how we finance current spending.
Also, who do those interest payments go to – primarily UK individuals/UK pension funds. You can think of it as a transfer payment to people within a country.
You could argue that it is a transfer payment from the average taxpayer to people with pension funds / city financiers – who are likely to be better off. But, more people with private pensions may benefit from government interest payments than they realise.
Interest rates are also very low, which means interest payments on government debt are quite a small percentage of GDP. (3%)
Use of private sector saving
In the great recession, there was a rapid rise in private sector saving. This was money not used, but just saved and unproductive.
If the government borrowed nothing, these resources would remain idle, aggregate demand would be lower and the recession deeper. Through government borrowing, we made use of this surplus savings and helped to stabilise the economy. (recession not as deep)
There are a raft of different methods of calculating government debt. It can be a little bewildering (even for an economics teacher!). I have tried to define the key terms in a simple format and also a more detailed and precise way. This only focuses on the UK.
Defining Public Sector Debt
Government Deficit – annual shortfall between spending and tax receipts. The amount the government have to borrow from private sector in a certain year. (see also: public sector net borrowing (PSNB) public sector net cash requirement (PSNCR), public sector borrowing requirement PSBR, net borrowing, cumulative public sector current budget)
US Federal Deficit as % of GDP
Government Debt – The total amount the government owe to private sector (see: also, public sector net debt, national debt, GGGD). This is the accumulation of borrowing over many years.
Debt as a % of GDP
Debt can be expressed in nominal figures or as a % of GDP.
in Jan 2009, UK public sector debt was £697bn which = 47.5% of GDP
Public Sector Net Debt – Total Amount government (central, local and corporations) have borrowed from Private sector – liquid assets. Often referred to as National debt (e.g. in 2009, Public sector net debt was £697bn or 47.5% of GDP
Public Sector Net Cash Requirement PSNCR – The amount governments need to borrow in a year to meet its shortfall of spending and tax receipts. (e.g. in 2008-09 government has a PSNCR of about £115bn) Often referred to as annual government deficit. Used to be called PSBR (Public sector borrowing requirement). – The PSNCR is similar to net borrowing and government borrowing
Debts Not Related to Government Debt
Current account Balance of Payment deficit – Not related to public sector net deficit. current account deficit related to level of net imports
External debt – Total amount that UK owes foreign countries. External debt includes government liabilities + private sector liabilities; it is not directly related to public sector debt.
Private sector debt – indebtedness of householders, finance sector and non-financial companies.
External debt – the amount we ‘owe’ to other countries
In addition, you might take into account – future liabilities, e.g. pension fund commitments. Also, equally important, is future economic growth, tax revenue and the ability to meet the current debt burden.
Debt burden as % of income
The most useful way to consider the debt burden. Is to consider:
Debt as a % of income.
Also, the % of income / taxes spent on debt interest payments
UK government borrowing fell to record levels in the early 1990s, but since the financial crisis, national debt as a % of GDP has increased to 78% of GDP (2015).
A related to concept to total national debt is the budget deficit. The budget deficit is the annual amount the government is borrowing.
Debt interest payments as % of GDP
Another important consideration is how significant are debt interest payments.
With low interest rates, the cost of servicing the UK government debt is lower than we might expect. Many economists suggest that when interest rates are low, the government should take advantage and borrow to finance investment.
The amount spent on debt interest payments is important for understanding the ‘debt burden’ If you take out a mortgage, the crucial thing is not the total amount outstanding, but the percentage of your income that is spent on mortgage monthly payments.
The majority of UK public sector debt is owned by the UK private sector / Bank of England.
Private sector debt
In addition to government debt it is also important to look at private sector debt. In particular household debt / company debt. For example, at the start of the recession, household debt fell because householders sought to increase savings and pay off their debts, due to low confidence. In this case the government borrowing is partly offsetting the rise in private sector saving.
Financial debt is more complicated. The UK tends to have a large share of financial debt as a % of GDP because it has a large finance sector. But, these large liabilities are offset by high financial sector assets. Financial sector debt becomes a problem if assets fall in value. (e.g. during credit crunch)
Readers Question. Just saw a video called ‘How to waste £375 billion? (The Failure of Quantitative Easing)’ by Positive Money. I’ve recently started reading your blog and find your posts very informative. I wonder what you make of the ideas in this video and of this group in particular?
(I haven’t seen the video. For some reason I never like watching videos only reading articles.)
I would say Quantitative easing has been a quantified success. Or perhaps a better way of evaluating quantitative easing is that – it could have been worse, if we hadn’t pursued quantitative easing.
A simple comparison is to compare the UK and US (who have both pursued quantitative easing) with the Eurozone (which hasn’t). In the past couple of years, the economic recovery has been stronger in the US and UK, the Eurozone is in danger of a double dip (or triple dip) recession. The Eurozone is heading towards a dangerous period of deflation. The UK and US have at least a better inflation rate.
