Public debt: Difference between revisions

Revision as of 09:23, 21 April 2009

The UK's Code for Fiscal Stability

In November 1997 the British government announced^[1] its adoption of two rules of fiscal conduct:

- a "golden rule":that over the economic cycle, the government would only borrow to invest and not for public consumption,and

- a "sustainable investment rule": that over the economic cycle, the government would ensure the level of public debt as a proportion of national income is held at a stable and prudent level (subsequently interpreted as 40 per cent of gdp);

and an analysis ^[2] published by the Treasury in 2008 concluded that:

- the average surplus on the current budget over the previous economic cycle was positive, thus meeting the golden rule; and,

- public sector net debt remained below the 40 per cent of GDP limit of the sustainable investment rule over the cycle.

But in November 2008 the government announced the replacement of those rules by a "temporary operating rule" under which it would set policies to improve the cyclically adjusted current budget each year, once the economy emerges from the downturn, so that it would reach balance with debt falling as a proportion of GDP once the global shocks had worked their way through the economy in full.

[1] A Code for Fiscal Stability, H M Treasury November 1997

[2] Meeting the Fiscal Rules Over the Past Cycle, (1997-98 to 2006-07) - Chapter 2 of End of Year Fiscal Report HM Treasury, November 2008

[1]

[2]

