Raise your hand if you’re starting to feel more afraid of the economic fallout of coronavirus than you are of coronavirus itself. (Keep your hand up if you wonder if this makes you a bad person.) Raise your hand if the picture below sums up your concerns:
Simon Wren-Lewis, emeritus professor of economics and fellow of Merton College, Oxford, would like to offer some cautious optimism in his article The scare stories about government debt are back. Ignore them.
But first, if you don’t know economics, don’t run away just yet. I am no economist either. But in the manner of the 90-year-olds who are helping each other learn to use Zoom because their children and grandchildren lose patience after five minutes, you and I will walk through this together (unless you do know economics, in which case you’re welcome to stay but there is to be no eye-rolling).
We’ll focus on the UK but we will also discuss some general principles.
LET’S START BY ACKNOWLEDGING: YES, THERE IS DEBT. IT IS HUGE AND GETTING HUGER.
Fighting the pandemic is an expensive business. In particular, lockdown is an expensive business.
Many governments have ploughed phenomenal amounts of money into ensuring that people still have an income even if they are not working.
No government has that amount of money just sitting around. It therefore has to be borrowed, mainly from financial institutions. (Borrowing money is often referred to as “selling debt” or “raising debt”, and lending money is referred to as “buying debt”, quite as if debt were a tangible thing rather than an anti-thing. It confers a bit of a looking-glass feel to discussions of government finances but we’ll roll with it.) So yes, there will be debt – an astonishing amount of it.
But massive debt is not necessarily worrying.
HOW CAN DEBT NOT BE WORRYING?!
For two main reasons:
a) What matters is the debt-to-GDP ratio, not the debt itself
The amount of debt you have is not in itself meaningful. It is meaningful only in the context of your financial situation.
To illustrate: if a rich person and a poor person each have the same amount of debt, that debt is less worrisome to the rich person.
In other words, it is not your debt itself that matters but your debt-to-wealth ratio.
If you are a country, then your debt-to-wealth ratio is called your debt-to-GDP ratio.
(This is because the GDP (gross domestic product) is a measure of a country’s wealth. It quantifies the value of goods and services produced and the amount of money moving around in the form of income and spending. This system of measurement is highly flawed and incomplete – for example, it doesn’t count unpaid work and it doesn’t differentiate between a society where everyone is comfortable and one where there are a few super-rich people and the rest live in poverty – but we use it anyway.)
Now suppose that you, a person, find your debt-to-wealth ratio too high for comfort and want to reduce it. You have two options:
- Pay off some of your debt;
- Become richer.
If you are a country, the equivalent options are:
- Pay off some of your debt;
- Increase your GDP. You can do this by producing more value in the form of goods and services and by getting more money circulating in the form of incomes and spending.
b) High debt doesn’t necessarily put off those whom you may want to borrow from in the future
Consider: you might lend money to a friend who already owes a lot of money (say, who has a mortgage) but who you know is generally responsible with money. What matters to you is not how much your friend owes in total but whether you trust the friend to pay you back.
Similarly, if a government can be trusted to honour its debts, potential lenders won’t fret if it has a high debt-to-GDP ratio.
In the case of the UK, the government has enough financial credibility that even if its debt-to-GDP ratio does go up, its creditors won’t freak out. This credibility is due in part to the fact that the Bank of England will lend the government as much money as is necessary to fund its debt repayments (yes, the government uses borrowed money to pay off its debts).
The Bank is happy to do so because it will not allow a situation where it looks as if the government is having trouble servicing its debts, because then interest rates would rise (because investors lending to a high-risk borrower demand high interest to make the risk worthwhile), and high interest rates slow the economy, which the Bank is committed to making grow.
(I know not all governments enjoy this credibility. If yours doesn’t, I am sorry and I share your frustration at how unjust the world is.)
In any case, even if lenders do start getting antsy over the high debt-to-GDP ratio, well, it can be lowered by boosting GDP, as explained in point (a) above.
SO WE WILL HAVE HUGE DEBT BUT WE CAN MAKE IT LESS WORRISOME BY INCREASING THE GDP. HOW DO YOU GO ABOUT THAT?
By ramping up production of goods and services, encouraging people to buy those goods and services, and boosting their incomes to enable them to do so. Essentially, having more buying and selling going on.
This can be achieved through fiscal stimulus.
What is fiscal stimulus?
Fiscal relates to government money and a stimulus is something that provokes a reaction. Fiscal stimulus means using government money to provoke the circulation of money.
How does fiscal stimulus work?
The government increases its spending and/or reduces taxes. This eases the financial pressure on people and boosts incomes, so they spend more freely, which boosts incomes, which makes people spend more freely, and the cycle continues.
EXCELLENT. SO WE HAVE A PLAN OF ACTION AND WE CAN RELAX.
No relaxing until everyone is on the same page! And not everyone is on the same page.
Wren-Lewis (the author of the article mentioned at the beginning) is worried that advisers in the UK Treasury (the economy and finance ministry) appear to have fallen into the trap of wanting to reduce the deficit before all else.
What is the deficit and how is it different from the debt?
Debt is a running total of the amount owed, including from previous years.
The deficit (or its opposite, surplus) is the difference between your outgoings and income over a certain period, usually the tax year, and is set back to zero at the beginning of the next period. (If my understanding is correct, this means you can run a deficit without going into debt, provided you start out with enough money to cover your deficit.)
The government has a deficit if it spends more (on things like healthcare, education, policing, etc.) than it earns (in taxes).
What’s wrong with reducing the deficit?
The government can reduce its deficit by spending less or by taxing more, or both.
These measures are called fiscal tightening or austerity measures.
Austerity hampers the economic recovery by putting citizens under financial stress, making them spend less, thus shrinking GDP.
Which is precisely the opposite of what we need if we are to ensure that the debt becomes manageable. Remember, we need to raise the GDP to tame the debt.
There is particular irony in the fact that the Treasury advisers are proposing to reduce the deficit in part by freezing the wages of public-sector workers, a category that includes most of the country’s healthcare workers – yes, the same ones who have been putting their lives on the line to treat covid patients.
WHY MIGHT WE BE OPTIMISTIC?
The current chancellor – the head of the Treasury and the person in charge of holding the UK’s economy together – is Rishi Sunak, who was catapulted into the role when his predecessor resigned suddenly, just before the national budget was due. He hit the ground running – sprinting! – and hadn’t even had time to catch his breath after delivering the budget before he was chucked the pandemic grenade.
Instead of having a nervous breakdown like a normal person, Sunak immediately put together a package of furlough measures to protect people’s incomes during the lockdown. The package was not perfect, but, considering the speed with which it was drawn up, it solved a lot of problems for a lot of people very quickly (and was refined in its next iteration).
Sunak recognises the importance of achieving economic recovery before dealing with the deficit.
Also, we’ve already experienced the kind of austerity that Sunak’s advisers are trying to nudge him towards – it was in place for a decade following the last economic crisis and delayed the recovery from 2010 to 2013 – and there is much less appetite for such discomfort this time around.
SO, IN SUMMARY
High debt is OK, as long as you have a high GDP (or are able to make it high in the future). In fact, you may need to run up lot of debt in order to support your GDP now and invest in its future growth.
So, counterintuitively, making your debt less intimidating in the future may entail making it more intimidating for now. You just have to make sure you keep a cool head throughout.
Here is a duck keeping a cool head: