It is inevitable that UK government debt will rise above pre-pandemic levels as government spending is stepped up, but there are good reasons not to fear such a scenario, and the pressure to return to austerity should be strongly resisted. The focus must be on boosting the recovery and reshaping the economy towards one that supports quality employment, sustainable industries and reduces economic and social inequalities.
The Covid-19 crisis has witnessed unprecedented action by governments around the world leading to substantial rises in government debt. This is unsurprising as the government extends life support to the economy with increased spending and borrowing, whilst collecting less tax revenue, due to higher unemployment and the business sector on pause. The UK government’s borrowing alone surged to £62 billion in April 2020, the largest monthly increase since records began in 1993. As a result, the Treasury’s Office for Budget Responsibility (OBR) forecasted a rise in the government debt-GDP ratio from 81% to 112% by 2020/21. While a recent report by the Institute for Public Policy Research (IPPR), estimated it could rise to as much as 120% under a 3 month lockdown, and as much as 140% under a 6 month lockdown scenario.
However, there are a number of reasons why higher government debt should not be a cause for alarm in the current moment. Firstly, from a historical perspective, the UK has sustained far greater levels of national debt. In 1946 UK government debt as a share of GDP peaked at 250%, much of which was spent setting up the post-war welfare state. This debt was incredibly useful in strengthening the health and wellbeing of our society, and over the following 30 years, the burden of debt was gradually eroded by higher growth, lower unemployment and modest inflation.
Secondly, fears that high government debt-GDP ratios spook potential investors are misplaced. One figure widely used after the 2008 financial crisis to justify austerity was the 90% debt-to-GDP cliff edge, but this has since been thoroughly debunked. When the government borrows to fund more spending, they sell debt, often referred to as ‘gilts’, to financial markets. Currently, despite rising government debt levels, demand for gilts is incredibly high as investors consider it to be a safe asset in these uncertain times. This high demand is keeping the effective interest rates on gilts at historic lows. For example, the UK Debt Management Office, which sells debt on behalf of the government, recently sold £3.8bn of gilts at a negative yield which means investors who hold the gilt will receive less back on their initial investment. In other words, investors are paying the government to lend to them, clearly disproving the austerity argument that high debt levels necessarily scare off investors.
Thirdly, the sustainability of government debt, depends just as much on the nature of the debt and who owns it, as on the overall amount. And fortunately for us – almost a quarter of UK government debt is technically owned by the UK government. This is because while the Bank of England is run independently it remains an institution owned by the UK government, with a mandate issued by Parliament. Since 2009, the Bank of England has engaged in quantitative easing (QE); creating new money to buy government and corporate bonds. Since the start of the coronavirus crisis, QE has increased by £200 billion taking the total value of government bonds purchased to £646 billion in March 2020. While QE has historically been an ineffective stimulus tool with negative side-effects, it is currently being used to facilitate the government’s spending, as it ensures that demand for gilts remains high and therefore effective interest rates on the government’s debt remain low.
Moreover, it is an illusion that government spending can only be financed through issuing debt or higher taxation. As mentioned above, the Bank of England has the ability to create money, and it also has the ability to give that new money directly to the government. For example, it can extend the government’s overdraft facility known as the Ways and Means Facility, which it recently announced it would be happy to do. This form of direct monetary financing would allow the government to spend directly rather than issuing debt through the bond market. Currently, this remains a limited and temporary measure but it could be used to support government spending without requiring any issuance of debt. This gives the government additional flexibility in dealing with the recovery and vulnerabilities facing the economy. Repaying the overdraft would be a purely political choice and make little technical sense in the context of ongoing QE.
Ultimately, fears over high government debt are unfounded, and those demanding a return to austerity because of them, must be challenged. The previous decade of austerity not only impeded our economic recovery, but led to soaring levels of poverty and inequality. Fortunately, so far the Prime Minister and the Chancellor have indicated no appetite for a return to draconian austerity measures and instead talk of ‘levelling up’ the economy. This is sensible, the government should be spending to support the economy while households and firms are hesitant. Given the severity of the crisis, the Bank of England’s offer of direct monetary financing should not be confined to a one-off measure, but rather integrated more permanently into the monetary policy toolkit. That way we really can build back better, and reshape our economy towards quality employment, sustainable industries and reverse a decade of growing economic and social inequalities.