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-{{subpages}}
-A country's [[national debt]] - also known as its public debt - is a matter of economic and political significance that has often been the subject of controversy. A policy objective of limiting public debt in normal times  is often adopted in order to enable it to be used to cope with unforeseen shocks such as wars, recessions and natural disasters.
-:''(terms shown in italics in this article are defined in the glossary on the [[/Related Articles|Related Articles subpage]])''
-==Definition==
-The OECD's broad definition of public debt as "the external obligations of the government and public sector "<ref>[http://stats.oecd.org/glossary/detail.asp?ID=2193. ''Public Debt'', OECD Glossary of Statistical Terms]</ref> is in general use, but national definitions <ref>For the US definition ses the Treasury Department guide [http://www.ustreas.gov/education/faq/markets/national-debt.shtml].<br>For the UK definition, see the ONS guide [http://www.statistics.gov.uk/downloads/theme_other/GSSMethodology_No_12_v2.pdfd]</ref> differ in detail <ref>[http://www.economicshelp.org/blog/uk-economy/understanding-government-debt-statistics/, ''Understanding Government Debt Statistics'', Economicshelp.org]</ref>and produce figures that may not be comparable. The European Union's definition embodied in its ''Stability and Growth Pact''<ref>[http://stats.oecd.org/glossary/detail.asp?ID=3066 ''Stability and Growth Pact'', OECD Glossary of Statistical Terms]</ref> of "General Government Gross Debt"<ref>[http://stats.oecd.org/glossary/detail.asp?ID=3066 ''General Government Gross Debt (Maastricht Definition)'', OECD Glossary of Statistical Terms]</ref> differs  in detail from the complete OECD definition.
-==Overview==
-{{TOC-left}}
-It is customary for governments to use borrowing to finance investment, and it is current practice for the main industrialised countries to allow national debt to  accumulate to between 40 and 60 per cent of GDP (except  Japan and Italy, with
-percentages of over 100). However, it is generally considered to be prudent to avoid excessive debt in normal times, in order to be able to cope with emergencies such as wars and recessions.  It is also normal practice for governments to allow national debt to rise to between  70 to 100 per cent of GDP during major recessions - as a result, mainly of the operation of their economies' ''automatic stabilisers'', but also from the use of ''fiscal stimuluses'', intended  to compensate for reductions in private sector spending.
-Such policies are not uncontroversial, however, and even relatively modest levels of national debt,  commonly meet with expressions of concern as being  "unhealthy" or even dangerous. Such popular concern may be  attributable  to an instinctive belief that saving is virtuous and borrowing is discreditable, or to the belief that it imposes unfair burdens on future generations, or to the once universal reverence for balanced budgets -  but it is also  attributable to  fears of  harmful economic consequences. Public choice theorists oppose government expenditure, even for the purposes of investment, on the grounds that the politicians concerned are mainly motivated by personal gain, rather than a desire to serve the public interest. Austrian School economists argue that fiscal stimulus expenditure is ineffective, partly  because of the "''Ricardian equivalence''" argument that it is nullified by increases in private sector saving and partly out of scepticism about the ability of politicians to manage the economy. Other economists have demonstrated that the  use of deficit financing is bound, if continued long enough, to lead to a "''debt trap''" from which a government cannot escape except by defaulting on its obligations, or by expanding the [[money supply]].  The 1931 German hyper-inflation, which was caused by the use of "''monetisation''" to manage high levels of postwar debt, has come to be seen as  a  dramatic warning of the dangers of deficit financing , and sovereign defaults such as  the 1998 default by the Russian government as a reminder that governments are not immune from the dangers of insolvency. ''Sovereign default '' among developing countries is not, in fact,  uncommon,  and although the danger that it it could happen to a major industrialised country is generally considered to be remote,  there is fear that a persistent rumour of its possibility might alarm investors to the point of making it self-fulfilling.
-==The history of national debt==
-===The British experience===
-In the 18th century and before, it had been the practice of kings to finance their wars by borrowing. It was cheaper than collecting taxes - and it was risk-free because a king could not be called to account for defaulting on his obligation to repay - and  "sovereign default" was a frequent occurrence. In England, however, Charles II's "Stop of Exchequer"<ref>[http://repositories.cdlib.org/cgi/viewcontent.cgi?article=1075&context=ucsbecon Der-Yuan Yang: ''The Origin of the Bank of England: A Credible Commitment to Sovereign Debt'', Department of Economics,  Working Paper 198, University of California, Santa Barbara]</ref> of 1672 was the last time it happened, because the "Glorious Revolution" of 1688 was followed by the "Financial Revolution"<ref>[http://www.litencyc.com/php/stopics.php?rec=true&UID=388 Colin Nicholson: ''Financial Revolution (1688-1750)'', The Literary Encyclopedia, 2001]</ref> during which Parliament assumed effective control over the national debt. The culmination of that revolution was the creation in 1749 of the "Consolidated Fund" <ref> The Consolidated Fund Bill provides Parliamentary authority for funds requested by the Government, and has been placed before Parliament every year since 1749 </ref>, and the issue of undated bonds known as "consols". Members of Parliament were concerned from the start to reduce the level of national debt, as evidenced by the passage of the National Debt Reduction Act 1786 <ref>[http://www.opsi.gov.uk/RevisedStatutes/Acts/apgb/1786/capgb_17860031_en_1 ''National Debt Reduction Act 1786'', UK Statute Law Database]</ref>. Their intentions were frustrated, however by the need to finance Britain's part in the Napoleonic War, and  between 1743 and 1815, Britain's national debt increased from £245 million to £745 million, which was twice its national income<ref>Niall Ferguson: ''The Ascent of Money'', Allen Lane, 2008</ref>.  