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.
- 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 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
- 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.
- 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