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Governments must borrow if their revenue is insufficient to pay for expenditure - a situation called a fiscal deficit. Borrowing, which can be short term or long term, involves the sale of government securities.
Bonds are long term securities that pay a fixed rate of return over a long period until maturity, and are bought by financial institutions and companies looking for a safe return. Bonds issued by the government are called gilts - short for gilt-edged, meaning they are as good as gold and payment of interest and at redemption is guaranteed. Treasury bills are issued into the money markets to help raise short term cash, and last only 90 days, whereupon they are repaid.
If the revenue from the council tax and central government support is insufficient to meet spending commitments, local authorities can also borrow by issuing bonds. Only around 25% of local authority spending is financed by local revenue raising, 75% coming from central government and by borrowing.
If the borrowing requirements of both central and local government is combined, the amount of borrowing required is called the public sector net borrowing (PSNB). The need to borrow varies considerably with the business cycle.
During periods of economic growth, tax yields rise and spending on welfare payments fall, pushing the public finances towards a surplus. During periods of economic slowdown, tax yields fall and welfare payments rise, pushing the economy towards a fiscal deficit.
In 2009, the government introduced a new measure of public sector borrowing, called Public Sector Net Borrowing Ex (PSNBEx). This measure excludes payments to the financial sector to ease the credit crisis.
The Chancellor’s golden rules for sustainable investment are firstly, to balance the books over a trade cycle, and secondly, only to borrow to fund capital projects, such as road building.
According to the Institute for Fiscal Studies (IFS), the central government net borrowing requirement in 2009, of approximately £150b, was almost double initial estimates. The main reason for this overshoot was the rescue package for the banking sector, following the global financial crisis.This package included:
£37b for recapitalization of the main banks, RBS, Lloyds and HBOS.
£21b to the Bank of England to help refinance the financial services sector.
Fiscal deficits occur when the revenue received by a government is less than spending during a financial year. These deficits will create the need to borrow by selling government securities - bills and bonds.
The national debt is the cumulative amount of annual borrowing that occurs when government spending is greater than revenue.
debt Hypothetical example to illustrate how the
national debt is calculated.
Annual fiscal deficit
Hypothetical example to illustrate how the
national debt is calculated.
A rising national debt can happen when tax revenues fall and government spending rises as the economy slows down or goes into recession, or when householders and firms spend less, so less VAT is collected, and householders and firm receive less income, so revenues from income taxes fall.
In 2010, Greece needed a massive bail-out from other members of the euro area to cope with debts which were estimated to be running at over 120% of GDP.
In the wake of the financial crisis Ireland had a public deficit in 2010 the equivalent of 32% of its GDP, over ten times the limit set as part of the Stability Pact. To help save the Irish economy from meltdown, and in an attempt to shore up the Euro, the Euro-16 along with the IMF agreed a financial rescue package of €750b. (See European Financial Stability Fund)
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