Wednesday, 22 April 2009

The Party's Over...

...and here’s the bill. So now we know more clearly the cost of this bust (in which GDP is now forecast to fall some 3.5% this year) and it is shocking. Public sector net debt was 36.5% of GDP in the fiscal year 2007/8 and today the Chancellor has projected public debt to rise to just a shade under 80% of GDP by 2013/14. Public debt was previously as large as 80% of GDP in 1968 when the trajectory was still gradually adjusting downwards after WWII. This government’s self-imposed Golden Rule, or threshold, for public debt of 40% of GDP has been shattered with some £790Bn of borrowing planned over years from 2008/9 to 2013/14.

Admittedly, accompanying this debt projection are some plans for taxes to rise and for the growth in government spending to fall somewhat more than earlier plans. But these new plans represent second order modifications around a potentially explosive path. The risks to the path for debt to GDP seem to lie on the upside should the economy continue to remain longer in the doldrums and, which may follow, should there be further calls on the public purse to bail out financial institutions.

The big picture is that a large quantity of debt, created during the long 1990s expansion which ended in 2008, has now been transferred from the private sector to the public sector. And the trick that the public sector is trying to pull off is to smooth the increase in taxes that need to be levied on the private sector to pay-off these debts. But the danger is that financial markets will see through this trick and start to treat the public sector as more risky, like the hapless private sector, and that is why the initial reaction has been for bond yields to rise some 8-10bp. Now where’s that aspirin?


NightBlue said...
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NightBlue said...

If this debt is being transferred to public sector, the public sector should behave like a person who goes under debt: Decrease expenditures by stopping inefficient spendings and counting small money seems insignificant.

Take this example: there is a bus stop just in front of my study room and everyday I see dozens of busses are passing by just in front of me. A huge amount of those busses are carrying maximum five people for the most of day. Such huge busses consume tons of diesel to carry 2-3 people. So, what is the result for the government? Inefficient non-productive government subsidy to the transportation company, in other words wasting money.

Take the other example: my landlady`s son has two children. He is not married and he is not working. He lives with the help of state benefits. Although he has two children, he managed to buy a car, to pay for the insurance and tax for the car, he can drink bottles of beer everyday and he can go out with another girlfriend. He can pay all of with the money he receives from the state. Moreover, he is not searching for a work. So, what is the result for the government: inefficient expenditure, over-protection.

After Second World War, governments were re-building the country. The increase in public debt was acceptable from this point. The fruits of these expenditures were gathered long ago. However, if the public debt goes to unproductive activities, the economy is doomed. Many examples are gathered in the South America.

Matthew Wilkinson said...

There's a great deal of discussion whether the UK will loose its AAA sovereign credit rating status because of this. Indeed, head-ache!

I think the BIGGER picture is that the Quantitative Easing (unleashing the inflation monster!) is going to be yet another redistribution of wealth, robbing the diligent savers in the UK to finance these bail outs.

What I find troubling with the UK government is that through these bail outs, we can't afford further stimulus. King has advised the Queen about this (unprecedented!).

We have a bitter pill to swallow as a nation, and heads should be rolling, right from the top.