Thursday, April 08, 2010

Public Debt 1

Strangely all the main parties agree[1] that the national debt is too big. But why is that? Why is the country borrowing money? Can't they balance their budget like a normal person me?

In case anyone is unclear, here is my idiot's[2] guide to public debt.

1. No one can borrow money more cheaply than the government.

This is almost[3] always true; governments of developed countries don't default on their debts, so there is no risk attached, making it easy for them to borrow money. If you or I borrow money from the bank we have to pay more to cover the chance of us failing to repay the money (or, to put it another way, we have to pay for everyone who fails to repay their loans (bad debts)).

2. The money borrowed is spent which helps to grow the economy.

The money borrowed gets spent on goods and services, employing people, who buy goods and services etc. etc. Gordon Brown, who has some knowledge of macroeconomic policy, set guidelines (which he did not always follow) that debt should only be increased to pay for capital projects, not for ongoing costs, salaries and maintenance etc. This ought to maximise the economic growth of the deficit spending as it would all go to pay for (for example) new roads, new hospitals, new computer systems, which would provide infrastructure for other economic activity.

3. The economy has grown since we borrowed the money, so it's cheaper to repay it.

As a thought experiment, if the size of the economy was £100 Million and I need to spend £20 Million, I'm going to need a 20% tax rate on everything. If I borrow the £20 Million at 5% interest, then at the end of the period I need to repay £21 Million. If the economy has grown by 6% to £106 Million in the meantime I need a tax rate of 21/106 = 19.8%. Obviously this requires a growing economy.



Anyway, that's the theory of public debt simplified to the point where it's slightly more true than not. If John Maynard Keynes were here today, he'd probably slap me for my generalisations (presumably after he'd told off the people who think Milton Keynes is named after him).

Next time[4], how the debt got so big.

[1] I say strangely, but there are many many such agreements - crime bad, employment good etc. And they all want to win lots of seats!
[2] The idiot is, of course, me as I attempt to explain some subtle and complex Keynesian economic theory in three bullet points, hopefully before both my readers fall asleep.
[3] People have been known to borrow small amounts of money from me at 0% interest. If you need £20 for a taxi or to cover the bill for a curry this is fine, but I'm not likely to lend you £100 000 000 for 10 years for a capital project. At least not at that rate.
[4] Based on my usual blogging schedule this will probably be during the next recession.

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