Government borrowing and national debt

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Greece - sovereign debt crisis

How did it come about?

A high budget deficit - 15% of GDP in 2009 (although 3% was maximum budget deficit for membership of the EU - corruption within Greece meant that extent of debt was hidden)

Mass tax evasion

large increases in government spending - public sector wages

global recession

What did the national debt peak at?

It was at 175% of Greece's GDP (there was a 60% limit for membership of the EU)

Consequences of this crisis?

People from the IMF and the European Central Bank have been placed in government departments to ensure that the large bail outs from IMF and the ECB (european central bank) are being used wisely

benefit generosity has been reduced / increase in the retirement age / large pay cuts for public service workers

high interest rates

'haircuts' - many of the creditors were asked to write-off a large proportion of the debt

increased measures to prevent tax evasion

increase in unemployment - 28% rate of u/e

increase in the prominence of fear politics - rise in support for the nationalist party

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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Definitions

  • The budget deficit - how much the government needs to borrow each financial year
  • National debt - the accumulation of this borrowing
  • Cyclical budget deficit - a deficit that rises and falls with the business cycle as automatic stabilisers kick in (i.e. more government borrowing is needed during a time of recession - tends to balance out)
  • Structural budget deficit - budget deficit at full employment, is an underlying deficit not affected by economic performance (causes - lower wages, ageing population, benefit dependency)
  • The golden rule - the government will only borrow for capital expenditure and not to fund current government spending / if future generations shall benefit, they should pay (This has been broken!)
  • Sustainable investment rule - government net debt as a percentage of GDP not to exceed 40% of GDP (this was also broken
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Why can budget deficits be ok?

  • A budget deficit may only be cyclical
  • government borrowing helps to stabilise AD during a downturn (counter-cyclical policy)
  • Borrowing to finance capital investment is positive - it adds to the economy's capital stock AND supports long run growth
  • Crowding-out theorists may be wrong, some government borrowing is self-financing and long term interest rates haven't risen
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Financing budget deficits

  • The government finances a deficit through the issue of government debt

BONDS:

1. those buying bonds are essentially loaning money to the issuer for a fixed period of time

2. at the end of this time the bond is repaid

3. However, there is a pre-determined rate of interest (called a coupon) that is usually paid annually

4. Bondholders can sell bonds to another before the end of the time period - trade indicates the level of confidence in the government issuing the bond

5. The return on a bond is measured by the YIELD - rate of interest expressed as a percentage fo its market value (so that if the market value decreases, the yield increases )

  e.g. if you bought a £100m bond with a 5% coupon, your yield would be 5% (coupon/ value of bond x 100)

         if bond fell to market price of £90m, yield would rise to 5.5%

         the higher the yield of the bond, the riskier it is seen to be and the greater the chance the government may not be able to repay the money

KEY FACT:

31% of UK

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