A further attempt signalled by a second debt reduction act <ref>[http://www.opsi.gov.uk/RevisedStatutes/Acts/ukpga/1866/cukpga_18660011_en_1 ''National Debt Reduction Act 1866'', UK Statute Law Database]</ref> was more successful and the ratio of national debt to national income was reduced to less than 50 per cent by 1900. But further two wars and the intervening [[Great Depression]] raised it again to over 100 per cent.  According to researchers at the Institute of Fiscal Studies <ref>[http://www.ifs.org.uk/bns/bn26.pdf Tom Clark and Andrew Dilnot ''Measuring the UK Fiscal Stance since the Second World War'', Fig 3, page 5, Institute of Fiscal Studies,2002]</ref>, it rose to over 150 per cent during the first world war, remained at above that percentage for most of the years between then and 1955. After then it was reduced steadily to about 50 per cent by 1975, and remained at between 45 and 55 per cent between 1975 and 1990 and between 35 and 55 percent through the 1990s.
-===The United States national debt===
-In 1783, the United States Congress was given the power to raise taxes, but in 1785, it was found that tax revenues were insufficient to meet the government's expenses and Alexander Hamilton argued the case for the raising of public, arguing that "A national debt, if it is not excessive,will be to us a national blessing." In  1789, Congress established The Treasury Department, naming Alexander Hamilton, as its Secretary, in 1790 it passed the first Funding Act, and by February 1792, interest-bearing government bonds were on sale and the national debt rose to $77 million about 25 per cent of national income. However, a strong preference for freedom from debt and the maintenance of a "balanced budget" was evident from the beginning, and in a 1793 message to the House of Representatives, George Washington advised them that &nbsp;"No pecuniary consideration is more urgent than the regular redemption and discharge of the public debt: on none can delay be more injurious, or an economy of the time more valuable."&nbsp;, and in 1799 Thomas Jefferson wrote: "I am for a government rigorously frugal & simple, applying all the possible savings of the public revenue to the discharge of the national debt." <ref>Thomas Jefferson's Letter to Elbridge Gerry of 26 January 1799, quoted in  Noble  Cunningham: ''Jefferson vs. Hamilton: Confrontations that Shaped a Nation'', Palgrave Macmillan, 2000 [http://books.google.co.uk/books?id=tQZn3VlFSyAC]</ref>. Jefferson's Secretary of the Treasury, reduce the public debt to $45 million by 1811, and by 1835 the national debt had been fully repaid. Following the war with Mexico, the national debt rose again to $65 million, and it reached $2.7 billion, or about 30 per cent of national income, by  the end of the Civil War. By the beginning of the First World War it had been reduced again to about 10 per cent of national income but rose again to 30 percent during that war, and to $260 billion, or about  120 percent in the course of the Second World War. It was reduced to below 40 per cent in the 1960s but had risen to over 60 per cent by 1982  and  by the end of  2008, it had reached $10.3 trillion, or about 60 per cent of GDP. <ref> Sources [http://www.publicdebt.treas.gov/history/history.htm ''The United States Bureau of the Public Debt''] and [http://www.optimist123.com/optimist/2005/01/national_debt_b.html ''National Debt Burden: Full History'', The Sceptical Optimist, 2009]</ref>
-==Economic consequences==
-===Fiscal sustainability===
-The ultimate  limit upon the size of the national debt is reached when more money is required for its repayment than the government can raise from taxation - at which point,  the only alternative to a default amounting to national bankruptcy is repayment with money created for the purpose by the central bank <ref>For an account of the process by which a central bank can create money, see the tutorials subpage of the article on banking [http://en.citizendium.org/wiki/Banking/Tutorials]</ref>.  Money creation aside, national bankruptcy  is, in fact,  an inevitable long-term outcome if  national debt persistently grows faster than gdp.  That  is known as the ''debt trap'', and its avoidance is the economic policy objective known as "fiscal sustainability". Fiscal sustainability normally<ref> Assuming that the interest paid on government bonds is greater than the gdp growth rate.</ref>  requires the maintenance of a surplus  of  tax revenue over public expenditure, when averaged over a period of five to ten years, and the   average size of that surplus, when expressed as fraction of the national debt,  has to be at least equal to the difference between the interest rate payable and the gdp growth rate<ref> According to the "fiscal sustainability  identity", which is examined on the [[/Tutorials|tutorials subpage]] and at page 315 of Frederic Fourie: ''How to Think and Reason in Macroeconomics''. JUTA 2001</ref>.
