I mentioned in my previous blog post that the government debt as a percentage of GDP has risen significantly from 83.8% to 102.8%, between 2019 and 2021, representing a total debt increase of £500bn.
One of the most common questions I hear when discussing the government debt levels is “Who does the government borrow from?”, so in this blog post, I will be explaining how the government debt works in the United Kingdom.
Why does the Government Borrow Money?
The government borrows money when its income, primarily from tax receipts, falls short of covering its expenditures. This situation, known as a government deficit, prompts the need for borrowing.
When faced with a deficit, the government has several options. It can choose to raise taxes, reduce spending, or implement a combination of both measures to restore a balance between income and expenses.
During the Coronavirus pandemic, the government faced substantial expenses, including crucial investments such as the Furlough scheme to safeguard workers through temporary leave and Loans for Businesses. These expenses significantly contributed to the national debt.
Given the government’s tendency to avoid tax hikes due to their unpopularity with voters, an alternative strategy was employed. Rather than increasing taxes, the focus shifted to boosting available funds through borrowing.
How does the Government Borrow Money?
It usually accomplishes this by issuing bonds, which are financial products accessible to investors like you and me.
A bond essentially allows an investor (you) to buy it for a fixed amount today (e.g., £1,000), with the promise of receiving a higher payment in the future (e.g., £1,050).
When a government issues bonds, it’s essentially saying, “I need more money today but will be in a better position later to pay you back.”
Bonds can vary in maturities (e.g., 3 months, 1 year, 10 years), and the interest rate often reflects the market’s health.
Longer-term maturities typically yield a higher interest rate than shorter-term ones due to investors taking more risk over time. However, if short-term maturities surpass long-term ones, it may signal an impending recession, suggesting that investors believe short-term rates will decline in the future.
The Bank of England might also buy some bonds to boost spending and investment in the domestic economy, a practice known as “Quantitative Easing.”
How Much Interest does the UK pay on its Debt?
The UK’s expenditure on servicing its national debt is substantial. In the 2022-23 fiscal year, the anticipated total debt interest, as reported by the OBR UK, is approximately £83 billion. This accounts for 5.2% of public spending and translates to £1,900 per household.
To put this in perspective, the expenditure on the NHS in 2021 amounted to £176 billion. Astonishingly, the sum allocated solely for servicing debt interest nearly reached 50% of the total spending on our healthcare system.
What can be done about the National Debt?
Historically, decreases in the national debt have primarily resulted from prolonged economic growth, with the 2008-09 Financial Crisis being the most recent significant shock to debt levels.
Post-World War II, where debt surged to 230% of GDP, a remarkable reduction occurred in just three decades, bringing it below 50%. While the coronavirus pandemic has led to substantial debt increases, the current situation is not entirely dissimilar.
The focus now appears to be on expanding the economy through strategic investments, financed by additional borrowing in a low-interest rate environment. This approach aims to create more job opportunities, boost tax receipts, and curtail social security spending.
Temporary tax cuts can also play a role in reducing the private savings rate, encouraging consumption to stimulate economic growth. However, this proves challenging with recent hikes in the Bank of England interest rate.
Despite reaching new post-war highs, the current level of national debt is deemed manageable. Opting against the austerity policies of the 2010s, and embracing a growth-oriented mindset, offers a promising prospect to bring debt levels back to pre-coronavirus and pre-2008-09 Financial Crisis levels.