Why cutting the deficit isn’t all it’s cracked up to be

Here’s a fun fact: since 1974/5, public sector net debt has fallen as a percentage of GDP in 18 years.

Yet of the 18 times it has fallen, only five times was it due to a budget surplus.

Just over two-thirds of the time when the public sector net debt ratio has been reduced, it’s been cut despite there being a budget deficit – thanks to the workings of the combination of economic growth, inflation and interest rates.

At its simplest, if the economy is growing, then you can both be running a deficit and reducing the debt:GDP ratio at the same time. There’s an added complication with how interest rates and inflation also have an impact, but the basic point is still the same: having a budget surplus is one way to reduce the debt:GDP ratio, but it’s the less common way. (I expanded on this point in Eliminating the structural deficit is aiming for the wrong target.)

Why does this matter? Well, I think we’ll find plenty of politicians – especially in the Conservative Party, but also in the Liberal Democrats and even a few in Labour – who for a variety of reasons slip from saying ‘we must get the debt:GDP ratio down to a sustainable level’ to ‘and so of course we must therefore run a budget surplus’.

That’s not so. One only follows from the other if you insert a much more contentious middle step about the speed of reduction you think is necessary. The question back to anyone who demands a surplus is to ask, ‘so why is that speed of reduction in the debt:GDP ratio the one you think we must have?’.

There may be some good answers to that, especially in future years as the longer-term outlook for the economy becomes clearer, but at the moment it’s a question notably neglected.

2 responses to “Why cutting the deficit isn’t all it’s cracked up to be”

  1. Mark, you miss the point.  Government debt and consumer debt are at levels the UK has never seen before. Debt to GDP ratios are not the point – largely because GDP is a pointless and silly measure.  For example, GDP includes government “productivity” which is an oxymoron.  The only thing that matters is debt and debt burden. This is not some esoteric measure because debt needs to be paid for.  If government debt is vast (and it is) the only thing that reduces it is surplus.  Deficits can’t reduce debt, only surpluses can.  And we’re very far from a surplus.  The government has reduced the deficit but it hasn’t reduced the debt.  We have a mountain of it. And it’s growing more under this coalition government than it ever has.  And, in tandem, so is consumer debt. Combined, the UK economy is indebted to the tune of around £3 Trillion.  And that number is getting bigger all the time.  And at the same time that debt is growing, productivity isn’t. But we’re seeing new asset bubbles fueled by debt – and government underwritten debt. London property price inflation is a new South Sea bubble.  

    So your argument misses the point.  Ratios aren’t the issue.  Debt is.

  2. JeffreyPeel  You can’t look at debt without a context to judge if it’s big or small. E.g. £500m of debt for you or me would be a huge amount of debt; for the government it’s a tiny amount. That’s because it is debt compared to your income and wealth that matters – hence what would be a small debt for the government would be crippling for you or me. 

    That’s also why making the amount of debt you have affordable isn’t only about thinking about its size – it’s also about thinking about how your income and wealth are changing.

    And that’s why the ratios do matter. But if you think they don’t, by all means take on £500m debt from the public sector for the rest of us. After all, it’s a small sum for the public sector, so if ratios don’t matter, it shouldn’t be a problem for you… 🙂

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