-Although that identity-based criterion would ensure fiscal sustainability in a stable, risk-free environment, it ia generally accepted that a more stringent criterion is needed in order to guard against operating risks. A government's ability to market bonds  offering any  particular rate of return depends upon the willingness of operators in the bond market to accept that rate of return, and that willingness is influenced by market  expectations.  A comparatively recent development is the availability of ''credit default swaps'' (CDS that enable market operators to insure against the risk of ''sovereign default''.  Operators in the bond market may be expected to require an increase in the rate of return on a government bonds sufficient to offset the premium (or ''sovereign spread''} on such insurance. Sovereign spreads tend to be greater, the greater the level of national debt as a percentage of gdp, but they are also influenced by  expectations of increases in that level, and by other factors, including expectations of gdp growth or decline.  Most of the sovereign defaults of recent years have been due to banking and currency crises rather than to a previously excessive level of public debt<ref>[http://www.cbo.gov/ftpdocs/0xx/doc18/Genacct.pdf Bianca di Paoli and Glen Hoggart: ''The Costs of Sovereign Default'', Bank of England Quarterly Bulletin]</ref>
-Prudent policy-makers tend in normal times to keep the level of national debt below the level required for sustainability in order to guard against market risks, and in order to preserve the option of  using it to cope with unforeseen shocks such as wars, natural disasters and recessions.
-===Intergenerational effects===
-It often claimed that the national debt places a burden upon future generations. William Baumol and Alan Blinder have pointed out that such claims are often based upon fallacious reasoning, and that, since it is impossible for repayments to be made to anyone not alive at the time, the repayment is necessarily a transfer of resources within the existing population <ref> William Baumol and Alan Blinder: "Bogus Arguments about the Burden of National Debt". on pp309-311 of ''Economics, Principles and Policy'', Harcourt, Brace Jovanovich 1979</ref>. It is nevertheless true that debt repayments normally involve an intergenerational transfer within the existing population because they are partly paid for by taxes paid by a new generation of people who tend not to be holders of government bonds. Also - to the extent that government bonds are subsequently passed by inheritance to a succeeding generation - similar transfers can be expected to affect future generations <ref> And, if the bonds were held by foreigners, repayment would, of course involve transfers to them.</ref>. Concern about that issue has led to the adaptation of "overlapping generation models" to its analysis<ref>[http://www.cepr.org/pubs/bulletin/dps/dp496.htm ''Public Debt Management: A Growing Burden?'', Centre for Economic Policy Research 1990]</ref>, and the development of  techniques of "generational accounting"<ref>[http://epress.anu.edu.au/agenda/003/04/3-4-A-2.pdf John Ablett ''Generation Accounting'', Agenda vol.3 no.4 1996]</ref><ref>[http://www.cbo.gov/ftpdocs/0xx/doc18/Genacct.pdf ''Who Pays What and When? An Assessment of Generational Accounting'', Congressional Budget Office. November 1995]</ref>. However, generational accounts require both  economic forecasts and assumptions about future policy, and are consequently controversial and subject to wide margins of uncertainty.
-===Inflationary consequences===
-It is generally recognised that the persistent  ''monetisation'' the national debt, (as an alternative to reducing it  by tax increases or spending cuts)  may be expected to have inflationary consequences. Some economists have even suggested that such inflationary consequences are the inevitable consequence of deficit financing <ref>[http://research.mpls.frb.fed.us/research/qr/qr531.pdf Thomas Sargent and Neill Wallace: ''Some Unpleasant Monetarist Arithmetic'', Federal Reserve Bank of Minneapolis]</ref>, but that proposition has been rejected by Milton Friedman<ref>[http://research.stlouisfed.org/publications/es/07/ES0701.pdf Edward Nelson: ''Milton Friedman on Inflation'', Federal Reserve Bank of St Louis Winter 2007]</ref>  and other monetarist economists<ref>[http://www.questia.com/read/5002142821 Allan  Meltzer: ''Monetarist'', National Review, Vol. 41, January 27, 1989]</ref>, and it is not supported by empirical evidence.  An analysis of historical experience<ref>[http://www.imf.org/external/pubs/ft/wp/2003/wp0365.pdf Luis Catāo and Marco Terrones: ''Fiscal Deficits and Inflation'', IMF Working Paper WP/OP/65, 1965]</ref>  has found an association between deficit financing and inflation among developing countries, but none among industrialised countries - a difference that has been attributed to differences in the short-term costs of tax collection.
-===Crowding-out and crowding-in===
-Under normal circumstances, private sector spending on government bonds is to some extent at the expense of spending on private sector bonds, with the consequence that some private-sector investment is "crowded out". To the extent that government bonds are used to finance consumption rather than investment, the total of the country's investment is diminished, leading in time to a loss of potential output. Crowding-out is seldom complete, however, but depends upon a range of factors including elasticities of demand for investment and for money <ref> See Frederick Fourie: ''How to Think and Reason in Economics'', Juta 2001</ref>. During a recession, crowding-out may to some extent be offset by  "crowding-in" as government spending makes up for the deficiency in private sector spending, leading to a recovery of demand and an increase in private-sector investment.  The balance between crowding out under particular circumstances is a matter of controversy <ref> See "The Crowding-out Controversy" on page 248 of William Baumol and Alan Blinder: ''Economics, Principles and Policy'', Harcourt Bruce Jovanovich, 1979 </ref> .
-==Political attitudes==