Therefore, I wouldn’t say we wasted £375 billion. Firstly, ‘wasting’ implies an opportunity cost – for example, finding it from higher taxes or lower spending. It was entirely created. For all its faults and limitations, the quantitative easing we pursued was better than nothing – especially given the degree of fiscal tightening pursued since 2010.
Problems with UK Quantitative easing
Perhaps a better description of UK quantitative easing is a wasted opportunity. True, we avoided some deflationary effects, but there are reasons to be disappointed and perhaps it could have been better.
Banks largely used the newly created money to make a profit from selling bonds to the Bank of England and improve their balance sheets; because of the recession, little of this extra money fed through into the real economy through higher bank lending (see: M4 lending stats). The side effect was some banks and the bond market did very and interest rates are at very low rates. True, low rates are part of the aim behind Quantitative easing, but low interest rates are of limited benefit, if firms are unable / unwilling to borrow and make use of cheap borrowing.
Parts of the financial services industry has benefited very well from quantitative easing. It is perhaps a little galling to see many of those culpable for aspects of the credit crisis gaining bonuses from the benefits of quantitative easing.
However, to say it solely benefited the rich is to ignore the contribution it may have made to reducing unemployment. UK unemployment has fallen for many reasons – the small economic stimulus is an important factor – never forget reducing unemployment is one of the most important factor in reducing relative poverty. The UK unemployment rate is now 50% lower than many areas in the Eurozone.
For some reason, the first thing that comes into my mind is the famous quote from Dr Strangelove – “how I learned to stop worrying and love the bomb (debt)”
I guess we can blame Charles Dickens and Wilkins Micawber from David Copperfield.
“Annual income twenty pounds, annual expenditure nineteen pounds nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds nought and six, result misery.”
No matter how much you talk about government debt, people won’t feel comfortable until we have a zero budget deficit and zero government debt. – (even though, I don’t think any modern economy has ever had such a situation – nor would one be particularly desirable.) Many issues are addressed here: The political appeal of austerity.
What does debt cost?
Another way of thinking about government debt is the annual cost of servicing the debt. What percentage of GDP is spent on debt interest payments? What percentage of tax revenues is spent on servicing the debt? You could have an increase in the real value of debt, but a smaller percentage spent on paying interest on the debt. Would you worry about a mortgage – if every year the monthly mortgage payments were becoming a smaller percentage of your disposable income?
The cost of servicing UK debt has risen in the past few years, due to rise in debt. But, by historical standards, it is still quite low and certainly quite manageable. More on Cost of borrowing
Of course, the cost of debt interest payments also depend on interest rates. A rise in interest rates will cause higher borrowing costs. But, with low interest rates predicted, we are unlikely to see a jump in borrowing costs – at least in the medium term.
The German economy has been one of the world’s strongest economies in the post-war period. There are many aspects of the German economy which deserve praise and emulation – not least strong productivity growth, a booming export sector and prolonged low inflationary growth. In the post-war period Germany has played an important role in promoting economic stability and prosperity within Europe.
But, in recent years, the German economy has seen several cracks appear and German economic thinking is now causing a major drag on Eurozone economic growth and prosperity.
The false goal of a balanced budget
An very important issue in German politics is the desirability of seeing a balanced budget (government spending = government tax revenue). Many German finance ministers have made balancing the budget their primary economic objective. In the UK and US, we see that austerity has a strong political appeal – but in Germany the appeal of ‘responsibility’ and avoiding debt is perhaps even greater. A German friend told me that there is a certain guilt attached to the idea of holding on to debt. (though this guilt is especially felt with government debt – mortgages and business loans are somehow different)
On the objective of reducing budget deficits Germany has been successful. It is also keen to enforce EU rules and the idea of encouraging a balanced budget for its struggling European neighbours.
Angela Merkel recently stated to the EU Parliament, that EU rules must be met:
“All, and I stress again all, member states must respect in full the rules of the strengthened stability and growth pact,” she said. “These rules must be applied credibly to all member states — only then can the pact fulfill as a central anchor for stability and above all for confidence in the eurozone.” (US Today)
A successful business does not have its objective to borrow nothing. A successful business knows that it needs to invest to make progress and retain its prosperity. Years of cutting government spending has meant that Germany has cut back substantially on public sector investment. There are widespread reports that Germany has a lack of investment in roads, bridges and other forms of transport. There is a fear that important infrastructure, such as roads and bridges are reaching the end of their 70 year cycle, but there is no money to successfully replace them. The economic problem is growing congestion, time wasted and damage to the long term productive capacity of the economy. The Guardian notes
Its (German) investment rate in 2013 was the fourth lowest in the EU; only Austria, Spain and Portugal spent less. Fratzscher, who is head of the German Institute for Economic Research, calculates there is an “investment gap” of €80bn (£63bn).
The Economist reports that German public sector investment is —a paltry 1.6% of GDP— one of lowest in Europe and has fallen since 2009.
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.