Deficits and Debt - where does the UK stand?

Deficits and Debt - where does the UK stand? 

By Alex Nuth

Financial Times Inspired Content

Historically national debt was accepted as a temporary response to major events, such as wars. However, more recently deficits (the annual difference between government revenue and spending) have become much more frequent, so much so that the UK government has only recorded 5 budget surpluses since the early 1970s. One of the main causes of this change in the borrowing dynamics is the lower interest rates that the UK experiences. As a result of this abundance of debt and many years of deficits, the UK government now spends over 10% of its budget servicing debt (paying interest payments on the debt). This is a monumental figure that is around £102bn! The total public sector debt is even more stifling standing at over £2.7 trillion, which is £38k per person in the UK. As previously mentioned, the main consequence of all this debt is that the UK faces these stark interest payments which consume a substantial proportion of its budget. 

The PSNFL is an important economic measure used in the UK to assess the financial health of the public sector. Specifically, it represents the total liabilities of the public sector (like debts or obligations) minus its liquid financial assets (such as cash or easily sellable securities). This method of measurement is far more comprehensive than the other method used (PSND) because it shows lower net liabilities. Our transition to using the PSNFL means that we can borrow more as a nation. 

                          

How is a government budget deficit funded? 

Budget deficits are funded through means such as government bonds, in which the government promises to pay the nominal amount back. The main buyers of these bonds are pension funds, insurance companies, overseas investors, as well as the BoE in secondary markets. 

One of the main owners of this debt is the BoE which holds almost 25% of it. Many of these bonds are bought through quantitative easing (QE). If interest rates rise, bond prices would fall, potentially leading to significant losses for the Bank of England, which holds a substantial portion of these bonds.

What is a structural deficit? 

A structural deficit is part of the deficit that is unrelated to the stage in the economic cycle. An example of is the UKs long term spending commitments on the NHS, which is spending that the UK experiences no matter that the period of the economic cycle is.  

Another type of deficit is a cyclical deficit, which is the part related to the economic cycle.                                                           

 

National debt sustainability 

The UK operates on its own sovereign currency, the pound, and hence does not rely on any external printing or borrowing. However, this does come with some costs, such as fiscal dominance (when BoE forced to print money or keep interest rates low to finance debt). 

Ways to reduce national debt 

Increased productivity is one of the main drivers for reducing this debt as well as an increased working population which also contributes to economic growth in most cases. Austerity (reduced public spending to public services) is a controversial method while it impacts the vulnerable but is sometimes the only feasible option. A financial repression could also be an option which forces banks to hold government bonds using legal restrictions on interest rate levels and credit allocation. Other ways include delaying the transition to net zero, but this may be a trade-off between the new renewable technology and a reduction in national debt. Furthermore, a strain on international relations may occur from this method. The UK could also reduce its defense spending (although making NATO angry). Other than all of this, higher taxes (wealth taxes?) could be a sensible alternative. But capital flight may occur as a result. 

Lastly, currency debasement could reduce debt (whereby governments inflate their currency) by printing money causing the value of money to fall which benefits the government as this lower value of money lowers the value of their nominal debt, hence making it easier to pay off debt. However, this can come with some controversial political tension as shown in Covid-19 when the BoE was accused of ‘monetisation of government debt’ because of its QE programs being closely aligned with the timing of government spending. Of course, this method also has its flaws while the purchasing power of money is thwarted and hence people become poorer. 

To conclude, this topic of economics is an overly complex and comprehensive one which has roots in many other aspects of the economy, largely due to the significant influence of interest rates on the UK's economic output.