-The nineteenth  aversion to the creation of national debt was reinforced  in the twentieth century by the emergence of its popular association with inflation - an association that was generated,  first by the German experience of hyperinflation<ref>[http://www.usagold.com/germannightmare.html. ''The Nightmare German Inflation'', Scientific Market Analysis, 1970.]</ref>, and later  by the inflationary consequences of numerous ill-judged attempts to use deficit finance to promote economic growth.  A second source of reinforcement was a desire to reduce government activity by a strategy known as "starving the beast", and survey evidence from the United States suggests that it has acquired a significant influence upon group psychology<ref>[http://papers.ssrn.com/sol3/papers.cfm?abstract_id=589283 Jonathan Barron and Edward McCaffery: ''Starving the Beast: The Psychology of Budget Deficits'',U of Penn, Inst for Law & Econ Research Paper 04-21; USC Law and Economics Research Paper No. 04-24; and USC CLEO Research Paper No. C04-21 December 2005]</ref>. Also, opposition politicians in many countries have often warned that government policies would lead to "national bankruptcy" or that they would impose a "burden on future generations".  As a result, public concern about national debt has become a matter of electoral importance (for example, an opinion poll in  February 2009, reported that it was one of the top two matters of concern to United States voters <ref> ''Voters’ Attitudes about America’s Growing Budget Deficit and National Debt'', Findings from a Nationwide Survey Among Registered Voters, Conducted by Hart Research Associates and Public Opinion Strategies [http://www.pgpf.org/resources/Peterson_030409_Survey_Summary.pdf]</ref> - awareness of which may have been behind the President's decision to set up a "fiscal responsibility summit"<ref>[http://www.whitehouse.gov/assets/blog/Fiscal_Responsibility_Summit_Report.pdf White House Report on the Fiscal Responsibility Summit, February 2009]</ref>).
-==Debt-limiting rules==
-===Overview===
-National legislatures have, from time to time,  sought to impose constitutional limits upon government borrowing, often with the objective of limiting government activity, and sometimes in order to avert the danger of default. In some countries, notably the United States, there have even been attempts at "balanced budget amendments" that would forbid all  borrowing, even for the purpose of investment. In recent years,  the practice of accepting  self-imposed limits has also been adopted by governments - a practice which, besides being electorally popular, serves the purpose  of promoting  investor confidence in the integrity of their bonds.  Among developing countries, the development of international capital mobility has made the  maintenance of  investor confidence a policy  imperative because panics among investors and anticipations of default by speculators have been a common cause of sovereign default - as explained by Paul Krugman <ref> Paul Krugman: ''The Return of Depression Economics'', pages 107-135, Penguin 2008</ref>. Paul Krugman explains the [[International Monetary Fund]]'s apparently perverse interpretation of the [[Washington Consensus]] as requiring the avoidance of deficits, even in periods of recession<ref>[http://www.econ.utah.edu/activities/papers/2004_09.pdf Alcino  Câmara and Neto Vernengo: ''Fiscal Policy and the Washington Consensus: A Post Keynesian Perspective'', Working Paper No: 2004-09, University of Utah Department of Economics, 2004]</ref> as a confidence-building tactic.
-The maintenance of investor confidence is a matter of mutual concern among governments  because  crises that can lead to ''sovereign defaults'' can be contagious, in much the same way that bank ''runs'' can generate banking panics. That consideration has prompted currency unions such as the European Monetary Union to set up deficit-limiting rules and monitoring systems.
 ===The UK's Code for Fiscal Stability===
 In November 1997 the British government  announced<ref>[http://archive.treasury.gov.uk/pub/html/docs/fpp/code/main.html ''A Code for Fiscal Stability'', H M Treasury November 1997]</ref> its adoption of two rules of fiscal conduct:<br>
-:-  a "golden rule":that over the economic cycle, the Government would  only borrow to invest and not for public consumption,and <br>
+:-  a "golden rule":that over the economic cycle, the government would  only borrow to invest and not for public consumption,and <br>
-:- a "sustainable investment rule": that over the economic cycle, the Government would ensure the level of public debt as a proportion of national income is held at a stable and prudent level (subsequently interpreted as 40 per cent of gdp);<br>
+:- a "sustainable investment rule": that over the economic cycle, the government would ensure the level of public debt as a proportion of national income is held at a stable and prudent level (subsequently interpreted as 40 per cent of gdp);<br>
 and an analysis <ref>[http://www.hm-treasury.gov.uk/d/pbr08_endofyear_403.pdf ''Meeting the Fiscal Rules Over the Past Cycle'', (1997-98 to 2006-07) - Chapter 2 of End of Year Fiscal Report HM Treasury, November 2008]</ref> published by the Treasury in 2008 concluded that:<br>
 :- the average surplus on the current budget over the previous economic cycle was positive, thus meeting the golden rule; and,<br>
-:-  public sector net debt  remained below the 40 per cent of GDP limit of the sustainable investment rule over the cycle.
+:-  public sector net debt  remained below the 40 per cent of GDP limit of the sustainable investment rule over the cycle.<br>
+But in November 2008 the government announced the replacement of those rules by a "temporary operating rule" under which it would  set policies to improve the cyclically adjusted current budget each year, once the economy emerges from the downturn, so that it would reach balance with debt falling as a proportion of GDP once the global shocks had worked their way through the economy in full.
-===The Maastricht Rules===
-==References==
-<references/>

Public debt: Difference between revisions

Revision as of 09:23, 21 April 2009

The UK's Code for Fiscal Stability

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