Choose a country and explain why they may have seen a rise in their fiscal deficit – create a short report on the country.

What is a deficit? WHEN total spending in a year is higher than total receipts, the government needs to borrow to cover the difference. This gap is known as the budget deficit or ‘public sector net borrowing’. When receipts are higher than spending, the government runs a surplus. Deficits and surpluses are similar to losses or profits for a company.

What the government are saying…. In , we expect a deficit of £73.5 billion or 3.9 per cent of national income – down from its post-war peak of £153.5 billion or 10.2 per cent of national income in We expect receipts to rise faster than spending over the next five years, so we forecast that the deficit will get smaller each year. Indeed, by we expect the Government to be running a surplus of £10.1 billion on current policy, at which point receipts would be 36.9 per cent of national income and spending would be 36.5 per cent of national income.

Movements in the budget deficit Movements in the budget deficit are in part the result of the ups and downs of the economy. When the economy is strong, the deficit will be lower as taxes flow in and welfare costs are reduced. The opposite is true when the economy is weak. Important to consider budget deficit as a proportion of GDP rather than its absolute size – consider it relative to economic growth

Debt The UK national debt is the total amount of money the British government owes to the private sector and other purchasers of UK gilts. In Dec 2015, Public sector net debt (ex. public sector banks) was £1,542.6 billion, equivalent to 81% of GDP Generally speaking, if the public sector runs a deficit in a particular year, debt will rise in cash terms. But it can still fall as a share of national income if the cash size of the economy is growing sufficiently strongly.

In Dec 2015, Public sector net debt (ex. public sector banks) was £1,542.6 billion, equivalent to 81% of GDP

After a period of financial restraint, from mid 1990s, public sector debt as a % of GDP fell to 29% of GDP by From 2002 – 2007, national debt increased to 37% of GDP. This increase in debt levels occurred despite the long period of economic expansion; it was primarily due to the government’s decision to increase spending on health and education. There has also been a marked rise in social security spending – public sector debt has increased sharply because of: recession (lower tax receipts, higher spending on unemployment benefits) The recession particularly hit stamp duty (falling house prices) income tax and lower corporation tax. Financial bailout of Northern Rock, RBS, Lloyds and other banks. From , the pace of increase in the public sector debt has slowed due to the government attempts to reduce the budget deficit. The government has announced strict spending limits.

Deficit down but debt up? One potential confusion is that politicians may say the budget deficit is coming down. But, at the same time, national debt is rising. If annual borrowing falls from £80bn to £50bn, the annual deficit is lower. But, at the same time, the national debt (total debt) is still rising. % of GDP The most useful measure of national debt is to look at debt as a % of GDP. For example in 1950, UK national debt was £640bn (at 2005 prices) – but this was 250% of GDP.

Comparison with other countries Although 80% of GDP is high by recent UK standards, it is worth bearing in mind that other countries have a much bigger problem. Japan for example has a National debt of 225%, Italy is over 120%. The US national debt is close to 80% of GDP Also the UK has had much higher national debt in the past, e.g. in the late 1940s, UK debt was over 200% of GDP.

Governments can finance their debt in two main ways Selling bonds to the private sector - either domestic or foreign The Central Bank can finance shortfall in revenue by increasing the money supply and buying bonds.

Factors which influence how much a government can borrow Domestic savings. If consumers have a high savings ratio, there will be a greater ability for the private sector to buy bonds. Japan has very high levels of public sector debt, but with high domestic savings, there has been a willingness by the private sector to buy the government debt. Similarly, during the Second World War, the government was able to tap into the high levels of domestic savings to finance UK debt. Relative interest rates. If government bonds pay a relatively high interest rate compared to other investments, then ceteris paribus, it should be easier for the government to borrow. Sometimes, the government can borrow large amounts, even with low interest rates because government bonds are seen as more attractive than other investments. (e.g. in a recession government bonds are often preferred to buying shares (which are more vulnerable in a recession). Lender of last resort. If a country has a Central Bank willing to buy bonds in case of a liquidity shortages, investors are less likely to fear a liquidity shortage. If there is no lender of last resort (e.g. in the Euro) then markets have a greater fear of liquidity shortages and so are more reluctant to buy bonds.

Prospects for Economic Growth. If one country faces prospect of recession, then tax revenues will fall, the debt to GDP ratio will rise. Markets will be much more reluctant to buy bonds. If there is forecast for higher growth. This will make it much easier to reduce debt to GDP ratios. The irony is that cutting government spending to reduce deficits, can lead to lower economic growth and increase debt to GDP ratios. Confidence and Security. Usually, governments are seen as a safe investment. Many governments have never defaulted on debt payments so people are willing to buy bonds because at least they are safe. However, if investors feel a government is too stretched and could default, then it will be more difficult to borrow. Therefore, some countries like Argentina with bad credit histories would find it more difficult to borrow more. Political uncertainty can make investors more concerned. Foreign Purchase. A country like the US attracts substantial foreign buyers for its debt (Japan, China, UK). This foreign demand makes it easier for government to borrow. However, if investors feared a country could experience inflation and a rapid devaluation, foreigners would not want to hold securities in that country. Inflation. Financing the debt by increasing the money supply is risky because of the inflationary effect. Inflation reduces the real value of the government debt, but, that means people will be less willing to hold government bonds.

How to reduce the debt to GDP ratio? Government spending cuts and tax increase (e.g. VAT) which improve public finances and deal with the structural deficit. The difficulty is the extent to which these spending cuts could reduce economic growth and hamper attempts to improve tax revenues. Some economists feel the timing of deficit consolidation is very important, and growth should come before fiscal consolidation.

Potential problems of National Debt Interest payments increase Higher taxes / lower spending in the future. Crowding out of private sector investment / spending. The structural deficit will only get worse as an ageing population places greater strain on the UK’s pension liabilities. (demographic time bomb)demographic time bomb Potential negative impact on exchange rate (link)link Potential of rising interest rates as markets become more reluctant to lend to the UK government. Reduction in credit rating, leading to a loss of confidence in the markets.