Should we be Worried About the National Debt

I recently saw a tweet (to be fair, I see a lot of tweets) from someone complaining about the press reacting to the fact that the UK’s national debt has reached 100 per cent of GDP. The person’s tweet read something along the lines of ‘I got interested in economics after I asked economists exactly what percentage of national debt is bad. None of them could answer’. Given that the person also ran an MMT podcast (as per their bio) I’m assuming they think that a large national debt is not a problem. Given that MMT is hokum and has been thoroughly debunked I ignored it. 

Then last night out of boredom (after a thrilling snooker final) I found myself watching the Press Preview on Sky News. This featured somebody condemning Rachel Reeves for essentially carrying on with austerity and saying that the government can essentially borrow what it likes to fund public spending and that arguments against it such as the government maxing out its credit card are myths made up by right wing economists.

In many ways this person was correct. The economy does not need more austerity - but that’s what we’ll be getting as tax rises are a form of austerity. She was also right to point out that the public finances are nothing like a household budget and the UK government does not have a credit card that it can ‘max out’. This is something which has been peddled for decades and is actually an incredibly effective messaging tool. It worked for Thatcher and it worked for the Coalition government. Like MMT, such an analogy is a load of nonsense. Public finances are nothing like a household budget and in fact there are probably no useful analogies which one can make when it comes to public finances which don’t either over simplify, mislead, or lead to greater confusion. 

However, all that being said, I felt it was a bit of a straw man from the guest on Sky News. While it is true that the UK’s public finances are not like a household budget, it is not true to say that the government can borrow whatever it wants. In reality, the UK government does face borrowing constraints and a high national debt is problematic.

I find it baffling that many people are currently saying that the government can essentially borrow whatever it wants without any negative consequences. I find it even more interesting when these are the same people who still like to erroneously claim that Liz Truss crashed the economy with her mini-budget. While the Truss-Kwarteng budget did not ‘crash the economy’ it did cause a spike in interest rates on gilts. This is because there were a number of unfunded tax cuts and spending commitments which would have had to be financed through increased borrowing. This spooked the bond market and led to an increase in gilt yields.

Now, this doesn’t necessarily mean that the UK can’t increase borrowing. As I’ve written before, the government doesn’t need to sticky rigidly to the ‘Fiscal Rules’ and if Truss and Kwarteng had actually taken their time, worked with the OBR to get a proper analysis of their plans, and done a much better job at communicating what their plans were then things would have worked out far better. 

What is more, we do not know exactly how much the government can borrow and I think if anyone gives an actual figure then they’re probably best ignored. However, there is clearly some limit. Countries do find that they can no longer convince others to buy their gilts. These do tend to be nations which are beset with many structural issues and such high national debt and have often already defaulted on their debts that no sane or responsible investor is willing to take the risk (even at a ridiculously high rate of interest). The UK is obviously nowhere near this but it does show that pretty much all countries do face borrowing constraints.

Moreover, the UK has probably missed the boat when it comes to massively increasing borrowing. The best time for the government to start borrowing more was in the aftermath of the Global Financial Crisis when interest rates were so low that it would have been incredibly cheap to borrow. I would add the caveat that the UK does have a significant proportion of gilts which are indexed-linked and so I felt some commentators were again being a bit naive thinking that the government could have borrowed whatever it wanted under the assumption that inflation and interest rates would continue to remain so low, but some extra borrowing in order to invest in energy and transport infrastructure would have been appropriate. Regardless, we are now in very different times and although interest rates are decreasing and inflation is returning to target, we are unlikely to see the return to very low interest rates anytime soon and so borrowing will be expensive.

Increasing borrowing will also increase the national debt. As with borrowing, I cannot say when the amount of national debt becomes a problem and if someone claims they can then I’m not sure they should be taken too seriously. However, just because you can’t give an exact figure does not mean it is not a problem. 

The government has to pay interest on the debt and eventually pay it back. To do so it can either borrow even more money (which we’ve already seen is not a great option) or it can introduce even more austerity by increasing taxes or cutting public spending in other areas. Increasing taxes which reduce growth and increase the burden on working people or spending less on public services such as the NHS or education in order to service the national debt is clearly suboptimal. Can I say exactly when this becomes a huge problem? No. Is it the biggest thing we should be worried about right now? Probably not. However, it clearly is problematic and it will become more of a problem as it increases.

A high national debt is also bad due to its potential impact on future borrowing. This may seem contradictory to what I’ve already argued (I don’t think that massively increasing borrowing is a good thing). However, borrowing serves an incredibly important purpose. We saw that during the Global Financial Crisis and the subsequent Great Recession and also during Covid that not only will the government need to massively increase public spending but it will also see a decrease in tax receipts as firms go bust and people lose their jobs. It is then essential that the government can fund public spending through borrowing. These crises will come when every country is – and should – be seeking to borrow more and so it is preferable that the national debt is not already too high so that increasing it even more does not become too much of a problem either in terms of convincing others to buy the gilts or meaning that the country does not have to implement even more painful austerity in order to service the debt.

So, there we have it. Are the public finances like a household budget? No. Can we say exactly when borrowing and the national debt becomes a bad thing? Again, no. However, that does not mean that they are not problematic or that the government faces no borrowing constraints.

Other stuff

Last week I wrote my semi-regular article on why the MPC of the Bank of England has messed up. It was again too cautious and should have continued to cut Bank Rate. You can read it here.

I also wrote an article for CapX on why the government should abolish subsidies for charities such as Gift Aid and Business Rates relief for charity shops. It’s available to read here.

Thanks as ever for reading. I imagine I’ll write at least one other thing this week given that we’re in Conference Seasons and there is likely to be lots of ‘interesting’ things being said by Labour and the Tories.

Have a great week!