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 simple explanation is that it needs to borrow money when the income it gets (from tax receipts) is not enough to cover its spending.
In the case that the two are not balanced (i.e. a government deficit), the government can usually decide to increase taxes, reduce spending, or pursue a combination of both.
In the case of the Coronavirus pandemic, necessary investments such as the Furlough scheme to protect workers by placing them on temporary leave, and Loans for Businesses, were significant expenses that hit our national debt heavily.
With a government that is typically against raising taxes (due to its unpopularity with voters), they instead shifted their focus to increasing their available cash by borrowing.
How does the Government Borrow Money?
It typically does this through the issuance of bonds – a financial product available to investors like you and me.
A bond essentially allows an investor (you), to purchase the bond for a fixed amount of money today (e.g. £1,000), with the promise that you will receive a higher payment at some point in the future (e.g. £1,050).
For a government to issue bonds, they are essentially saying “I need more money today but will be in a better position later to pay you back”.
Bonds can come in many different maturities (e.g. 3 months, 1 year, 10 years), and the interest rate is typically a good indicator of the health of the market.
Longer term maturities typically have a higher interest rate than shorter term maturities due to the investor taking more risk over time, but in the case that short term maturities exceed long term maturities, this could be indicative of an impending recession, due to investors believing that short term rates to decline in the future.
The Bank of England may also purchase some of the bonds to increase spending and investment in the domestic economy – known as “Quantitative Easing”.
How Much Interest does the UK pay on its Debt?
The amount of money spent on servicing the national debt is not negligible – the total debt interest according to OBR UK in 2022-23 is expected to be around £83bn, which is 5.2% of public spending, and equivalent to £1,900 per household.
Spending on the NHS in 2021 was £176bn, so the amount just servicing debt interest was almost 50% of the total spend on our health service.
What can be done about the National Debt?
Past reductions in the level of national debt has usually been due to a prolonged period of economic growth, with the 2008-09 Financial Crisis being the last observed shock to the levels of debt in the economy.
After World War 2, where debt ballooned to 230% of GDP, it was reduced to under 50% just three decades later – the coronavirus pandemic has seen significant increases in debt, but the situation we find ourselves in should not be seen as too dissimilar.
All signs point to us focussing on expanding the economy through investments, funded by further borrowing in the lower interest rate environment to provide more opportunities for job seekers, increasing tax receipts, and reducing spending on social security.
Furthermore, cutting tax temporarily can help reduce the private savings rate, encouraging consumption to further stimulate growth in the economy – something that is proving very difficult now due to the recent increases in the Bank of England interest rate.
The level of national debt is currently at a manageable level, despite it reaching new post war highs. If the government decides against pursuing the austerity policies that failed in the 2010s, and instead adopts a growth mentality, then we have a good chance to reduce our debt levels back to those seen before the recent coronavirus pandemic, and 2008-09 Financial Crisis.