Public debt

A country's national debt - also known as its public debt - is a matter of economic and political significance. It has often been the subject of controversy, and some have considered it to have moral significance.

(terms shown in italics in this article are defined in the glossary on the Related Articles subpage)

Definition

The OECD's broad definition of public debt as "the external obligations of the government and public sector " is in general use, but national definitions differ in detail and produce figures that may not be comparable. The European Union's definition embodied in its Stability and Growth Pact of "General Government Gross Debt" differs in detail from the complete OECD definition.

Overview

Template:TOC-left It is customary in normal times for governments to use borrowing to finance investment, and it is current practice for the main industrialised countries to allow national debt to accumulate to between 40 and 60 per cent of GDP (except Japan and Italy, with percentages of over 100). It is also normal practice for governments to allow national debt to rise to between 70 to 100 per cent of GDP during major recessions - as a result, mainly of the operation of their economies' automatic stabilisers, but also from the use of fiscal stimuluses, intended to compensate for reductions in private sector spending.

Such policies are not uncontroversial, however, and even relatively modest levels of national debt, amounting to no more than 50 per cent of GDP, commonly meet with expressions of concern as being "unhealthy" or even dangerous. Such popular concern may be attributable to an instinctive belief that saving is virtuous and borrowing is discreditable, or to the belief that it imposes unfair burdens on future generations, or to the once universal reverence for balanced budgets - but it is also attributable to rational fears of harmful economic consequences. Public choice theorists oppose government expenditure, even for the purposes of investment, on the grounds that the politicians concerned are mainly motivated by personal gain, rather than a desire to serve the public interest. Austrian School economists argue that fiscal stimulus expenditure is ineffective, partly because of the "Ricardian equivalence" argument that it is nullified by increases in private sector saving and partly out of scepticism about the ability of politicians to manage the economy. Other economists have demonstrated that the use of deficit financing is bound, if continued long enough, to lead to a "debt trap" from which a government cannot escape except by defaulting on its obligations or by expanding the money supply. The 1931 German hyper-inflation, which was caused by the use of "monetisation" to manage high levels of postwar debt, has come to be seen as a dramatic warning of the dangers of deficit financing , and sovereign defaults such as the 1998 default by the Russian government as a reminder that governments are not immune from the dangers of insolvency. Sovereign default among developing countries is not, in fact, uncommon, and although the danger that it it could happen to a major industrialised country is generally considered to be remote, there is fear that a persistent rumour of its possibility might alarm investors to the point of making it self-fulfilling.

The history of national debt

In the 18th century and before, it had been the practice of kings to finance their wars by borrowing. It was cheaper than collecting taxes - and it was risk-free because a king could not be called to account for defaulting on his obligation to repay - and "sovereign default" was a frequent occurrence. In England, however, Charles II's "Stop of Exchequer" of 1672 was the last time it happened, because the "Glorious Revolution" of 1688 was followed by the "Financial Revolution" during which Parliament assumed effective control over the national debt. The culmination of that revolution was the creation in 1749 of the "Consolidated Fund" , and the issue of undated bonds known as "consols". Members of Parliament were concerned from the start to reduce the level of national debt, as evidenced by the passage of the National Debt Reduction Act 1786 . Their intentions were frustrated, however by the need to finance Britain's part in the Napoleonic War, and between 1743 and 1815, Britain's national debt increased from £245 million to £745 million, which was twice its national income. A further attempt signalled by a second debt reduction act was more successful and the ratio of national debt to national income was reduced to less than 50 per cent by 1900. But further two wars and the intervening Great Depression raised it again to over 100 per cent. According to researchers at the Institute of Fiscal Studies , it rose to over 150 per cent during the first world war, remained at above that percentage for most of the years between then and 1955. After then it was reduced steadily to about 50 per cent by 1975, and remained at between 45 and 55 per cent between 1975 and 1990 and between 35 and 55 percent through the 1990s.