Fiscal Policy and the National Debt

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Budget deficits are an issue of international concern. The Maastricht Treaty imposed a limit on the deficit run by central and local government taken together of 3 per cent of GDP as a precondition for monetary union and set 60 per cent of GDP as a desirable upper limit for government debt. In 1989 Denmark, France, Germany, Spain and the United Kingdom met the conditions. In 1993 none of these EU countries did (OECD Economic Outlook, No. 54. p. 16). The change in the UK's fiscal position has been particularly sharp. From a surplus of |pounds~1.8 billion in 1990, the Public Sector Borrowing Requirement has risen to a likely level of |pounds~50 billion in 1993. The Public Sector Financial Deficit, which omits the receipts from privatisation has similarly increased from |pounds~0.7 billion to |pounds~55.2 billion. Do these changes matter? This article summarises the history of the UK National Debt and presents the theoretical basis for concern about continuing budget deficits. An attempt is made to estimate the long-term cost of the national debt to the UK economy and to show how long-term debt management can be combined with short-term demand management.

The UK public sector debt

Chart 1 shows the UK public sector debt in nominal terms. For the period up to 1952 the data relate to the UK national debt while from 1953 onwards they describe the net public sector debt. The history of the debt can be split into four phases. After the first world war, budgetary policy was clearly to keep the debt constant in nominal terms. There were minor fluctuations, but the outstanding nominal debt changed little between 1920 and 1938.

The second world war led to a four-fold increase in nominal debt. Rapid growth continued to 1947 but stopped after that. For the next 25 years or so there was only a modest upward drift in public sector debt. But as inflation gathered pace in the 1970s the debt was allowed to rise sharply. This came to an end with the period of modest debt reduction in the late-1980s. Recently the debt has begun to increase again.

Measured as a fraction of GDP at factor cost the story is quite different. In the early-1920s and early-1930s falling prices and output raised the debt burden. The large increase during the war was followed by a fall that was almost as steep, as rising prices and, to a lesser extent growth in output, drove up GDP. By 1990 UK public debt/GDP was smaller than that of most other countries. Although the large budget deficits of the last two years have led to an increase in the ratio again, it is not obvious from Chart 2 why there should be such concern over the budgetary position.

As Pain, Young and Westaway (1993) emphasise, the change in the national debt is only a part of the picture. National debt may be incurred to finance the acquisition of real or financial capital assets. The net worth of the public sector shows the values, at current market prices or replacement cost, of publicly-owned assets net of liabilities and thus does not include debt which has been incurred to finance capital assets.(1) Chart 3 shows how this has changed since 1957. The net position of the public sector appears to be sound even though net worth has fallen to 40 per cent of GDP compared with over 80 per cent in the 1970s. The chart also shows the net public sector holding of revenue-earning assets, defined as net financial assets plus the value of the assets of the public corporations and the public sector housing stock. This is important because it is net holdings of revenue-earning assets which, broadly-speaking, together with real interest rates themselves, determine the net real interest burden faced by the taxpayer.

Chart 3 suggests that, while the government's balance sheet is not as healthy as it was in the late-1970s, there is no obvious immediate cause for alarm over the government's budgetary position. But the chart does not show future trends in the government's income and expenditure. …