Unit 4 June 2010 Essay 3 Q12 (PLAN)

12) To what extent should government borrowing be a cause for concern ( 25 Marks)

Introduction + Development 

  • Government Borrowing (definition)- This is the borrowing the public body through securities, bonds and bills. The borrowing tends to come from internal lenders and and also foreign lenders.
  • The government would normally borrow in order to invest in the public for example building schools, hospitals, better roads. (stimulate Aggregate Demand) Also tax revenues are very unpredictable , political pressures causing them to borrow to spend more e.g. high pension rates.

POINT 1 –  Can Cause Crowding Out

  • This is how government itself can cause high interest rates in order to sell more government securities it will need to attract people with these interest rates.
  • However this would cause a bad effect as it would lead to private sector not borrowing to invest due to these interest rates
  • This could also lead to both aggregate demand and supply not rising in the future.

However:

  • Crowding out does not always occur because Keynsians argue saying that it depends what time it is economically.
  • If there is a recession therefore the private sector would have a lack of/ idle resources already. So the government is just taking advantage of these idle resources.
  • More likely to affect when there is a boom in the economy.

Point 2: Borrowing would mean higher debts

  • The interest payments are said to be very high as in 2011 debt interest will be £48 billion a year( 3 % of GDP)
  • This would mean debt would be the 4th highest department after social security, health and education. Debt interest payments could rise to £70 bn.
  • This may represent an opportunity cost as the government may have to pay off the debt and not spend it on areas of priority such as healthcare, new infrastructure.

However:

  • However if it is in a recession there may be a decrease in private sector spending and more saving. Therefore borrowing may help to maintain AD and prevent falls in spending.
  • Need to consider what the money borrowed is spent on if the government themselves are spend on long term measures like education and training it might be worthwhile.

Point 3: Can effect the exchange rate and international competitiveness

  • If a country like the UK has high debt and has no credible plan with dealing with it that can have negative impact on its currency.
  • This would cause a depreciation as there would be less demand for sterling as foreigners would not be interested in putting their money in our banks.
  • This could have a bad effect as our imports would be cheaper and firms would have to raise its costs to higher raw material costs- cost push inflation

However

  • This may favour our international competitiveness as our goods would be cheaper than normal and this could help with the cure of a recession.
  • Also need to consider how much government is borrowing in the first place as it could accumulated debt they are trying to cut down and recently borrowing has lessened down.

Conclusion

  • Overall I believe that debt needs to be cleared and there is a high risk that it will cause a crowding out effect and that is when it is serious. When it is also affecting aggregate demand and for future aggregate supply.
  • The exchange rate could be affected in both ways in that it can potentially increase our exports in a recession but however may cause trouble for business’ who are already struggling.
  • However if the government can attract more capital flows in therefore the national debt can be manageable
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