Does Corporations Lend Money To The Government

This section is condensed from an appendix from our book Modernising Coin.

What is the national debt?

The government has three master sources of revenue:

Taxes & fees – such as Income Tax, National Insurance, Value Added Tax (VAT), taxes on alcohol, fuel, flights then on.
Borrowing – this is mainly achieved through the issuing of bonds.
Creation of money – the revenue from this source is negligible under the electric current monetary organisation.

If government spends more it collects in taxes the difference is called the 'deficit'. If information technology collects more in taxes than it spends, this divergence is called a 'surplus'. Surpluses have been relatively rare in the UK in recent decades, with the authorities typically running deficits, spending more than than they collect in taxes and borrowing to make up the difference. These deficits have increased the outstanding nominal (i.e. non adjusted for aggrandizement) value of the national debt (whereas surpluses would have reduced it).

Who does the government infringe from?

Rather than borrowing from banks, the government typically borrows from the 'market place' – primarily alimony funds and insurance companies. These companies lend money to the government past buying the bonds that the regime problems for this purpose. Many companies favour investing coin in regime bonds due to the lack of chance involved: the U.k. government has never defaulted on its debt obligations and is unlikely to in the time to come, primarily considering information technology is able to collect money from the public via taxation. The market in government debt too tends to be stable and liquid, and offers an interest rate in excess of that which is available on other riskless investments (i.e. concrete cash).

Does regime borrowing create new money?

In virtually cases the process of government borrowing does non create any new money. While most individuals and businesses have banking concern deposits in payment, the UK government does non; they require that the purchasers of new bonds 'settle' the transaction by transferring central depository financial institution reserves (encounter The Three Types of Money) into a regime-owned account at the Bank of England. This means that new money is not created in the procedure of authorities borrowing.

For case, allow's say a pension fund holds an account at MegaBank, and wishes to buy £1 million in government bonds. The fund asks MegaBank, which is i of the Gilt-Edged Market Makers (a banking concern authorized to bargain directly with the regime in the buy of new bonds), to buy £one million of new government bonds. MegaBank decreases the pension fund's business relationship by £1 meg and and so purchases the bonds on behalf of the pension fund. To settle its transaction with the regime, information technology transfers £1 meg of reserves to the government's business relationship at the Bank of England. The residue of MegaBank'south account at the Depository financial institution of England will drop by £i meg. The government at present has £ane million of fundamental bank reserves in its account at the Depository financial institution of England, which can be used to make payments. Information technology has borrowed the money without any additional deposits being created.

To spend the money it could now transfer the reserves to Majestic Bank where an NHS infirmary holds an account. Regal banking company would then receive £one meg of central banking concern reserves, and could increase the account residue of the hospital by £1 million.

So through a rather convoluted process, £1 million of bank-created bank deposits take been taken from pension fund contributors and passed to an NHS hospital. No boosted money has been created; just pre-existing deposits accept been moved from ane identify to another. Considering the majority of government borrowing is done in this way it does not constitute a budgetary stimulus to the economic system.

(The exception to this rule is with Private Finance Initiatives, where the government borrows straight from banks. In this case, so long as the government accepts banking concern deposits rather than requiring a payment into its business relationship at the Banking concern of England, then banks create the money that the government borrows via Private Finance Initiatives).

Is it possible to reduce the national debt?

The debt is currently higher (in nominal terms) than it's always been before. While the government talks about reducing the arrears, the reality is that the total national debt volition keep growing. Even if it stops the debt growing, taxpayers will continue paying effectually £120 meg a mean solar day in involvement on the national debt.

It is very unlikely that the government will be able to reduce debt in the current system. To understand why, consider what would need to happen for the debt to be paid down. Outset, the government would demand to kickoff paying the annual involvement on the national debt each year out of revenue enhancement revenue, rather than but borrowing the money to pay it. Interest payments totalled £43bn for 2012, and so if the government wanted to reduce the debt it would have to observe an additional £43bn in taxes, which would require, for example, raising VAT (sales taxation) to roughly thirty% (from its current level of 20%).

