11) Fiscal Policy 4: Debt

Question 1

How long does a budget deficit last?

Answer 1

Lasts from one financial (eg a year) to another, at the end of the period, that deficit is recorded and a new budget takes its place for the following period, including a new target for G&T and a new deficit (however this does not imply that the deficit has been paid off)

Question 2

What happens to the deficit after a new budget takes its place for the following period?

Answer 2

The deficit has now become a debt

Question 3

What is the most common way for the government to borrow money?

Answer 3

Through selling government bonds (called Gilts in the UK)

Question 4

Describe characteristics of government bonds:

Answer 4

Some of these are short-term (eg repaid to the debtor after 3 months), but most funds are raised using long term bonds (eg to be repaid by the government in 10 years’ time)

Question 5

Why does a deficit ultimately become a debt?

Answer 5

The money borrowed to fund a deficit then becomes a debt, money owed by the government, often stretching well into the future

Question 6

Todays budget deficit (a year) becomes tomorrow’s…

Answer 6

National debt (lasts forever)

Question 7

The accumulation of deficits, year after year, means that national debt tends to grow at an…

Answer 7

Exponential rate

Question 8

What is the problem with national debt? (Talk about spending commitments)

Answer 8

It always needs to be repaid, debt repayments therefore become one of the government’s biggest spending commitments each year, almost as much they plan to spend on education

Question 9

What is the problem with national debt? (Talk about opportunity cost)

Answer 9

It creates a big opportunity cost, the more you borrow today the less spending you have available for the future

Question 10

What is the problem with national debt? (Talk about generations)

Answer 10

Creates an imbalance between generations, eg if the government borrow more to pay for increases pension payments, the todays’ older generation take all the benefit but their grandchildren and great grandchildren and great great grandchildren will have to pay for it, probably in higher taxes 20 years down the road

Question 11

What is the problem with national debt? (Talk about self perpetuation)

Answer 11

It can be seen as self-perpetuating, if your debt interest repayments are very good, you may need to borrow more in order to repay it, the start of a vicious cycle of ever-deepening national debt

Question 12

What does ”defaulting” on debt mean?

Answer 12

In badly managed or vulnerable economies, this could lead to the country “defaulting” on this debt, ie going bankrupt

Question 13

Who are keen to avoid “defaulting” on debt?

Answer 13

International organisations such as the IMF and the EU

Question 14

What does International organisations (eg IMF/EU) do to avoid ”defaulting “ on debt?

Answer 14

They set limits, known as fiscal rules which member countries are expected to observe

Question 15

What are fiscal rules?

Answer 15

Limits to avoid defaulting on debt

Question 16

What fiscal rules have international organisations put in place for members to observe?

Answer 16

This recommends that a budget deficit should be no more than 3% of GDP whilst the national debt should not exceed 60% of GDP (however sometimes even well-organised governments break these rules)

Question 17

What is an example of the UK government breaking fiscal rules?

Answer 17

During the 2020 pandemic, the UK government needed a deficit of over 13% and, in subsequent years, the debt to GDP ratio was close to 100%

Question 18

What is the negative consequence of the UK breaking fiscal rules in 2020?

Answer 18

Future generations will be bearing this cost for decades to come

Question 19

In these flash cards, we have referred here to the national debt, what does this mean?

Answer 19

The debt owed by the government, ie the public sector debt

Question 20

What is the total national debt?

Answer 20

If you were also to include debt owed by households (eg private sector debt eg mortgages) the total national debt would be about 150% higher still

Question 21

What is the consequence of debt owed by households?

Answer 21

Not the governments responsibility, so it’s main future impact is likely to be reduced AD as householders need to repay their debt

Question 22

What sectors are almost always top 3 for government expenditure?

Answer 22

1) social security
2) health
3) education

Question 23

What are people’s opinions on national debt?

Answer 23

• many commentators say that the huge national debt is a time boom ready to explode
• others however are less worried

Question 24

Why are some commentators unworried by national debt?

Answer 24

• eg if inflation is high then the amount of money that needs to be repaid may be a lot less in real terms than the amount borrowed
• alternatively if interest rates were low, it surely makes a lot of sense for the government to borrow money cheaply today and invest in infrastructure, schools, hospitals etc ensuring the country can have sustainable future growth

Question 25

What saying do many economists agree with, said by Keynes?

Answer 25

“In the long term we are all dead”

Question 26

What does “in the long term we are all dead” mean?

Answer 26

Eg in relation to the pandemic, they ask what else the government could realistically do, pointing out that risking higher debt burdens in the future is better than allowing millions to suffer and perhaps die prematurely today.
Going back to WW2 - what choice did the UK have - borrow money or lose to the Nazis?
So ultimately it will depend on the size of the existing debt, the economic situation of the time and unforeseen circumstances (ceteris paribus) which may take precedence