Part 1. What is government debt?
“The Government is maxing out its national credit card” – or so it was claimed by Laura Kuennesberg on national TV back in November 2020. Her statements on the BBC 10 o’clock news programme provoked a response from 34 leading economists, who wrote in to the BBC’s Director General to rebuff the claim that we are reaching dangerous levels of public debt, at a time when sustained government spending was imperative. On the surface, the fact that the UK Government currently holds £2.1 trillion worth of debt sounds worrying. But is debt always bad?
A widespread misconception about government debt stems from how we understand it to work in the context of our own lives. I know that if I’m in debt, I’m in trouble. But governments are nothing like households, and government debt is nothing like household debt. Governments that issue their own currency cannot go broke because they can always pay back their debt, given that the central bank can bail them out using its legal authority to create money. So they are not constrained by how much they can borrow. Rather, they are constrained by the impacts of that borrowing on things like inflation and exchange rates.
How does government borrowing actually work? Right now in the UK, any spending that exceeds expected tax receipts is raised via the purchase of government debt. Most Government debt is raised via the sale of a type of government bond called ‘gilts’ purchased mainly by domestic insurance and pension funds, or overseas private investors. Not all gilts are the same – they can be ‘index-linked’ (which means their value and the interest they generate fluctuate with inflation), have varying maturities, and be held by domestic or foreign entities.
During periods of crisis, The Bank of England might buy up some of these government bonds from the secondary market in order to lower interest rates and stimulate investment (because the more demand there is for borrowing, the cheaper borrowing is – or so the theory goes. Whether this actually transpires is another question, addressed in part 3). The Bank of England essentially creates money in order to do this, by simply crediting the account that the bank used by the bond seller holds with the Bank of England, through a computer. In other words, the actual money came from nowhere but simply appears on balance sheets as the Central Bank decides to undertake the transaction. This is quite abstract and hard to picture – more on this dynamic in part 3.
This frees up cash for those private creditors that held the gilts previously, who can then use this new liquidity to invest in other parts of the economy, placing much of the government debt in the hands of the Bank of England. Once it’s on the Bank of England’s balance sheet, it effectively becomes money that the Government owes itself. The limit to the amount of money that the government can borrow from itself in this way is at the discretion of the Monetary Policy Committee in the Bank of England, who decides how much government debt they’re willing to buy up based on various macroeconomic indicators. The limit is currently set to £895 billion (much to Andy Haldane’s dismay).
There is also a mechanism through which the Bank of England can legally lend to the Government called the Ways and Means facility. It’s essentially an overdraft account that the Government holds directly with the Bank of England which can be tapped into in case of emergency. The limit to borrowing from the Ways and Means Facility is currently £370m, but it shot up to £20bn during the 2008 financial crisis and there’s no reason why it couldn’t do the same again now. Again, this limit is at the Bank of England’s discretion – it’s just a more direct way for the Government to borrow from them. When the Government withdraws from the Ways and Means facility, it is very similar to selling bonds directly to the Bank of England, except it is supposedly short-term and must be repaid within the next year.
The table below lists other ways in which the government can create money.
Source: Bringing the helicopter to the ground: a historical review of fiscal-monetary coordination to support economic growth in the 20th Century, Ryan-Collins & Van Lerven, 2018
So before launching into theoretical debates on government debt and deficit, let’s be clear that all economists would agree that the UK Government is not running out of cash nor maxing out its credit card because it can always borrow form itself. That is a truism. We should therefore be wary of oversimplified reports like Kunessberg’s credit card analogy, which perpetuate overly pessimistic views of government debt. The danger is that these narratives stoke public opinion towards a need to return to austerity – which is now generally understood by economists to be incredibly damaging.
The consensus amongst economists around the role of government spending in time of crisis has shifted since the 2008 crisis, but appears to be less well reflected in the media which hyperbolises discussions on public finances and conflates pubilic with household debt.
There are certainly limits to government spending, and those limits are hotly debated in the economic sphere. But, as asserted by 50 leading economists and global institutions such as the OECD and the IMF, during a time of recession government spending is vital to avoid the devastating consequences that followed the austerity years. And as well articulated in Andy Verity’s recent commentary on the BBC, those limits on government spending are certainly not defined by bounded money supply.
Jaya Sood is an Analyst in HM Treasury. Please feel free to email her with any questions
Things to think about
- Why do governments have to pay interest on debt they owe to themselves? Do central banks ever write off government debt?
- How do countries without central banks fit into this? E.g. developing countries, the EU?
- Why does the media perpetuate household metaphors when this is not how government debt really works? How can economists effectively shift this narrative when it is so ingrained?
- Debate about implications of large fiscal stimuli continues between prominent economists: what degree of threat do different consequences of large programmes of government spending pose?
Further reading/watching/listening for this blog series
- Exploring Economics events:
- Understanding Pandemic Response: The Modern Money Theory Perspective (L. Randall Wray)
- Inside the Black Box: the public FInances after Coronavirus (Jo Michell)
- Monetary Policy in a Pandemic (Josh Ryan-Collins)
- A Conversation with Lawrence H. Summers and Paul Krugman – opposing views on the optimal size of the Biden stimulus
- Review of Stephanie Kelton’s ‘Deficit Myth’, a book debunking 6 myths purporting that government deficits are inherently bad
- Against MMT (James Meadway)