In addition, in the five years before the banking crisis the government spent an boilerplate of 10.6% more than it received in taxes every yr. So even later the £43bn interest on the national debt is paid, to run a 'balanced budget' right now, it would need to raise an extra £22bn in taxes (to cover the x.six% shortfall), or cut public services by £22bn – equivalent to shutting down a fifth of the National Health Service.

Then far in this example, the authorities has raised VAT by thirty% and cut £22bn of public services and has yet only managed to stop the debt growing. In gild to actually reduce the debt, it needs to raise taxes even further, or reduce public spending even more than. If the government decided that it wanted to pay off £30bn of national debt every unmarried year, then it would demand to heighten another extra £30bn in taxes: equivalent to doubling council tax. Even at this level it would have thirty years to pay down the national debt, assuming tax revenue is unaffected by these changes.

Of grade, increasing taxes by such large amounts is likely to lead to a recession and even a low: businesses will pass on the costs of higher taxes to their consumers, with the increment in prices probable to lower need for goods and services. As well, faced with college taxes, individuals will have lower levels of dispensable income, and, independent of the increase in prices this will negatively affect need. Both factors will feed through to lower sales and therefore lower sales taxes, forcing the regime to farther increase taxes to hitting its debt reduction target. Lower demand for goods and services will also pb to businesses cutting employment, lowering the government'due south income from employment taxes. Higher levels of unemployment will also increase the government's spending on unemployment benefits, which will take to be funded through further borrowing, again preventing the regime from hitting its targets.

Alternatively the regime could cut its spending. Withal, this is likely to have similar furnishings to increasing taxes. During recessions people tend to cut their spending – if the authorities cuts its spending at the same fourth dimension the result tin be a catastrophic driblet in demand. This of course lowers output and therefore the revenue enhancement take. Indeed, in a newspaper looking at eight episodes of fiscal consolidations (i.e. cuts in government spending), Chick and Pettifor (2010) find that:

"The empirical evidence runs exactly counter to conventional thinking. Fiscal consolidations accept not improved the public finances. This is truthful of all episodes examined, except at the end of the consolidation after Globe State of war II, where action was taken to eternalize private demand in parallel to public retrenchment."

As they point out this runs contrary to mainstream thinking, where recessions are thought to be, at least in the long-term, self-correcting. The presumption is that eventually the autumn in demand will lead to lower prices, at which point demand increases (as the fall in prices increases relative wealth), which increases need (the Pigou-Pantinkin consequence). All the same, as was discussed in Affiliate ix, when money is created with a corresponding debt, a autumn in prices leads to an increment in the real value of debt, thus the negative consequence on the existent value of debt offsets the positive effects on existent wealth. Thus lowering spending/increasing taxes is likely to pb to a fall in tax revenues, requiring fifty-fifty further tax increases/spending cuts and then on. In fact, in this situation a debt deflation scenario is far more likely if the population is highly indebted to brainstorm with.

Is it desirable to reduce the national debt?

On the surface, paying off government debt may be beneficial because lower government debt frees up regime acquirement for core services. It is argued that high levels of government debt may also be problematic in the long run because:

Government bonds compete with individual sector investments for funds, and then regime borrowing diverts money abroad from private sector investments and increases the rate of interest the private sector pays to attract investment.
Individuals may first saving more (and so spending less) in expectation of an increase in hereafter taxes (to pay off the debt). (This is known as Ricardian Equivalence).
Because of the potential for adverse effects to long term interest rates and the exchange rate.

There is also the danger that excessive government debt can atomic number 82 to a sovereign debt crisis, as seen in Greece and other Eurozone countries. However, for countries that retain command of their currencies (i.due east. those that have central banks that are able to print currency, such as the UK, the US, Japan, but crucially not the Eurozone countries) defaulting on debt is only one of two options, every bit the state could simply print currency to pay off its debts. Of course, if this printing of currency caused significant aggrandizement it would reduce the real value of the debt and correspond a form of hidden default, in that the holders of the debt would not be repaid every bit much, in existent terms, equally they initially invested.

However it is important to besides recognise the positive effects that come from having at least some national debt:

Beginning, every bit mentioned previously, the debt gives the private sector a safe asset in which it can invest. This strengthens private sector balance sheets, increasing their robustness in the face of downturns and negative shocks (because bond prices don't fluctuate as severely every bit stock prices).
2nd, information technology allows a degree of certainty for institutional investors looking for long term returns (such as pension funds with older beneficiaries, who need security over capital gains).
3rd, information technology allows the private sector (excluding the government), in aggregate to concord a positive residual of wealth (see for example Godley and Lavoie (2012)).
Fourth, it is misleading to recollect of the national debt in the same way as nosotros think about private debts. The major holders of the national debt are Uk investors: mainly pension funds and insurance companies. Thus, it is in many senses a debt nosotros owe to ourselves (admitting information technology i owed past current taxpayers to electric current holders of the debt, which tin can create an inter-generational transfer of wealth). That said, approximately 40% of the national debt is owned to foreign investors (also pension funds and insurance companies).

In addition, it is important to remember that the nominal value of the debt is not actually important; it is the level of debt (and its maturity) relative to the earning capacity of the economy that is the important figure. For case, an private with no income and no assets may consider a debt of £ten,000 impossible to repay, nevertheless an individual that earns £ane meg a yr would consider the aforementioned debt an inconsequential sum. Broadly speaking, the 'income' of the nation tin be represented past Gdp (Gdp). The chart beneath shows the national debt equally a percentage of the Uk's Gross domestic product:

This brings into context the comments made earlier about the government never actually paying off its debt. Instead of paying off the debt by actually reducing its nominal value, the debt tends to be reduced over fourth dimension in terms of its burden. Rather than decrease the nominal amount of the debt, the earning ability of the economy (Gross domestic product) is increased.

Unsurprisingly the national debt to GDP ratio tends to shoot upwardly during wars – such as World War I (from £650m in 1914 to £7.4bn in 1919) and World State of war II (from £vii.1bn in 1939 to £24.7bn in 1949). It also shot up significantly in 2008 onwards, as the tax take plummeted due to the recession and spending (for example on unemployment benefits) increased. (The borrowing to bailout banks is not included in the main national debt figures.) It is pertinent to note here that despite the fiscal crisis, public debt is actually at a relatively depression level (albeit at its highest level historically in the absence of a World State of war). In addition, we must be articulate that the largest role of the recent increase in public debt came about not due to likewise much spending, but rather as a result of the government'south reaction to the financial crisis.

This brings u.s. to the crux of the argument. The first half of this volume [Modernising Coin] was largely concerned with the upshot of the cyberbanking sector on the economy and society every bit a whole. The excessive creation of individual (i.e. household and concern) debt was shown to be a major cause of nail bosom cycles, financial crises, recessions, etc. Every bit tin exist seen from the chart below, the level of individual debt far exceeds the level of public debt, and as such this should be the focus of debt reduction efforts:

Likewise equally looking at absolute values, the cost of debt (i.east. the interest rate on the debt) should also be considered. In this context the overall interest rate on the national debt between 2000 and 2012 worked out at around 5.6% per annum (Webb & Bardens, 2012). In contrast, the involvement rate for household debt ranges between vi% and above for mortgages, right upwardly to 17% on credit cards and up to 29% on store cards. Overall, the average interest rate is undoubtedly higher for households than it is for the authorities. For these reasons, the regime should focus on enabling the public to reduce its debts.

Source: https://positivemoney.org/how-money-works/advanced/what-about-the-national-debt/

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